Credit Crunch? An Empirical Test of Cyclical Credit Policy

30 Pages Posted: 7 Jul 2009

See all articles by Risto Herrala

Risto Herrala

European Central Bank (ECB) - Directorate General International and European Relations

Date Written: March 24, 2009

Abstract

In this paper we test the hypothesis that credit policies are pro-cyclical. Our approach is based on a stochastic frontier analysis of borrower data, as in Chen and Wang (2008). We extend the applicability of the approach, and propose a novel test specification which is informative of many types of pro-cyclicality. The analysis of representative samples of household borrowers during a huge cycle and its aftermath yields evidence of time-varying credit policy. We find that the focus of credit policy changed from collateral to current income during the cycle. Instead of a credit crunch, ie, an overall tightening of credit during the economic and financial contraction, we find a tightening of credit limits with respect to a minority of borrowers and an easing for the majority. In the course of the post-crisis period, credit policy became more lenient. Both the level of credit limits and the ‘tailoring’ of limits to group-specific characteristics of households increased. A reduction in the idiosyncratic variance of limits suggest that banks have become more consistent in their credit policies.

Keywords: credit policy, credit constraints, household borrowing, frontier analysis

JEL Classification: D14, E32, E51, G21

Suggested Citation

Herrala, Risto, Credit Crunch? An Empirical Test of Cyclical Credit Policy (March 24, 2009). Bank of Finland Research Discussion Paper No. 10/2009, Available at SSRN: https://ssrn.com/abstract=1428823 or http://dx.doi.org/10.2139/ssrn.1428823

Risto Herrala (Contact Author)

European Central Bank (ECB) - Directorate General International and European Relations ( email )

Kaiserstrasse 29
D-60311 Frankfurt am Main
Germany

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