How can macroprudential policies transmit within a banking group?

The unpredicted shock symbolized through the COVID-19 pandemic illustrates the significance of building robust macroprudential frameworks to improve countries’ resilience against sudden disruptions in markets. Right now, a prevalent opinion among commentators and policy makers would be that the macroprudential frameworks which were implemented in the last decades were good at moderating market stress, a view based on ample evidence on the potency of macroprudential policies.

Inside a new information project, we place the functioning of macroprudential policies underneath the magnifier, finding out how intra-group links between banks’ headquarters as well as their regional branches modify the pass-through of reserve needs to credit supply in South america. Shifting the main focus to banks’ group structures when looking for the potency of reserve needs is essential as adjustments inside a group can make relevant blind spots for policy makers. Around the one for reds, intra-group liquidity dynamics can intervene using the preferred aftereffect of steering banks’ credit by managing banks’ available funding. On the other hand, banks might have incentives to reallocate funds heterogeneously across regions and industries like a reaction to the insurance policy, using their group structure. The second may open the scope for unintended distributional effects.

To understand more about these questions, we create a research design according to matched bank-branch data for South america covering 2008 to 2014. The sample period includes several episodes by which reserve needs when needed deposits – a macroprudential tool commonly used through the Brazilian Central Bank – were adjusted to influence banks’ credit supply. Considering that policy decisions could be a purpose of credit market dynamics, it’s not straightforward to locate a setting that enables for any clean identification of supply-negative effects. Our setting addresses identification concerns the following:

First, we reduce reverse causality concerns by concentrating on credit by individual municipal branches, separating the organization level where reserve needs are enforced (that’s, headquarters) in the level where loans are granted (that’s, branches).

Second, we find out the aftereffect of reserve needs by exploiting the truth that bank headquarters vary within their reliance upon targeted demand deposits.

Third, to isolate credit supply, we exploit that several branches of various headquarters are active per town, allowing us to manage for local credit demand.

This empirical design enables us to attract conclusions from the wealthy sample of 6,081 individual bank branches tracked on the quarterly frequency and owned by 56 banks operating in 1,678 Brazilian municipalities.

Figure 1 shows the evolution of reserve needs from 2006 to 2014, illustrating the multiple alterations in reserve needs during this time period. The figure contrasts this evolution with trends in mix-border banking flows to and from South america. This comparison highlights another dimension in our identification: in the past, reserve needs have taken care of immediately shifts in capital flows, looking after ease banks’ funding when global financial conditions tighten. This dynamic, by which reserve needs respond to global factors, further mitigates reverse causality concerns.

Figure 1: Quarterly evolution of reserve needs and mix-border banking claims in South america

A line chart showig Figure 2 (read explanation note at the end from the chart to learn more).

Note: This graph describes the pattern from the reserve needs for demand deposits (in %, solid line – left axis) as supplied by the Central Bank of South america. The dashed (dotted) line describes the evolution of quarterly mix-border liabilities (assets) from the Brazilian banking system (in vast amounts of USD), as acquired in the Locational Banking Statistics from the Bank for Worldwide Settlements.

Our empirical approach delivers robust results, supplying new evidence around the functioning of macroprudential policies for example reserve needs inside a banking group. Our primary results suggest that…

… alterations in reserve needs targeting banks’ headquarters considerably affect bank branches’ credit supply. The result is bigger for branches associated with headquarters relying more about targeted demand deposits.

However, this result depends crucially around the stage from the economic cycle as well as on banks’ possession structure. Particularly, the result turns up in periods when reserve needs are reduced (for instance, the global financial trouble), while branches of condition-owned banks react probably the most towards the policy tool.

How can group structures and characteristics of person units drive these results? To reveal this, we use detailed data on branches’ balance sheets including their reliance upon internal funding. Concentrating on the subsample of condition-owned banks for that period when reserve needs were best (that’s, throughout the 2008-09 global financial trouble), we discover that branches having a low ex-ante profitability along with a high reliance on internal funds were most attentive to reserve needs and responded more to some loosening from the policy by expanding loans. Two important conclusions are attracted out of this finding:

First, branches’ own liquidity constraints appear to become one element in explaining the heterogeneous reaction to reserve needs.

Second, our results suggest the existence of a within-bank reallocation of funds toward less strong branches, highlighting the significance of corporate political factors for that transmission of macroprudential policies.

Our findings possess the following implications for policy makers worried about the functioning of reserve needs in emerging market economies. Around the one hands, intragroup structures result in a heterogeneous aftereffect of macroprudential policies on banks’ credit supply, opening the scope for possible distributional effects in the macro level, for example across regions and industries. However, the significance of corporate political factors for that transmission of macroprudential policies raises queries about the emergence of market distortions. Both of these conclusions present an interesting venue for future research.

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