Do Financial Regulatory Tools Impact the Transmission of Capital Inflow Shocks into Credit Extension and Induce a Reallocation of Sectoral Credit Shares?

Are excess capital adequacy ratio (CAR) and excess liquid asset holdings (LAH) of banks conduits in the transmission of capital inflows and outflow shocks on credit growth and the reallocation of sectorial credit shares? Evidence in this chapter establishes that high excess CAR and excess LAH post-2008 coincided with the decline in the share of credit to households and an increase in the share of credit to companies. Positive gross capital outflow (inflow) shocks depress (increase) credit growth and GDP growth but move the shares of credit to companies and households in different directions. In addition, gross capital outflow shocks induce more fluctuations in credit growth than the gross capital inflow shock. Evidence shows that positive (negative) gross capital inflow shocks lead to a significant reduction (increase) in excess CAR, excess LAH and loan loss provisions. Thus, capital inflow shocks loosen the credit and financial constraints banks operate in since they have an impact on excess CAR, excess LAH and loan loss provisions. Evidence shows that excess CAR cushioned (dampened) aggregate credit growth following a positive capital outflow (inflow) shock. Thus, indeed excess CAR acts as a buffer or a shock absorber. Contractionary monetary policy, excess CAR and excess LAH shocks exert the same downward effects on aggregate credit growth. As financial regulatory tools, excess CAR and excess LAH complement each other and the effects of contractionary monetary policy on aggregate credit growth. Macro-prudential tools such as the National Credit Act, loan-to-value and repayment-to-income ratios also exert additional effects on credit growth and the macro-economy. Hence, there needs to be coordination of the financial regulation, macro-prudential and monetary policy tools.