Determining the variables that are relevant in the monetary transmission process is the hallmark to an effective monetary policy implementation. A clear knowledge of the monetary transmission channels helps in the accurate selection of intermediate target variables (such as monetary aggregates and interest rates). It also improves our understanding of the link between the financial sector and the real economic sector, thus enabling timely policy implementation.
Based on this premise, this study intends to investigate the importance of bank lending in linking monetary policy to the real economy in the Malaysian case. The motivation to focus on bank lending as a channel for monetary policy transmission stems from the importance of bank lending
Malaysia is committed to further develop its financial market as outlined in the Bank Negara Malaysia’s Financial Sector Masterplan 2003. The Masterplan outlines the strategies to enable the domestic financial sector to cope with the rapid pace of economic development and transformation that creates new demands and opportunities. The objective of the Masterplan which is “….to develop a more resilient, competitive and dynamic financial system with best practices, that supports and contributes positively to the growth of the economy throughout the economic cycle…” (Bank Negara Malaysia, 2003: 11) is a clear manifestation of the importance of bank lending in the economy. By having this objective, Bank Negara Malaysia is clearly emphasising on ensuring a healthy and stable financial system that can provide continuous financing to the economy. The objective could well be implied to financing in the form of bank loans since 70% of total financing in the Malaysian economy comes from bank lending. The Masterplan also emphasises the changing requirements of the economy on its financing needs. Amid the country’s rapidly changing financial landscape, this study hopes to reiterate and show further evidence on the relevance and importance of bank loans in financing the economy as well as in transmitting the monetary policy
Suppose that bank lending is an important channel for monetary policy transmission, it is critical to ensure the stability of the banking sector due to its great repercussions on the economy as a whole. In such circumstances, ensuring the stability of the banking system is a crucial pre-condition towards economic stability. At the same time, it is also important to assess the distributional consequences of monetary policy on various economic sectors of the economy. Some economic sectors are more sensitive to changes in monetary policy variables (interest-sensitive sectors), while others are quite resilient to interest rate changes. Similarly, some economic agents are more sensitive to changes in monetary policy compared to others. For example, several studies have shown that changes in monetary policy have greater impact on smaller firms compared to bigger ones (see for example, Gertler and Gilchrist, 1994; Gelos and Werner, 2002; Domac,