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Is there a credit crunch in East Asia?

  • Wei Ding
  • Domac, Ilker
  • Ferri, Giovanni

The issue of the credit crunch in the aftermath of the Asian crisis has stimulated much debate. Indeed, some features of the East Asian economies, such as bank-based financial systems and high leverage, make them particularly vulnerable to monetary and financial shocks. Under such circumstances, the credit channel of transmission of these shocks is likely to lead to a credit crunch, affecting the flow of bank loans to those agents--households and small and medium-sized enterprises--for whom close substitutes for bank credit are unavailable. In turn, the disruption to the availability of finance for bank-dependent borrowers may stymie economic activity. In practice, however, it is difficult to detect the credit channel effects that lead to a credit crunch. Reliance on trends of credit aggregates alone is inadequate to prove that there has been an adverse shift in the supply of loans: even a decline or slowdown of credit could stem from a decrease or deceleration in demand. A frequently used methodology to overcome this problem focuses on both credit aggregates and the yield spread between bank loans and risk-free assets, such as government bonds. If this spread rises while credit aggregates slow down, one can conjecture that the supply of loans has either decreased more or increased less than demand. But further qualification is needed. The increase of the spread might simply reflect a rising risk premium triggered by the fact that the negative shock reduces the net worth of economic agents because of larger financial outlays. Accordingly, the relevant spread to capture the worsening credit conditions that affect bank-dependent borrowers is the spread between bank lending rates and corporate bonds. The yield spread corporate and government bonds measures the general risk premium. The study applies this methodology to Indonesia, Malaysia, the Philippines, the Republic of Korea, and Thailand, and shows that the credit crunch is widespread, while its negative impact particularly affects small banks and enterprises. On the basis of the findings, the authors claim that 1) a protracted and heavy reliance on tight monetary policy, entailing high real interest rates, appears inappropriate for restoring market confidence; 2) it is desirable to consider alternative policy instruments that do not place further stress on the banking sector and on its lending to the corporate sector; and 3) policy actions are warranted to alleviate the strain that the crisis has put on small banks and enterprises.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1959.

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Date of creation: 31 Aug 1998
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Handle: RePEc:wbk:wbrwps:1959
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  1. R. Glenn Hubbard, 1995. "Is there a "credit channel" for monetary policy?," Review, Federal Reserve Bank of St. Louis, issue May, pages 63-77.
  2. Mark Gertler & R. Glenn Hubbard & Anil K. Kashyap, 1990. "Interest rate spreads, credit constraints and investment fluctuations: an empirical investigation," Finance and Economics Discussion Series 137, Board of Governors of the Federal Reserve System (U.S.).
  3. Bernanke, Ben S & Blinder, Alan S, 1988. "Credit, Money, and Aggregate Demand," American Economic Review, American Economic Association, vol. 78(2), pages 435-39, May.
  4. Frederic S. Mishkin, 1991. "Asymmetric Information and Financial Crises: A Historical Perspective," NBER Chapters, in: Financial Markets and Financial Crises, pages 69-108 National Bureau of Economic Research, Inc.
  5. Bruce C. Greenwald & Joseph E. Stiglitz, 1988. "Financial Market Imperfections and Business Cycles," NBER Working Papers 2494, National Bureau of Economic Research, Inc.
  6. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  7. Anil K Kashyap & Jeremy C. Stein, 1997. "What Do a Million Banks Have to Say About the Transmission of Monetary Policy?," NBER Working Papers 6056, National Bureau of Economic Research, Inc.
  8. R. Glenn Hubbard, 1995. "Is there a "credit channel" for monetary policy?," Proceedings, Federal Reserve Bank of St. Louis, issue May, pages 63-77.
  9. N. Gregory Mankiw, 1986. "The Allocation of Credit and Financial Collapse," NBER Working Papers 1786, National Bureau of Economic Research, Inc.
  10. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
  11. Anil K. Kashyap & Jeremy C. Stein & David W. Wilcox, 1991. "Monetary policy and credit conditions: evidence from the composition of external finance," Finance and Economics Discussion Series 154, Board of Governors of the Federal Reserve System (U.S.).
  12. Lang, William W. & Nakamura, Leonard I., 1995. "'Flight to quality' in banking and economic activity," Journal of Monetary Economics, Elsevier, vol. 36(1), pages 145-164, August.
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