The bank lending channel theorizes that changes in monetary policy will shift the supply of intermediated credit, especially credit extended through commercial banks. The bank lending channel is essentially the balance sheet channel as applied to the operations of lending institutions. Monetary policy actions may affect the supply of loanable funds available to banks (i.e. a bank's liabilities), and consequently the total amount of loans they can make (i.e. a bank's assets).Bernanke, Ben and Allen Blinder. 1988. "Credit, Money, and Aggregate Demand." American Economic Review 1988, 78. pp. 435–439. Banks serve to overcome informational problems in credit markets by acting as a screening agent for determining credit-worthiness.Mishkin, Frederic. 1996. "The Channels of Monetary Transmission: Lessons for Monetary Policy." NBER Working Paper Series No. 5464. Thus many agents are dependent on banks to access credit markets. If the supply of loanable funds banks possess is affected by monetary policy changes, then so too should be the borrowers who are dependent on banks' funds for business operations. Firms reliant on bank credit may either be shut off from credit temporarily or incur additional search costs to find a different avenue through which to obtain credit. This will increase the external finance premium, consequently reducing real economic activity.
