Tight Money Periods Research Articles

Signaling through government subsidy: Certification or endorsement

We document the credit transmission channel of monetary policy in China by examining the signaling effect of government subsidies on the credit transmission process. We divide the signaling effect of government subsidies into a certification effect (indicating that firms have good quality) and an endorsement effect (indicating that firms have the recessive guarantee of government). Our results show that banks pay more attention to the endorsement effect of government subsidies when they make credit decisions, especially during tight money periods.

Trade Credit, Bank Credit, and Flight to Quality: Evidence from French SMEs

This paper investigates the impact of the global financial crisis on the allocation of credit to small and medium‐sized enterprises (s). Using samples of rench s from four industries, we found support for the prediction of the flight‐to‐quality hypothesis that in bad times, credit flows away from smaller constrained firms to larger, higher grade firms. We also examined the relation between bank credit and trade credit in terms of two hypotheses: the substitution hypothesis and the complementary hypothesis. The results of fixed effects panel regressions showed that trade credit for small firms during periods of tight money acts generally as complement rather than substitute to bank credit, thus providing empirical support for the redistribution view of trade credit.

Access to Institutional Finance and the Use of Trade Credit

I develop a conceptual framework for analyzing the effect of the availability of institutional loans on firms' demand for supplier (trade) finance. I test for the existence of credit constraints and their effect on corporate financing policies. My empirical results support the hypothesis that trade credit is taken up by firms as a substitute for institutional finance at the margin when they are credit constrained. Further, in line with studies on the credit channel of monetary policy transmission, I find an increased reliance on trade credit by financially constrained firms during periods of tight money.

Bank borrowing constraints and the demand for trade credit: evidence from panel data

AbstractMonetary policy contractions exacerbate credit constraints stemming from asymmetric information, incentive problems and limited collateral. During such periods financial intermediaries reduce the supply of credit to smaller businesses. Although trade credit is a less desirable alternative of corporate financing, it may play a special role in alleviating credit rationing. This paper is an empirical investigation of the interaction of monetary policy, credit market conditions and corporate financing over the business cycle. It provides a simple test of the existence of a credit channel of monetary policy transmissions. Using individual firm data we find that during periods of tight money the proportion of bank‐borrowing constrained firms increases. Borrowing constrained films are found to substitute away from bank credit to trade credit. Such evidence supports the existence of a credit channel of monetary policy transmission: firms do not voluntarily cut bank loans (e.g. because of demand slowdown) since they increase their demand for a less desirable alternative (trade credit). Copyright © 2003 John Wiley & Sons, Ltd.

Internal Capital Markets in Financial Conglomerates: Evidence from Small Bank Responses to Monetary Policy

This paper investigates internal capital markets in financial conglomerates by studying the responses of small banks to changes in monetary policy. I find that if a small bank operates on a stand-alone basis, then that bank's loan growth becomes significantly more dependent on its own cash flows as monetary policy is tightened. In contrast, if a small bank operates under a multi-bank holding company with another bank with easy access to nonreservable funds, then the small bank's loan growth does not become more sensitive to its own cash flows in periods of tight money. My evidence shows that internal capital markets in financial conglomerates relax the constraints faced by affiliates unable to raise funds via liabilities that bear credit risk. Further analysis indicates that internal capital markets have the potential of lessening the impact of Fed policies on bank lending activity. The paper also examines the role of internal capital markets in influencing the investment allocation process of conglomerates. In a sample of constrained (unconstrained) multi-bank holding companies, comparisons across bank affiliates of the same conglomerate show that the funding of new loans becomes less (more) sensitive to affiliate-level cash flows for the worst affiliates relative to the best affiliates following a tightening. My findings suggest that frictions between conglomerate headquarters and external capital markets are at the root of investment inefficiencies generated by internal capital markets.

Inside the Black Box: The Credit Channel of Monetary Policy Transmission

The ‘credit channel’ theory of monetary policy transmission holds that informational frictions in credit markets worsen during tight-money periods. The resulting increase in the external finance premium--the difference in cost between internal and external funds--enhances the effects of monetary policy on the real economy. The authors document the responses of GDP and its components to monetary policy shocks and describe how the credit channel helps explain the facts. They discuss two main components of this mechanism, the balance sheet and bank lending channels. The authors argue that forecasting exercises using credit aggregates are not valid tests of this theory.

Effects of Tight Money Policy on the Availability of Bank Loans to Small Businesses

Despite efforts in the past, the issue of whether tight money policy unfairly discriminates against small businesses remains an unsettled debate. More statistical investigation of the issue seems to offer the only answer to resolve the issue. This paper presents results from a statistical investigation of the financial conditions of small manufacturing corporations. The time-series analysis covering three cycles and one minor slump during '66–67 reveals that commercial banks did drastically reduce the volume of loans to small manufacturers during tight money periods when large corporations demanded more accommodation from banks.

The Horizontal Integration of the Banking Firm, Credit Rationing and Monetary Policy

The purpose of this paper is to derive the implications of horizontal integration of functions within a banking firm for the equilibrium interest rate, the degree and structure of credit rationing and the operation of monetary policy. A banking firm usually handles, besides credit, a number of other activities like demand and time deposits, foreign exchange transactions and in some countries like Israel even brokerage functions. It is widely recognized, certainly within the banking business community, that there is a positive association between the propensity of a customer to generate various businesses in the bank and the amount of credit that he obtains from the bank. Other things being equal, one would expect that such a relationship would imply that customers with more business would obtain more credit or better terms, or both. Empirical evidence on this point supports this implication. For example Harris [3, p. 238] finds that the value of the customer relationship is an important consideration in the allocation of credit to customers. In a related work, Harris [2] finds that the value of a customer as a depositor or a source of collateral business is an important consideration in lending decisions, particularly during tight money periods. In one way or another, credit as a means to influence the demand for banking services facing the bank is implicit in the theoretical literature on banking as well. Hodgman [4] and [5] considers the allocation of credit to customers as a means to increase the size and durability of the customer's deposit with the bank. The long-run value of a customer as a source of deposits and other business as a factor which influences the credit allocation decision of the bank appears also in Kane and Malkiel [8]. The purpose of this paper is to explore the implications of the existence of a positive dependency between the demand for banking services' and the amount of credit granted to a customer, for the nature of equilibrium in the credit market and the effects of monetary policy. This is done for an individual representative bank which operates under oligopolistic conditions since this seems to be the usual market structure of the banking industry in many countries.2 The basic model of a bank which sells credit and a composite banking service, the demand for which is positively related to the amount of credit the bank allocates, is presented in Section 1. It is shown that if the bank is constrained to charge all customers within a certain class the same rate of interest there will be some rationed customers even when the bank sets the rate of interest at its equilibrium level and even if there is no risk of default. Customers who have a higher marginal propensity to buy banking services when granted credit will not be rationed. Those with such low marginal propensities will be rationed. The equilibrium rate of interest will be lower than in a situation with no demand dependencies, the non-rationed customers will get more credit and the rationed customers

What to Do about Savings and Loan Associations?

THE CONCERN PROVOKED for the future of savings and loan associations, with the related problem of efficient housing sector subsidization, may well be the most lasting effect of the tight money periods of 1966 and 1969-70 in the United States. In both the wide-ranging Study of the Savings and Loan Industry directed by Irwin Friend [4] and the policy-oriented Report of the Presidential Commission on Financial Structure and Regulation (the Hunt Commission Report) [8], attention has been focused on the possible insolvency of savings and loan associations in future periods of tight money, resulting primarily from the associations' awkward imbalance between short-term liabilities and long-term assets. In addition, since the savings and loan associations have been a major conduit through which the housing sector has been stimulated, questions of the well-being of the associations have been naturally related to the means for effective government intervention in the housing sector. In the Hunt Commission Report, in particular, besides the general intent of freeing capital markets from regulatory constraints, specific recommendations were made to expand significantly both the asset and liability powers of the savings and loan associations as a solution to their problem. Also,

Should Variable Policy Loan Interest Rates Be Adopted?

The final report of the Presidents' Committee on Financial Structure and Regulation has recommended that serious consideration be given by the life insurance industry to changing a long standing practice of making loans available to policyholders at fixed interest rates, usually 5 or 6 percent. The proposal is to switch to a variable interest rate system under which borrowing rates in life insurance would change with market interest rates. This system has been widely adopted abroad. A major advantage claimed for the proposed system would be to slow down the disintermediation process which has caused some life insurers to lose substantial amounts of investible funds when market rates of interest exceed the fixed rates. It is argued in this paper that the variable interest system might have more disadvantages than advantages for the life insurance industry and for policyowners; it would be no panacea for many of the ills about which certain members of the industry are complaining. For a variety of reasons, discussed below, life insurance companies in the United States have been concerned with the problems caused by the fact that most life insurance policies now specify fixed rates of interest applicable to policy owners who borrow on policies with cash values. In periods of tight money and high open market interest rates, this has produced substantial increases in policy loans and has tended to disrupt the direction of the normal flows of capital through life insurance companies. In the recent report of the Hunt Commission,'' developed after two years of Mark R. Greene, Ph.D., is Distinguished Professor of Insurance in the University of Georgia. Dr. Greene is a Past President of A.R.I.A. This paper was submitted in October, 1972. The author acknowledges with appreciation the helpful comments and criticisms of an earlier draft of this paper by Mr. Abram T. Collier and E. N. Wadsworth of New Enaland Life Insurance Co., and to Dr. John W. Eilert of the professional staff of the Life Insurance Association of America. 1 The report of the President's Commission on study and investigation, specific recommendations on life insurance structures were made, which included one to amend state laws to allow life insurers to issue policies containing flexible policy loan interest rates, subject to appropriate usury laws establishing interest rate maximums. In justifying this recommendation, the

Some Recent Developments in the Savings and Loan Deposit Markets

Savings and loan associations (StLs) hold most of their assets in long-term mortgages while the liability side of their balance sheets is dominated by short-term passbook accounts, which are effectively demand deposits. It is widely recogllized that this structure has caused problems for the industry, particularly during periods of tight money as in 1966 and 1969. When market interest rates rise associations must respond with deposit rate increases if they are to maintain deposit balances. But this is difficult to doS given the fact that they are locked into old mortgages which yield a low rate of return, and for which virtually no secondary market exists. Some progress has been made toward correcting this ;iasset-liability imbalance' through lengthening the maturity of liabilities. Between January 1967 and January 1969, the passbook traditionally employed by the industry were held approximately constant. Over the same period, accounts at S&Ls grew from $13.6 billion to $32 billion, or roughly 235 percent. Like certificates of deposit at commercial banks, these special deposits normally pay a higher rate and have some combination of minimum-term and minimum-balance restrictions. In January 1969, the bulk of special deposits at savings and loan associations had minimum terms of at least six months. Thirty-one percent required the commitment of funds for a year or more [5] . While this is much shorter than the eight-toten year life of a typical residential mortgage, it represents a substantial lengthening over the demand type of passbook account. As a result) studies of these special instruments have found that they have decreased deposit turnover and somewhat im-

Credit Standards and Tight Money

OF THE VARIOUS TENETS1 of the availability doctrine, the one which seems to plague economists most is the thesis that commercial banks will tend to systematically raise tlleir standards of credit worthiness during tight money periods, and to lower them during periods of easy money. While financial practitioners (including the monetary authorities) seem to accept this aspect of tight money as a matter of course, economists llave traditionally been more skeptical. Why, they ask, should a banker pass up the chance to take lligher profits in the form of higher interest rates, and clloose instead to eliminate potential borrowers by imposing a more stringent set of credit criteria?2 A good question. Implicit in it is a concept of the bank as an unconstrained profit maximizer; the bank will not invoke other criteria in loan agreements if its sole concern is with profits. The general nature of the answer must therefore lie in placing behavioral restraints on the bank's activities. Hodgman, for example, finds such a constraint in the prime rate convention, which places a lower bound on the loan rate charged even very good customers.3 The bank is

Corporate Debt Structure and the Differential Effects of Monetary Policy

In the eynesian view, a restrictive moneIn the Keynesian view, a restrictive monetary policy in response to inflationary pressure is designed to reduce aggregate expenditures by eliminating marginal borrowers from the market for loanable funds. Since the monetary authority typically implements a restrictive monetary policy through open market operations and since open market operations serve only to alter the quantity of financial resources available, the responsibility for eliminating marginal borrowers falls primarily upon the commercial banking system. If bank lending rates were sensitive to changes in money market conditions, the borrowers eliminated would tend to be those whose proposed projects were insufficiently profitable to justify debt financing. The fact that bank lending rates tend to be sticky rather than responsive with respect to changes in money market conditions has fostered a suspicion that banks discriminate between large and small borrowers during tight money periods. Although size may merely be a surrogate for other characteristics, this suspicion has prompted at least one investigator to attribute detrimental sideeffects on the market structure of the economy to monetary policy.l Moreover, the

Japan's Interest Rates and the "Grey" Financial Market

JN THE PAST DECADE business investment and national income have grown extremely rapidly in Japan,' and more than half of investment has been financed from external sources. Japan has a highly organized and relatively effective financial system, which on the whole effectively provided the funds for the surge in productive investment. The city banks are at the core of the financial system; they engage in an aggressive, national branch-banking business and dominate in terms of loans, deposits and other indicators of banking activity.2 While individual Japanese financial institutions operate in a generally highly competitive environment, competition is limited by certain major restraints, of which the most notable is the successful government attempt to freeze long-term interest rates. This has produced an official structure relating short-term and long-term interest rates which is distorted relative to that expected under competitive conditions. The purpose of this article is to examine the nature of this distorted interest-rate structure and to trace a variety of marginal market responses to it. Particularly in tight-money periods various unusual and subterranean techniques have been utilized in a grey financial market in an effort to raise effective interest rates and to narrow the disequilibrium between demand for and supply of loanable funds. Some of the broader effects are briefly discussed in a final section. A main focus of governmental controls over interest rates has been on government and private domestic bonds. Five categories of bonds are issued in the capital market. Listed in descending order of amount outstanding, they are: bank debentures (issued primarily by long-term credit banks), industrial bonds (mainly for electric power and manufacturing, plus some for transportation), public corporation bonds (usually guaranteed by the

COMPENSATORY CYCLICAL BANK ASSET ADJUSTMENTS*

MANY STUDENTS OF monetary policy have remarked in recent years on the problem of commercial bank dumping of U.S. government securities during periods of tight money. To put it briefly, the argument points out that short-term government securities may be shifted with a minimum of capital loss when interest rates are high; hence banks, faced with a rapidly loan demand and little or no increase in reserves, may expand their loan portfolios by liquidating Treasury bills. If the new holders of the Treasury bills had previously held idle demand deposits, then idle money is converted to active money via this process. The result is a rise in velocity and hence a weakening of the effectiveness of monetary policy. It is not the purpose of this note to quarrel with the substantive conclusions of the argument cited above. Rather, the point to be made here is that this argument incorporates an erroneous description of the adjustment process of commercial banks-an error that involves some serious consequences for monetary policy. The error lies in the belief that it is primarily their short-term securities that banks liquidate in tight-money periods. Thus, e.g., Warren Smith holds that rising interest rates do not seriously deter commercial banks, which commonly hold large portfolios of short-term government securities, from selling such securities to meet a demand for loans.1 And G. L. Bach and C. J. Huizenga remark that bankers are generally thought to draw first on short-term government securities to obtain loan funds when reserves become tight.2 It will be shown in Section I that it is, in fact, their longer-term governments that banks tend to liquidate during tight-money periods. Section II will consider some of the consequences of this distinction.

THE BANK OF JAPAN: A CASE STUDY IN THE EFFECTIVENESS OF CENTRAL BANK TECHNIQUES OF MONETARY CONTROL*

THE PURPOSE OF this study is to examine the effectiveness of monetary controls by the Japanese central bank-the Bank of Japanand to analyze the relative importance of various instruments of central bank control. The study is concerned with the description and analysis of monetary policy in Japan in the tight-money periods of 1953-55 and 1957-58 only as this is necessary to demonstrate the efficacy of monetary controls in this particular institutional and environmental context. In Part I the hypothesis is examined that Bank of Japan monetary policy can be an effective means of implementing economic stabilization policy, especially in the restriction of realized business investment under conditions of excessive domestic demand. This hypothesis is significant because, (a) given its factor proportions, Japan has had to rely structurally upon imports for economic growth and, (b) given success in meeting capital formation requirements, the major operative constraint on stable growth has been periodic balance-of-payments crises emanating from excessive domestic demand and attendant inflationary pressures. The analysis focuses on corporate business reliance on external funds to finance investment activities and the reliance of the commercial banking system on central bank financing. Internal generation of funds by corporation business has been insufficient to finance the high level of business-planned investment emanating from the rapid growth of the economy. Capital markets have been relatively undeveloped; consequently, business has relied heavily on borrowing from the banking system, especially from the city banks. Under conditions of relatively interest-inelastic demand for funds and relatively low maximum legal lending rates, the availability of funds from the banking system, rather than simply their cost, has been an important determinant of realized business investment.