Bank capital buffer, bank credit and economic growth: evidence from India

This paper studies the procyclical behaviour of bank capital and bank credit by investigating the causal relationship among bank capital, bank credit and economic growth in government-owned public sector banks of India. In this study Granger causality test, cross correlation function and Pearson correlation test are applied. Also, augmented Dickey-Fuller test is used to find out the stationarity of time series data. Using bank level data of 322 observations from 23 banks during 2000-2013, the study found that bank capital buffer and tier-1 capital has a tendency to induce procyclicality in bank credit. Further, the study found that there are bi-directional causality and positive correlation between bank credit and economic growth. The result confirms the presence of causal relationship and provides strong evidence to the presence of procyclicality and its associated risk in the economy. The study suggests that banks should maintain adequate bank capital buffer to mitigate the risk associated with the procyclicality. It provides support to the implementation of RBI guidelines on the countercyclical buffer by all banks in India.