Wonderful Question Brahim.....!!

We should however keep in mind that expansionary monetary policy doesn't necessary mean sub-prime lending for banks.... Banks have to venture into businesses which are represented by real assets and rather not lend into fiction... Banks have to evaluate the proposals on merit and only if they fall within the acceptable norms only then can banks lend... This not only will prevent Non-Performing Assets for Banks but will ensure proper and efficient allocation of funds which will in turn lead to sustainable economic growth....

Moreover such practice would prevent from Bank failures and the Domino-effect arising thereof...... So far as I think... enhanced Banking Supervision will just enhance the quality of Credit and effective allocation of funds rather than restricting the effectiveness of expansionary monetary policy...

Thanks

Khaki

This is indeed a very good question because it highlights the need to coordinate, in a very concrete terms, monetary and financial supervision policies.It may be easily the case that tougher bank supervision(e.g. more capital requirements) may lead to a lower pass-through from the monetary policy interest rate to deposit and lending rates.This result shpuld be taken into account in delibrating what is the the warranted change in the monetary policy rate cto acchieve the objective of monetary policy.

Expansionary MP indicates more money in circulation and lowered interest rates - i.e. cheap money policy, giving hopes for borrowers that they can get loans cheaper and enabling banks to lend more, and hence to choose even unworthy borrowers called 'adverse selection'- after all banks have to be in business and to increase their business they need to lend the resources mobilised. On the other hand, enhanced banking regulations would call for higher capital adequacy and even restrict easyh lending, makes borrowing difficult, prescribe restrictive conditions to take a loan (say lower Loan to value ratio) etc. Moreover in view of cheap money availability, the same could be accessed to allocate to undeserving uses like speculation which would be sought to be curbed by tight regulations. Thus for a prima facie reading both expansionary money policy and tighter bank regulation work in opposite directions and one has to really see if the empirical data and its analysis throw up concrete and reliable negative correlation and results.

dr Durairajan

There is a clear tension in the U.S. between the Fed with its monetary policy hat on and the Fed with its regulatory hat. Let's take the case of mortgage lending, where QE by direct purchases of Treasuries and Agency MBS is trying to hold down mortgage rates to boost the housing market. With its other hat, the Fed and other bank regulators are trying to reduce the risk of lending. As a result, many borrowers cannot get into the mortgage market. The result of this is the buy-to-let model, where households are renting a house for more than it would cost them to buy because they cannot qualify for a mortgage. We are in a period of regulatory overzealousness and it would be simpler if the Fed and other regulators (and ultimately Congress) set high capital standards and then let banks be banks.