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Modelling the Demand for Bank Loans by Private Business Sector in Pakistan

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  • Hassan, Faiza
  • Qayyum, Abdul

Abstract

The importance of studying demand for bank loan by private business sector stems from the fact the money supply is ‘credit-driven’ and demand-determined and at the rate of interest determined by the central bank the money supply function is horizontal as illustrated by Moore and Threadgold (1985), Coghlan, (1981), Moore (1979, 1983). The analysis of the demand for bank loan by private business sector is important for understating the monetary transmission mechanism and formulation of the effective monetary policy to achieve macroeconomic objectives. The study aimed to model the demand for bank loan by private business sector in Pakistan. We use Hylleberg, et al., (1990) seasonal unit root test for investigation of properties of data. The dynamic Autoregressive Distributed Lag (ARDL) model is used for long rung and the short run analysis of demand for bank loans by the business sector. For the testing long run relationship among the variables we used bounds test proposed by Pasaran and Shin (1995). Real rate of return on advances, economic activity, expectations about future state of economy, macroeconomic risk, inflation and foreign demand pressure are taken as the determinants of demand for bank loan by private business sector. Economic activity, real rate of interest, macroeconomic risk and inflation were found significant in affecting demand for bank loans while the estimated equation do not provide evidence for the role of foreign demand pressure and expectations about future state of economy in effecting demand for bank loans. The sign of the coefficients of real rate of return on advances, inflation and macroeconomic risk is negative whereas economic activity is directly related to demand for bank loans by private business sector. The short run model shows that the speed of adjustment is 8.5% quarterly. Therefore it takes three years to go back to the long run equilibrium level. In the short run change in rate of inflation, RRA and economic activity have negative impact. The short run equation explores that change in real rate of return (RRA) does not affect RDBL. It implies that in very short run business cannot change their demand for bank credit in response to changes in real interest rate. Changing in macroeconomic risk appears in the model in form against a priori expectations. Foreign demand pressure (FDP) has no long run effect and in short run has the coefficient having low value. The demand for bank loan by private business sector was found interest elastic and gives the provision to central bank to control credit in the economy through variations of interest rate.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 55366.

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Date of creation: Dec 2013
Date of revision: Apr 2014
Handle: RePEc:pra:mprapa:55366

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Keywords: Demand for Bank Loans; Private Business Sector; HEGY Test; ARDL Model; Cointegration Pakistan;

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References

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  1. Pesaran, M. H. & Shin, Y. & Smith, R. J., 1996. "Testing for the 'Existence of a Long-run Relationship'," Cambridge Working Papers in Economics 9622, Faculty of Economics, University of Cambridge.
  2. Breusch, T S, 1978. "Testing for Autocorrelation in Dynamic Linear Models," Australian Economic Papers, Wiley Blackwell, vol. 17(31), pages 334-55, December.
  3. Melitz, Jacques & Pardue, Morris, 1973. "The Demand and Supply of Commercial Bank Loans," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 5(2), pages 669-92, May.
  4. M. Hashem Pesaran & Yongcheol Shin & Richard J. Smith, 2001. "Bounds testing approaches to the analysis of level relationships," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 16(3), pages 289-326.
  5. Benjamin M. Friedman, 1981. "The Roles of Money and Credit in Macroeconomic Analysis," NBER Working Papers 0831, National Bureau of Economic Research, Inc.
  6. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
  7. P. Arestis & I. Biefang-Frisancho Mariscal, 1995. "The Endogenous Money Stock: Empirical Observations from the United Kingdom," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 17(4), pages 545-559, July.
  8. repec:fth:inseep:9645 is not listed on IDEAS
  9. Pesaran, M.H., 1996. "The Role of Economic Theory in Modelling the Long Run," Cambridge Working Papers in Economics 9612, Faculty of Economics, University of Cambridge.
  10. Frederic S. Mishkin, 1995. "Symposium on the Monetary Transmission Mechanism," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 3-10, Fall.
  11. Basil J. Moore, 1983. "Unpacking the Post Keynesian Black Box: Bank Lending and the Money Supply," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 5(4), pages 537-556, July.
  12. Godfrey, Leslie G, 1978. "Testing against General Autoregressive and Moving Average Error Models When the Regressors Include Lagged Dependent Variables," Econometrica, Econometric Society, Econometric Society, vol. 46(6), pages 1293-1301, November.
  13. Davidson, Paul & Weintraub, Sidney, 1973. "Money as Cause and Effect," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 83(332), pages 1117-32, December.
  14. Hicks, Sydney Smith, 1980. "Commercial banks and business loan behavior," Journal of Banking & Finance, Elsevier, vol. 4(2), pages 125-141, June.
  15. Basil J. Moore, 1979. "The Endogenous Money Stock," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 2(1), pages 49-70, October.
  16. Yannis Panagopoulos & Aristotelis Spiliotis, 1998. "The Determinants of Commercial Banks' Lending Behavior: Some Evidence for Greece," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 20(4), pages 649-672, July.
  17. Laffont, Jean-Jacques & Garcia, Rene, 1977. "Disequilibrium Econometrics for Business Loans," Econometrica, Econometric Society, Econometric Society, vol. 45(5), pages 1187-1204, July.
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