Monetary Policy Not Hurt by Rise of Nonbank Finance

IMF News, September 29, 2016

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Impact of monetary policy actions on economic activity has generally strengthened since 2000.
Nonbank credit increases the effectiveness of monetary policy.
Risk taking by banks and nonbanks responds to monetary policy.
The growth in credit by financial institutions that are not banks has, if anything, strengthened the impact of monetary policy on the economy over the past 15 years.
Like banks, nonbanks cut credit when central banks increase policy interest rates, and, in general, they cut credit even more than traditional banks.
Nonbanks amplify the effect of monetary policy on the economy by adjusting the degree to which they take risks; for example, investment funds tend to sell riskier bonds quickly when monetary policy rates rise, making yields on bonds rise further and increasing the cost of borrowing, thereby restraining economic activity.

The structure of financial markets has changed considerably since 2000.
Ongoing financial innovation, weak bank balance sheets following the financial crisis, changes in business models, and strengthened bank regulation have supported a shift from bank lending to bond issuance by nonbanks as a source of financing in advanced and emerging market economies.
This shift has enabled a larger role for nonbanks to fill the gap and provide credit to the economy.

The potency of monetary policy appears to be, on average, stronger in countries with financial sectors dominated by nonbanks.
The chapter does not attempt to ascertain the strength of monetary policy in specific countries at the current juncture.
As the importance of banks’ and nonbanks’ risk taking grows, the effects of monetary policy changes on countries’ economies may become more rapid and pronounced.
Changes in regulations are likely to influence how monetary policy affects the economy because some differences in banks’ and nonbanks’ responses to monetary policy actions reflect differences in their regulatory regimes.

Central banks should take into account the size and composition of banks and nonbanks’ balance sheets to better gauge changes in their risk appetite.
Regulators and supervisors should monitor the effects of monetary policy on financial stability.
Countries should continue to improve data collection on nonbanks.
“The effects of monetary policy on financial stability are becoming more important,” said Gaston Gelos, Division Chief of the Global Financial Stability Analysis Division at the IMF. “The reason is that risk taking by nonbanks can change sharply in response to monetary policy. This suggests that prudential and regulatory authorities need to be vigilant.”

IMF NEWS, Policy, September 29, 2016.
The IMF will release more details from its Global Financial Stability Report on October 5.

Source: IMF News — Monetary Policy Not Hurt by Rise of Nonbank Finance (September 29, 2016).