Do Capital Inflows Relieve Banks’ Credit Constraints and Boost Credit Growth? Evidence from Credit Conditions and Bank Credit Risk

Do capital inflows relieve credit constraints by loosening credit conditions? First, we establish that high (low) levels of non-performing loans and tight (loose) credit conditions result in low (high) credit growth. Tight credit conditions post-2007Q3 led to a lower transmission of positive portfolio banking shocks into credit growth. However, looser credit conditions pre-2007Q3 did not lead to much higher credit growth. There are asymmetric effects in the transmission of portfolio banking flow shocks due to prevailing credit conditions. Tighter credit conditions had a larger dampening effect on credit growth post-2008Q1 compared to the period pre-2008. During periods of severe global and domestic financial constraints, the direct and indirect ability of positive capital inflow shocks to stimulate credit growth is highly neutralised by the prevailing tight credit conditions. Prevailing credit conditions are conduits through which capital inflow shocks are transmitted to credit growth. In addition, credit conditions are sources of shocks to credit growth. The data fails to reject the hypothesis that a capital inflow shock leads to the loosening of credit conditions. Capital inflow shocks affect credit growth directly and indirectly via the credit conditions and credit risk channels. Thus, policy initiatives that loosen (tighten) credit conditions tend to lead to the amplification (dampening) of capital inflow shocks on credit growth.