The Impact of Interest Rate Changes on Bank Lending Behavior and Financial Stability in Emerging Markets

Posted: Aug 29, 2023

• Owen White
• Riley Carter
• Riley Flores

Abstract

The transmission mechanism of monetary policy in emerging markets represents one of the most complex and poorly understood phenomena in financial economics. Traditional economic models, predominantly developed for advanced economies, often fail to capture the unique institutional characteristics, market imperfections, and behavioral patterns that characterize banking sectors in emerging economies. This research addresses this critical gap by introducing a revolutionary computational framework that integrates principles from quantum computing with financial econometrics to model the intricate relationship between interest rate changes, bank lending behavior, and systemic financial stability. Emerging market economies exhibit distinctive features that complicate monetary policy transmission, including shallow financial markets, high levels of dollarization, volatile capital flows, and institutional weaknesses in banking supervision. Conventional linear models struggle to account for the threshold effects, regime changes, and non-linear dynamics that characterize these economies. Our approach fundamentally reimagines how banks in emerging markets process interest rate signals and make lending decisions, proposing that their behavior exhibits quantum-like properties where multiple potential strategies coexist until market conditions force a definitive choice. This research addresses three primary questions that have remained inadequately explored in the existing literature. First, how do interest rate changes propagate through the unique institutional architecture of emerging market banking systems? Second, what are the critical thresholds beyond which monetary policy interventions produce disproportionately large effects on lending behavior? Third, how can computational methods from quantum-inspired optimization improve our understanding of financial stability dynamics in these complex systems? The novelty of our approach lies in its cross-disciplinary integration of quantum computing principles with financial economics.