Identifying the Demand and Supply Effects of Financial Crises on Bank Credit--Evidence from Taiwan

1. Introduction

The credit market in Taiwan underwent rapid development in the first half of the 1990s. As a step toward financial liberalization, the government lifted the ban on new establishments of commercial banks in 1991, pushing 18 new domestic banks to set up by the end of 1996. The 1997 Asian financial crisis, however, inflicted a serious blow to the market. The annual growth rate of bank loan supply was on average 17% from 1991 to 1996, but the figure dropped to 11% between 1997 and 2000. At the same time, the economy suffered the worst recession since 1950. Although it is widely acknowledged that declining bank credit is one of the major causes of the recession, the sources of the credit contraction in the aftermath of the financial crisis are subject to debate.

The purpose of this paper is to provide a novel empirical approach to discern the demand and supply effects of the changes in credit growth. The approach is based on the short-side rule of market transactions to infer the relative shifts of demand and supply. The novelty is particularly shown in our proposed micro data model in which only the demand- or supply-side data is required for the analysis.

We use econometric models to examine whether the slowdown of the credit growth following the crisis came from a shift in the demand or a shift in the supply. In particular, we seek to answer the following questions: How did the demand and supply of bank credits change after the financial crisis, and what were the contributing factors? How did the changes explain the dramatic credit slowdown? What types of firms were affected the most in the credit slowdown? Results of this study should shed light on the causes and consequences of a dramatic change in the bank credit market in the event of a large and systematic shock.

Declines in bank lending can occur either because firms demand less credit...