Abstract
This study assesses the behaviour of credit extension over the business cycle in South Africa for the period 2000 to 2012. This is motivated by the proposal of the Basel Committee on Banking Supervision to look at credit extension over the business cycle as a reference guide for implementing countercyclical capital buffers for financial institutions. The study finds that credit extension in South increases during the trough phase, while the relationship between credit extension and the business cycle becomes insignificant during the peak phase. The study also finds that credit extension decreases during the expansion phase, while it increases during the contraction phase. Thus we do not find any evidence of procyclical behaviour of credit extension in South Africa, and the latter should therefore be used with caution and not as a mechanical rule based common reference guide for countercyclical capital buffers for financial institutions.
Highlights
The 2008 global financial crisis highlighted the vulnerability of the financial system and its ability to generate economic instability through endogenous credit booms
The study was motivated by the suggestions on the part of the Basel Committee on Banking Supervision (BCBS) (2010a, 2011) at the Bank for International Settlements, which has identified credit extension as one of the major causes of financial crises
The behaviour of credit extension over the business cycle was analysed using the logistic smooth transition autoregressive (LSTAR) Model, which distinguishes between the peak and the trough phases, as well as the expansion and the contraction phases, of the business cycle
Summary
The 2008 global financial crisis highlighted the vulnerability of the financial system and its ability to generate economic instability through endogenous credit booms. The reason is that the willingness of financial institutions to lend tends to increase during periods of booming economic conditions and to decrease in periods of weakening economic conditions. This procyclical behaviour of credit extension can have adverse implications for economic activity by amplifying the fluctuations in the business cycle and considerably prolonging and deepening recessions (Borgy, Laurent & Jean-Paul, 2009; Jeong, 2009). The Basel III framework was intended to improve the quality and quantity of bank capital, enhance liquidity and leverage ratios, broaden risk coverage, and supplement
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