A framework for analysing Banking sector lending

Elizabeth Duke has given an excellent speech on recent bank lending trends in US . Being a former banker, she knows how should one analyse bank lending  especially in these troubled times.

She gives three ways in which one can analyse bank lending:

1) macroeconomic view – When looking at aggregate borrowing, it is important to remember that a change in debt outstanding can be driven by any one of three factors or, more commonly, a combination of all three. In the macroeconomic view of credit, I will discuss indicators related to changes in demand for credit. I will also examine two determinants of the supply of credit. The first determinant relates to lenders’ assessment of the creditworthiness of borrowers given future economic conditions. The second relates to credit constraints caused by the financial condition of the lenders.

2)financial intermediation view : illustrates the importance of supporting the availability of all forms of lending, whether it be on-balance-sheet lending by banks, credit originated by banks and securitized and sold to investors, or credit supplied by nonbank lenders.

3) banking view: Because banks remain central to financial intermediation, they deserve a closer look, particularly during this time of financial-sector turmoil. In my discussion of the “banking view” of credit, I will summarize the current state of the banking industry.

She then looks into each of the views. I would have loved to analyse the speech in detail but time does not permit. The summary is:

The macroeconomic view of credit highlighted the importance for the flow of credit of reduced demand due to weaker economic activity, reduced supply because borrowers appear less creditworthy, and reduced supply because lenders face pressures that restrain them from extending credit

The financial intermediation view of credit highlighted that banks have remained important financial intermediaries long after the originate-to-distribute model for funding credit became the dominant model and can play an important safety-valve role for the financial system.

Finally, the banking view of credit emphasized that there are many types of banks in the United States, and the extraordinary stress in the financial system, the downturn in the U.S. and global economies, and the associated reductions in asset values have affected each bank differently. As such, some banks have likely fulfilled the credit needs of consumers and businesses that had been turned away by their peers.

In the banking view she shows it is basically large banks that are not lending but small banks are.

I came across another paper from St Louis Fed economists which also look at whether banks are lending or not in the crisis. It has pretty similar findings with credit crunch coming in Q4 2008 with small banks still going strong.

We show that credit expansion, as defined in this paper, began declining during the first half of 2008 while credit contraction began steeply increasing only between the third and fourth quarters of 2008. Until then net credit growth was below trend but positive and not dissimilar to the 1980 and 2001 recessions. However, between the third and fourth quarter credit contraction grew larger than credit expansion across all types of loans (real estate, individual, commercial, and industrial loans) and for the largest banks. On the contrary, smaller banks continued to display positive net credit growth. Once we include 2008:Q4 data, the cyclical properties of our series most resemble the beginning of the 1991 recession and the intensification of the Savings and Loan crisis.

What is Monetary Base?

Richard Anderson has written a nice primer on what is meant by Monetary Base of a Central Bank. As we know Fed has expanded its balance sheet(and so have others) by purchasing assets. The purchases have mainly been financed by increase in monetary base which appear on the liabilities side of the Balance sheet.

Now what is Monetary Base? Read Anderson’s paper for details.

Institutions or macro policies: A case from Barbados and Guyana

I had posted about a paper from Peter Henry Blair where he looks at whether macro policies matter or institutions matter. He looks at the case of Barbados and Jamaica who had near similar institutions but had different growth patterns with latter outperforming. He says it is not institutions but macroeco policies that matter (atleast in this case).

I came across another paper from Michael DsCosta (of IMF) which studies the case of Barbados and Guyana. Again Barbados outperfroms Guyana despite both getting independence in 1966 and starting with near similar economic indicators. In nutshell he says it is the quality of institutions in Barbados that matters. He says institutions are in turn determined by colonial history and Geography both of which favored Barbados.

On virtually all measures—institutional quality, incomes, human development, and poverty— Guyana lags Barbados and most other former British Caribbean colonies. This paper argues that much of the origins of this divergence lies in Guyana’s colonial history and its geography, which influenced the quality of the country’s institutions. In particular, the separate administration of the country’s three regions for about two centuries prior to unification in 1831 contributed to fragmented development and a weak sense of national cohesion. This was exacerbated by geography and difficult settlement conditions, as the priority placed by settlers on securing a satisfactory return on the heavy capital investment required for sugar cultivation in those conditions led to the development of a type of extractive state in which inadequate attention was paid to promoting sound domestic institutions.

Barbados’s colonial history of more than 300 years contributed to the early development of forms of representative government and well-entrenched parliamentary practices. Also, the island’s geography contributed to relatively favorable settlement conditions, which helped promote the early development of institutions. These factors, together with small size, vulnerability to external shocks, and the absence of ethnic tensions, helped cultivate a sense of cohesion, national unity and a tradition of dialogue. Also, these characteristics  and limited resources probably helped foster a propensity toward saving and fiscal discipline.

Very interesting Stuff. Though macroeco policies also matter as unlike Barbados which went for foreign and private investment, Guyana adopted state control of the economy. Both dependent heavily on Sugar. When Sugar prices rose in 1973 , Barbados created a windfall fund to finance low cost housing but Guyana simply used it to further nationalise the sugar industry. However, unlike Henry who stresses on macropolicies DaCosta stresses on quality of institutions (which were in turn dependednt on geography and colonial history).

At the end of the colonial period, therefore, Barbados was generally better prepared to meet the challenges of independence and faced more favorable long term prospects. Much of this advantage appeared to be due to the quality of its institutions, including political stability and the rule of law.

This paper has a bit more of history of Carribean countries, how colonies came up in this region and formed institutions etc. Great Reading.

PS. I had always loved Carribean countries for their brand of Cricket. I didn’t know it has such interesting insights for economic history and development.

Assorted Links

1. Cowen says creditors should suffer as well

2. Krugman on Japan’s recovery

3. Mankiw points to a new paper on Great Depression

4. Rodrik on how ideas shape policies

5. FMB points Euroarea is in recession since Q1 2008.

6. ASB points to some views on G-20 meeting

7. TTR on Turner Review

8. Urbanomics points to views of Fed Balance Sheet and deflation