Credit Procyclicality and Financial Structures in EU

Abstract

This paper empirically analyzes the linkages between credit procyclicality and financial architecture in Europe over the time period from 1999 to 2012 using panel VAR model with interaction terms. This framework allows to make response of credit to an real activity shock conditional to the financial structure of the different economies. Based on financial accelerator theory, we presume that 4 indicators of country's financial architecture (bank competition, bank business model, nature of the financial system as well as risk-weighted capital) can mitigate asymmetry information problems and alleviate incentives to risk-taking. Our findings show that bank competition, bank-based financial system as well as well capitalized system imply a weaker procyclicality of bank credit, that we consider as an evidence of a higher stability. Results for bank business model are more mixed. The findings suggest that financial structures matter for stability and for business cycles. Since we assume procyclicality as a measure of instability, our contribution is related to the literature analyzing the effects of financial structures on stability.