Macro-prudential banking regulation, interest rate spread and the conduct of monetary policy in South Africa

The joint implementation of macro-prudential regulatory and monetary policies is necessary for modern banking systems not only to achieve optimal interest rate spread but to cushion the economy against the catastrophic effects of systemic risk. Therefore, the understanding of the interconnection between macroprudential regulation, interest rate spread and monetary policy, supported with empirical evidence, enables economies to build health and sound financial systems and achieve desirable growth rates. Thus, this study utilises the Vector Error Correction (VEC) mechanism to empirically investigate the interconnection between macro-prudential regulation, interest rate spread and monetary policy in South Africa. Quarterly time series data for the period from 1994 to 2016 was employed with the New Keynesian Dynamic Stochastic General Equilibrium (NKDSGE) model as the framework for analysis. The findings of this study suggest that a negative relationship exists between interest rate spread, macro-prudential regulation and monetary policy in South Africa. Moreover, the systems equation provided evidence that a short run causality running from macroprudential regulation to monetary policy is prevalent in South Africa. The empirical model of the study was found to be desirable as evidence of no serial correlation, no ARCH effect and non-normality in residuals was detected. Evidence from this study further suggest that interest rate spread has a dampening effect on monetary policy, but in the long-run this effect seems reversible in South Africa. As a result, this study recommends that caution should be taken on the appropriate selection of measures of macro-prudential regulation and its tool-kit as it can be used to disguise the symptoms of a lax monetary policy. This implies that the South African Reserve Bank (SARB) should sternly supervise and regulate the extension of credit by commercial banks in line with its inflation targeting monetary policy rule in order to achieve financial stability and ensure optimal interest rate spread that can stimulate the economy to growth