The availability of credit has been an issue of particular concern in Germany during the financial meltdown of 2008-2009. Lending to domestic non monetary financial institutions by banks in Germany has dampened since the summer of 2008. Contraction of loans, especially business loans, together with an ongoing recession led to a growing fear about an upcoming ”credit crunch” in Germany. In fact, a credit tightening is observed Euro-zone wide as well.
It is necessary to define a ”credit crunch” before attempting to identify if it exists or not. However, this term is used in an interchangeable way to describe different occasions. First of all, we have to make sure that anecdotal evidence of credit denials is hardly evidence of a credit crunch. Some borrowers could be too optimistic and far from evaluating the risks of their projects realistically; whereas some loan officers could be too skeptical. Such denials might occur simply due to incomplete information. Thus, it is essential to explore this concept more carefully. Bernanke and Lown (1991)(5) define a credit crunch as ”a significant leftward shift in the supply curve for bank loans, holding constant both the safe real interest rate and the quality of potential borrowers”. The definition of credit crunch that we adopt in this paper is brought up by Council of Economic Advisors (1991)(15) and follows ”a credit crunch is a situation in which the supply of credit is restricted below the range usually identified with prevailing market interest rates and the profitability of investment projects.” The reduction in the available supply of credit might be due to some funding problems of the lenders caused by disintermediation or strict regulation. It might also result from the weaknesses of lender’s balance sheet. In the literature, this mechanism is called bank lending channel. Bernanke and Gertler (1995)(4) enlighten the credit channel of monetary policy transmission and propose two possible linkages between credit markets and monetary policy: the first one is the above mentioned ”bank lending channel” and the second one is ”balance sheet channel”. The See Syron (1991)(17).
second channel embraces that the balance sheets of the borrower and their income statements, and therefore their decisions about future investments depend on the changes in monetary policy. A vast amount of literature has discussed these linkages, such as Bernanke and Blinder (1988)(3), Bernanke (1993a)(2), Hubbard (1995)(10), Kashyap and Stein (1994) (11), Bernanke et al. (1996)(6). Theoretical studies are supported by a wide range of empirical works. Ding et al. (1998)(8) analyzes East Asian experience of credit shortage during after going into a detailed description of propagation mechanism of a credit crunch. Lang and Nakamura (1995)(12) look at bank lending channel in US and show that it plays a role in the transmission of monetary policy.
In Germany, there are several facts which trigger the fear of a credit crunch. First of all, as it is mentioned above, lending to enterprises and self employed has slowed down since mid of 20082. Between November 2008 and April 2009, German banks have significantly reduced their asset positions due to global financial crisis. Yet this trend still continues at a slower pace. Especially, the insolvency of US investment bank Lehman Brothers in September 2008 has trimmed down the external and inter-bank assets in German banking sector. Bank Lending Survey (BLS) (Bundesbank, 2009 (7)) results also cast doubt on a possible credit crunch. From the start of the financial turmoil in the third quarter of 2007, particularly from the third quarter of 2008 on, German banks report that they tightened their credit standards in some incidents. What is more, Basel II rules have been revised and extensive changes were made in the international framework for liquidity risk measurement, standards and monitoring. New rules will be legislated by the end of 2010. Basel Committee on Banking and Supervision has also considered raising capital requirements of banks. Losses of banks together with higher capital base requirements might cause banks to restrict their credits. Above all, in case the estimated write-offs in German banking sector realize, this would put the credit availability at a high risk. Therefore, the fragile path of economic upturn would veer off the road again in Germany, where the domestic bank loan is the key financing source for enterprises and households. Illiquidity might result in an output level below potential together with job losses and even default, which then amplifies recession. This chain of happenings then turns into a vicious circle.
Contents
1 Introduction
2 The Model
3 Empirical Analysis
- 3.1 Data
3.2 Empirical Results
4 Conclusion
