Uncertainty and the transmission of monetary policy via bank liquidity creation

Abstract

Purpose

This paper investigates the moderating role of uncertainty in the impact of monetary policy on bank liquidity creation.

Design/methodology/approach

Utilizing data from Vietnam spanning 2007–2022, the paper measures uncertainty in the banking industry through the dispersion of shocks to crucial bank-level variables and considers both interest rate- and quantity-based tools of the monetary policy regime. The study regresses economic models using different econometric methods, including the generalized method of moments (GMM) estimator in the main section and the least squares dummy variable corrected (LSDVC) estimator for the robustness check.

Findings

Monetary expansion enhances banks’ ability to create liquidity, affirming the existence of the bank liquidity creation channel. Further analyses suggest that monetary policy adjustments aimed at regulating bank liquidity creation may be less effective in the presence of higher uncertainty in the banking system. This observation holds for both interest rate- and quantitative-based monetary policy tools, emphasizing the functioning of the monetary policy transmission mechanism through bank liquidity creation and the mitigating effect of uncertainty.

Originality/value

This study contributes novel insights to the existing literature by presenting the first attempt to explore the dynamics of monetary policy transmission through the bank liquidity creation channel in the context of banking sector uncertainty. Moreover, our contribution extends to examining a multi-tool environment, incorporating both interest rate- and quantitative-based indicators.