Identifying the Demand and Supply Effects of Financial Crises on Bank Credit—Evidence from Taiwan

Abstract

In the aftermath of the Asian financial crisis, Taiwan's bank credits slowed down dramatically while the economy experienced one of the worst recessions in recent history. Whether the slowdown was mainly caused by the demand or the supply effect is unclear. An innovative empirical approach is adopted that uses the short‐side rule of bank loans' market transactions to help infer the relative shifts of the demand and supply. For the disaggregate data, a novel model is proposed that accommodates the short‐side rule and yet requires only data from the borrowers or the lenders. We find that a large decline in supply is mainly responsible for the slowdown, and we identify the deposit drain and the increase in overdue loans as the main contributing factors. Results also indicate that smaller firms are disproportionately affected by the credit cutback, and that shrinkages in alternative financing sources might have indirectly contributed to the excess demand.