Linkages between the Financial and Real Sectors across Interest Rate Regimes: The Case of the Czech Republic

I employ the threshold Bayesian VAR with block restrictions to evaluate the nonlinear dynamics across different interest rate regimes using the example of the Czech Republic. The study compounds the information on aggregate credit and non-performing loans (NPL) to find that the procyclicality of financial sector tends to vary across interest rate regimes. The impulse responses of real economy to shocks to the credit and NPL provide a mixed picture. While the responses to credit shocks are roughly similar across regimes, the reaction to the NPL shocks differ both in size and timing and can be likely aligned with the cyclical factors. The direct impact of foreign factors on lending seems to be rather limited given that the financial sector in the Czech Republic is largely bank-based and funded predominantly by domestic deposits. The measured responses to foreign shocks instead seem to reflect the convergence path of the Czech economy over a longer time horizon.