Reserve Accumulation and Bank Lending: Evidence from Korea

Reserve accumulation is funded by the central bank’s domestic borrowing as it al- ways sterilizes reserve purchases by increasing domestic liabilities. The central bank borrowing could crowd out firms’ borrowing under imperfect international capital mo- bility. I present a model that illustrates the mechanism and examine monthly balance sheets of Korean banks from September 2003 to August 2008 to find that bank lending to firms did decline after reserve accumulation. Controlling for individual effects and time effects, it is estimated that bank lending declined by 50 cents after one addi- tional dollar of reserve accumulation. A causal relationship is verified by differences- in-differences identification. After one standard deviation reserve accumulation shock, primary dealer banks and foreign bank branches cut lending growth by 0.4 and 1.6 per- centage points more than non-primary dealer banks and domestic banks, respectively.