Over the last decades, banks operated in an extremely competitive environment, which forced them to become more effective in order to survive. In addition, the recent period of crisis in credit markets has highlighted the role of the bank lending channel.
Two aspects concerning the role of banks need to be examined: first, the manner banks either affect or are affected by the economic situation and second, their ability to do so. This is accomplished by investigating how the bank lending channel operates, if monetary policy decisions can be transmitted through it and whether bank efficiency affects in any way the operation of this channel.
Two main views exist in the literature that explain the transmission of the monetary policy: the money view or interest rate channel and the credit view. The former states that monetary policy can influence aggregate demand through interest rates, whereas the latter supports the idea that monetary policy affects the economic activity without much variation in the open market interest rate, but by altering the availability and supply of loans (Hernando et al., 2001). The presence of the bank lending channel and the extent to which it can be separated from the interest rate channel has been debated extensively in the past. Empirical evidence has shown that it is difficult to identify quantitatively important effects of interest rates through the cost of capital and therefore is in favor of the presence of the lending channel (Bernanke and Gertler, 1995; Mishkin, 1995).
The bank lending channel is one of the two separate mechanisms of the credit channel, that are capable of affecting loan supply. It “stems from financial market incompleteness and relies on imperfect substitutability between bank loans and privately issued debt” (Gambacorta, 2005) and operates through banks and loan supply. The second mechanism is the balance sheet channel, the operation of which is based on the fact that monetary policy can affect the financial situation of a borrower due to asymmetric information in credit markets. In particular, a contractionary (expansionary) monetary policy weakens (strengthens) the balance sheet of borrowers by increasing (decreasing) the collateral value of their assets (Kishan et al., 2000).
As far as bank efficiency is concerned, it has been analyzed in accordance to the economic growth by many surveys (King et al., 1993; Lucchetti et al., 2001; Koetter et al., 2007), which argue that a sound financial system fosters economic growth and vice versa. Lucchetti et al. (2001) state that banks have effects on economic development if they are able to recognize the most innovative entrepreneurs and allocate their financial and real resources in the most efficient and productive way, opinion which agrees with that of Minsky (1986) and Moore (1988).
The “major shortcoming” of the above studies as Koetter et al. (2007) point out is that they analyze the relationship between financial development and growth using quantitative variables, such as size, liquidity, capitalization, rather than measuring the quality, which can be translated as the efficiency of the banking sector. In particular, bank efficiency measures the performance of a bank relative to the performance of a best-practice bank and in this way ranking of the banks is feasible and useful for the government policy by showing the effects of deregulation or mergers, for research reasons and for identifying the best and worst practices in order to improve managerial performance (Berger et al., 1997).
There have been many empirical research surveys about the relationship between quantitative bank-specific variables and loan supply, but, to the best of our knowledge, there has been no theoretical or empirical connection between the bank lending channel and bank efficiency. In this paper, we investigate the bank efficiency and whether bank efficiency is capable of affecting in any positive or negative manner the operation of the lending channel and consequently the impact that a monetary decision may have on economic activity.
The rest of the paper is organized as follows. Section 2 and 3 report a short analysis of the concepts of the bank lending channel and bank efficiency respectively. Section 4 describes the data whereas the econometric methodological approach is described in Section 5. Section 6 presents the results and finally, Section 7 concludes.
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Bank Efficiency and Bank Lending Channel: Evidence from a Panel of European Banks
