Testing how banks generate credit in the USA under the Basel III framework

Abstract

This paper revisits the determinants of the loan generating process as it is revealed through the idiosyncratic role of banks, in the case of the United States. Specifically, if banks are primarily mainstream “financial intermediaries”, then their financial role is expressed through a credit growth process emanating from the reserves of banks, in the period before Basel requirements, and from banks' equity during the era of Basel I, II & III restrictions. On the other hand, if banks are primarily “credit and money creators”, as an heterodox point of view would have it, then every proxy of the aggregate demand (AD) needs, is expected to play a leading role in the credit creation process. The innovative liquidity risk ratios, like LCR & NFSR, brought new instruments in this debate thus, extending the alternatives between the two extremes. Hence, the combination of a predominant role for AD needs along with acknowledgment of liquidity restrictions as drivers of credit growth, characterises an eclectic approach. According to our empirical results, credit to both US firms and households, is primarily driven by aggregate demand (AD) factors. Solvency and liquidity risk ratios do play a role, during the examined period but the overall results are closer to the eclectic approach, concerning the role of US banks, which seems to be more encompassing and realistic.