A marked decline in bank lending after the recent financial crisis in the Republic of Korea amplified the real effects of the tightened monetary policy implemented in response to the crisis. A substantial excess demand for bank loans in the wake of the crisis was caused essentially by a capital-induced bank credit crunch rather than by a weak demand for loans. This finding reveals compelling evidence of the importance of the credit channel after the crisis.
Kim investigates whether the credit channel is a key monetary transmission mechanism in the Republic of Korea, especially after its recent financial crisis.
To identify the existence of a distinctive credit channel (especially the bank lending channel), he applies two empirical tests to both aggregate financial data and disaggregated bank balance sheet data.
As a more definitive analysis of the role of the credit channel, he estimates a disequilibrium model of the bank loan market, specifying separate loan demand and supply equations to characterize the credit crunch and identify its intensity in the wake of the crisis.
He finds convincing evidence of the importance of the credit channel in the aftermath of the crisis. Bank lending plays a significant independent role in amplifying the real effects of the tightened monetary policy implemented in response to the crisis.
There is strong evidence to suggest a substantial excess demand for bank loans following the crisis. This excess demand was caused by a sharp decline in loan supply largely attributable to pervasive and stringent bank capital regulation (a capital-induced bank credit crunch), rather than by weak demand for loans.
This paper—a product of the Financial Sector Development Unit, East Asia and Pacific Sector Units—was presented at the international conference on Exchange Rate Stability and Currency Board Economics on November 18-29, 1998, in Hong Kong. Copies of this paper are available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Debbie Peterson, room MC3-844, telephone 202-473-2692, fax 202-522-3454, Internet address dpeterson2@worldbank.org. The author may be contacted at hkim8@worldbank.org. (32 pages)
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