The Relationship Between Credit Availability and Investments Contraction During Recent Systemic Banking Crises: A Study of Causal Relationships

Abstract

Economic literature has uncovered biases in identifying the connection between credit supply and overall output during financial turbulence. From this standpoint, a banking crisis typically leads to a reduction in the amount of credit offered by banks, accompanied by a deceleration in economic activity. Under these circumstances, various causal relationships elucidate the simultaneous occurrence of these two fundamental phenomena: the contraction of credit and the deceleration of the economy. Moving from the database of Laevan and Valencia [1] we consider 151 episodes of systemic banking crises, examining the primary factors and consequences that have affected 118 countries to varying degrees in terms of credit constraints and economic deceleration. The analysis of various aspects of credit demand and supply during financial crises provides compelling evidence that supports the hypothesis that, in certain situations, the contraction of credit during financial crises is primarily due to a decrease in credit demand from households and businesses rather than a deliberate reduction of credit by banks.