Monetary policy transmission through bank lending in a small-open economy : a structural var approach for the case of Malaysia

Abstract

The main objective of this study is to investigate the presence of the bank lending channel as a monetary policy transmission mechanism in Malaysia from the period 1980 to 2008. The purpose behind this study sterns from the debate among policy makers on the mechanism that transmits the impact of monetary policy to the real economy and the credit channel is considered as a significant mechanism in the case of a growing country like Malaysia. This study develops an open economy structural vector autoregssion (SV AR) model to characterize and identify the dynamic effects of foreign and domestic monetary policy shocks on the Malaysian economy. This SVAR approach with block exogeneity contemporaneous restriction is used to analyze the magnitude and timing of the effect of both domestic and foreign monetary policy on the Malaysian economy. The analysis shows that there is clear evident on a direct relationship from the monetary policy indicator to bank loans, and from bank loans to industrial production. This finding shows that the bank lending channel is operative in the Malaysian economy and hence bank loans are considered as important nexus for economic growth. The study then extends its analysis on the transmission of monetary policy through financing extended by Islamic banks. The findings reveal that Islamic bank financing significantly transmits monetary policy shocks to the real sector. Overall, the results of the study show clear evidence that the bank lending channel is operative in Malaysia. This finding contributes to giving a clearer understanding of the monetary transmission mechanism in Malaysia which will help policy makers determine the most suitable and effective policy to undertake.