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Bank capital and monetary policy transmission: Analyzing the central bank's dilemma in the Indian context

Author

Listed:
  • Rajeswari Sengupta

    (Indira Gandhi Institute of Development Research)

  • Harsh Vardhan
  • Akhilesh Verma

    (ESRI & Trinity College)

Abstract

This paper explores the role of bank capital in monetary policy transmission within the Indian economy, where the banking sector is the primary channel for financial intermediation. Using a panel dataset of 18 commercial banks from 2002 to 2018, we assess how varying levels of bank capital influence monetary policy transmission. Our findings reveal that though monetary contractions reduce credit growth, yet banks holding higher capital show significantly lower sensitivity to monetary policy changes compared to those with lower capital. This effect is stronger in well-capitalized private sector banks. Our results suggest that bank capital helps mitigate the adverse impact of higher interest rates on credit supply, thereby weakening the overall effectiveness of monetary transmission. However, the buffering effect of bank capital on credit growth diminishes during periods of high nonperforming assets (NPAs). These results highlight the Reserve Bank of India's challenge in balancing financial stability with effective monetary policy implementation.

Suggested Citation

  • Rajeswari Sengupta & Harsh Vardhan & Akhilesh Verma, 2024. "Bank capital and monetary policy transmission: Analyzing the central bank's dilemma in the Indian context," Indira Gandhi Institute of Development Research, Mumbai Working Papers 2024-019, Indira Gandhi Institute of Development Research, Mumbai, India.
    • Handle: RePEc:ind:igiwpp:2024-019
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    File URL: http://www.igidr.ac.in/pdf/publication/WP-2024-019.pdf
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    More about this item

    Keywords

    Bank capital; Monetary transmission; Balance sheet channel; Non-performing assets; Public-sector banks;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • G2 - Financial Economics - - Financial Institutions and Services

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