The bank lending channel of monetary policy: identification and estimation using Portuguese micro bank data

ln( D / P ) S = γ о+Yιlⁿ(R / P) t⁺γ 2 lt⁺γ 3i⁺ γ 4 r

where R stands for the bank reserves, l_t for the interest rate on loans, i_t for the interest
rate on bonds and r_t for the relevant monetary policy interest rate controlled by the central
bank. We note that equation (3.2) should be perceived as a generalisation of the textbook
equation, according to which the money supply is equal to bank reserves times the money
multiplier, which, in turn is a function of l_t , i_t , r_t and the required reserve ratio (assumed
constant for ease of presentation).

In equilibrium equations (3.1) and (3.2) determine the equilibrium interest i_t and the
equilibrium quantity of money for given P, y, π, R, l and r .

Let us now focus on the credit market. The loan demand by the non-banking sector
may be specified as

ln(C/P)_t^d =λ₀+λ₁lny_t+λ₂π_t+λ₃l_t+λ₄i_t
(+)     (-)    (-) (+)

where y_t captures the transactions demand for credit, π_t the uncertainty in the economy
and i_t the possibility of the private sector to have access to sources of funding which are
not perfect substitutes of bank loans. The null λ₃ ≠ 0 captures the idea that borrowers
cannot fully insulate their real spending from changes in the availability of bank credit.

For the loan supply we have

ln( C / P ) S = α 0 + α₁ln(D / P)_t + α ₂π_t + α 3 l_t + α 4 i_t

where it is assumed that the loan supply depends on the level of total deposits held by the
private sector with the banks, on the inflation rate as a measure of uncertainty in the
economy as well as on the loan and bond interest rates ³. Assets held by banks in the form
of bonds are seen as substitutes for loans, held mainly for liquidity reasons. The null

³ The specification of the loan supply equation with deposits as an explanatory variable closely follows
Bernanke and Blinder (1988). The introduction of such a variable in the supply schedule may be justified in
theoretical terms in the context of a profit-maximizing bank, in which the amount of deposits is out of the
control of the bank being determined by central bank policy. See, for instance Kashyap and Stein (1995) and
Courakis (1988). We shall return to this issue further below in the empirical section, in which we argue for the
need of the loan supply equation to also account for the banks’ own capital.

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