David Elliott, Ralf Meisenzahl and José-Luis Peydró
Capital flows and credit growth are strongly correlated across countries. Macroeconomic evidence suggests that this ‘global financial cycle’ is largely driven by US monetary policy: expansionary policy by the Federal Reserve drives increases in lending globally, while contractionary Fed policy leads to a tightening of global financial conditions. Existing academic literature emphasises the role of banks in propagating these US monetary policy spillovers. But in recent decades, nonbank financial intermediaries have grown in importance. In a recent paper, we investigate the impact of US monetary policy on international dollar lending by nonbanks relative to banks, and show that nonbank lenders play an important role in absorbing US monetary policy shocks.
Empirical challenges
A key empirical challenge in comparing lending by banks and nonbanks is that different institutions lend to different borrowers. This means that differences in observed lending by banks and nonbanks might be driven not by differences in credit supply between banks and nonbanks – which is what we are interested in – but rather by differences in the credit demand of their borrowers. To address this challenge, we focus on the global syndicated lending market. This is one of the most important sources of debt financing for large corporates – similar in size to the corporate bond market – and a key source of cross-border credit. Crucially for our purposes, it is also a market where corporates borrow from multiple lenders (including both banks and nonbanks) at the same time. This allows us to identify credit supply effects by comparing how banks (deposit-taking institutions) and nonbanks lend to the same borrower at the same time. Specifically, we run panel regressions of dollar lending quantities on US monetary policy at the borrower-lender-quarter level, which allows us to use borrower-quarter fixed effects to control for credit demand in the spirit of Khwaja and Mian (2008). Our main sample consists of dollar loans to non-US borrowers from 1990 to 2019, and includes around 5,000 borrowers and 2,000 lenders in 120 countries. In our main sample, the average loan size is around US$330 million, and the average borrower has around US$12 billion in total assets.
A second challenge is that US monetary policy is not decided randomly, but is instead affected by economic conditions which might themselves affect bank and nonbank credit supply. To isolate the impact of US monetary policy from broader economic conditions, we therefore follow an instrumental variables approach. In our regressions, we instrument US monetary policy using the monetary policy surprises of Jarociński and Karadi (2020), which remove information about the economic outlook from the monetary policy measure. We also control for local economic conditions in both the borrower country and lender country, as well as other key global macroeconomic factors (eg the strength of the dollar and financial market volatility).
Substitution from bank to nonbank credit
We find that when US monetary policy tightens, nonbanks increase the supply of syndicated dollar credit to non-US corporates, relative to banks. The difference is substantial: a 25 basis point monetary tightening is associated with a relative increase in nonbank loan size of around 5%. In other words, nonbank lenders weaken international spillovers from US monetary policy. The relative increase in lending holds for both main types of nonbank lender in this market (investment banks and finance companies), US and non-US lenders, and within-border and cross-border loans.
We next consider whether the relative increase in nonbank credit leads to real economic effects on their corporate borrowers. We find that when US monetary policy tightens, non-US corporates that already have existing relationships with nonbank lenders are more likely to obtain new dollar syndicated credit, and experience a relative increase in total debt, investment, and employment. That is, better access to nonbank credit helps to stabilise corporates’ real economic activity.
What could be driving this?
Our results are consistent with two mechanisms driving the substitution from bank to nonbank credit. First, tighter regulation implies that banks typically have lower risk tolerance than nonbanks (Buchak et al (2018); and Irani et al (2021)), and banks tend to cut foreign lending first in response to shocks (Giannetti and Laeven (2012); and De Haas and Van Horen (2013)). This suggests that international bank lending is likely to be more sensitive than international nonbank lending to increases in the credit risk of corporate borrowers caused by contractionary US monetary policy. In line with this idea, we find that the relative increase in nonbank lending is larger for loans to riskier borrowers: specifically, borrowers from emerging markets and borrowers paying higher yields on their loans.
Our findings also support the funding-based mechanism proposed by Drechsler et al (2017) and Xiao (2020). In the domestic US context, those authors show that tighter monetary policy causes deposits to flow from banks to money market funds, who in turn lend to ‘downstream’ nonbank lenders, leading to an improvement in funding conditions for nonbank lenders relative to banks. We present suggestive evidence consistent with a similar mechanism at the international level: when US monetary policy tightens, nonbank financial intermediaries headquartered outside of the US increase their funding via short-term dollar debt markets relative to banks, consistent with a relative improvement in international dollar funding conditions for nonbanks.
Policy implications
US monetary policy spillovers have been a major source of concern for policymakers internationally, particularly in emerging markets, where the spillover effects are most pronounced. We show that these spillovers are weaker once nonbank lenders are taken into account. This suggests that firms with better access to nonbank credit are less exposed to the capital flow volatility stemming from US monetary policy spillovers.
However, there may also be important financial stability trade-offs. Several recent papers have found that nonbank lenders are more fragile than banks in financial crises (Fleckenstein et al (2020); Irani et al (2021); and Aldasoro et al (2023)). So when accessing nonbank credit, there may be a trade-off between improved access to credit during times of US monetary policy tightening, versus more fragility during financial crises, particularly given our finding that nonbanks focus their credit supply on riskier borrowers. Better understanding this trade-off is a crucial area for future research.
David Elliott works in the Bank’s Monetary Policy Outlook Division, Ralf Meisenzahl works at the Federal Reserve Bank of Chicago and José-Luis Peydró works at Imperial College London, ICREA-UPF-BSE and CEPR.
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