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Capital requirements, bank behavior and monetary policy: A theoretical analysis with an empirical application to India

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  • Saibal Ghosh

    (Department of Economic Analysis and Policy, Reserve Bank of India, S.B.S. Marg, Fort, Mumbai - 400001, India.)

Abstract

The paper addresses the issue of monetary policy transmission through the banking sector in the presence of a bank capital regulation. A model of bank behavior is presented, which shows how a monetary policy shock affects both deposit and lending, in the short run (when equity capital is assumed to be fixed) as well as in the long run (when equity is endogenous). The analysis is extended to incorporate a salient feature of Basel II incorporating loans with differential risk weights. The basic spirit of the model is empirically examined using data on Indian banks for 1993-2004. The findings indicate that constrained banks raises lending to less risky borrowers in response to a monetary contraction.

Suggested Citation

  • Saibal Ghosh, 2008. "Capital requirements, bank behavior and monetary policy: A theoretical analysis with an empirical application to India," Indian Economic Review, Department of Economics, Delhi School of Economics, vol. 43(2), pages 205-227, December.
    • Handle: RePEc:dse:indecr:v:43:y:2008:i:2:p:205-227
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    More about this item

    Keywords

    Basel accord; bank equity; credit risk; monetary policy;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers

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