Monetary policy transmission and bank lending channel in Vietnam

Abstract This study tries to investigate the existing of interest rate channel, exchange rate channel, asset price channel, and bank lending channel in Vietnam which are seen as the main

MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HO CHI MINH CITY

*****

NGUYEN PHUC CANH

MONETARY POLICY TRANSMISSION AND BANK LENDING CHANNEL IN VIETNAM

Major: Finance and Banking

Code: 62.34.02.01

SUMMARY OF PHD THESIS

ACADEMIC ADVISORS

1 Prof Dr SU DINH THANH

2 Assoc Prof Dr VO XUAN VINH

HO CHI MINH CITY, 2016

LIST OF AUTHOR’S PUBLICATION

Journal of banking science and training 154, 3/2015, p.29 – 41, Institution of Banking, Vietnam

Võ Xuân Vinh & Nguyễn Phúc Cảnh (2014), “Monetary policy and bank credit risk in Vietnam pre and post global financial crisis”, Contemporary Studies in Economic and Financial Analysis, Vol

96; Risk Management Post Financial Crisis: A Period of Monetary Easing, Emerald Group Publishing Limited, United Kingdom, p.277-290

Nguyễn Phúc Cảnh, Trầm Thị Xuân Hương, Võ Xuân Vinh (2014), “Truyền dẫn của chính sách tiền tệ: một số mô hình kiểm định phù hợp” (in English: Monetary policy transmission: some suitable

econometric testing models), Journal of Development and Integration 16 (26), P.41 - 46, 6/2014, UEF, Vietnam

Nguyễn Phúc Cảnh, Trầm Thị Xuân Hương, Võ Xuân Vinh (2014), “Nới lỏng định lượng và lạm phát mục tiêu trên thế giới - bài học cho Việt Nam” (in English: Quantitative easing and inflation

targeting in the world and lessons for Vietnam), Journal of Banking technology 99, p.40 - 48, 6/2014, Banking University Ho Chi Minh City, Vietnam

Nguyễn Phúc Cảnh, Trầm Thị Xuân Hương, Võ Xuân Vinh (2014), “Truyền dẫn của chính sách tiền tệ qua kênh lãi suất ngân hàng tại Việt Nam trước và sau khủng hoảng” (in English: Monetary

policy transmission through the interest rate channel in Vietnam before and after the crisis), Journal of Economic Development 283, p.42 - 67, 5/2014, University of Economics Ho Chi Minh City, Vietnam

Nguyễn Phúc Cảnh, Trầm Thị Xuân Hương, Võ Xuân Vinh (2014), “Truyền dẫn của chính sách tiền tệ qua kênh tỷ giá tại Việt Nam – trước và sau khủng hoảng” (in English: Monetary policy

transmission through exchange rate channel in Vietnam - before and after the crisis), Journal of banking science and training 143, p.27 - 35, 4/2014, Institution of Banking, Vietnam

Nguyễn Phúc Cảnh (2014), “Truyền dẫn của chính sách tiền tệ qua kênh giá tài sản tài chính: nghiên cứu thực nghiệm tại Việt Nam”, Journal of Integration and Development 19(29), 11-12/2014,

UEF

Nguyễn Phúc Cảnh (2013), “Chính sách lạm phát mục tiêu- cơ chế giám sát độc lập và cơ hội

cho việt nam trong quá trình tái cấu trúc hệ thống ngân hàng thương mại” (in English: Inflation

targeting policy - independent monitoring mechanisms and opportunities for Vietnam in the restructuring

process of the commercial bank system), Journal of Integration and Development 13 (23), 11/2013, UEF, Vietnam

Nguyễn Phúc Cảnh, Nguyễn Quốc Anh, Nguyễn Hồng Quân (2013), “Đặc điểm ngân hàng tác

động đến sự truyền dẫn của chính sách tiền tệ qua kênh tín dụng ngân hàng tại Việt Nam” (In English:

Bank characteristics affecting the transmission of monetary policy through bank credit channel in Vietnam), Journal of Economic Development 276, 10/2013, p.75 – 91, UEH, Vietnam

Seminars

Võ Xuân Vinh, Nguyễn Phúc Cảnh (2014), “Monetary policy transmission in Vietnam: evidence from a VAR approach”, the 27th Australasian Finance and Banking conference, 16 – 18 December 2014, UNSW Business School, Sydney, Australia

Trầm Thị Xuân Hương, Võ Xuân Vinh, Nguyễn Phúc Cảnh (2014), “Effect of monetary policy

to trade balance on open developing country: a case of Vietnam”, ICFE 2014 - The International

Conference on Finance and Economics Ton Duc Thang University, Ho Chi Minh City, Vietnam, June 2nd

- 4th, 2014

Nguyễn Phúc Cảnh (2014), “Bank risk pre and post global financial crisis in Vietnam: a survey”, ICFE 2014 - The International Conference on Finance and Economics Ton Duc Thang University, Ho Chi Minh City, Vietnam, June 2nd - 4th, 2014

Trầm Thị Xuân Hương, Võ Xuân Vinh, Nguyễn Phúc Cảnh (2014), “Hiệu quả công cụ lãi suất trong điều hành chính sách tiền tệ Việt Nam” (in English: Effective tools in managing interest rate

monetary policy Vietnam), Workshop Summary some theoretical issues - over 30 years of practical innovation, Economic University of Ho Chi Minh City, 01/21/2014

Trầm Thị Xuân Hương, Nguyễn Phúc Cảnh (2013), “Truyền dẫn của Chính sách tiền tệ qua kênh lãi suất ngân hàng thương mại ở Việt Nam” (in english: The transmission of monetary policy

through interest rate commercial banks in Vietnam), Risk Analysis Workshop in interest rates of commercial banks operating in HCM City and precautions, Bank University, Vietnam

Research projects

Nguyễn Phúc Cảnh, Võ Xuân Vinh (2015), “Vai trò của tỷ giá hối đoái trong điều hành chính sách tiền tệ tại Việt Nam” (in English: the role of exchange rate in Vietnamese monetary policy

conducting), University of Economics Ho Chi Minh City, CS-2015-44

Võ Xuân Vinh, Nguyễn Phúc Cảnh (2014), University research projects “Monetary policy and bank credit risk in Vietnam pre and post global financial crisis”, University of Economics Ho Chi Minh

City, Vietnam (member)

Nguyễn Phúc Cảnh, Nguyễn Quốc Anh, Nguyễn Hồng Quân (2013), University research project:

“Đặc điểm ngân hàng tác động đến sự truyền dẫn của chính sách tiền tệ qua kênh tín dụng ngân hàng tại Việt Nam” (in English: Bank characteristics affect to monetary policy transmission through

credit channel in Vietnam), University of Economics Ho Chi Minh City

Abstract

This study tries to investigate the existing of interest rate channel, exchange rate channel, asset price channel, and bank lending channel in Vietnam which are seen as the main channels in monetary policy transmission In addition, this study tries to investigate the determinants of bank lending channel and the effects of the 2008 global financial crisis on bank lending channel in Vietnam This study has found the evidence of cost channel in Vietnam that reflects the ineffective of monetary policy in controlling inflation thus it is a big challenge for Vietnamese policy makers in conducting monetary policy But, this study did not find statistical evidences of exchange rate channel and asset price channel which may be suggest that they are weak or do not exist in Vietnam This study found the evidences of bank lending channel in Vietnam, it was also affected by the commercial bank characteristics such as bank capital, bank size This study also found that the 2008 global financial crisis had significant effects on bank lending channels which

is stronger in crisis

First of all, this study has contribution to the empirical literature about the existence of cost channel in

a small open economy Secondly, this study contributes empirical evidences of bank lending channel, the determinants and the effects of the crisis on bank lending channel in an emerging market Thirdly, this study has major contributions to Vietnamese policy makers in conducting monetary policy and stabilizing the banking system and financial markets, especially in the case of facing further external shocks in the future such as the global crisis With the academic contributions, this study defined that economists should test all transmission channels in one model for better controlling the interactions between channels and better measuring the effectiveness of each channel With the empirical results, this study has significant practical implications for Vietnamese policy makers in developing debt and equity markets, controlling the risky activities of banking systems and applying unconventional monetary policies such as inflation targeting

CHAPTER 1 INTRODUCTION 1.1 The overview of Vietnamese economy and monetary policy

The Vietnamese economy has gone through high growth periods from 1994 especially in period of 2000 to

2007 In which, it has had two slow periods due to the 1997 Asian economic crisis and the 2008 global financial crisis

1.1.2 The State Bank of Vietnam

The operations of SBV were more apparent in the 2007 – 2012 period when the Vietnamese economy fell into crisis In 2010, the Vietnamese parliament approved the 2010 state bank act with changes in comparison

to the 2003 version, in which the most important change was the SBV’s function of monetary policy conducting in article 2

1.1.3 The Vietnamese monetary policy

SBV had expanded the monetary policy in the 2000 – 2007 period to cope with the 1997 Asian crisis and

to stimulate economic growth, then they expanded and tightened monetary policy on numerous occasions

in the 2008 – 2012 period

1.1.4 The Vietnamese monetary policy and macroeconomics factors

1.1.4.1 Market interest rates

Market deposit rates and lending rates had changed in the same patterns with VNIBOR, they were stable at

a low level in the 2000 – 2007 period, but they fluctuated with the changes in monetary policy by increasing

in 2008, decreasing in 2009, increasing in 2010, 2011, and dropping in 2012

1.1.4.6 Summary

Vietnamese economy grew rapidly in the 2000 – 2007 periods The rapid economic growth was seemly contributed from expansionary monetary policy, bank credit operations with low inflation and low interest rates, and other elements Monetary policy was expanded with low policy rates, high money supply growth

in the 2000 – 2007 period, but it reversed and change many times in the 2008 – 2012 period

1.2 Research objectives and questions

Firstly, this study attempts to test the existence of interest rate channel, exchange rate channel, and asset

price channel in Vietnam, these results are significant considerations for Vietnamese policy makers in

conducting the monetary policy Furthermore, this study attempts to investigate the existence of bank

lending channels and then analyze the determinants of bank lending channel including the effects of the

2008 global financial crisis In order to achieve these research objectives, this study goes to answer these questions

1 Which do channels of interest rate channel, exchange rate channel and asset price channel exist in Vietnam?

2 Does bank lending channel exist in Vietnam? And do bank size, bank capital, bank liquidity, bank risk, and the 2008 global financial crisis effect on bank lending channels in Vietnam?

1.3 The scope of this study

This study is going to examine the monetary policy transmission and bank lending channel in Vietnam in period from 2003 to 2012

1.4 Research methodologies and data

1.4.1 Methodologies

In the first main body, this study is going to use the VAR models to investigate the existence of interest rate

channel, exchange rate channel, and asset price channel in Vietnam through a monthly time series from

2003 to 2012 one by one Then this study is going to use the SVAR model as the main model to check the

test the evidences of above channels In the second main body, this study uses the system GMM model to

investigate bank lending channel in Vietnam, in which this study also measures the impacts of bank characteristics and the 2008 global financial crisis on bank lending channel by yearly panel data in 2003 –

2012 period

1.4.2 Research data

This study will use two kinds of data: Vietnamese macroeconomic data and microeconomic data from commercial banks in the 2003-2012 period

1.5 Some key concepts

Monetary policy, Central bank, Monetary policy targets, Monetary policy tools, Monetary policy transmission, Bank lending channel

1.6 The structure of study

Chapter 5: Conclusions and policy implications

CHAPTER 2 THEORETIAL FRAMEWORK AND LITERATURE REVIEW 2.1 Monetary policy

2.1.1 Introduction

Monetary policy is expressed in many aspects, it has seen as actions that are undertaken by central bank to alter money supply or policy rates to aim at inflation stability, economic growth, fully employment, and exchange rate stability (Araújo, 2015, Drakos and Kouretas, 2015, Sánchez, 2012)

2.1.2 Central bank

Central bank is monopolized for printing and issuing money, it is also the government bank, the bank of commercial banks, the lender of last resort, the manager of payment system, the agency for monetary policy

implementation, and the supervisor of the banking system (Blinder et al., 2008, Friedman, 1999)

2.1.3 Monetary policy targets

Central bank conducts monetary policy to aim at economic stability, optimal unemployment, financial system stabilizing, but price stability is always the most important target (Cecchetti and Krause, 2002, Geraats, 2002, Issing, 2004, Spyromitros and Tuysuz, 2012, Van der Cruijsen and Demertzis, 2007, Jean

Louis and Balli, 2013)

2.1.4 Monetary policy tools

Central bank uses different policy rates to conduct monetary policy such as rediscount rate, and interbank offer rate Central bank also buys or sells short-term securities on the open market to directly impact on money supply and money demand thereby it has an effect on market interest rates and other economic elements (Thành and Hằng, 2008) And they use mandatory reserve requirements to impact on money supply since reserve requirements have a direct influence on the monetary creating multiplier that is created

by banking system

2.1.5 The ineffectiveness of monetary policy

Expansionary monetary policy sometimes can’t stimulate economic growth due to the liquidity trap (Dieppe

and McAdam, 2006) Deflation is also another problem in monetary policy conducting

2.1.6 Monetary policy and fiscal policy

The interactions between monetary policy and fiscal policy affect the effectiveness of overall macroeconomic policies in many countries (Buti et al., 2001a, Buti et al., 2001b, Melitz, 2000, Leith et al.,

2015)

2.1.7 Unconventional monetary policies

2.1.7.1 Quantitative easing program

Quantitative easing program (QE) is an unconventional monetary policy to cope with the deflation and near nil interest rate situation by the central banks in Japan, U.K., and U.S The real effects of QE remain controversial, yet it helped curb and prevent the crisis and promote economic growth in Japan (Girardin and Moussa, 2011), but it couldn’t do the same in the case of the U.K (Lyonnet and Werner, 2012)

2.1.7.2 Inflation targeting policy

Inflation targeting policy originated in New Zealand in 1989, then many countries have applied this policy, such as Chile, Canada, Israel, England, Sweden, Finland, Australia and Spain (Svensson, 2000) In inflation targeting, central banks set an inflation target for monetary policy, and then will do anything to achieve this target

Central banks conduct monetary policy to aim at price stability, economic growth, full employment, and financial system stability However, central banks can’t achieve all targets once, there are some tradeoffs between targets such as inflation and unemployment Central banks conduct monetary policy through policy rates, open market operations, and reserve requirements to impact on aggregate demand and aggregate supply through intermediate variables such as market interest rates, exchange rates, asset prices, and expectations Monetary policy may not take effect in the case of deflation, liquidity trap, or near nil interest

rates

2.2 Monetary policy transmission

2.2.1 Conceptual framework

Monetary policy transmission is the process that transmits the changes in policy rates or money supply to

a series of other changes in economic variables such as market interest rates, asset prices, exchange rates, cash flow, bank credit supply, private spending and consumption, etc and ultimately aims at price, output and unemployment (Mankiw and Taylor, 2011) The changes in money supply or policy rates of central bank have an effect on other economic variables which are studied in the IS – LM model that is seen as the basis of monetary policy transmission with forms many transmission channels

2.2.2 Monetary policy transmission channels

2.2.2.1 Interest rate channel

Central bank may change money supply and/or policy rates to alter real interest rates, investment, aggregate demand, and output The interest rate channel is confirmed by many studies as the main transmission channel of monetary policy in many countries and areas (Friedman, 1956, Hannan and Liang, 1993, Taylor,

1995, Cecchetti, 1995)

2.2.2.2 Exchange rate channel

Besides IRC, ERC is also an important channel of monetary policy transmission (Golinelli and Rovelli,

2005, Demir, 2014), which transmits monetary policy through exchange rate to trade and investment activities, and other international shocks, thus ERC will be almost ineffective in a closed economy Empirical studies confirm that ERC is an important transmission channel besides IRC in many countries However there are some cases such as Eritrea, Mengesha & Holmes (2013) didn’t find evidence of ERC, but they found the existence of ERC in the illegal foreign exchange market

2.2.2.3 Asset price channel

APC has two related mechanisms: Tobin's q theory and wealth effect, both mechanisms are related to the relationship between the asset price with investment and consumption APC exists in most developed countries, yet it just exists in a few developing countries due to the lack of debt and equity security markets (Mishra and Montiel, 2012)

2.2.2.4 Credit channel

Credit channel includes bank lending channels (BLC), balance sheet channels (BSC), cash flow channels (CFC), unexpected price level channels (UPLC), and household effects liquidity (HLE) These sub-channels are quite diversifiable from IRC, ERC, and APC because they mainly focus on the impact of monetary policy on commercial bank credit and balance sheets of enterprises and households (Bernanke and Gertler, 1995, Ramey, 1993, Iacoviello and Minetti, 2008, Kashyap and Stein, 1995, Ciccarelli et al., 2014) Most studies about the credit channel have focused on large countries with comprehensive national data such as the U.S and European countries; they mainly focus on two main channels: the balance sheet channel and the bank lending channel Credit channel is found in U.S (Bernanke and Blinder, 1992, Kashyap and Stein, 2000, Kishan and Opiela, 2000, Liu and Minford, 2014, Orlowski, 2015), in European (Altunbas et al., 2002, Mojon et al., 2002, Chrystal and Mizen, 2002, Altunbas et al., 2009), and many countries

2.2.2.5 Expectation channel

Expectation channel is hard to work separately because it helps exaggerate the effects of other channels Mukherjee and Bhattacharya (2011) and Dabla-Norris and Floerkemeier (2006) also mentioned about expectation as a channel of monetary policy transmission

2.2.3 The lag and effectiveness of monetary policy transmission

2.2.3.1 The transmission lag of monetary policy

Price usually reacts slowly to monetary policy and it lags for about a year (Christiano et al., 1999, Mojon,

2001, Goodhart and Hofmann, 2001, Sander and Kleimeier, 2002, Hülsewig et al., 2009)

2.2.3.2 The effectiveness of monetary policy transmission

Monetary policy is not transmitted fully in the long term and in almost all countries due to transmission barriers (de Bondt, 2002)

2.3 Bank lending channel

2.3.1 Introduction

As one of the main transmission channels in the credit channel, bank lending channel supplements IRC to strengthen the impact of monetary policy on economic variables through bank credit supply

2.3.2 Transmission mechanism

When central bank tightens monetary policy, funds of commercial banks are decreased, if they are difficulty

in issuing debt and equity instruments to offset the decrease in funds, they have to cut their credit supply and vice versa (Bernanke and Blinder, 1988)

2.3.3 Existing conditions

BLC will exist with some certain conditions in the economy, commercial banks and customer

characteristics: enterprises depend on funds from commercial banks (Bernanke and Blinder, 1988),

commercial banks can’t replace entire funds from deposits (Bernanke and Blinder, 1988), central bank can

impact on credit supply of commercial banks (Kashyap and Stein, 1995)

2.3.4 Empirical evidences

The first study mentioned BLC as a channel of monetary policy transmission was Bernanke (1986) and then other studies such as Bernanke et al (1991), Bernanke and Blinder (1992), Kashyap et al (1993), and many studies have done with more details BLC is found in Japan (Asako et al., 1989, Hoshi and Kashyap,

1990, Hayashi and Inoue, 1991, Ogawa and Suzuki, 1998), in South Korea (Ferri and Kang, 1999, Kim, 1999), in Germany (Barran et al., 1996, De Bondt, 2004, Ehrmann, 2004, Ehrmann and Worms, 2004, Holtemöller, 2003, Hulsewig et al., 2001, Kakes and Sturm, 2002, Von Kalckreuth, 2001, Worms, 2001),

in European (Altunbas et al., 2002, Altunbas et al., 2009, Altunbas et al., 2010, Altunbas et al., 2012, Sander and Kleimeier, 2004, Angeloni and Ehrmann, 2003, Bredin et al., 2001, Burgstaller, 2003, de Bondt, 2002,

De Bondt, 2004, Petturson, 2001, Kleimeier and Sander, 2000, Sander and Kleimeier, 2002, Toolsema et al., 2001, Cantero-Saiz et al., 2014, Leroy, 2014, Apergis and Christou, 2015), and in many other countries such as Indonesia, Canada, Thailand and in South Asia areas (Perera et al., 2014)

2.3.5 Determinants of bank lending channel

2.3.5.1 Macroeconomic conditions

BLC is different between countries because of differences in macroeconomic conditions, it will be stronger

in small economy with low-developed financial markets, but it is affected by locality characteristics BLC may be affected by the economic openness, crisis, economic structure, and also by level of public debt Especially, BLC will be stronger if central bank is more independence

2.3.5.2 The development of financial markets

BLC is weaker if financial markets are more development, it is also affected by financial market structure,

by financial transaction cost, and by innovations in financial markets

2.3.5.3 Regulations in banking sector

BLC is affected by the capital management and monitoring mechanisms of central bank, especially regulations on interest rate and the transparency of macroeconomic policies

2.3.5.4 The competition in banking sector

BLC will be weaker if the banking sector is less competitive

2.3.5.5 Microeconomic determinants

The size of commercial bank BLC is stronger in small commercial banks, in which small commercial

banks react to monetary policy shocks through credit supply, meanwhile large commercial banks react through interest rate

The capital of commercial bank Commercial banks with capital barriers react stronger to contractionary

monetary policy, meanwhile they react weaker to expansionary monetary policy

The liquidity of commercial bank BLC is stronger at commercial banks with low liquidity, in which BLC

is weaker if the asset of commercial banks has better quality, and loan securitized activities may make BLC weaker, but loan securitized activities sometimes may make BLC stronger

The risk of commercial bank Commercial banks always consider risk factor before responding to

monetary policy shocks thus BLC is affected by the risk of commercial banks

The customer characteristics of commercial bank Commercial banks with different customer segments

will react differently to monetary policy, in which BLC is stronger if customers of commercial bank are

small and medium enterprises, and if customers of commercial bank have more financial barriers, or the industry of customers is more competitive BLC is also affected by the behavior of enterprise managers, and it is weaker if commercial banks have longer relationship with their customers

The ownership of commercial bank BLC is stronger at private commercial banks

2.4 Studies of monetary policy transmission and bank lending channel in developing countries

Firstly, the proxy of monetary policy in developing countries Beside the money supply the policy rate

especially short-term policy rates have been become the main proxy for monetary policy at developing countries as in developed countries

Secondly, the channels of monetary policy transmission The monetary policy transmission in developing

countries such as Vietnam is difference country by country, but we are also noted by the evidences of many empirical studies that the interest rate channel and the credit channel seemly are the main channels in developing countries, meanwhile the exchange rate channel and the asset price channel may be weak due

to the characteristics of each country In addition, the almost studies did not search or find the evidence of expectation channel in developing countries due to the lack of data

Thirdly, the bank lending channel Bank lending channel may or may not exist that depend on the economic

conditions at each countries and it is strongly affected by the bank characteristics

2.5 Studies of monetary policy transmission and bank lending channel in Vietnam

Using information from journals, electronic libraries, and doctoral thesis to search for studies of BLC in Vietnams monetary policy transmission, I haven’t found any specific detailed study outside of Lân (2012), but the study of Lân (2012) focused on the transmission channel and the role of the transmission channel

as well as the intensity of the BLC, he didn’t go into the details of characteristics and responses of commercial banks in the BLC A number of other studies relate to the relationship between the monetary policy and commercial banks but they are not completely done and they are just the work of a master thesis that has not been published, while they just take a short view on the monetary policy and commercial bank operations and risk

2.6 Summary and research motivations

Studies of monetary policy have been done from the 1990s and thrived in the period after 2000 in Vietnam However, most of the studies have not applied the quantitative method due to the weakness of data statistics, recent studies have used certain models but they were not abundant and they mainly focused on monetary policy during and after the 2008 global financial crisis There is almost no deep and careful study about BLC in Vietnam, but related studies suggested evidence of the existing conditions for it Besides that, most studies do not have appropriate data with enough length of time and variables thus we need a research with appropriate models and comprehensive data for Vietnam There is clearly a research gap in monetary policy transmission and monetary policy transmission via BLC in Vietnam

CHAPTER 3

METHODOLOGY 3.1 Monetary policy transmission testing models

3.1.1 The relationships between monetary policy, output and inflation

Monetary economists always try to explain the relationship between monetary policy, interest rate, aggregate demand, output, and prices Correlation between inflation and the growth rate of money supply

is almost 1, varying from 0.92 to 0.96, and it is dependent on the definition of money supply This is consistent with many previous studies such as Lucas (1980), Rolnick and Weber (1994) Thus when we understand the relationships between them in both long-term and short-term, we can explain the transmission of monetary policy in reality

3.1.2 Estimating effects of monetary policy

Tools have been employed to estimate the impact of monetary policy evolved overtime because of series econometrics development and changes in specific questions by theory Tobin (1970) was the first economist who formally modeled the idea that the positive correlation between money and output could reflect the opposite view: the output might be caused by money One of the first time-series econometric studies tries to estimate effects of monetary policy is Friedman and Meiselman (1963) They try to test the role of monetary policy in determining nominal income through equation:

3.1.3 Database in study of monetary policy transmission

In studies of monetary policy transmission, data included macroeconomic elements such as policy rates, money supply, reserve requirement, GDP, unemployment, industrial production, exchange rate, and microeconomic elements that relate to specific transmission channels

3.1.4 Proxy variables for monetary policy

3.1.4.1 Policy rates

According to the traditional economic theory, central banks change money supply to influence interest rates rather than other economic variables Nowadays, central bank mainly changes directly to policy rates to conduct monetary policy thus policy rates are often used as a good proxy for monetary policy

3.1.4.2 Money supply

Besides policy rates, money supply is one of the most important proxies of monetary policy It is also the intermediate target that central bank aims in monetary policy conducting

3.1.5 Variables of commercial bank characteristics in bank lending channel

Economists agree that commercial bank characteristics have impacted on monetary policy transmission via BLC and they use three variables: scale, capital, and liquidity of banks (Kashyap and Stein, 2000) In which,

Bank scale is logarithm of total asset, Bank liquidity is ratio of liquidity assets to total assets, in which total

liquidity assets include total cash, deposits at central bank and other banks, investment securities, and short

– term securities), Bank capital is ratio of bank capital to total assets

3.2 Economic models for monetary policy transmission testing

3.2.1 VAR and related models

3.2.1.1 VAR model

VAR was introduced by Sims (1972) and Sims (1980), it can be used by macro economists to quantify responses of macro variables that do not require strong conditions to determine shocks Then VAR gradually becomes one of the most popular models used for time-series data over time

3.2.1.2 SVAR model

Besides VAR, structural VAR model (SVAR) is also popularly used in the research of monetary policy

transmission in general and in particular with BLC SVAR is widely used because SVAR helps clarify the

structural shocks and unstructured shocks which standard VAR models can’t clarify, meanwhile SVAR also provides two tools to analyze monetary policy transmission: impulse response function and variance decomposition

3.2.2 Cointegration models

3.2.2.1 ECM

ECM is a dynamic system with characteristics that the deviation of current state from its long-run relationship will be fed into its short-run dynamics ECM is a category of multiple time series models that directly estimates the speed at which a dependent variable returns to long-term equilibrium after a change

in an independent variable (Engle and Granger, 1987)

3.2.3 DSGE model

Many researchers study monetary policy transmission using VAR, but Dynamic stochastic general equilibrium modeling (DSGE) is also used in the case we have all the utility functions of economic agents such as households, firms, government, central bank (George et al., 2008, Cogley and Sargent, 2005)

3.2.4 GMM model for panel data

GMM is often proposed to study monetary policy transmission through BLC in general and monetary policy transmission through BLC in the case of caring effects of bank characteristics on BLC GMM helps to solve endogeneity and other problems in panel data (Arellano and Bond, 1991) In the GMM, widely alternatives

in within estimation are methods such as Arellano-Bond differences in Arellano & Bond (1991) and

Blundell-Bond system GMM (Blundell and Bond, 1998) GMM methods are considered superior to alternatives in handling endogeneity, heteroskedasticity, serial correction and identification (Hall, 2003)

3.3 Research methodologies for this study

3.3.1 Research procedures and testing hypothesizes

This study goes into investigating the interest rate channel, asset price channel, exchange rate channel, and bank lending channel in Vietnam by using three main models: VAR, SVAR, and GMM in 4 steps as following:

Step 1 and 2 In order to answer the study’s question 1, this study uses the results from literature review in

chapter 2 to clarify the following testing hypothesizes: Hypothesis 1: the interest rate channel exists in Vietnam, Hypothesis 2: the exchange rate channel may or may not exist in Vietnam, Hypothesis 3: the asset

price channel may or may not exist in Vietnam In order to test these hypothesizes, this study builds VAR and SVAR to test three main monetary policy transmission channels in Vietnam including the interest rate channel, exchange rate channel, and asset price channel

Step 3 and 4 This study goes to measure the existence and the impact of commercial bank characteristics

on bank lending channels by using the GMM model with the following hypothesizes: Hypothesis 4: the bank lending channel is existed in Vietnam, Hypothesis 5: the bank lending channel is affected by bank size, bank capital, bank liquidity and bank risk, Hypothesis 6: the BLC is affected by the 2008 global

financial crisis In order to test these hypothesizes, this study recruits the GMM model which has been used

in many previous studies and is considered as an appropriate model for the bank lending channel with micro data from commercial banks

3.3.2 Vietnam monetary policy transmission testing models

in which: Y t is endogenous vector of domestic variables, X t is exogenous variables, 𝜑, 𝜃 are coefficient

vector, ɛ: residual vector Exogenous variables include world commodity index (Compi world), U.S policy

rate (i us ), and U.S output (y us)

X t = [Compi world i us y us ] (3.19) Meanwhile, the endogenous vector expresses Vietnam economic factors which include Vietnam industrial

production (IPVN) which presents for Vietnamese output, Vietnam price index (Prices), and Vietnam monetary policy rate (i)

Y t = [IPVN Prices i] (3.20)

In order to measure monetary policy transmission through the interest rate channel, exchange rate channel, and asset price channel, this study also incorporates endogenous variables which represent each specific channel including market interest rates, nominal effective exchange rate of USD/VND, and VNindex

3.3.2.2 SVAR model

This study uses the SVAR model from study of Neri and d'Italia (2004) then adjust to the form as

Table 3.2 SVAR restriction matrix

Source: author’s building

In which: cp (world commodity price index), y (Vietnam industrial production), r (Vietnam policy rate), ms

(Vietnam money supply), md (Vietnam money demand), exc (Vietnam nominal exchange rate), le (Vietnam lending rate), vni (Vietnam stock index), and p (Vietnam consumer price index) Structural shocks include:

u cp , u y, u r , u m , u exc , u lr , u vni , and u p are world price shock, domestic output shock, monetary policy shock,

money demand shock, international shock (exchange rate shock), lending interest rate shock, asset price shock, and price shock respectively

3.3.3 Bank lending channel testing model

The model is used by Altunbas et al (2010) has form:

Source: Altunbas et al (2010)

In which, Loan is outstanding loans of commercial banks, GDP is output, i is policy rate, EDF is expected default frequency, SIZE is bank size, LIQ is bank liquidity, CAP is bank capital, LLP is bank loan loss

provision The model equation has form:

Δln(loan) i,t = αln(loan) i,t-1 + σ 2 ln(GDP) t-1 + ϕ 1 Δi t + ϕ 2 Δi t-1 + φ 1 Δi t *SIZE i,t-1 + τ 1 Δi t *LIQ i,t-1 + Ω 1 Δi t *LLP

i,t-1 + ¥ 1 SIZE i,t-1 + ψ 1 Δi t *CAP i,t-1 + ω 1 LIQ i,t-1 + λ 1 CAP i,t-1 + µ 1 LLP i,t-1 + ɛ i,t (3.34)Variables in this model are the same as Altunbas et al (2010), loan growth is affected by monetary policy,

in particular through interest rate tool

3.3.4 Research data

Firstly, the monthly data from 2003 to 2012 which are used in VAR and SVAR models including world

commodity index (Compi world ), US policy rate (i us ), and U.S output (y us ), Vietnam output (IPVN), Vietnam price index (Prices), and Vietnam monetary policy rate (i), market interest rate (LER), the nominal exchange rate of USD/VND (NEER), and VNindex (VNI) are compiled primarily from the International Monetary

Fund (IMF), General statistics office of Vietnam, and State bank of Vietnam We also collect the SBV’s

rediscount rate (RDR), SBV’s refinance rate (RFR), and money supply (M2) in place of VNIBOR for

Vietnams monetary policy rate in order to test the consistence of VAR and SVAR models Meanwhile, the annual data which uses the GMM model are collected from financial reports of commercial banks in the