Bank diversification and the effectiveness of monetary policy transmission: Evidence from the bank lending channel in Vietnam

Abstract

The study empirically examines the impact of bank diversification on monetary policy transmission through the bank lending channel. Based on monetary and bank-level data from 2008 to 2018 in Vietnam, a diverse environment of monetary policy tools, results show that bank diversification significantly drives the bank lending channel in different ways. Using the changes in lending rates and policy rates as monetary policy indicators, the study posits strong evidence to indicate that the transmission of the bank lending channel becomes weaker as banks get more involved in non-traditional activities. In contrast, we observe that bank diversification promotes the effectiveness of monetary policy transmission by the intervention of foreign exchange reserves, with no clear-cut link in the case of open market operations. Further analysis indicates the weakening effect is almost confirmed in all bank groups, while the strengthening effect works only for banks with large capital buffers. In brief, the results suggest that monetary authorities should be vigilant when they are strongly encouraging bank diversification. Besides, they also need to choose the appropriate monetary tools to apply and establish specific policies for different groups of banks.