Bank regulation induced new credit channels and obscure obstruction of monetary transmission

In response to the financial crisis, some central banks have employed quantitative easing policies to stimulate economic recovery. Furthermore, stringent bank regulatory policies were introduced to ensure economic stability. The interplay between these measures has raised concerns about the effectiveness of monetary transmission. We aimed to examine the credit creation of banks with bank regulations and how these regulations reshape the transmission of monetary policy through bank lending. The results revealed that each bank regulatory requirement forms a maximum amount of credit, named as a credit capacity, which constrains credit creation of banks. Additionally, banks would reconstruct the balance sheets as a response to these regulations. Thus, bank regulations can reshape bank lending via the following two ways. Firstly, with the influence of bank regulations on bank lending, new monetary channels emerge, including new bank capital, new risk-taking, new bank lending, and new bank balance sheet channels. Specifically, the new bank capital channel refers to monetary shocks changing the amount of bank capital, which is subject to the CAR and LR regulations and affects bank lending via corresponding credit capacity. The new risk-taking channel is also related to the CAR regulation, which results in a variation in credit capacity due to changes in the bank's weighting parameters of risky assets. Both the new bank lending and new bank balance sheet channels are transmitted via the credit capacity formed by multiple bank regulations. Secondly, we proposed some plausible obstacles in the monetary transmission and analyzed the reasons for their formation. When banks' credit creation is subject to multiple bank regulations, the credit capacity is determined by the tightest bank regulation. As the tightest one shifts between various bank regulations, the bank credit base also undergoes constant changes. Only when a monetary shock effectively increases the credit base corresponding to the tightest regulations can the bank's credit capacity increase, ensuring the effectiveness of monetary policy; otherwise, obstacles may arise. The empirical results showed that after the financial crisis, capital regulation has become the tightest constraint to the expansion of bank credit. We believe that our theoretical findings can lay a new foundation for designing effective monetary policy.