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A model of bank lending in the global financial crisis and the case of Korea

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  • Leony, Larissa
  • Romeu, Rafael
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    Abstract

    This paper studies two interrelated banking sector issues in the context of the global financial crisis and its impact on Korea: (i) To what extent did state owned banks expand lending to offset declining credit as private sector bank balance sheets deteriorated? (ii) In the recent crisis, was bank lending constrained because of funding or liquidity factors? To address these issues, a framework of optimal bank lending is presented in which banks face adverse selection in a market for risky investment projects, pay regulatory costs, and borrow in wholesale and traditional funding markets. The model implications are tested on bank-level data with a focus on the global financial crisis. The results point to significant credit expansion by public sector banks in response to deteriorating international credit conditions. Estimates of private sector lending during the crisis suggest that, at best, the credit crunch was less profound than it could have been. Wholesale funding is not found to have been a major driver of deteriorating credit conditions in Korea, reflecting, at least in part, strong policy support from the authorities during the crisis.

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    File URL: http://www.sciencedirect.com/science/article/pii/S1049007811000248
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Asian Economics.

    Volume (Year): 22 (2011)
    Issue (Month): 4 (August)
    Pages: 322-334

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    Handle: RePEc:eee:asieco:v:22:y:2011:i:4:p:322-334

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    Web page: http://www.elsevier.com/locate/asieco

    Related research

    Keywords: Financial crisis Banking Regulation;

    References

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    1. Lev Ratnovski & Rocco Huang, 2010. "The Dark Side of Bank Wholesale Funding," IMF Working Papers 10/170, International Monetary Fund.
    2. Barth, James R. & Caprio Jr, Gerard & Levine, Ross, 2001. "The regulation and supervision of banks around the world - a new database," Policy Research Working Paper Series 2588, The World Bank.
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    9. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
    10. Huang, R. & Ratnovksi, L., 2009. "The Dark Side of Bank Wholesale Funding," Discussion Paper 2009-59 S, Tilburg University, Center for Economic Research.
    11. Franklin Allen & Ana Babus & Elena Carletti, 2009. "Financial Crises: Theory and Evidence," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 97-116, November.
    12. Madhavan, Ananth & Smidt, Seymour, 1993. " An Analysis of Changes in Specialist Inventories and Quotations," Journal of Finance, American Finance Association, vol. 48(5), pages 1595-1628, December.
    13. Clarke, George R.G. & Cull, Robert & Shirley, Mary M., 2005. "Bank privatization in developing countries: A summary of lessons and findings," Journal of Banking & Finance, Elsevier, vol. 29(8-9), pages 1905-1930, August.
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