ABSTRACT
Introduction This chapter empirically examines the effects of the global financial crisis in 2008 on total bank lending to retail and corporate customers in selected countries, as declining bank credit is one of the major causes of economic slowdown or recession. In many cases, bank credit could also decline as a result of the slowdown. The goal of the chapter, therefore, is to first investigate whether the global credit crisis and ensuing world economic recession resulted in a decline in bank private sector credit. Second, the study addresses whether this decline, if any, was supply-or demand-driven by bank borrowers. The former could be the case if bank credit to the private sector was constrained by a decline in deposits, an increase in non-performing loans, and issues of risk aversion by banks reflected in adverse selection and moral hazard mechanisms, whereas the latter could result from an increase in unemployment, a decline in business opportunities, and risk aversion by borrowers regarding investment profitability. To test whether there has been a contraction of bank credit following the global credit crisis and whether it came from a shift in the demand or a shift in the supply or both, we build on the methodologies commonly used in the literature addressing both the determinants of bank lending and the means to disentangle the shift of loan supply from the shift of loan demand. We first develop a credit theoretical model in line with the existing models in the literature. Then we rely on empirical methodology to estimate with panel data the overall impact on banks’ loan extension using a comprehensive quarterly International Financial Statistics data set of banking sector claims on the private sector for eight countries for the period January 1995-December 2013. We divide the data into two sub-periods: before the crisis and after the crisis. An OLS analysis is conducted to identify the determinants of bank credit to the private sector. The credit demand and supply functions used in our econometric estimations include some supply and demand variables and are derived from the theoretical model. As such, if there are supply-side or demand-side effects on bank lending they are likely to be equally important for both retail and corporate customers. The distinction in the cause of credit slowdown or retreat has important policy implications. If the credit decline is related to weak demand for bank loans, whether due to pessimistic economic perspectives, deteriorations in borrowers’ balance
sheets, excessive leverage, or other factors, then policies aiming at stimulating aggregate demand could be effective. If, on the other hand, the decline is due to banks’ inability and reluctance to lend because of a decline in bank deposits, of capital losses (related to loan losses or asset price collapse), and increased riskiness, then other sets of measures, including easy monetary policy, are needed to revive bank lending and foster investment. The chapter is organized as follows. The next section discusses the financial crisis of 2008 and its possible impact on the selected countries. The third section reviews the literature that has examined the impact of financial crises in general on credit and examines the conclusions reached concerning the demand and supply causes. This is followed by a section highlighting the testing methodology and the results reached in the current study, while the next section reports the estimation results. The final section concludes with policy recommendations.
