The Impact Of Financial Development On Monetary Policy Transmission

This thesis is to investigate the channels of monetary policy transmission in the banking sector of Cote d’Ivoire over the last three decades(primarily bank lending,firm balance sheets,and interest rates).These channels are also investigated in terms of financial development.This study is motivated by the need to demonstrate how monetary policy affects the real economy via various media that may contribute to economic growth.Furthermore,we emphasize the significance of financial intermediaries in the financial market(banks and financial institutions).We discuss how the risk diversification approach can be used to reduce agency,transaction,and search costs between lenders(banks)and borrowers(firms and households)in order to solve the asymmetric information problem while diversifying and reducing risks in financial market transactions.This project complements the monetary regulator’s initiative by improving saving allocation among economic agents and promoting economic development.As a result,the study of monetary policy transmission must consider financial development,which may play a significant role.The analysis of monetary policy transmission related to the banking sector and examining the impact of financial development using various economic indicators is an essential aspect of this study.Thus,our research was divided into three main empirical chapters that examined the three channels of monetary policy transmission through the banking sector(bank lending,bank balance sheets,and interest rates)and the effect of financial development on these channels.Chapter three examined the bank lending channel in Cote d’Ivoire using bank panel data from 1988 to 2018.Bank lending channels were discussed in light of the financial sector’s development.We used a variety of panel data estimation techniques,including fixed effect estimates,two-stage least squares(2SLS),first-difference generalized method of moments(FD-GMM),and system generalized method of moments(SGMM)(SYS-GMM).As a result of our findings,the bank lending channel theory in C(?)te d’Ivoire is confirmed.Our findings indicate that more prominent,better capitalized,and more liquid banks have a weaker effect on bank loans and,as a result,a more vulnerable bank lending channel.Large,wellcapitalized,and liquid banks in Cote d’Ivoire offer relatively simple external funding.However,in Cote d’Ivoire,small banks’ capital-to-asset ratios and securities-to-asset ratios negatively correlate with bank loans.The capital characteristic variable also hurts bank loans because poorly capitalized banks have significantly higher average loans than highly capitalized banks.Even though these findings are surprising,they will have little effect when considering the policy interest rate variable.Because of their balance sheet structure,large and well-capitalized banks in Cote d’Ivoire typically have relatively high external funding capabilities.Compared to small banks,bank balance sheets in Cote d’Ivoire show that large banks still hold a relatively high proportion of average bank securities,total equity,total liquid assets,and liquidity to total assets.Banks with better capitalization(capital to asset ratio)and liquidity(liquidity to asset ratio)have better access to external funding sources than poorly capitalized banks.Furthermore,highly liquid banks in Cote d’Ivoire have more bank securities,capital,and liquid assets than their less liquid counterparts.As a result,larger banks,more incredible wealth,and greater liquidity will reduce the impact of policy interest rates on bank loans in Cote d’Ivoire,weakening the bank lending channel.A study of the effects of financial sector development on bank lending discovered that banking sector development(both in size and activity).Capital market development(both in size and activity),bond market development(financial innovation),and financial system liberalization all lead to a similar conclusion in the development of the bank lending channel.Financial intermediation,financial market liquidity,and external funding opportunities improve as the banking industry grows.Banking loans and services are becoming more accessible to customers as the banking sector expands.As a result of the banking sector’s development,banks now have more opportunities to obtain loans,access external sources of funding,and access banking products and services.If there is more financial competition,banks can access other financing sources at a lower cost(a lower concentration ratio).As a result of this increased ability to access alternative external funding sources,the effect of the policy interest rate via the bank lending channel may be diminished.Furthermore,the growth of capital markets,bond markets,and financial innovation increase the likelihood that banks will be able to obtain additional funding sources through securities and equity investments,new financial instruments,and risk diversification strategies.As a result of deregulation policies,the policy interest rate will be less affected by bank loans and the bank lending channel(liberalization of capital accounts and relaxing restrictions on financial institutions and markets).The economic liberalization in C(?)te d’Ivoire may also harm bank lending.As a result,bank loans are less affected by the policy interest rate because there are more opportunities to obtain additional funding.Chapter four examined the firm balance sheet channel in Cote d’Ivoire and the impact of financial sector development on it from 1988 to 2018.The study examined the impact of firms’ economic conditions(cash flow and leverage)on their investment to demonstrate the existence of the company’s balance sheet channel.We looked into it using firm panel data and GMM estimation(first-difference generalized method of moments(FD-GMM)and generalized system method of moments(SGMM))(SYS-GMM).This model also supports the firm balance sheet channel theory,as higher cash flow and lower leverage ratios significantly impact firm investment decisions.The findings show that increased cash flow improves strong creditworthiness and investment spending.Furthermore,increased firm leverage leads to risky behavior(higher agency costs and default risk),resulting in a lower investment return and a higher external finance premium.Our sub-sample results(small versus large firms and high versus low dividend payouts)show that firms’ cash flow positively impacts investment,with a relatively greater impact in small versus large firms.As a result,small and lowdividend companies face more financial constraints(a less reliable reputation and less valuable net worth)than large and high-dividend companies,resulting in fewer external funding opportunities.On the other hand,leverage ratios significantly negatively impact small and medium-sized firms while having a minor and insignificant impact on large and highdividend firms.As a result,small and low-dividend companies have lower reputations,net worth,and external funding costs than large and high-dividend companies.Their default risk and agency costs will be higher than those of large,high-dividend-paying corporations.The leverage ratio has little impact on investment in large and high-dividend firms.Explain why they face fewer financial constraints(firm leverage),not just because leverage has a lower impact on their investment but also because it has no significant impact on their investment.As a result of our findings,monetary policy may have a weaker effect on the firm balance sheet channel,particularly in firms that are less financially constrained(large,high dividend companies)than in firms that are more constrained.As a result,less financially constrained firms have a higher reputation and net worth,lower external funding costs,and a more reliant relationship with external finance,reducing the impact of monetary policy on firm balance sheets.We discovered that the development of the financial sector in Cote d’Ivoire has a similar impact on the country: firms have a better chance of obtaining external funding sources as a result of financial development in Cote d’Ivoire(growth of the banking sector,development of capital markets,development of financial competition,innovation,and liberalization of the financial industry).Banking sector development(in terms of size and activity)leads to an increase in bank size.As a result of this condition,bank loans and external funding costs will be reduced.They will be able to reduce their reliance on internal funds(cash flow)while also lowering their external funding costs(agent costs),increasing the amount of debt they can finance for investments(leverage).Financial competition(lower concentration ratios)allows other banks to easily access borrowers’ information and other funding sources,resulting in lower risk,lower external finance premiums,and easier access to external funding sources.As a result,firms’ investments will be less dependent on their internal finances(cash flow),and leverage will impact them less.According to our findings,capital market development(both in terms of size and activity)will reduce the impact of internal finance(cash flow)on investment while increasing the use of debt finance(leverage).As a result of this development,firms will rely less on internal funding(cash flow).As capital markets develop,firms can raise debt for investment at lower agency costs and external funding costs.Firms’ reliance on internal financing will be reduced as the equity and bond markets expand.Financial innovation(developing new financial instruments and techniques)reduces firms’ external funding costs and liquidity risks,increasing debt financing(leverage).Since Cote d’Ivoire’s financial liberalization,firms have faced fewer financial constraints.As an example(liberalizing interest rates and relaxing many financial market controls).As a result,they are less reliant on internal funds for investment.Firms become more reliant on external finance,and their external funding costs decrease.Based on our sub-sample estimation,financial development produced similar results to the entire sample.A case involving the development of the banking sector,the development of capital markets,economic competition,financial innovation,and financial liberalization will reduce firms’ reliance on internal financing and increase their reliance on external funding.These aspects of financial development have a greater impact on small and low-dividend firms,while large and high-dividend firms are less affected.Firms with lower dividend payouts(small and low dividend payout)are more reliant on internal funds and incur higher agency and external financing costs.In contrast,firms with more constrained balance sheets(cash flow and leverage)benefit from greater investment support.As a result,financial development will impact these firms more.Financial development did not affect the sensitivity of investment to the balance sheet(cash flow and leverage)of firms,especially in less financially constrained firms.Large and high-dividend companies already have greater access to external funding sources and relatively low external funding costs and agency costs compared to small and low-dividend companies,which rely primarily on internal funds.As a result,these less constrained firms will be unaffected by financial development because they have low agency costs,low external fund prices,and low default risks.When there is financial development,firms become less reliant on internal funds and more reliant on external funds,and this effect is stronger in more constrained firms.As a result,this finding has implications for the theory of balance-sheet channels.Monetary policy shocks weaken firms’ balance sheets as they seek external funding.Because financial development can undermine the balance sheet channel,this effect is much stronger in more financially constrained firms.The fifth chapter investigates interest rate pass-through in Cote d’Ivoire from 1988Q1 to2018Q4.We used Cote d’Ivoire quarterly interest rate data and the VECM technique.The long-run pass-through of interest rates is insufficient,whereas the short-run pass-through is much higher.This result is consistent with our theoretical expectations,as various important factors contribute to incomplete pass-through.This leads to interest rate volatility(credit rationing and the risk-sharing behavior of banks,asymmetric information,and costs faced by investors and banks,namely switching costs and adjustment costs).Our study period also coincided with the development of the country’s financial sector,which likely contributed to the high pass-through rate.Various maturities of time deposit interest rates(3 months,six months,12 months,and two years)were studied to see if the pass-through was higher in the long run or lower in the short run based on the maturity of the time deposit interest rate.According to our theoretical forecast,the short-run interest rate pass-through is meanreverting.As a result,the policy interest rate will affect short-term interest rates more than long-term interest rates.We find a significant negative coefficient in the speed of adjustment in all short-run pass-through models,confirming that the short-run model is out of equilibrium.We discovered that capital market development,financial liberalization,banking competition,and financial innovation would substantially affect monetary policy transmission via the interest rate channel due to greater pass-through.Financial competition(lower concentration)can cause banks to reduce their interest rate margins because they do not want to pass on bank costs to their customers.As a result,banks are more likely to lower their retail interest rates in order to remain competitive.When the interest rate pass-through model is considered a marginal cost pricing model,a more competitive environment will increase the amount of pass-through.When the capital market develops,the pass-through degree increases(in size and activities).Alternative funding and investment options are now available to investors and savers.Increasing the demand elasticity of loans and deposits increases the degree of interest rate pass-through and strengthens the interest rate channel.Many deregulation policies in Cote d’Ivoire,such as the elimination of interest rate ceilings,capital controls,and the relaxation of foreign exchange controls,have also contributed to Cote d’Ivoire’s financial liberalization.Furthermore,capital inflows and currency transactions increase economic openness.Due to higher demand elasticity for loans and deposits,expanding alternative investment sources for bank customers strengthens interest rate pass-through and the interest rate channel.On the other hand,the development of the banking sector will have a weaker effect on interest rates.A more significant banking sector will result in increased financial intermediation and bank influence among borrowers and depositors(both in size and in activities).As a result of the reduced demand elasticity of loans and deposits,there will be less pass-through of interest rates and a weakened interest rate channel.When we performed recursive estimations of the coefficient of the degree of passthrough(coefficient),we discovered that all of the(coefficient β)in both the lending and deposit rate equations are stable throughout the period,with some changes occurring at specific points.The pass-through degree of both lending and deposit interest rates tends to adjust upwards between 1990Q1 and 1994Q1 due to commercial banks’ adjustment of the short-term deposit interest structure.As an example(the three and 6-month deposit interest rate ceiling was adjusted upwards to achieve an interest rate level comparable to the 12-month deposit rate).The relaxation of the retail interest rate ceiling in Cote d’Ivoire and other deregulation policies resulted in a higher degree of pass-through,as evidenced primarily by an increase in the(coefficient β)during 1990Q1.Furthermore,the(coefficient β)indicates a negative adjustment in 1994 Q.In conclusion,this study provides several findings through a detailed discussion of the results and specific policy implications for achieving sustainable development goals by reducing agency in response to the asymmetric information problem.Through the risk diversification approach,the transaction and search costs between lenders(banks)and borrowers(firms and households)diversify and minimize risk in financial market transactions.These policy implications are thoroughly discussed in the thesis’ s final section.