The Bank Lending Channel of Monetary Policy Transmission: A Dynamic Bank-level Panel Data Analysis on Tanzania

Abstract

This study uses dynamic panel data estimation models, employing annual bank-level data spanning the period 2001-2011, to empirically investigate whether or not changes in the monetary policy in Tanzania influence bank lending behaviour, i.e., existence of a bank lending channel (BLC). It also examines the distributional effects of the monetary policy on banks with different balance sheet characteristics and ownership structures.

The findings lend support to the hypotheses that, first: BLC operates in Tanzania, suggesting that bank loans are important channel through which monetary policy shocks are transmitted to the economy. The findings mirror the arguments that the banking sector still dominates the financial system in the country, whereas money, capital, and real estate markets are still at their infant stages. Banks account for about three-quarters of the financial sector’s assets, reflecting their dominance of sources of funding. Meanwhile, about two-thirds of bank funding comes from private sector deposits, probably constraining banks in offsetting the decrease in funds from deposits by raising funds from other sources. Second, banks react asymmetrically to policy changes influenced by size, capital strength, and ownership structure. The lending channel is stronger through domestically-owned banks and privately-owned banks than it is with foreign-owned banks and public-owned banks. The reason is that, for foreign-owned banks, they could enhance their capital through raising of equity abroad and/or benefit from retained earnings; while for public-owned banks, it could be because they are not under pressure to make profit and, therefore, may opt not to cut-down their loans following a monetary policy shock.

The policy implications are that, in assessing the stance of the monetary policy, beside short-term interest rates, it is critical for the monetary authority to trace banks reaction to monetary policy changes as reflected in loan supply to the private sector. Such investigation should also factor in possible asymmetric responses by banks influenced by size, capitalization, as well as ownership structure.