What explains the lack of monetary policy influence on bank holding companies?

• DOI: http://doi.org/10.1016/j.rfe.2014.09.002
• Published date: 01 November 2014
• Author: M. Kabir Hassan,Abdullah Mamun
• Date: 01 November 2014

What explains the lack of monetary policy influence on bank

holding companies?☆

Abdullah Mamun

a,

⁎, M. Kabir Hassan

b

a

EdwardsSchool of Business, Universityof Saskatchewan,Canada

b

Departmentof Economics and Finance,University of NewOrleans, USA

abstractarticle info

Articlehistory:

Received21 March 2013

Receivedin revised form 6 August 2014

Accepted16 September 2014

Availableonline 20 September2014

JEL classification:

G21

G28

Keywords:

Monetarypolicy

Commercial banks

Off-balancesheet hedging

In this paper,we investigate how monetarypolicy innovationsaffect the equity returnsof bank holding compa-

nies (BHCs). We also examine bank characteristics to determine what explains the cross-sectional and time-

seriesvariation in the returns' sensitivity.Similar to non-financialfirms, we find that onlyunanticipated compo-

nents affectbank equity returns; however,this effect is absent in the second halfof our sample period. Smaller,

lessliquid banks have highersensitivity;a higher ratio of time depositsto total depositsreduces this sensitivity.A

higherratio of non-interest incometo total income also reduces thissensitivity, while capital-constrainedbanks

havea higher sensitivity tomonetary policy innovations.We argue thata higher dependence onnon-interest in-

comeand the use of interest rate derivativestogether may explainthe disappearinginfluence of monetary policy

on these BHCs.

© 2014 ElsevierInc. All rights reserved.

1.Introduction

In this paper,we investigate how monetarypolicy affects theequity

returns of bank holding companies (BHCs). Be rnanke and Kuttner

(2005) and Kuttner(2001), among others,show that only unanticipat-

ed components of monetary polic ya ffect asset prices. Following the

method proposed by Bernanke and Kuttner (2005),wedecompose

monetary policyinto anticipated and unanticipatedcomponents using

federal funds futures data. Bernanke and Kuttner (2005) argue, “The

most direct and immediate effects of monetarypolicy actions, such as

changesin the federal funds rate,are on the financial markets;by affect-

ing asset prices and returns,policymakers try to modify economic be-

havior in ways that will help to achie ve their ultimate objectives”

(p. 1221). Similar to non-financial firms, a change in monetary policy

should also affect the equity prices of commercial banks. Banks offer

contracts on both sides of thei r balance sheets that are priced wit h

respect to the market interestrate. Monetary policy is a major driving

forcebehind the market interestrate (Kuttner, 2001, p. 524); as a result,

monetarypolicy action affects the valuationof all commercial banks by

affectingthe value of their assets and liabilities.

Similar to Bernanke and Kuttner, we find that only unanticipated

components of monetary policy affect equity ret urns for a sample of

BHCs. Surprisingly, when we divide our sample period (1996–2007)

into two sub-periods (Period1: 1996–2001andPeriod2:2002–2007),

we find that unanticipated monetarypolicy has no effecton bank port-

folio returns in Period2. To examine whether the effect is size-related,

we create three size-sorted portfolios and estimate the sensitivity of

monetary policy on those portfolios. We find that only unanticipated

components of monetary policy affect the equity returns of smalland

medium BHC portfolios in Period 1. In Perio d 2, none of the size-

sorted BHC portfolios are sensitive to una nticipated components of

monetary policy.

In this paper, ourgoal is to explain the variation of monetary policy

(e.g., unanticipated components) sensitivity across BHCs; in addition,

we also attempt to expl ain why this sensitivity is disappeari ng. Ac-

cording to the literature on the bank lending channel (Bernanke &

Blinder, 1992; Stein, 1998), banks are well situated to deal with cer-

tain types of borrowers in the presence of credit market imperfec-

tions, especially small firms and firms that cannot access the

financial markets thr ough stocks and bonds. This lite rature indicates

that the effect of monetary policy on bank credit supply depends on

bank capital, the compositions of deposits, and bank liquidity. We

Reviewof Financial Economics 23 (2014)227–235

☆We areindebted to Ken Kuttner for hiscomments at the earlier stageof this research.

The firstauthor also wishes to thankNimita Azam and Abdullah Shahidfor their research

assistance.This paper was the recipient of 2011 McGraw-Hill/IrwinDistinguished Paper

Awardat the SouthwesternSociety of Economists.Both authorswish to thank participants

of the award winningpaper session of the Southwestern Societyof Economists for their

comments.

⁎Correspondingauthor at: Departmentof Finance and ManagementScience, Edwards

School of Business, Univ ersity of Saskatchewan, Saskatoon, Saskatch ewan S7N 5A7,

Canada.

E-mailaddress: mamun@edwards.usask.ca (A. Mamun).

http://dx.doi.org/10.1016/j.rfe.2014.09.002

1058-3300/©2014 Elsevier Inc. All rightsreserved.

Contents listsavailable at ScienceDirect

Review of Financial Economics

journal homepage: www.elsevier.com/locate/rfe