Federal Funds Rate Spillover Effect On Emerging Market Banking Liquidity And Capital – Evidence From Indonesia

Wahyu Fahrul Ridho

doi:10.24176/bmaj.v6i2.10162

Federal Funds Rate Spillover Effect On Emerging Market Banking Liquidity And Capital – Evidence From Indonesia

Wahyu Fahrul Ridho

Abstract

This paper examines the spillover effect of the fed fund rate (FFR) on emerging banking liquidity and capital in emerging markets, especially in Indonesia, using the Structural Equation Model (SEM). Data were collected from the Indonesia Central Bank and Financial Services Authority. Our model reveals a significant indirect negative relationship between FFR, banking liquidity, and capital. This relationship was examined both directly and indirectly using the model. While the FFR influence was robust, the impact on liquidity and capital was translated through the local bank rates. It is found that rising interest rates would still result in tighter liquidity to some extent. FFR also impacts capital decisions because the rising interest rate might incentivize managers to borrow from a lower market environment. Thus, observing the indirect relationship, the impact of the FFR depends on the local central bank monetary policy transmission to mitigate the spillover effect resulting from developed economy monetary policy.

Keywords

Fed Fund Rate, Spillover Effect, Emerging Market, Banking Liquidity

Full Text:

PDF

References

Abbas, F., Iqbal, S., & Aziz, B. (2020). The role of bank liquidity and bank risk in determining bank capital: Empirical analysis of Asian banking industry. Review of Pacific Basin Financial Markets and Policies, 23(03), 2050020.

Ahmad, R., Ariff, M., & Skully, M. J. (2008). The determinants of bank capital ratios in a developing economy. Asia-Pacific Financial Markets, 15(3), 255–272.

Aiyar, S. S. (2011). How did the crisis in international funding markets affect bank lending? Balance sheet evidence from the United Kingdom. Balance Sheet Evidence from the United Kingdom (April 18, 2011). Bank of England Working Paper, 424.

Al-Harbi, A. (2017). Determinants of banks liquidity: Evidence from OIC countries. Journal of Economic and Administrative Sciences.

Andrian, T., & Lestari, T. P. (2013). Analisis Dampak Target the Fed Rate Terhadap Kebijakan Moneter Bank Indonesia (Periode 2005: 07-2013: 12). Jurnal Dinamika Ekonomi & Bisnis, 10(2).

Beirne, J., Caporale, G. M., Schulze-Ghattas, M., & Spagnolo, N. (2013). Volatility spillovers and contagion from mature to emerging stock markets. Review of International Economics, 21(5), 1060–1075.

Belke, A., Orth, W., & Setzer, R. (2010). Liquidity and the dynamic pattern of asset price adjustment: A global view. Journal of Banking & Finance, 34(8), 1933–1945.

Benchimol, J., Kazinnik, S., & Saadon, Y. (2021). Federal reserve communication and the COVID-19 pandemic. Covid Economics, 79, 218–256.

Bentler, P. M., & Huang, W. (2014). On components, latent variables, PLS and simple methods: Reactions to Rigdon’s rethinking of PLS. Long Range Planning, 47(3), 138–145.

Bisbe, J., & Malagueño, R. (2015). How control systems influence product innovation processes: Examining the role of entrepreneurial orientation. Accounting and Business Research, 45(3), 356–386.

Brownlees, C. T., & Engle, R. F. (2011). Volatility, Correlation and Tails for Systemic Risk Measurement. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1611229

Brusa, F., Savor, P., & Wilson, M. (2020). One central bank to rule them all. Review of Finance, 24(2), 263–304.

Bundesbank, D. (2018). The importance of bank profitability and bank capital for monetary policy. Monthly Report, 70(1), 27–52.

Cetorelli, N., & Goldberg, L. S. (2012). Liquidity management of US global banks: Internal capital markets in the great recession. Journal of International Economics, 88(2), 299–311.

Chang, C.-P., & Lin, J.-H. (2006). Bank as a liquidity provider and interest rate discovery: An option-based optimization. Expert Systems with Applications, 31(2), 360–369.

Chen, M. J., Griffoli, M. T. M., & Sahay, M. R. (2014). Spillovers from United States monetary policy on emerging markets: Different this time? International Monetary Fund.

Cornett, M. M., McNutt, J. J., Strahan, P. E., & Tehranian, H. (2011). Liquidity risk management and credit supply in the financial crisis. Journal of Financial Economics, 101(2), 297–312.

Covitz, D., Liang, N., Suarez, G., He, Z., Nini, G., Lupoff, P., & Stein, J. (2009). The Evolution of a Financial Crisis: Panic in the Asset-Backed Commercial Paper Market.” Federal Reserve Bank of. Bank Runs, Deposit Insurance, and Liquidity.” Journal of Political Economy.

Dahlhaus, T., & Vasishtha, G. (2020). Monetary policy news in the US: Effects on emerging market capital flows. Journal of International Money and Finance, 109, 102251.

Daniel, W. (2021). Ketua OJK Ungkap Kondisi Sektor Keuangan Terkini Saat Pandemi. CNBC Indonesia. https://www.cnbcindonesia.com/market/20210808155048-17-267008/ketua-ojk-ungkap-kondisi-sektor-keuangan-terkini-saat-pandemi

De Haas, R., & Van Lelyveld, I. (2010). Internal capital markets and lending by multinational bank subsidiaries. Journal of Financial Intermediation, 19(1), 1–25.

Dehejia, R., Montgomery, H., & Morduch, J. (2012). Do interest rates matter? Credit demand in the Dhaka slums. Journal of Development Economics, 97(2), 437–449.

Demirgüç-Kunt, A., & Huizinga, H. (2000). Financial structure and bank profitability. Available at SSRN 632501.

Detragiache, E., & Gupta, P. (2006). Foreign banks in emerging market crises: Evidence from Malaysia. Journal of Financial Stability, 2(3), 217–242.

Dinger, V. (2009). Do foreign-owned banks affect banking system liquidity risk? Journal of Comparative Economics, 37(4), 647–657.

Edwards, S. (2010). The international transmission of interest rate shocks: The Federal Reserve and emerging markets in Latin America and Asia. Journal of International Money and Finance, 29(4), 685–703.

Eichengreen, B., Mody, A., Nedeljkovic, M., & Sarno, L. (2012). How the subprime crisis went global: Evidence from bank credit default swap spreads. Journal of International Money and Finance, 31(5), 1299–1318.

Ekarina, F. T., & Fedrichson, G. (2021). Peran Bank Sentral Di Tengah Pandemi COVID-19. Bank Indonesia. https://www.bi.go.id/id/publikasi/laporan/Documents/6.Bab-3__Artikel_III-2020.pdf

Gatev, E., Schuermann, T., & Strahan, P. E. (2009). Managing bank liquidity risk: How deposit-loan synergies vary with market conditions. The Review of Financial Studies, 22(3), 995–1020.

Hair, J. F., Sarstedt, M., Pieper, T. M., & Ringle, C. M. (2012). The use of partial least squares structural equation modeling in strategic management research: A review of past practices and recommendations for future applications. Long Range Planning, 45(5–6), 320–340.

Hair Jr, J. F., Hult, G. T. M., Ringle, C. M., & Sarstedt, M. (2017). A primer on partial least squares structural equation modeling (PLS-SEM). Sage publications.

Hameed, A., Kang, W., & Viswanathan, S. (2010). Stock Market Declines and Liquidity. The Journal of Finance. https://doi.org/10.1111/j.1540-6261.2009.01529.x

Harun, T. W. R., Kamil, N. K. M., Haron, R., & Ramly, Z. (2020). Determinants of Banks’ Capital Structure: A Review of Theoretical and Selected Empirical Research. International Journal of Business and Social Science, 11(12), 131–141.

Ivashina, V., & Scharfstein, D. (2010). Bank lending during the financial crisis of 2008. Journal of Financial Economics, 97(3), 319–338.

Juhro, S. M., & Njindan Iyke, B. (2009). Monetary policy and financial conditions in Indonesia. Bulletin of Monetary Economics and Banking, 21(3), 283–302.

King, M. R. (2010). Mapping capital and liquidity requirements to bank lending spreads.

Kock, N. (2015). A note on how to conduct a factor-based PLS-SEM analysis. International Journal of E-Collaboration (IJeC), 11(3), 1–9.

KPMG. (2020). COVID-19: Impact on the banking sector - KPMG Global. KPMG. https://home.kpmg/xx/en/home/insights/2020/07/covid-19-impact-on-banking-m-and-a-2020.html

Kumar, B., & Sujit, K. S. (2018). Determinants of dividends among Indian firms—An empirical study. Cogent Economics & Finance, 6(1), 1423895.

Männasoo, K., & Mayes, D. G. (2009). Explaining bank distress in Eastern European transition economies. Journal of Banking & Finance, 33(2), 244–253.

Martinez-Jaramillo, S., Carmona, C. U., & Kenett, D. Y. (2019). Interconnectedness and financial stability. Journal of Risk Management in Financial Institutions, 12(2), 168–183.

Mukhlis, I., Hidayah, I., & Retnasih, N. R. (2020). Interest Rate Volatility of the Federal Funds Rate: Response of the Bank Indonesia and its Impact on the Indonesian Economic Stability. Journal of Central Banking Theory and Practice, 9(1), 111–133.

Nitzl, C. (2016). The use of partial least squares structural equation modelling (PLS-SEM) in management accounting research: Directions for future theory development. Journal of Accounting Literature.

Olaberría, E. (2015). US long-term interest rates and capital flows to emerging economies. Journal of International Commerce, Economics and Policy, 6(02), 1550008.

Pokutta, S., & Schmaltz, C. (2011). Managing liquidity: Optimal degree of centralization. Journal of Banking & Finance, 35(3), 627–638.

Ringle, C. M. (2015). Partial Least Squares Structural Equation Modelling (PLS-SEM) Using SmartPLS 3.

Siahaan, L. M., & Hidayat, P. (2015). Analisis kausalitas dan kointegrasi antara tingkat suku bunga Bank Indonesia (BI Rate) dengan suku bunga Bank Amerika Serikat (The Fed). Ekonomi Dan Keuangan, 1(8).

Skeie, D. R. (2008). Banking with nominal deposits and inside money. Journal of Financial Intermediation, 17(4), 562–584.

Tillmann, P., Kim, G.-Y., & Park, H. (2019). The spillover effects of US monetary policy on emerging market economies. International Journal of Finance & Economics, 24(3), 1313–1332.