Does Exchange Rate Volatility Affect the Bank Lending Channel?

The bank lending channel is one of the most debated channels of the transmission mechanism, especially in Turkey. According to many studies, exchange rate volatility is a good indicator of macroeconomic, financial and political instability. This study tests whether the bank lending channel is affected by exchange rate volatility in Turkey. Thus, we aim to obtain an important finding on why the bank lending channel works weakly in Turkey. To test this hypothesis, the Vector Auto Regression (VAR) model is used for the period January 2011- September 2023. Evidence from the impulse response function suggests that exchange rate volatility has a negative impact on loans, while variance decomposition results show that exchange rate volatility has a high power to explain the change in loans. Credit may not always respond to expansionary (contractionary) monetary policy in an increasing (decreasing) direction. In periods of high exchange rate volatility (political, financial, macroeconomic instability), banks may not increase lending even in a low interest rate environment. This is because when exchange rate volatility is high, banks avoid taking risks under uncertainty. Therefore, for the bank lending channel to work more effectively, macroeconomic, financial and political stability should be ensured in addition to monetary policy.