Essays in banking, credit and the macroeconomy

Abstract

Over the last two decades, banks have become increasingly large and interdependent due to the ongoing process of globalization of international trade and finance, as well as the advent of a wide range of technological advances that have made financial services more easily accessible to the public. These developments in the banking sector translate into more credit availability in the financial system. Credit availability is essential for households and firms’ financing and investment decisions with potential direct effects on economic growth. On this regard, scholars agree that while, on the one hand, a sustainable credit expansion can foster economic growth, on the other, such expansion can undermine financial stability if not properly handled. Thus, the magnitude and time dynamics of credit aggregates pose significant policy challenges for policy-makers. This thesis contributes to the ongoing debate on the nexus between banking and the real economy, in the attempt of leaping forward in the quest of causality between finance, stability and growth. In Chapter Two, we investigate the link between shocks originating from the banking sector and aggregate leverage, as measured by the credit-to-GDP gap. Using a balanced panel of 15 advanced countries for the period 1989-2016, we build on the Granularity Hypothesis and investigate banking granular shocks, based on balance sheet data of large banks, as an indicator of banking distress. Using methods that account for potential endogeneity between the real and financial sectors, we find that banking shocks Granger-cause aggregate leverage risk. In particular, banking shocks tend to increase the level of leverage and cause departures of the credit-to-GDP ratio from its long term trend. This result highlights the importance of closely scrutinising how the lending activities of large banks evolve, as the cohort of large banks is capable of moving upward/downward overall leverage of the entire financial systems. In Chapter Three, we first uncover the time series properties of private credit in a panel factor model of 12 Eurozone and 8 non-Eurozone European countries and find evidence of credit convergence. We then focus on the first principal component of total credit, credit-to-GDP ratio, and credit-to-GDP gap series, and find the occurrence of long-run relationships between the latter and measures of ECB’s unconventional monetary policy, such as total assets and the shadow interest rate. Such a relationship is robust even after accounting for multiple structural breaks in the data. Within a structural factor augmented VAR (SFAVAR) approach, shocks to the above unconventional monetary policy variables are found to be positively related to the common factor of total credit, which we take as evidence on the transmission mechanism of UMP through the credit channel. In Chapter Four, we examine the factor structure of private and public debt for a cohort of 22 advanced economies over the period 2000-2019. We control for cross-sectional dependence in the panel data using a principal component approach, where we also disentangle the data into unobserved common factors and idiosyncratic components. Using methods that account for the long- and short run dynamics and potential endogeneity, as well the presence of cross-sectional dependence, we shed light on the heterogeneous behaviour across credit types and countries. Empirical results show that common factors affect the causality in the credit-growth nexus.