DIFFERENTIAL DEPOSIT GUARANTEES AND THE EFFECT OF MONETARY POLICY ON BANK LENDING

This paper utilizes differences in de jure deposit insurance coverage across banks and changes in coverage over time to identify a bank-lending channel in Poland. Banks with partial guarantees have a stronger loan response to monetary policy than banks with full guarantees. Furthermore, the weak response of the fully guaranteed banks is attributed to their ability to raise low-reserve, uninsured time deposits relative to the partially covered banks. When differential coverage is eliminated, there is no disparity in the loan response between the two groups. This lending channel has implications for credit control and financial system development in emerging markets .( JEL E52, G21, G28) I. INTRODUCTION The bank-lending channel (BLC) emphasizes the role of bank loans in the transmission of monetary policy. According to the BLC, contractionary monetary policy can decrease the loan supply of banks that face informational constraints. Additionally, some of the borrowers of these banks are bank dependent, so that a fall in loan supply decreases the expenditures of these customers. This channel complements the usual interest rate/money channel by offering an explanation for why contractionary policy has severe effects on the economy. It also implies that policy has distributional effects across banks and their customers. Evidence of a BLC is gleaned from the cross-sectional asymmetric loan responses of constrained versus unconstrained banks. Empirical studies usually approach the identification of the BLC by dividing banks using balance sheet constraints. This approach implicitly assumes that bank balance sheet structure is independent of monetary policy. However, because bank balance sheet constraints can be influenced indirectly by the effects of policy on the behavior of bank customers, it is not clear whether these studies are measuring shifts in loan supply or loan demand. This paper identifies a BLC utilizing data on a banking system where de jure deposit guarantees were differentially applied. From 1995until1999,thePolishgovernmentgranted full guarantees to one group of banks, while the others had only a partial guarantee. A full guarantee could give banks an advantage in raising nonreservable, uninsured funds, allowing these banks to circumvent contractionary monetary policy by continuing loan growth. Conversely, the loans of banks with only partial guarantees should decrease due to the inability of these banks to raise alternative funds during contractionary policy. The existence and extent of a BLC are measured in this paper by testing for a differential loan growth response between these two groups of banks. Additionally, we test for the disappearance of *The author began this article while on a Fulbright Research Scholarship at the NBP and the Warsaw School of Economics. He thanks the NBP for supplying data and DePaul University for financial support. In particular, he thanks Marta Go1ajewska for assistance in gathering data and information, Ewa Nikiel for insightful discussions, and two anonymous referees for comments that substantially improved this paper.