Monetary policy transmission in Nigeria: Does the credit channel work?

The debate on the effective of the credit channel of monetary policy transmission has been a burning issue on monetary policy discourse for a while. Romer and Romer (1989), Ramsey (1993), Oliner and Rudebusch (1995), and Morris and Sellon (1995) raised some doubts about the existence and effectiveness of the credit channel. Alternatively, several other studies have found support for the credit/bank lending channel (see for instance, Bernanke and Blinder (1988), Bernanke and Blinder (1992), Gertler and Gilchrist (1994), Bernanke and Gertler (1995), Peek and Rosengren (1995), Kashyap, Stein and Wilcox (1993), Kashyap and Stein (1995, 2000), and Suzuki (2004). Therefore, the validity of bank lending/credit channels remains largely inconclusive and an empirical issue. Although the transmission mechanism of monetary policy in Nigeria has been examined in numerous studies, there is no consensus on the most effective channel; and there is scant evidence of the role of credit channel in the transmission of monetary policy. In this paper, we examine the validity and efficacy of the credit channel in the monetary policy transmission in Nigeria, using a vector autoregressive model to analyse monthly data spanning ten years (2008-2018). The empirical analysis relies on Uslu (2016) modified slightly to substitute Bank total asset and Bank deposits to represent the asset side and liability side of the bank's balance sheet, respectively. Purchasing Managers Index (PMI), consumer price index (CPI) and the real effective exchange rate (REER) are used as proxy for development in macroeconomic activity; while all share index (ASI) and market capitalization (MK) denote substitutable assets in the balance sheet of the banks. All series except the money market rates were transformed into natural logarithms. In addition, nominal series were transformed to real variables by normalization using the consumer price index. We find that a positive shock to monetary policy rate has no effect on bank lending to private sector. This could be due to a few factors. Primarily, the Nigerian financial industry is plagued by a low ratio of lending to private sector. Nigerian banks show a preference for government bonds and other securities, which stifles lending to the presumably risky private sector. It is also possible that monetary policy rates are already so high, driven by Nigeria's growing debt needs and exchange rate crises; that the lending to private sector has declined to such a level that it no longer responds to positive credit shocks.