THE CREDIT SUPPLY CHANNEL OF MONETARY POLICY TRANSMISSION MECHANISM: AN EMPIRICAL INVESTIGATION OF ISLAMIC BANKS IN PAKISTAN VERSUS MALAYSIA
AbstractThe transmission mechanism of monetary policy is explained through the relationships between a change in money supply and the level of real income. Monetary policy transmits to the real sector through several different channels. Such channels include the interest rate channel, the exchange rate channel, the asset-pricing channel, the credit supply channel, and the bank balance sheet channel. This paper empirically investigates the credit supply channel of monetary policy and explores the differential impact of monetary policy on credit supply of Islamic banks in Pakistan versus Malaysia. The robust two-step System-Generalize Method of Moments (GMM) estimator is applied on an unbalanced panel dataset over the period 2005-2016. While estimating the effects of three alternative measures of monetary policy on banks’ credit supply, several bank- specific variables are included in the specification as control variables. We provide strong evidence on the existence of credit supply channel in the baseline models for both countries and differential impact of monetary policy through Islamic banks in Pakistan versus Malaysia in the extended models. Our findings suggest that there is a vital need to consider the nature of Islamic banks while devising the instruments of an effective monetary policy in countries with dual banking system like Pakistan, Malaysia, Indonesia, Bahrain, Saudi Arabia, Qatar and others.
Akhatova, M., Zainal, M.P., & Ibrahim, M.H. (2016). Banking Models and Monetary Transmission Mechanisms in Malaysia: Are Islamic Banks Different? Economic Papers, 35(2),169–183.
Alaro, A. R., & Hakeem, M. (2011). Financial Engineering and Financial Stability: The Role of Islamic Financial System. Journal of Islamic Economics, Banking and Finance, 7(1), 34-55.
Alper, K., Hulagu, T., & Keles, G. (2012). An Empirical Study on Liquidity and Bank Lending. Central Bank of the Republic of Turkey, Working Paper, 4.
Anwar, S., & Nguyend, L. P. (2018). Channels of Monetary Policy Transmission in Vietnam. Journal of Policy Modelling, 40(4), 709-729.
Arellano M., & Bond S. (1991). Some Tests of Specification for Panel Data: Monte Carlo Evidence and An Application to Employment Equations. Review of Economic Studies, 58(3), 277–297.
Arellano M., & Bover O. (1995). Another Look at the Instrumental Variable Estimation of Error-Components Models. Journal of Econometrics 68, 29–51.
Auclert, Adrien (2017). Monetary Policy and The Redistribution Channel. NBER Working Paper Series, Working Paper 23451, Cambridge, MA 02138.
Aysun, U. & Hepp, R. (2013). Identifying the Balance Sheet and the Lending Channels of Monetary Transmission: A Loan-Level Analysis. Journal of Banking & Finance, 37(2), 2812-2822.
Bernanke, B. S., Lown, C. S., & Friedman, B. M. (1991). The Credit Crunch. Brookings Papers on Economic Activity. 22(2), 205-248.
Bernanke, B.S. & Blinder A.S. (1995). Inside the Black Box: The Credit Channel of Monetary Policy Transmission. Journal of Economic Perspectives, American Economic Association, Fall 9(4), 27-48.
Bernanke, B.S., Gertler, M. & Gilchrist, S. (1999). The Financial Accelerator in a Quantitative Business Cycle Framework. Handbook of Macroeconomics. Amsterdam: Elsevier.
Blundell R., & Bond, S. (1998). Initial Conditions and Moment Restrictions in Dynamic Panel Data Models. Journal of Econometrics 87(2), 115–143.
Cecchetti, S., G. (1999). Legal Structure, Financial Structure, and the Monetary Policy Transmission Mechanism. NBER Working Paper No. W 7151.
Chapra, M. U. (1985). Towards A Just Monetary System. Leicester: The Islamic Foundation, 223 London Road, Leicester, UK.
Chaudary N, N., & Mirakhor, Abbas. (1997). Indirect Instruments of Monetary Controlling an Islamic Financial System. Islamic Economic Studies, 4(2), 27-65.
Ehrmann, M., Gambacorta, L., Martínez-Pagés, J., Sevestre, P., & Worms, A., (2001). Financial Systems and the Role of Banks in Monetary Policy Transmission in the Euro Area. ECB Working Paper, 105.
Erdogdu, Aylin, (2017). Functioning and Effectiveness of Monetary Transmission Mechanisms: Turkey Applications. Journal of Finance and Bank Management, American Research Institute for Policy Development, 5(1), 29-41.
Evans, C., Fisher, J., Gourio, F., & Kran, S. (2015). Risk Management for Monetary Policy Near the Zero Lower Bound. Brookings Papers on Economic Activity, 141-219.
Farahani, Y, G., & Dastan, M. (2013). Analysis of Islamic Banks’ Financing and Economic Growth: A panel co-integration approach. International Journal of Islamic and Middle Eastern Finance and Management, 6(2), 156-172.
Friedman, M., and Schwartz, A. J. (1963). A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, New Jersey, USA.
Gertler, M., & Gilchrist, S. (1993). The Role of Credit Market Imperfections in the Monetary Transmission Mechanism: Arguments and Evidence. The Scandinavian Journal of Economics, 95(1), 43–64.
Girardin, E., & Moussa, Z. (2011). Quantitative Easing Works: Lessons from the Unique Experience in Japan 2001–2006. Journal of International Financial Markets, Institutions and Money, 21(2), 461-495.
Hardianto, Erwin. (2004). Shariah Transmission Mechanism in Indonesia. Journal of Economic Cooperation and Development, 8(2), 20-38.
Janjua, P. Z., Rashid, A., & Qurrat-Ul-Ain. (2014). Impact of Monetary Policy on Bank’ Balance Sheet in Pakistan. International Journal of Economics and Finance, 6(11), 187-196.
Jermann, Urban (2019). Negative Swap Spreads and Limited Arbitrage. NBER Working Paper No. 25422.
Jimborean, R. (2009). The Role of Banks in the Monetary Policy Transmission in the New EU Member States. Economic Systems, 33 (2), 360–375.
Kaleem, A., & Isa, M. (2006). Islamic Banking and Money Demand Function in Malaysia: An Econometric Analysis. Pakistan Economic and Social Review, XLIV (2), 277-290.
Kashyab, A. K., & Stein, J. C. (1994). Monetary Policy and Bank Lending in Monetary Policy. Chicago: The University of Chicago Press, USA.
Kashyab, A. K., & Stein, J. C. (1995). The Impact of Monetary Policy on Bank Balance Sheets. NBER, Working Paper No. 4821.
King, Robert G. and Charles I. Plosser (1984). Money, Credit, and Prices in a Real Business Cycle. The American Economic Review, 74(3), 363-380.
Kishan, R. P., & T. P. Opiela. (2000). Bank Size, Bank Capital, and the Bank Lending Channel. Journal of Money, Credit and Banking, 32(1), 121–141.
Köhler, M., Judith H., & Matthias, G. (2006). The Role of Banks in the Transmission of Monetary Policy in the Baltics. Centre for European Economic Research (ZEW), Discussion Paper, 06-005.
Majid, M. S., & Hasin, Z. (2012). Islamic Banks and Monetary Transmission Mechanism in Malaysia. Journal of Economic Cooperation and Development, 35(2), 137-166.
Mishkin, F. S. (1996). The Channels of Monetary Transmission: Lesson for Monetary Policy. NBER Working Paper No. 5464.
Pruteanu, Anca. (2004). The Role of Banks in the Czech Monetary Policy Transmission Mechanism. Czech National Bank, Working Papers 2004/03.
Sanrego, Y. D., & Nikmawati, K. (2010). Transmission Mechanism of Sharia Financing in Malaysia. The Journal of Muamalat & Islamic Finance, Research (JMIFR). 7(1). 121-135.
Sanrego, Y. D., & Rusydiana A. S. (2013), Transmission Mechanism in Dual Monetary System: Comparison between Shariah and Conventional Monetary System. Journal of Islamic Economics, Banking and Finance, 9(2). 111-124.
Santis, R. A., & Surico, P. (2013). Bank Lending and Monetary Transmission in the Euro Area. Economic policy, 28(75), 423–457.
Shah, M. A. Rehman., Rashid, A., & Zaman, M. Khaleequz. (2017). Capital Structure Decisions in Islamic Banking: Empirical Evidence from Pakistan. Journal of Islamic Banking and Finance, 34(2), 88-103.
Shah, M. A. Rehman., Rashid, A. and Mansoori, M. Tahir. (2018). The Role of Islamic versus Conventional Banks in Monetary Policy Transmission: An Empirical Investigation for Pakistan. FWU Journal of Social Sciences. Summer 2018, 12(1), 56-72.
Sharpe, Steven A. (1995). Bank Capitalization, Regulation, and the Credit Crunch: A Critical Review of the Research Findings. Board of Governors of the Federal Reserve System, Finance and Economics Discussion Series No. 12(1). 95-20.
Sims, C., (1992). Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy. European Economic Review, 36(5), 975-1000.
Stepanchuk, S., Tsyrennikov, V. (2015). Portfolio and Welfare Consequences of Debt Market Dominance. Journal of Monetary Economics, 74 (2), 89-101.
Sukmana, R., & Kassim, S. H. (2010). Roles of the Islamic Banks in the Monetary Transmission in Malaysia. International Journal of Islamic and Middle Eastern Finance and Management, 3(1), 7-19.
Wong, K. (2000). Variability in the Effects of Monetary Policy on Economic Activity. Journal of Money, Credit and Banking, 32(2), 179-198.
Zaheer, Sajjad., Ongena, S., & Wijnbergen S. J. G. (2013). The Transmission of Monetary Policy Through Conventional and Islamic Banks. International Journal of Central Banking Duha 8(2), 175-224.
Journal of Islamic Monetary Economics and Finance is licensed under a Creative Commons Attribution-NonCommercial 4.0 International License.