Bank Credit Extension and Real Economic Activity in South Africa - The Impact of Capital Flow Dynamics, Bank Regulation and Selected Macro-prudential Tools

Preface

Part I: Global Liquidity, Capital Flows, Asset Prices and Credit Dynamics in South Africa

Part II: Credit Supply Dynamics and Economy

Part III: Financial Regulatory Uncertainty and Bank Risk-Taking

Part IV: Macro-prudential Tools and Monetary Policy

Acknowledgments

Contents

List of Figures

List of Tables

1: Introduction

1.1 The Role of Global Liquidity, Capital Flows, Assets Prices and Credit Dynamics in South Africa

1.2 Asset Price Booms and Costly Asset Busts

1.3 Changing Relationships Between GDP and Capital Flows

1.4 The Relationship Between Capital Flows and Domestic Credit Growth

1.5 How Strong Is the Link Between Credit Supply Dynamics and the Real Economy?

1.6 Financial Regulation, Bank Risk Channels, Credit Supply Shocks and the Macroeconomy

1.7 Does a Tit for Tat Exchange Exist Between NCA and Monetary Policy Shocks?

1.8 Credit Loss Provisions as a Macro-­prudential Tool

1.9 Loan-to-Value Ratios, the Contractionary Monetary Policy Stance and Inflation Expectations

1.10 Repayment-to-Income and Loan-to-Value Ratios Shocks on the Housing Market

Part I: Global Liquidity, Capital Flows, Asset Prices and Credit Dynamics in South Africa

2: The Inverse Transmission of Positive Global Liquidity Shocks into the South African Economy

2.1 Introduction

2.2 How Does the Inverse Transmission of Global Financial Shocks such as QE Arise?

2.3 Developments in Policy Rates and Central Bank Balance Sheets

2.4 Are There Any Differences in the Impact of Quantity and Price Measures of Global Liquidity Shocks on the South African Economy?

2.4.1 Is There an Inverse Transmission Relationship Between Global Liquidity Shocks and Selected Macroeconomic Variables Before and After 2008Q4?

2.4.2 What Do the Counterfactual Scenarios Say About Inverse Transmission?

2.4.3 Policy Rate and Inflation Responses to Various Phases of QE

2.4.4 Did the US Fed and ECB Bank Balance Sheet Shocks Exert Inverse Transmission Effects on the South African Economy?

2.4.5 The Role of Commodity Prices: Inferences from the Counterfactual Analysis

2.5 Conclusion and Policy Implications

3: The Impact of Capital Flows on Credit Extension: The Counterfactual Approach

3.1 Introduction

3.2 The Relationship Between GDP and Net Capital Flows Over Time

3.3 How Are Capital Flow Shocks Transmitted Through the Balance of Payments Components?

3.4 The Counterfactual Analysis of Capital Flows and GDP

3.5 To What Extent Did Capital Flows Drive Credit Growth, if at All?

3.5.1 What Do the Counterfactual Scenarios Suggest the Role of Capital Flows on Credit Growth Is?

3.5.2 What About Commodity Prices, Do They Play Any Meaningful Role?

3.5.3 Does the Composition of Capital Flows Change the Role of Commodity Prices on Credit?

3.6 Conclusion and Policy Implications

4: Capital Flow Episodes Shocks, Global Investor Risk and Credit Growth

4.1 Introduction

4.2 The Classification of Capital Flow Episodes and the Importance of Separating Between Foreign and Domestic Investor Activity

4.3 How Do Capital Flows Wave Categories Impact Real Economic Activity and Credit Growth?

4.3.1 How Do Capital Flows Episodes Shocks Affect GDP Growth?

4.3.2 Through Which Channels Are Capital Flows Wave Episodes Transmitted?

4.4 How Do Capital Flows Wave Categories Impact Credit Growth?

4.4.1 Evidence from Impulse Responses

4.4.2 Evidence from Historical Decompositions

4.4.3 Evidence from Variance Decompositions

4.5 Does Global Risk Aversion Shock Impact Capital Flow Surges, Sudden Stop Episodes and Credit Growth?

4.6 Counterfactual Scenarios and the Propagation Effects of Commodity Prices and the Exchange Rate

4.7 Conclusion and Policy Implications

5: Bank, Non-bank Capital Flows and Household Sector Credit Reallocation

5.1 Introduction

5.1.1 Does the Sectorial Reallocation of Credit Extension Matter?

5.2 Relationship Between Credit to Households, Bank and Non-bank Capital Flows

5.3 VAR Results

5.3.1 Fluctuations in Credit to Households Explained by Bank and Non-bank Capital Flows

5.3.2 The Counterfactual Contributions

5.4 Conclusion and Policy Recommendations

6: Capital Flows and the Reallocation of Credit from Companies

6.1 Introduction

6.2 Does the Relationship Between Credit to Companies Depend on the Definition of the Capital Flow Category?

6.3 The VAR Results

6.4 Fluctuations in Credit to Companies Explained by Bank and Non-bank Shocks

6.5 Do Capital Flows Amplify the Responses of the Repo Rate to Positive Inflation Shocks? Evidence from the Counterfactual Contributions

6.6 The Historical Decompositions and Counterfactual Scenarios

6.7 Conclusion and Policy Implications

Appendix

7: Stock Price Returns, Volatility and Costly Asset Price Boom–Bust Episodes

7.1 Introduction

7.2 Stylized Facts in the Relationship Between Economic Growth and Stock Market Dynamics

7.3 Differential Effects Between Stock Price Returns and Volatility on Economic Growth

7.3.1 Do Stock Price Dynamics and Fluctuations on Economic Growth Relative to Other Shocks

7.3.2 Stock Price Returns and Volatility Transmit Portfolio Outflow Shocks

7.3.3 Volatility and Monetary Policy Tightening Shocks Impacts on Economic Growth

7.3.4 Economic Growth Evolution and the Role of Stock Returns and Volatility

7.4 Asset Price Booms and Busts: Inferences from Various Measures

7.4.1 Credit or Collateral Channel in South Africa Accompanying Costly Booms

7.4.2 Financial Imbalance Build-Ups During the Identified Episodes of Costly Booms

7.4.3 Inferences From the Role of Monetary Policy Based on Deviations from the Taylor Rule

7.5 Conclusion and Policy Implications

Appendix A7.1

8: The Interaction Between Credit Conditions, Monetary Policy and Economic Activity

8.1 Introduction

8.2 Construction of Credit Conditions Index

8.2.1 The Credit Conditions Index

8.2.2 Credit Conditions Index and Business Cycle and Bank Lending Standard Indicators

8.2.3 The Relationships Between Credit Conditions, Repo Rate and Economic Activity

8.3 The Empirical Methodology

8.3.1 Empirical Results and Discussion

8.3.2 Repo Rate Dynamics and the Evolution of the Credit Conditions Index

8.3.3 Impact of Credit Conditions on Residential and Non-residential Sector Activity

8.4 Tight Credit Conditions Versus Contractionary Monetary Policy and Negative Equity Price Shock

8.4.1 Tight Credit Conditions Versus Contractionary Monetary Policy and Negative Business Confidence Shock Effects

8.4.2 Tight Credit Conditions Versus Negative Coincident and Leading Business Cycle Shocks

8.4.3 Contributions of Credit Conditions and Business Confidence to Manufacturing Production Growth

8.5 Deriving Policy Implications

8.6 Conclusion and Policy Implications

9: Credit Conditions and the Amplification of Exchange Rate Depreciation and Other Unexpected Macroeconomic Shocks

9.1 Introduction

9.2 How Do Credit Conditions and Lending Standards Impact GDP Growth?

9.3 Fluctuations and Nonlinearities Induced by the CCI

9.3.1 Fluctuations Induced by Credit Conditions on GDP and Inflation

9.3.2 Is There a Nonlinear Effect of Credit Conditions on GDP Growth?

9.4 Amplification Due to Credit Conditions: A Counterfactual VAR Approach

9.4.1 Inflation Response to Rand Depreciation Shocks in the Absence of the CCI

9.5 The Role of Tight Credit Conditions and GDP Growth in the Repo Rate Reactions to Positive Inflation Shocks

9.5.1 Historical Decomposition and Counterfactual Approaches

9.6 Conclusions and Policy Implications

Part II: Credit Supply Dynamics and the Economy

10: The Lending-Deposit Rate Spread and the Bank Pricing Behavior

10.1 Introduction

10.2 Dynamics of Lending and Deposits Rates

10.3 What Can Lead to a Momentum and Asymmetric Effects in Lending-Deposit Spread Adjustment?

10.4 Is There an Asymmetric Adjustment in the Spread Between Lending Rates and Deposit Rate Since 2008?

10.4.1 Second Step: Is There Evidence of the Momentum Change in Lending Deposit Spread?

10.4.2 Evidence from the Model-Estimated Threshold

10.4.3 Evidence from a Zero Threshold

10.4.4 So How Does the Lending-Deposit Spread Adjust Based on a Different Technique Such as the Asymmetric Error Correction Approach?

10.5 Conclusion and Policy Implications

11: Adverse Credit Supply Shocks and Weak Economic Growth

11.1 Introduction

11.2 The Importance of Proper Identification of Loan Demand and Supply Shocks

11.3 Theoretical Relationship Between Loan Spreads and Adverse Credit Supply and Demand Shocks

11.3.1 Margins on Credit, the Repo Rate and Growth in Credit

11.3.2 Financial Regulatory Uncertainty Contribution to an Increase in Margins

11.3.3 Facts Between Margins and Selected Macroeconomic Variables

11.3.4 Cross Correlations and Macroeconomic Bilateral Interdependencies

11.4 Effects of an Adverse Credit Shock, Tight Monetary Shock and Spreads and Elevated Global Economic Uncertainty Shock

11.4.1 Can Economic Growth Mitigate Higher Spreads?

11.4.2 Evidence Based on the Penalty Function Sign Restriction Approach

11.5 Adverse Credit Supply Shock and the Conduct of Monetary Policy and Loan Rate Margins

11.5.1 Is There a Threshold Level Beyond Which Loan Spreads Have Adverse Effects on Economic Growth?

11.6 Conclusion and Policy Implications

Appendix

12: Credit Supply Shocks and Real Economic Activity

12.1 Introduction

12.2 Credit Supply Shock and Economic Activity

12.2.1 Effects of These Shocks on Growth in GDP and Investment

12.2.2 The Influence of Credit Supply Shocks on Economic Growth, Credit and Investment

12.3 Relationship Between Bond Yields and Credit Supply Shock Contributions to GDP Growth Post 2007Q2

12.3.1 Relationship Between Credit Risk, Credit Supply and Demand Contributions to GDP Growth Post 2000

12.3.2 Do Aggregate Supply Shocks Explain Sluggish Growth in Credit and GDP?

12.3.3 Credit Supply and Credit Demand Shocks and Subdued GDP, Credit and Investment Growth

12.4 Conclusion and Policy Implications

13: Credit Growth Threshold and the Nonlinear Transmission of Credit Shocks

13.1 Introduction

13.2 Why May the Nonlinear Response of Economic Activity to Various Shocks Depend on Credit Regimes?

13.3 Descriptive Statistics

13.3.1 Cross Correlations Between Macroeconomic Variables

13.4 Dynamics Between Credit Growth, Inflation and Economic Activity

13.4.1 Does the Credit Threshold Lead to a Nonlinear Response of Inflation and Real Economic Activity to an Unexpected GDP Growth Shock?

13.4.2 What Is the Threshold Value for Credit Growth?

13.4.3 Nonlinear Threshold Responses of Inflation and Repo Rate

13.4.4 Inflation Shocks and Economic Growth Effects

13.4.5 Are the Prevailing Credit Market Conditions an Important Nonlinear Propagator of Economic Shocks?

13.5 Do Inflation Shocks Have Asymmetric Effects on Economic Growth Dependent on Credit Regimes?

13.5.1 Do Credit Regimes Impact the Repo Rate Reaction to Positive Inflation Shocks?

13.6 Conclusion and Policy Implications

14: Credit Regimes and Balance Sheet Effects

14.1 Introduction

14.2 Do Negative Credit Shocks Lead to Larger Declines in Output in the Low Credit Regime Relative to the High Credit Regime?

14.2.1 Do Positive Economic Growth Shocks Lead to Higher Credit Growth in the Lower Credit Regime Relative to the Higher Credit Regime?

14.3 Conclusion and Policy Implications

Part III: Financial Regulatory Uncertainty and Bank Risk Taking

15: The Banking Risk-Taking Channel of Monetary Policy in South Africa

15.1 Introduction

15.2 What Is the Bank Risk-Taking Channel of Monetary Policy?

15.3 Relationship Between Funding Risk and Economic Growth

15.4 Can the Model Capture the Stylized Effects of an Unexpected Repo Rate Hike?

15.1.1 Is There Evidence of the Bank Risk-Taking Channel of Monetary Policy?

15.1.2 Are the Direction and Significance of the Results Sensitive to Sample Size?

15.1.3 Is There a Risk-Taking Channel via Non-­performing Loans and House Prices?

15.1.4 Which Risk Shocks Depress Economic Growth as Well as Propagating Fluctuations in Economic Growth?

15.1.5 What Would Economic Growth Be Like in the Absence of Various Banking Risk Shocks?

15.1.6 Do Contributions from the Repo Rate Reinforce Those of Combined Banking?

15.5 Conclusion and Policy Implications

Outline Placeholder

16: Financial Regulation Policy Uncertainty and the Sluggish Recovery in Credit Growth

16.1 Introduction

16.2 Why Should Policymakers Be Concerned About Regulatory Uncertainty Shocks?

16.3 To What Extent Have Banks’ Balance Sheet Items Changed in the Period Pre- and Post-recession in 2009?

16.3.1 Is There Evidence of a Systematic Shift in Bank Funding Sources?

16.3.2 Studies in Other Countries Indicated Rising Funding Cost Margins Post-2009, How Did Funding Margins in South Africa Evolve?

16.3.3 Did Lending Spreads Widen as Postulated by Theory During Episodes of Low Interest Rates?

16.3.4 Liability and Asset Sides of Bank Balance Sheets

16.4 What Can the Lessons Be About the Funding Rate Reactions to the FRPU Shocks?

16.5 Stylized Effects of Interest Rate Margins, the FRPU and Key Macroeconomic Variables

16.6 What Can the Policymaker Learn About the Effects of FRPU on the South African Economy?

16.6.1 Do the Macroeconomic Effects of an Unexpected Increase in the FRPU Vary from Those of an Unexpected Rise in the Repo and Installment Sales Interest Rate Margins Shocks?

16.6.2 Does It Matter if the Shock Originates from the Other Loans and Advances or Installments Sale Side?

16.6.3 To What Extent Is It Possible to Attribute the Evolution of Both Margins to Own and FRPU Contributions?

16.6.4 To What Extent Did the Margins Impact the Evolution of Credit Extension?

16.6.5 Growth in House Prices and Retail Sales and Regulatory Uncertainty Shocks

16.6.6 How Does Credit Risk React to the FRPU, House Prices and Installment Sale Credit Rate Margins Shocks?

16.6.7 What Would Have Happened to Credit Loss Provisions as a Measure of Risk Pre- and Post-­recession in 2009?

16.7 Conclusion and Policy Implications

Part IV: Macro-prudential Tools and Monetary Policy

17: Excess Capital Adequacy and Liquid Asset Holdings and Credit

17.1 Introduction

17.2 What Does Preliminary Data Analysis Suggest Is the Link Between Excess CAR, LAH and Credit Growth?

17.3 How Has the Interdependence Between Credit Growth and Lending Changed?

17.3.1 Impact of an Unexpected 25 Basis Points Increase in the Lending Spread on Credit Growth

17.3.2 The Evolution of Lending Spreads and Unexpected Negative Growth in Credit Shock

17.4 Tight Credit Regulation Shocks on Economic and Credit Growth

17.4.1 Spill-Over Effects of Regulatory Shocks to Real Economic Activity

17.4.2 Is Monetary Policy Neutral to Unexpected Credit Regulatory Shocks?

17.4.3 Cumulative Effects of Unexpected Regulatory Shocks on Growth in Credit and Lending Spreads

17.4.4 Counterfactual Responses

17.5 Conclusions and Policy Recommendations

Appendix

18: Credit Loss Provisions as a Macro-­prudential Tool

18.1 Introduction

18.2 Why Should Policymakers Be Made Aware of the Effects of Credit Provisions?

18.3 What Is an Unexpected Positive Credit Loss Provisioning Shock and Its Expected Impact on Credit and the Real Economy?

18.4 Stylized Facts

18.5 How Well Does the Estimated Model Capture the Established Responses of Selected Variables in Literature?

18.5.1 What Are the Effects of Credit Provisioning on the Real Economy?

18.5.2 To What Extent Does the Annual Change in Credit Provisions Influence the Business Cycle?

18.5.3 What Does Nonlinearity in the Credit Loss Provisioning Mean for Economic Activity and Credit Growth Shock?

18.5.4 Do Nonlinear Effects Matter?

18.5.5 Did the Changes in the Business Cycle After 2007M8 Lead to Nonlinear Credit Provisioning Shocks Effects?

18.5.6 Counterfactual Analysis

18.6 Conclusion and Policy Implications

Appendix

19: The National Credit Act, Monetary Policy and Credit Growth

19.1 Introduction

19.2 Effects of Unexpected Policy Shocks on Economic Activity

19.3 How Resilient Is Credit Growth to the Repo Rate and NCA Shocks?

19.4 Is There Evidence That the Monetary Policy and NCA Shocks Complement Each Other?

19.5 Counterfactual Responses

19.6 Policy Implications

20: Loan-to-Value Ratios, Contractionary Monetary Policy and Inflation Expectations

20.1 Introduction

20.2 How Are the LTVs and RTIs Determined in South Africa?

20.3 How Have RTIs and LTVs Evolved in South Africa?

20.3.1 Are Households Deleveraging or Have LTVs and RTIs Shifted the Scales?

20.3.2 Are Households Making Excessive Repayments Relative to Their Income?

20.3.3 Is the Ratio of Residential Non-performing Loans Still Inhibiting Credit Extension?

20.4 To What Extent Did the LTV Tightening Shock Reinforce or Offset the Effects of the Repo Rate Tightening Shock?

20.4.1 Sensitivity of Household Disposable Income, Debt and Financing Costs to Repo Rate and LTV Tightening Shocks

20.4.2 Do LTV and Repo Rate Shocks Reinforce Each Other in Impacting Household Balance Sheet Assets?

20.4.3 What Moves the Ratios Due to a Positive Repo Rate Shock and LTV Tightening Shock? Is It the Numerator or the Denominator?

20.4.4 Consumption Spending Channel: What are the Policy Implications Regarding the Inflation Outlook and Inflation Expectations?

20.4.5 LTV Tightening Shock and the Evolution of Inflation Outcomes and Expectations

20.4.6 Do High Inflation Expectations Pose Risks to Financial Stability Via the LTV Channel?

20.5 Counterfactual Scenarios

20.6 Conclusion and Policy Implications

21: Repayment-to-Income and  Loan-to-­Value Ratios Shocks on the Housing Market

21.1 Introduction

21.2 Why Does the Repayment-to-Income Ratio Matter?

21.3 Disentangling the Role of the LTV in Housing Market Activity

21.3.1 What Is the Relationship Between the LTV, House Prices and Valuers’ Demand and Supply Strength Indices?

21.3.2 Do Non-performing Loans Impact LTVs?

21.4 Which Methodology Is Best Used for the Empirical Analysis and to Answer the Relevant Questions?

21.4.1 Do Lending Standards Measured by the LTV React to Economic Shocks?

21.4.2 To What Extent Do the LTV Responses Differ from Those of the RTI?

21.4.3 Should Monetary Policy Authorities Be Concerned About Unexpected Developments in LTV Dynamics?

21.4.4 When Did the LTV Tightening Shock Series Exhibit both Loosening and Tightening Phases?

21.4.5 Is It Possible That the LTV Tightening Can Be Attributed to Adverse Developments in Mortgage Advances?

21.4.6 Is There Further Evidence That LTV Tightening Shocks Have Beneficial Spill-Overs to Price Stability?

21.4.7 What Can Monetary Policymakers Infer from the Influence of the LTV Tightening Shock on the Level of the Repo Rate?

21.4.8 How Influential Is the RTI Shock in Driving Repo Rate Dynamics?

21.5 The Counterfactual Scenarios

21.6 Conclusion and Policy Implications

References

Index