Bank Credit Extension and Real Economic Activity in South Africa: The Impact of Capital Flow Dynamics, Bank Regulation and Selected Macro-prudential Tools

612 Pages·2017·19.61 MB·English

by  Nombulelo Gumata

Nombulelo Gumata and Eliphas Ndou
The Impact of Capital Flow Dynamics,
Bank Regulation and Selected
Macro-prudential Tools
Bank Credit Extension and Real Economic
Activity in South Africa
Nombulelo Gumata • Eliphas Ndou
Bank Credit
Extension and Real
Economic Activity in
South Africa
The Impact of Capital Flow Dynamics, Bank
Regulation and Selected Macro-prudential Tools
Nombulelo Gumata Eliphas Ndou
Economist Economist
South African Reserve Bank, South Africa South African Reserve Bank, South Africa
ISBN 978-3-319-43550-3 ISBN 978-3-319-43551-0 (eBook)
DOI 10.1007/978-3-319-43551-0
Library of Congress Control Number: 2016958293
© The Editor(s) (if applicable) and The Author(s) 2017
This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether
the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of
illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and trans-
mission or information storage and retrieval, electronic adaptation, computer software, or by similar or
dissimilar methodology now known or hereafter developed.
The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication
does not imply, even in the absence of a specific statement, that such names are exempt from the relevant
protective laws and regulations and therefore free for general use.
The publisher, the authors and the editors are safe to assume that the advice and information in this book
are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or
the editors give a warranty, express or implied, with respect to the material contained herein or for any
errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional
claims in published maps and institutional affiliations.
Cover illustration: © Ben Oliver / Alamy Stock Phot
Printed on acid-free paper
This Palgrave Macmillan imprint is published by Springer Nature
The registered company is Springer International Publishing AG
The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland
Preface
The four parts of this book examine a variety of issues. Among them are
establishing the strength of links between credit supply dynamics and the
real economy and determining if they are responsible for fragile economic
growth recovery. We also assess the impacts of financial regulation uncer-
tainty, regulator excesses and bank risk-taking channels in South Africa.
We use simple scatterplot analysis cross-correlation to examine the lead-
lag relationship and then apply advanced econometric analysis to show
linkages that could not be shown using simple basic statistical techniques.
Unconventional Monetary Policies Since the onset of the US subprime
crisis, which translated into global financial crisis and recession followed
by serious economic uncertainties, the South African economy has expe-
rienced a fragile recovery. To deal with domestically weak economic
growth recoveries in the USA, UK and the Eurozone, monetary policy-
makers embarked on quantitative easing, which injected liquidity using
various instruments. It is undeniable that prevailing low interest rates in
these economies led to capital flows into emerging markets, including in
South Africa. Thus increased demand for assets in these economies may
lead to high asset prices and a reversal of capital flows through disposing
of these assets may lower their prices.
v
vi Preface
Recent Policy Changes Currently, as policymakers are implementing pru-
dential polices, we give new insights into what policymakers infer from
the role of existing macro-prudential tools which were implemented by
financial institutions themselves for the residential sector on economic
activity. These macro-prudential policies coincide with different mon-
etary policy phases; hence we give new insights into the extent of the
interaction between macro-prudential policies and monetary policy and
show that prudential policies also spill over into price stability and infla-
tion expectation. In addition, inflationary pressures and expected infla-
tion rates may lead to undesirablly tight prudential tools. We fill these
gaps by showing the strength of spill over linkage.
Part I: Global Liquidity, Capital Flows, Asset
Prices and Credit Dynamics in South Africa
Subsequent to the 2007 global financial crisis, key central banks in
advanced economies embarked on conventional and unconventional
accommodative monetary policies. The policy rates were lowered to very
low levels and bank balance sheet expanded considerably. While large
amounts of global liquidity may be desirable, there are mixed views on
the extent to which South Africa (SA) has benefited from abundant
global liquidity during this period of low interest, made possible through
increased capital inflows which impact the real economy. Amidst this
expectation, the debate is captured via the views of the “initiator countries
vs the recipient countries”. First, the tapering of asset purchases can be
interpreted as an indication that the US economy is recovering, and this
can be seen as good news for the South African economy to the extent
that, with positive growth impulses from the USA, global growth and
demand benefit South African exporters. The thesis is that an improve-
ment in world output (global demand) will lead to increased demand
for South African exports. Thus, spill-over to foreign economies could
occur via exports growth amongst other key channels of transmission.
While income effects encompassed within the trade channel and tend to
dominate the development, this is not the only channel that fully reflects
Preface vii
the spill-over effects of foreign demand. The exchange rate appreciation
linked to G3 central bank liquidity injection could lead to undesirable
outcomes.
Global liquidity can operate via different channels, hence we investi-
gate its effects through assessing different aspects. Is there any evidence
of the inverse transmission of global liquidity shocks into the domestic
economy? We apply counterfactual analysis to see what would happen
to selected variables in the absence of G3 liquidity. Are there any dif-
ferential effects on gross domestic product (GDP) growth between US
and European Central Bank (ECB) liquidity? We extend the analysis and
quantify the undesirable effects of capital flow uncertainty by providing
a systematic analysis of how large capital inflows, capital inflow reversals
and net portfolio flow volatility affect economic performance, and show
there exists an understated sectoral reallocations transmission channel. To
give further insights, we perform a counterfactual analysis to assess how
economic growth, changes in the Real Effective Exchange Rate (REER)
and growth in credit extension would have evolved in the absence of
the contributions of capital flows. While credit market indicators may
exhibit divergences, to overcome this and enable proper indication of
prevailing conditions, we construct a credit conditions index (CCI) for
South Africa. This matters as we examine the extent to which tighter
credit conditions impact real economic activity. We use the constructed
CCI to examine the extent to which the massive policy rate reduction
since 2009 impacted credit conditions. Are the repo rate contributions
during the recession similar to those in other periods when the repo rate
was lower before the tightening phase in 2007? Given that equity markets
are impacted by capital flows dynamics, we identify episodes of real stock
price busts and the associated economic costs, the behavior of selected
macroeconomic variables and the possible existence of financial imbal-
ances prior, during and after episodes of costly booms, especially before
the unwinding of unconventional policy measures and the imminent
normalization of monetary policy settings. We demonstrate how eco-
viii Preface
nomic growth would have likely evolved in the absence of stock returns
and volatility as well as their propagation.
Part II: Credit Supply Dynamics and Economy
The second part of the book focuses on credit supply dynamics and
real economic activity. Theory suggests that credit and GDP growth are
linked. As shown in Fig. 1, neither credit nor GDP levels have returned
to pre-recession trends and have remained fairly subdued. Some quarters
use this to explain the fact that the economy has been plagued by two
negative gaps in the credit markets and the real economy.
The close movement between GDP and credit could indicate that
credit supply dynamics matter for the real economy such that the adverse
credit supply shock may be responsible for weak economic growth recov-
ery and elevated credit interest rate spreads. Certain chapters in Part II of
the book disentangle the adverse credit supply shock effects from those
of tighter monetary policy and adverse credit demand shocks. It is only
the demand and supply side effect of credit that matters, so it is possible
that regulatory changes which require banks to hold liquid government
securities play a big role. In this context, we determine the relation-
ship between government credit supply contributions to growth in (i)
Fig. 1 Credit and GDP trends pre- and post-global financial crisis and reces-
sion (Source: South African Reserve Bank and authors’ calculations)
Preface ix
GDP and (ii) gross fixed capital formation and bond yields and credit
risk. Apart from influencing GDP growth, we show policymakers that
credit market frictions introduce nonlinear effects with implications for
the direction and magnitudes of the repo rate adjustment and inflation
dynamics, paths and magnitudes of the policy rate adjustments in any
way towards the primary mandate of curbing inflationary pressures. We
establish thresholds and show that nonlinearities in credit market dynam-
ics are relevant for monetary policy and financial stability, and that this
an under-researched area. The nonlinearities may reveal if negative credit
shocks lead to larger declines in output under a low credit regime rela-
tive to the high credit regime. In addition, the nonlinearities may reveal
whether positive economic growth shocks lead to higher credit growth in
a lower credit relative to the higher credit regime.
Part III: Financial Regulatory Uncertainty
and Bank Risk-Taking
The third part of the book focuses on financial regulation uncertainty,
regulators excesses and interest rate spreads and the bank risk-taking
channel. In Fig. 2 the capital adequacy ratio (CAR) has exceeded the
minimum required ratio over the long horizons. The liquidity asset hold-
ings of banks have exceeded the minimum required levels since 2009.
In addition to regulatory amounts or quantities, the National Credit Act
(NCA) was passed into legislation in 2005 and implemented in June 2007.
Empirically, little is known about this macro-prudential tool’s effectiveness
and how it interacts with monetary policy. So to what extent did the NCA,
holding excess Capital Adequacy Ratio (CAR) and Liquid Asset Holdings
(LAH), impact credit dynamics? In view of the costs involved, did these
excesses induce any frictions in credit markets by raising lending spreads?
How do the effects of these excesses differ from those associated with the
NCA and Basel III shocks? We also show that the NCA does propagate the
effects of monetary policy on credit and output, which may be indicative
of an economic case for these tools to be coordinated. Regulatory uncer-
tainty may also be a significant player which impacts the interdependence
between growth in credit and lending spreads before and after the financial
x Preface
Fig. 2 Capital adequacy ratio and the holding of liquid assets (Source: South
African Reserve Bank and authors’ calculations)
crisis in August 2007, inflation and the repo rate shocks. We apply the
financial regulatory policy uncertainty as constructed by Nodari (2015) to
show the extent that regulatory uncertainty could be responsible for ane-
mic macroeconomic performance
Part IV: Macro-prudential Tools
and Monetary Policy
Little is known about the effects of macro-prudential tools in South
Africa, and Part IV of the book focuses on the effects of selected tools. The
macro-prudential policies for residential mortgage lending tools include
the repayment-to-income (RTI) ratio shock and unexpected tightening
in loan-to-value (LTV) ratio. Credit provisions tend to move together
with the repo rate; however, this has changed since 2010. This change in
the relationship may have unintended policy consequences (Fig. 3).
We rely on the literature on the interaction of monetary and financial
policy, which argues that some features of the housing market explain dif-
ferences in the transmission of monetary policy and can amplify swings
in the real economy and can be sources of financial instability. The inter-
action of macro-prudential policies for residential mortgage lending and
monetary policy can induce macroeconomic fluctuations, particularly if