Monetary policy, funding liquidity, and undisbursed loans in Indonesia: The bank lending channel revisited

Abstract

This paper extends the literature on the bank lending channel by assessing the interplay between monetary policy and funding liquidity in affecting undisbursed loans. Using a sample of Indonesian banks, our empirical findings highlight that a higher monetary policy interest rate increases undisbursed loan growth, suggesting that the bank lending channel affects borrower decisions. Furthermore, we find that banks with higher funding liquidity exhibit lower undisbursed loan growth in response to contractionary monetary policy. However, the role of funding liquidity in reducing undisbursed loans due to a higher monetary policy interest rate is more pronounced for weakly capitalized banks and small banks. On one hand, this paper emphasizes the role of funding liquidity, particularly for weakly capitalized banks and small banks, in maintaining financial intermediation during the implementation of contractionary monetary policy. On the other hand, we also emphasize that the effectiveness of the bank lending channel is mainly driven by highly capitalized banks and large banks.