On the empirical side, there has
been quit extensive work in industrialized economies on the relationship
between bank credit, investment and industrial sector development. Most
empirical research in this area focuses on the banking sector for reasons of
data availability. Country specific studies reveal strong evidence of dynamic
interactions between industrial sector development and bank credit in Hong Kong
Gerlach and Peng (2002). The Netherlands de Greed et al (2000), Rouwendal and
Alessie (2002) and United State Quigley (1999). Gerlach and Pench, for example,
found both short term and long-term causality running from general prices and
interest rates to credit but not the opposite. They also highlighted the effect
of regulatory changes on credit expansion. Sanchez, Clarke, Cull and Peria
(2002), using bank level data for Argentina, Chile, Colombia, and Peru over the
mid 1990s, examined the impact of foreign bank entry on the
share and growth rate
of credit to small firms. Consistent with evidence from the US they found that
medium and large domestic banks in the four countries devote less of their
credit (as share of total credit) to small firms than small domestic banks.
Also, in most countries, the share of credit devoted to small firms by domestic
banks was dropping in the late 1990s evidenced by the negative and significant
trend in the share estimations. Contrary to popular belief, public banks do not
appear to surpass private banks in the extent to which they give credit to
small firms. This would seem to indicate that the argument that privatization
of public banks would hurt small firms is at best weak. Regarding the impact of
foreign bank entry on credit to small firms they found, consistent with
conventional wisdom, that on average, foreign banks in he four countries generally
gave credit less to small firms (as share of total credit) than private
domestic banks (at least by end of period). However, the difference appears to
be primarily due to the behaviour of small foreign banks. In all four cases,
small foreign banks gave credit, considerably less to small firms than small
domestic banks. In contrast, the difference was considerably smaller for large
and medium sized banks. In fact, after controlling for other factors that might
affect credit, large foreign banks actually appear to give more credit to small
firms (as share of total credit) than large domestic banks in two of the four
cases study countries, Chile and Colombia. Finally, in Argentina and Chile, the
two cases were the ratio of banking sector assets to GDP consistently grew over
the sample period, credit to small firms by medium and large foreign banks was
positive and was growing more quickly than for similar domestic banks.
In contrast,
credit by small foreign banks was shrinking and was growing far more slowly
than for similar domestic banks. Quigley (1999) showed that the history of
business activities and products/services prices play an important role in
their determination and not merely fundamentals. He also suggested that moral
hazard and over credit drive prices of goods and services as well as property
price bubbles, for example in East Asia in the 1990s. Hofman (2001) looked into
a panel of sixteen (16) countries and found evidence that bank credit and house prices
have a significant two-way interaction in the short run but that long run causality
is from property prices to bank credit. Goodhart (1995) investigated the role
of house prices in determining credit growth in the United Kingdom and the United
State. He found that changes in house prices significantly affected credit
growth in the United Kingdom but not in the United State. There are also a few
studies based on asset prices that include a mix of residential and commercial
property prices (generally with a much higher weight of residential property).
Goodhard (1995) explained credit conditions with asset prices while Borie et al
(1994) explained asset prices with credit conditions (debt/GDP ratio), and both
found significant result.
Hofman (2001) included a mixture of residential and
commercial poetry prices in a vector error correction model (VECM) structure
and again finds a strong dynamic interdependence between bank credit and
property prices with the later being the causal element. He also found that
fluctuations in bank credit and property prices are jointly determined by
changes in real short-term interest rates. He notes that a difficulty with most
macro level work including his own is to distinguish between credit demand and
credit supply effects of real estate prices, both of which may be operative.
Recently, Borie and Lowe (2002) have shown that credit growth and property
prices have predictive power over financial instability using the Kaminsky and
Reinhard (1999) framework, Pugh and Dehesh (2001) argued that financial
liberalization has contributed to a closer interdependence between property and
industrial sector developments in a number of countries since the 1980s. In
addition, some recent studies have looked into the real effects of house price
fluctuations. Work by Higgins and Osler (1997) and Helbling and Terrones
(2003), found that house price busts cause reductions in output, especially in
bank-based financial systems. Hendershott and kane (1992) noted that the early
1990s credit crunch in the United states could be partly attributed to capital
rebuilding by financial institutions that had made large real estate loses.
Moreover, on the demand side, the recession itself may have linked to a
collapse in investment reflecting excessive capital formation in terms of real
estate.
Ludwig and Slok (2002) suggested that, in market-based economies,
housing prices tend to have a significant effect on consumption, similar is
provided by Boone et al (2001) and Barrell and Davis (2004). Furthermore, Choi
and Smith (2002) extended existing real option theories by incorporating the
stochastic interaction between unit price and cost, applied in commercial bank
credit. They further empirically examined an implication derived from the model
as to the relationship between credit practices in the banking industry and
future uncertainties. They focused on
credit institutions to analyse the effect of uncertainties on credit
(investment) decision for several reasons. For it is easy to identify the main source
of uncertainties for the assets and liabilities of the financial
institutions-default risk and interest rate changes. Second, the commercial
credit institution provides a unique environment in which the correlation
between investments cost (Liabilities) and output (loans) prices is quite high
and positive since both depend heavily on interest rates. In all, bank credit
may be subject to a high degree of irreversibility (e.g substantial loss in
defaults). The real option model explains the relationship between levels of
credit, loans-to-assets, and the uncertainties regarding interest income and
expense cross-sectional credit activities, which confirms the importance of
risk management. These results also showed that as banks increase one type of
risk, e.g. interest rate risk. The risk as measured by loans/assets.
Esterly, (2005) found that repeated
structural adjustment credit from either the World Bank or the IMF failed to
produce improvement on multiple macroeconomic outcomes including industrial
growth.
According to the theories of
corporate credit or finance, there are three main categories of sources to
finance the investment: first the internal finance, which depends on the
retained earnings of the firm, the only cost of this kind is the shareholders
return and the opportunity cost of this fund. Second, debt finance, this kind
may be secured debt or unsecured debt, which include loans, bonds, this cost of
these kinds represent in the interest payable plus any premium on repayment.
Third equity finance, share issues, ordinary and preference, the cost of these
kinds are earning price per share (EPS) and fixed dividend company should not
only alter its capital structure to take advantage of changes in the explicit
and implicit cost of various source of finance, but also to maximize control
and capital gearing for the company. External factors represented by the degree
of the development of the financial system and the changes in its structure
affect the investment decision Modighani and Miller (1958).
According to the theory of
investment, in the absence of financial restriction, firm investment depends on
the (q ratio) or the q value of the firm, which equal to the market value of
the firm to its replacement value, Jorgensem (1971). When the firm faces
constraints on external finance its internal resources will determine its
investment. The degree of leverage of the firm (debt to capital ratio) also
depends on the development of the financial sector and its structure. When the
firm faces imperfect financial market this ratio decline and deter the
availability of external finance, even after controlling the q value,
Francisco, Norman, Loyza (2008). Therefore, we assume that the firms face
better function of financial system when investment is more responsive to q
Tobin. Investment is less determined by the firm cash flow. Investment is less negative
affected by the firm liability composition. There are a lot of applied
literature investigated on this issue, due to financial liberalization and the substantial
change in the structure of the financial market they concentrate on the effect
of such change on the growth and investment at the firm level
.
The most recent literatures are the
study of Marten Comelmen: describe the developments that have transpired in
Mexico’s financial structure over the last two decades. Then he analyzed how
the increase in credit to the private sector brought about by these
macroeconomic and financial developments affected output and investment in
different sectors and therefore, growth in the Mexican economy. He used the
Vector Error Correction methodology to show that an increase in the
availability of credit has a relatively large effect on the output of those
sectors such as manufactures, durables, construction, and investment in the
construction sector. The study of Babatz and Conesa, (1997) used macro economic
data to analyze the importance of financial factors on capital formation, they examined
whether the privatization of banks 1991 has a significant effect on how
different types of firms finance investment. They used data for 71 stock listed
companies over the period 1994. By selecting a prior those firms, which were 24
more likely, to be financially constrained to use internal sources of
financing. They found that larger firms experienced significant relaxation in
their financial constraints.
Rene (2000), in his paper examined
how a country’ financial structure affects economic growth through its impact
on how corporation raise funds. The paper defined country’s financial structure
to consist of the institution, financial technology, and rules of the game tat
define activity as organized at a point in time. It emphasized that the aspects
of financial structure that encourage entrepreneurship are not the same as
those that insure the efficiency of established firms. Financial structures
that permit the development of specialized capital by financial intermediaries
are crucial for economic growth.
Fancisco, et al., (2008) analyzed
the changes in both the access to financial markets and the financing (balance
sheet) decisions in a sample of Chilean firms. The sample consists of 79 firms
that are quoted in the stock market. The paper estimated and tested
econometrically by OLS and GMM approached three issues. The first is whether
the firms’ reliance on internal funds for investment has decreased in the more
financially open period of the 1990s relative to the 1980s and, thus, whether
investment has been more responsive to changes in the q-value of the firm. They
examined whether financial liberalization and the development of the banking,
stock and bond markets at the maturity of debt in the balance sheet of firms.
They studied the extent to which firms specify and how aggregate financial
market developments have impact on firm growth. They concluded that financial
developments at the macro level indeed had an impact on the firm access to
capital markets their financial structure and their rate of growth.
Gelos and Werner, (1999) used
plant-level data from the Mexican manufacturing sector, they find that cash
flow is significantly correlated with investment before and after financial
liberalization contributed to easing financing liberalization contributed to
easing financing constraints for small firms and therefore to higher investment
levels by increasing the availability of credit to these types of firms. They
also found that collateral, in the firm of real estate, played an important
role in determining investment especially after 1989.
Lan, Jack, and Ananth (2000)
examined the dynamics of external corporate financing choices in an
international context. It analyzes jointly the reliance on domestic versus
foreign financing and debt versus equity financing using panel-data on 30
countries from 1980-1997. The results shed light on current debates regarding
the choice of debt and equity financing choices. In particular, privatization
activity is initially followed by foreign equity issuance, but eventually lead
to a higher level of domestic bond issues. Further, they found that
macroeconomics stability is highly correlated with the choice of financing.
In particularly, they found no evidence that firms use external
financing differently if they are in countries classified as bank based or
market based, on the basis of the development of their banking sector relative
to their securities markets. They also found that securities market and bank
development have a different effect on the type of external finance firms
obtain, particularly at relative low levels of financial development. In those
countries where the legal contracting environment predicts a high level of
development for securities markets, more firms grow at rates requiring long
term external finance. They did not find the same effect for predicted bank
development, differences in contracting environments that affect the relative
development of the stock market and the banking system may have implications
for which firms and which projects obtain financing. Laporta, lopez-de Silanes,
Shleifer and Vishny, (1999), Modigliani and Perotti (1998), argued that the
legal system in a country is a primary determination of the effectiveness of
its financial market based and bank based. Financial systems may not be of
primary importance for policy in the absence of a strong legal system that can
protect the rights of external investors, which financial transactions are
intermediated through.