Bank Credit Extension and Real Economic Activity in South Africa (eBook)

Nombulelo Gumata holds a Master’s degree in Economics from the University of Johannesburg, South Africa. She in an economist at the Reserve Bank of South Africa and a part-time lecturer/tutor at the Centre for Education in Economics and Finance Africa (CEEF.Africa). CEEF.Africa supports students who study with the University of London for degrees and diplomas in Economics and Finance. She is the co-author of “Global Growth and Financial Spill-Overs and South African Economy” (Palgrave, 2015). Eliphas Ndou holds a Bachelor of Science in mathematical statistics and economics, a Bachelor of Economic Science (Honours), a Master of commerce and a PhD in economics from the University of the Witwatersrand, South Africa. He is an economist at the South African Reserve Bank and a lecturer at the University of the Witwatersrand. He is the co-author of “Monetary policy and the Economy in South Africa” (Palgrave, 2013) and “Global Growth and Financial Spill-Overs and South African Economy” (Palgrave, 2015).

Preface 5
Part I: Global Liquidity, Capital Flows, Asset Prices and Credit Dynamics in South Africa 6
Part II: Credit Supply Dynamics and Economy 8
Part III: Financial Regulatory Uncertainty and Bank Risk-Taking 9
Part IV: Macro-prudential Tools and Monetary Policy 10
Acknowledgments 12
Contents 13
List of Figures 29
List of Tables 44
1: Introduction 45
1.1 The Role of Global Liquidity, Capital Flows, Assets Prices and Credit Dynamics in South Africa 52
1.2 Asset Price Booms and Costly Asset Busts 54
1.3 Changing Relationships Between GDP and Capital Flows 57
1.4 The Relationship Between Capital Flows and Domestic Credit Growth 61
1.5 How Strong Is the Link Between Credit Supply Dynamics and the Real Economy? 67
1.6 Financial Regulation, Bank Risk Channels, Credit Supply Shocks and the Macroeconomy 70
1.7 Does a Tit for Tat Exchange Exist Between NCA and Monetary Policy Shocks? 81
1.8 Credit Loss Provisions as a Macro-­prudential Tool 81
1.9 Loan-to-Value Ratios, the Contractionary Monetary Policy Stance and Inflation Expectations 84
1.10 Repayment-to-Income and Loan-to-Value Ratios Shocks on the Housing Market 85
Part I: Global Liquidity, Capital Flows, Asset Prices and Credit Dynamics in South Africa 91
2: The Inverse Transmission of Positive Global Liquidity Shocks into the South African Economy 92
2.1 Introduction 93
2.2 How Does the Inverse Transmission of Global Financial Shocks such as QE Arise? 95
2.3 Developments in Policy Rates and Central Bank Balance Sheets 96
2.4 Are There Any Differences in the Impact of Quantity and Price Measures of Global Liquidity Shocks on the South African Economy? 99
2.4.1 Is There an Inverse Transmission Relationship Between Global Liquidity Shocks and Selected Macroeconomic Variables Before and After 2008Q4? 102
2.4.2 What Do the Counterfactual Scenarios Say About Inverse Transmission? 105
2.4.3 Policy Rate and Inflation Responses to Various Phases of QE 111
2.4.4 Did the US Fed and ECB Bank Balance Sheet Shocks Exert Inverse Transmission Effects on the South African Economy? 111
2.4.5 The Role of Commodity Prices: Inferences from the Counterfactual Analysis 115
2.5 Conclusion and Policy Implications 118
3: The Impact of Capital Flows on Credit Extension: The Counterfactual Approach 120
3.1 Introduction 120
3.2 The Relationship Between GDP and Net Capital Flows Over Time 121
3.3 How Are Capital Flow Shocks Transmitted Through the Balance of Payments Components? 122
3.4 The Counterfactual Analysis of Capital Flows and GDP 123
3.5 To What Extent Did Capital Flows Drive Credit Growth, if at All? 126
3.5.1 What Do the Counterfactual Scenarios Suggest the Role of Capital Flows on Credit Growth Is? 128
3.5.2 What About Commodity Prices, Do They Play Any Meaningful Role? 131
3.5.3 Does the Composition of Capital Flows Change the Role of Commodity Prices on Credit? 131
3.6 Conclusion and Policy Implications 134
4: Capital Flow Episodes Shocks, Global Investor Risk and Credit Growth 136
4.1 Introduction 137
4.2 The Classification of Capital Flow Episodes and the Importance of Separating Between Foreign and Domestic Investor Activity 137
4.3 How Do Capital Flows Wave Categories Impact Real Economic Activity and Credit Growth? 138
4.3.1 How Do Capital Flows Episodes Shocks Affect GDP Growth? 139
4.3.2 Through Which Channels Are Capital Flows Wave Episodes Transmitted? 143
4.4 How Do Capital Flows Wave Categories Impact Credit Growth? 145
4.4.1 Evidence from Impulse Responses 145
4.4.2 Evidence from Historical Decompositions 145
4.4.3 Evidence from Variance Decompositions 145
4.5 Does Global Risk Aversion Shock Impact Capital Flow Surges, Sudden Stop Episodes and Credit Growth? 146
4.6 Counterfactual Scenarios and the Propagation Effects of Commodity Prices and the Exchange Rate 149
4.7 Conclusion and Policy Implications 152
5: Bank, Non-bank Capital Flows and Household Sector Credit Reallocation 157
5.1 Introduction 157
5.1.1 Does the Sectorial Reallocation of Credit Extension Matter? 158
5.2 Relationship Between Credit to Households, Bank and Non-bank Capital Flows 160
5.3 VAR Results 165
5.3.1 Fluctuations in Credit to Households Explained by Bank and Non-bank Capital Flows 165
5.3.2 The Counterfactual Contributions 168
5.4 Conclusion and Policy Recommendations 171
6: Capital Flows and the Reallocation of Credit from Companies 172
6.1 Introduction 172
6.2 Does the Relationship Between Credit to Companies Depend on the Definition of the Capital Flow Category? 173
6.3 The VAR Results 176
6.4 Fluctuations in Credit to Companies Explained by Bank and Non-bank Shocks 178
6.5 Do Capital Flows Amplify the Responses of the Repo Rate to Positive Inflation Shocks? Evidence from the Counterfactual Contributions 181
6.6 The Historical Decompositions and Counterfactual Scenarios 183
6.7 Conclusion and Policy Implications 185
Appendix 186
7: Stock Price Returns, Volatility and Costly Asset Price Boom–Bust Episodes 189
7.1 Introduction 190
7.2 Stylized Facts in the Relationship Between Economic Growth and Stock Market Dynamics 192
7.3 Differential Effects Between Stock Price Returns and Volatility on Economic Growth 192
7.3.1 Do Stock Price Dynamics and Fluctuations on Economic Growth Relative to Other Shocks 194
7.3.2 Stock Price Returns and Volatility Transmit Portfolio Outflow Shocks 198
7.3.3 Volatility and Monetary Policy Tightening Shocks Impacts on Economic Growth 201
7.3.4 Economic Growth Evolution and the Role of Stock Returns and Volatility 201
7.4 Asset Price Booms and Busts: Inferences from Various Measures 205
7.4.1 Credit or Collateral Channel in South Africa Accompanying Costly Booms 211
7.4.2 Financial Imbalance Build-Ups During the Identified Episodes of Costly Booms 213
7.4.3 Inferences From the Role of Monetary Policy Based on Deviations from the Taylor Rule 215
7.5 Conclusion and Policy Implications 216
Appendix A7.1 218
8: The Interaction Between Credit Conditions, Monetary Policy and Economic Activity 220
8.1 Introduction 221
8.2 Construction of Credit Conditions Index 221
8.2.1 The Credit Conditions Index 223
8.2.2 Credit Conditions Index and Business Cycle and Bank Lending Standard Indicators 223
8.2.3 The Relationships Between Credit Conditions, Repo Rate and Economic Activity 228
8.3 The Empirical Methodology 231
8.3.1 Empirical Results and Discussion 231
8.3.2 Repo Rate Dynamics and the Evolution of the Credit Conditions Index 233
8.3.3 Impact of Credit Conditions on Residential and Non-residential Sector Activity 236
8.4 Tight Credit Conditions Versus Contractionary Monetary Policy and Negative Equity Price Shock 236
8.4.1 Tight Credit Conditions Versus Contractionary Monetary Policy and Negative Business Confidence Shock Effects 240
8.4.2 Tight Credit Conditions Versus Negative Coincident and Leading Business Cycle Shocks 240
8.4.3 Contributions of Credit Conditions and Business Confidence to Manufacturing Production Growth 243
8.5 Deriving Policy Implications 243
8.6 Conclusion and Policy Implications 246
9: Credit Conditions and the Amplification of Exchange Rate Depreciation and Other Unexpected Macroeconomic Shocks 248
9.1 Introduction 248
9.2 How Do Credit Conditions and Lending Standards Impact GDP Growth? 249
9.3 Fluctuations and Nonlinearities Induced by the CCI 254
9.3.1 Fluctuations Induced by Credit Conditions on GDP and Inflation 254
9.3.2 Is There a Nonlinear Effect of Credit Conditions on GDP Growth? 254
9.4 Amplification Due to Credit Conditions: A Counterfactual VAR Approach 256
9.4.1 Inflation Response to Rand Depreciation Shocks in the Absence of the CCI 260
9.5 The Role of Tight Credit Conditions and GDP Growth in the Repo Rate Reactions to Positive Inflation Shocks 260
9.5.1 Historical Decomposition and Counterfactual Approaches 264
9.6 Conclusions and Policy Implications 265
Part II: Credit Supply Dynamics and the Economy 268
10: The Lending-Deposit Rate Spread and the Bank Pricing Behavior 269
10.1 Introduction 269
10.2 Dynamics of Lending and Deposits Rates 272
10.3 What Can Lead to a Momentum and Asymmetric Effects in Lending-Deposit Spread Adjustment? 274
10.4 Is There an Asymmetric Adjustment in the Spread Between Lending Rates and Deposit Rate Since 2008? 275
10.4.1 Second Step: Is There Evidence of the Momentum Change in Lending Deposit Spread? 276
10.4.2 Evidence from the Model-Estimated Threshold 276
10.4.3 Evidence from a Zero Threshold 278
10.4.4 So How Does the Lending-Deposit Spread Adjust Based on a Different Technique Such as the Asymmetric Error Correction Approach? 278
10.5 Conclusion and Policy Implications 279
11: Adverse Credit Supply Shocks and Weak Economic Growth 281
11.1 Introduction 281
11.2 The Importance of Proper Identification of Loan Demand and Supply Shocks 282
11.3 Theoretical Relationship Between Loan Spreads and Adverse Credit Supply and Demand Shocks 284
11.3.1 Margins on Credit, the Repo Rate and Growth in Credit 287
11.3.2 Financial Regulatory Uncertainty Contribution to an Increase in Margins 289
11.3.3 Facts Between Margins and Selected Macroeconomic Variables 289
11.3.4 Cross Correlations and Macroeconomic Bilateral Interdependencies 291
11.4 Effects of an Adverse Credit Shock, Tight Monetary Shock and Spreads and Elevated Global Economic Uncertainty Shock 293
11.4.1 Can Economic Growth Mitigate Higher Spreads? 299
11.4.2 Evidence Based on the Penalty Function Sign Restriction Approach 299
11.5 Adverse Credit Supply Shock and the Conduct of Monetary Policy and Loan Rate Margins 307
11.5.1 Is There a Threshold Level Beyond Which Loan Spreads Have Adverse Effects on Economic Growth? 310
11.6 Conclusion and Policy Implications 312
Appendix 314
12: Credit Supply Shocks and Real Economic Activity 316
12.1 Introduction 316
12.2 Credit Supply Shock and Economic Activity 317
12.2.1 Effects of These Shocks on Growth in GDP and Investment 321
12.2.2 The Influence of Credit Supply Shocks on Economic Growth, Credit and Investment 321
12.3 Relationship Between Bond Yields and Credit Supply Shock Contributions to GDP Growth Post 2007Q2 327
12.3.1 Relationship Between Credit Risk, Credit Supply and Demand Contributions to GDP Growth Post 2000 330
12.3.2 Do Aggregate Supply Shocks Explain Sluggish Growth in Credit and GDP? 333
12.3.3 Credit Supply and Credit Demand Shocks and Subdued GDP, Credit and Investment Growth 333
12.4 Conclusion and Policy Implications 336
13: Credit Growth Threshold and the Nonlinear Transmission of Credit Shocks 337
13.1 Introduction 337
13.2 Why May the Nonlinear Response of Economic Activity to Various Shocks Depend on Credit Regimes? 339
13.3 Descriptive Statistics 341
13.3.1 Cross Correlations Between Macroeconomic Variables 341
13.4 Dynamics Between Credit Growth, Inflation and Economic Activity 345
13.4.1 Does the Credit Threshold Lead to a Nonlinear Response of Inflation and Real Economic Activity to an Unexpected GDP Growth Shock? 346
13.4.2 What Is the Threshold Value for Credit Growth? 347
13.4.3 Nonlinear Threshold Responses of Inflation and Repo Rate 348
13.4.4 Inflation Shocks and Economic Growth Effects 351
13.4.5 Are the Prevailing Credit Market Conditions an Important Nonlinear Propagator of Economic Shocks? 354
13.5 Do Inflation Shocks Have Asymmetric Effects on Economic Growth Dependent on Credit Regimes? 357
13.5.1 Do Credit Regimes Impact the Repo Rate Reaction to Positive Inflation Shocks? 359
13.6 Conclusion and Policy Implications 361
14: Credit Regimes and Balance Sheet Effects 363
14.1 Introduction 363
14.2 Do Negative Credit Shocks Lead to Larger Declines in Output in the Low Credit Regime Relative to the High Credit Regime? 364
14.2.1 Do Positive Economic Growth Shocks Lead to Higher Credit Growth in the Lower Credit Regime Relative to the Higher Credit Regime? 365
14.3 Conclusion and Policy Implications 366
Part III: Financial Regulatory Uncertainty and Bank Risk Taking 369
15: The Banking Risk-Taking Channel of Monetary Policy in South Africa 370
15.1 Introduction 370
15.2 What Is the Bank Risk-Taking Channel of Monetary Policy? 371
15.3 Relationship Between Funding Risk and Economic Growth 374
15.4 Can the Model Capture the Stylized Effects of an Unexpected Repo Rate Hike? 374
15.1.1 Is There Evidence of the Bank Risk-Taking Channel of Monetary Policy? 377
15.1.2 Are the Direction and Significance of the Results Sensitive to Sample Size? 381
15.1.3 Is There a Risk-Taking Channel via Non-­performing Loans and House Prices? 381
15.1.4 Which Risk Shocks Depress Economic Growth as Well as Propagating Fluctuations in Economic Growth? 389
15.1.5 What Would Economic Growth Be Like in the Absence of Various Banking Risk Shocks? 392
15.1.6 Do Contributions from the Repo Rate Reinforce Those of Combined Banking? 394
15.5 Conclusion and Policy Implications 395
Outline Placeholder 397
16: Financial Regulation Policy Uncertainty and the Sluggish Recovery in Credit Growth 398
16.1 Introduction 398
16.2 Why Should Policymakers Be Concerned About Regulatory Uncertainty Shocks? 400
16.3 To What Extent Have Banks’ Balance Sheet Items Changed in the Period Pre- and Post-recession in 2009? 401
16.3.1 Is There Evidence of a Systematic Shift in Bank Funding Sources? 401
16.3.2 Studies in Other Countries Indicated Rising Funding Cost Margins Post-2009, How Did Funding Margins in South Africa Evolve? 401
16.3.3 Did Lending Spreads Widen as Postulated by Theory During Episodes of Low Interest Rates? 404
16.3.4 Liability and Asset Sides of Bank Balance Sheets 405
16.4 What Can the Lessons Be About the Funding Rate Reactions to the FRPU Shocks? 407
16.5 Stylized Effects of Interest Rate Margins, the FRPU and Key Macroeconomic Variables 408
16.6 What Can the Policymaker Learn About the Effects of FRPU on the South African Economy? 412
16.6.1 Do the Macroeconomic Effects of an Unexpected Increase in the FRPU Vary from Those of an Unexpected Rise in the Repo and Installment Sales Interest Rate Margins Shocks? 418
16.6.2 Does It Matter if the Shock Originates from the Other Loans and Advances or Installments Sale Side? 419
16.6.3 To What Extent Is It Possible to Attribute the Evolution of Both Margins to Own and FRPU Contributions? 424
16.6.4 To What Extent Did the Margins Impact the Evolution of Credit Extension? 428
16.6.5 Growth in House Prices and Retail Sales and Regulatory Uncertainty Shocks 432
16.6.6 How Does Credit Risk React to the FRPU, House Prices and Installment Sale Credit Rate Margins Shocks? 433
16.6.7 What Would Have Happened to Credit Loss Provisions as a Measure of Risk Pre- and Post-­recession in 2009? 435
16.7 Conclusion and Policy Implications 438
Part IV: Macro-prudential Tools and Monetary Policy 439
17: Excess Capital Adequacy and Liquid Asset Holdings and Credit 440
17.1 Introduction 440
17.2 What Does Preliminary Data Analysis Suggest Is the Link Between Excess CAR, LAH and Credit Growth? 444
17.3 How Has the Interdependence Between Credit Growth and Lending Changed? 447
17.3.1 Impact of an Unexpected 25 Basis Points Increase in the Lending Spread on Credit Growth 450
17.3.2 The Evolution of Lending Spreads and Unexpected Negative Growth in Credit Shock 450
17.4 Tight Credit Regulation Shocks on Economic and Credit Growth 452
17.4.1 Spill-Over Effects of Regulatory Shocks to Real Economic Activity 454
17.4.2 Is Monetary Policy Neutral to Unexpected Credit Regulatory Shocks? 457
17.4.3 Cumulative Effects of Unexpected Regulatory Shocks on Growth in Credit and Lending Spreads 460
17.4.4 Counterfactual Responses 465
17.5 Conclusions and Policy Recommendations 465
Appendix 468
18: Credit Loss Provisions as a Macro-­prudential Tool 470
18.1 Introduction 471
18.2 Why Should Policymakers Be Made Aware of the Effects of Credit Provisions? 473
18.3 What Is an Unexpected Positive Credit Loss Provisioning Shock and Its Expected Impact on Credit and the Real Economy? 474
18.4 Stylized Facts 475
18.5 How Well Does the Estimated Model Capture the Established Responses of Selected Variables in Literature? 477
18.5.1 What Are the Effects of Credit Provisioning on the Real Economy? 479
18.5.2 To What Extent Does the Annual Change in Credit Provisions Influence the Business Cycle? 480
18.5.3 What Does Nonlinearity in the Credit Loss Provisioning Mean for Economic Activity and Credit Growth Shock? 484
18.5.4 Do Nonlinear Effects Matter? 486
18.5.5 Did the Changes in the Business Cycle After 2007M8 Lead to Nonlinear Credit Provisioning Shocks Effects? 489
18.5.6 Counterfactual Analysis 490
18.6 Conclusion and Policy Implications 494
Appendix 499
19: The National Credit Act, Monetary Policy and Credit Growth 500
19.1 Introduction 500
19.2 Effects of Unexpected Policy Shocks on Economic Activity 502
19.3 How Resilient Is Credit Growth to the Repo Rate and NCA Shocks? 504
19.4 Is There Evidence That the Monetary Policy and NCA Shocks Complement Each Other? 507
19.5 Counterfactual Responses 510
19.6 Policy Implications 512
20: Loan-to-Value Ratios, Contractionary Monetary Policy and Inflation Expectations 513
20.1 Introduction 514
20.2 How Are the LTVs and RTIs Determined in South Africa? 517
20.3 How Have RTIs and LTVs Evolved in South Africa? 518
20.3.1 Are Households Deleveraging or Have LTVs and RTIs Shifted the Scales? 519
20.3.2 Are Households Making Excessive Repayments Relative to Their Income? 520
20.3.3 Is the Ratio of Residential Non-performing Loans Still Inhibiting Credit Extension? 521
20.4 To What Extent Did the LTV Tightening Shock Reinforce or Offset the Effects of the Repo Rate Tightening Shock? 522
20.4.1 Sensitivity of Household Disposable Income, Debt and Financing Costs to Repo Rate and LTV Tightening Shocks 526
20.4.2 Do LTV and Repo Rate Shocks Reinforce Each Other in Impacting Household Balance Sheet Assets? 528
20.4.3 What Moves the Ratios Due to a Positive Repo Rate Shock and LTV Tightening Shock? Is It the Numerator or the Denominator? 531
20.4.4 Consumption Spending Channel: What are the Policy Implications Regarding the Inflation Outlook and Inflation Expectations? 531
20.4.5 LTV Tightening Shock and the Evolution of Inflation Outcomes and Expectations 539
20.4.6 Do High Inflation Expectations Pose Risks to Financial Stability Via the LTV Channel? 542
20.5 Counterfactual Scenarios 545
20.6 Conclusion and Policy Implications 545
21: Repayment-to-Income and  Loan-to-­Value Ratios Shocks on the Housing Market 551
21.1 Introduction 551
21.2 Why Does the Repayment-to-Income Ratio Matter? 554
21.3 Disentangling the Role of the LTV in Housing Market Activity 555
21.3.1 What Is the Relationship Between the LTV, House Prices and Valuers’ Demand and Supply Strength Indices? 555
21.3.2 Do Non-performing Loans Impact LTVs? 560
21.4 Which Methodology Is Best Used for the Empirical Analysis and to Answer the Relevant Questions? 561
21.4.1 Do Lending Standards Measured by the LTV React to Economic Shocks? 562
21.4.2 To What Extent Do the LTV Responses Differ from Those of the RTI? 565
21.4.3 Should Monetary Policy Authorities Be Concerned About Unexpected Developments in LTV Dynamics? 569
21.4.4 When Did the LTV Tightening Shock Series Exhibit both Loosening and Tightening Phases? 571
21.4.5 Is It Possible That the LTV Tightening Can Be Attributed to Adverse Developments in Mortgage Advances? 572
21.4.6 Is There Further Evidence That LTV Tightening Shocks Have Beneficial Spill-Overs to Price Stability? 576
21.4.7 What Can Monetary Policymakers Infer from the Influence of the LTV Tightening Shock on the Level of the Repo Rate? 578
21.4.8 How Influential Is the RTI Shock in Driving Repo Rate Dynamics? 581
21.5 The Counterfactual Scenarios 582
21.6 Conclusion and Policy Implications 582
References 586
Index 599