The Credit Crunch: More of a Needed Adjustment than an Overreaction
AUTHORS
Sangkyun Park,Independent
ABSTRACT
The credit crunch of the early 1990s in the U.S. was notable in that banks sharply reduced business loans. To infer whether banks overtighten lending standards during a credit crunch, this paper examines how future loan performance was related to loan growth and capital ratios during the credit crunch of the early 1990s. Overtightening of lending standards may occur if banks overreact to increased loan losses, if a high cost of equity financing forces banks to meet capital requirements by reducing loans instead of raising equity, or if regulators excessively constrain banks from making loans. Tighter lending standards should lead to lower loan loss rates later. The main finding is higher loan loss rates in future periods for banks that reduced lending significantly and banks that had insufficient regulatory capital. Based on this finding, there doesn’t appear to have been much overtightening either voluntary or forced. Banks that reduced lending were those banks that had suffered high loan losses before the credit crunch. Those banks appear to have tightened lending standards, but not tightened enough. Undercapitalized banks had suffered high loan loss rates too. They also appear to have insufficiently tightened lending standards. It appears that risky banks continued to pursue risky strategies, despite tighter regulation and supervision.
KEYWORDS
Credit crunch, Capital requirements, Basel accord, Loan performance
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