What does excess bank liquidity say about the loan market in Less Developed Countries?

Abstract

Evidence about developing countries' commercial banks' liquidity preference suggests the following about their loan markets: (i) the loan interest rate is a minimum markup rate; (ii) the loan market is characterized by oligopoly power; and (iii) indirect monetary policy, a cornerstone of financial liberalization, can only be effective at very high interest rates that are likely to be deflationary. The minimum rate is a markup over a foreign interest rate, marginal transaction costs and a risk premium. A calibration exercise demonstrates that the hypothesis of a minimum markup loan rate is consistent with the observed stylized facts.

Excess liquidity and the foreign currency constraint: the case of monetary management in Guyana

“…The implication being a surplus or deficit of US dollars in the foreign exchange market is not likely to elicit a substantial change in the supply of bank loans to private agents. This outcome is consistent with the hypothesis of Khemraj (2006Khemraj ( , 2007 that LDC banks demand a minimum mark-up loan rate (owing to oligopoly power) in the loan market.…”

“…In such a situation, therefore, the banks are not likely to set the loan rate and even the bid rate on Treasury bills (at primary auctions) endogenously of central bank monetary policy (or liquidity) shocks. Rather, banks are more likely to set these rates exogenously by marking up the rates (see Khemraj, 2007).…”

“…The increase in NFA means a build-up of excess reserves that can stimulate bank loans and domestic demand (consumption + business investments) once borrowers are willing to pay the rate of interest stipulated by the desired minimum mark-up loan rate, which is derived in Khemraj (2006;2007). Also an exogenous increase of bank loans diminishes excess reserves as illustrated by the double-pointed arrow linking the loan market with excess reserves (or the interbank market).…”

Banking consolidation, credit crisis and asset quality in a fragile banking system

“…Theoretically, also, excess liquidity can lead to free cash flow behavior among bank managers. This again is coupled with the fact that most of the liquid assets held by banks in less developed economies are usually non‐remunerated (Khemraj, 2010). The result here is understandable, given that due to the general market instability, individual banks might find it difficult to go for the recommendation that requires banks with a large amount of very liquid assets to sell off such in order to shield loan portfolio (Ehrmann et al , 2003).…”

ALM practices, multiple uncertainties and monopolistic behavior: a microeconomic study of banking decisions

“…It complements the study of Gonzalez-Hermosillo and Li (2008) that focuses on the relationships among market, credit and liquidity risks. It also complements the study of Khemraj (2010) that barriers to entry in the borrowing and lending markets. Here we consider a monopolistic banking system following the traditional Monti-Klein approach for analyzing behavioral issues.…”