Abstract
       ​Full research (Hebrew)


  • The research examines
    the effect of monetary policy on firms’ supply of credit through the firms’ balance
    sheet channel, and finds evidence of a Bank of Israel impact via this
    transmission channel
    .
  • Based on the research’s findings, the sharp
    interest rate reduction in Israel in 2008–09, by nearly four percentage points,
    led to a marked increase in total credit to firms that were facing financial constraints
    or distress during that period.
  • According to the research, the effect of the
    interest rate reduction on the supply of credit derives from its contribution
    to increasing the firms’ market value, which acts to ease terms of credit for
    them. The research finds that an interest rate reduction of 25 basis points
    leads to an average increase of 1.25 percent in the firms’ market value, and
    for financially constrained firms, to an increase of about 0.6–1.2 percentage
    points in total credit.

 

Research
conducted by Gilad Cohen Kovacs from the Bank of Israel Research Department
examined the effect of monetary policy on firms’ credit supply via the firms’
balance sheet channel.

 

The
firms’ balance sheet channel is one of the mechanisms through which monetary
policy impacts on firms’ supply of credit, and through that on economic
activity. According to this approach, an interest rate reduction acts to
increase the firms’ market value, and therefore to reduce the risk for banks
and other financial institutions in providing credit to those firms, and thus to
expand the supply of credit to those companies.

 

The
research sought to answer the questions of whether the Bank of Israel has an
impact via this mechanism, and the magnitude of such an impact. The research
utilizes a new methodology for identifying the effect of the firms’ balance
sheet channel and uses a sample of approximately 200 public companies traded on
the Tel Aviv Stock Exchange in 2007–10.

 

The
research finds that a 25 basis-point reduction leads to an average increase of
1.25 percent in the market value of the firms in the sample. In addition, the
research finds differences in the market value response of firms to an interest
rate reduction deriving from, among other things, differences in their
financial structure (Figures 1 and 2).

 

According
to the research’s findings, the increase in market value deriving from a 25
basis-point reduction leads to an average increase of 0.6–1.2 percentage points
in the quantity of credit for firms facing financial constraints or distress,
with the main impact being on long term credit.

 

Overall
the findings support the existence of a balance sheet channel in Israel, and
based on them it may be assessed that the sharp interest rate reduction in Israel
in 2008–09, of approximately 4 percentage points, led to a marked increase in
total credit to financially constrained firms.

 

 

Figure 1

The
effect of interest rate surprises on market value

 

New Research: The effect of monetary policy on the supply of credit: a new approach to identifying the firms' balance sheet channel

 

 

 

Note: The figure depicts the distribution of
the interest rate’s effect on the market value of the firms in the sample. The
magnitude of the average response of the market value to an interest rate
surprise is -0.05 and the economic significance is that an interest rate
reduction of 1 percentage point causes an average increase of 5 percent in the weighted
market value of the firms in the sample.

 

 

Figure 2

The
estimated effect of changes in the interest rate on market value during the
sample period

New Research: The effect of monetary policy on the supply of credit: a new approach to identifying the firms' balance sheet channel

 

 
 

 

 

 

Note: The figure depicts the effect of changes
in the interest rate during the sample period on the market value of the
company with the external sensitivity to changes in the interest rate (that is,
the company whose strength of response of market value to an interest rate
surprise is at the median of the distribution in Figure 1). The figure
indicates that the sharp interest rate reduction that occurred at the end of
2008 led to a marked increase in the market value of most firms in the sample.