Some research effort has been
devoted to examining the linkages between financial instability and down turns
in industrial growth. One major observation is that money market booms and busts
have preceded banking crises not only in developed countries (ECB, 2000). Davis
1995 but in emerging market economies as well (Collyns and Senhadji (2002),
Davis (1999), Renaud (1999). Based on the above hypotheses of financial sector
cycles, there are at least three dimensions of interaction between industrial
growth and commercial bank credit. First, bank interest rates may affect the
volume of bank credit for various reasons. From the borrowers’ point of view,
changes in the interest rates of banks will have a large effect on their
perceived wealth and borrowing capacity, inducing them to change their
borrowing plans and credit demand (given positive
costs of bankruptcy when net
worth becomes negative).
The low liquidity and interest rate volatility of
various bank services/products should induce caution among borrowers in taking
full account of loans for credit rises. However, from the banks’ point of view,
banks have been involved in financial markets not only directly by owning
investment loans, but also by providing credit that are collateralized by
assets. Giving credit to property and construction companies along is one of
the most procyclical and volatile elements of banks’ provisioning (Davis,
1993). Accordingly, adding these mechanisms together, changes in property
prices will have major impacts on banks’ asset quality and the value of bank
capital, and therefore affect banks’ credit capacity. Banks are willing to
provide more investment credits and property prices are higher, generating a
propagation mechanism through which credit cycles are strongly linked with each
other. Such a cycle may be exacerbated by capital inflows intermediated by
domestic banks, as in East Asia in the mid 1990s, as well as poor regulation
(Collyns and Senhadji, 2002).
A further complementary effect may operate via
the above mentioned financial accelerator mechanism, whereby credit givers
become less concerned about moral hazard and adverse selection when net worth
is high, as borrowers have more to lose from default. This implies that changes
in asset prices over the cycle gives rise to procyclical feedback effects of agency
costs on the cost of external finance and hence on real corporate expenditures.
This channel might be more powerful if banks tend to underestimate the default risk
of investment related loans in a business boom and the moral hazard to which
borrowers financing business investments are subject. In practice, this
tendency can be the result of various factors, including poor risk management
practice, inadequate data or pervasive incentives of banks, including moral
hazard linked to the safety net (Herring and Wacher, 2002). Second, bank credit
may affect industrial development via various liquidity effects. Changes in
credit availability and credit attitudes have a sizable impact on the demand
for real investment decisions, which will ultimately lead to changes in
economic prices. Zhu, (2002), it has been widely documented that floods of
capital seeking investment opportunities and the industrial competition among financial
institutions after financial deregulation helped to stimulate the building
frenzy phenomenon in a number of countries in the 1980s and 1990s, Davis (1995)
and Demirgue-Kunt and Detragiache (1998), Hargraves et al (1993) note in
addition that financial liberalization tends to derive the higher quality corporate
borrowers to the bond market and depositors
to money funds, thus leading banks to take excessive risks to re-establish
margins.
Finally, credit cycles can be driven by common economic factors. Its behaviour
is largely determined by economic conditions and prospects (notably GDP and
interest rates). On the other hand, the state of economic activity also exerts
important forces on the money market. Changes in the business environment will
cause demand and supply imbalances in commercial property and generate
variations in investments and prises. These external shocks can arise from the
demand side, such as changes in income. Interest rates and demographic factors;
or they can arise from the supply side such as input costs as well as changes
in restrictions enhancing the availability of credit or land for development
(Dokko et al 1999), Chen and Patel (1998). Financial disclosure and business
information transparency is a critical element in ensuring more stable capital
flows. Effective debtor-creditor and insolvency regimes are critical to
absorbing business failure and releasing assets for productivity use, hence
bank credit are essential ingredients in overcoming industrial sector crises,
IMF (2004). Commercial bank provides resources for social sector programmes to
reduce the impact of poor infrastructure on industrial crises. In the Republic
of Korea, banks helped the government create a financial supervisory commission
and a financial supervisory service combining four regulatory agencies. Banks
are helping the government support numerous small no medium enterprises, which
are under stress from the financial crises, in restructuring liabilities and
increasing their demand for credit. In Thailand, banks helped recapitalise
other financial intermediaries, strengthen the legal and regulatory framework
for the financial sector, and stress to specialized financial institutions
capacity to increase credit in order to ease credit contraction. Outside East
Asia, banks have provided credit or non-credits services with some degree of
financial sector vulnerability, including financial sector assessment policy
reviews and intensive dialogue with government authorities.
There are many reasons why formula
provision of financial services may be limited in Nigeria and other developing
countries, even after liberalization. High levels of government debt have often
constrained access to credit for private firms and individuals, and high
inflation has discouraged saving. Poor physical and institutional infrastructure
(e.g intermittent electricity supplies, inadequate telecommunications services,
weak institutions for contract enforcement etc) raise the cost of provision, particularly
to poor and rural areas. At the same time, poorer people have no collateral or
credit record and many countries lack credit bureau, all of which serve to
deter credit giving. Regulatory requirements that guard against money
laundering can also make it difficult for poor people to open a bank account,
as they may not have the necessary documentation. Thus widening access to
financial services may simply be unprofitable in many cases. Indeed, given the
many types of market failures present in financial services, the market is likely
to under-provide. It is also the case that weak competition policy in some
countries has results in quite a concentrated financial sector even after
liberalization, allowing high spread to persist, which blunts incentives to
expand access to unfamiliar and risky market segments, even where they may be
potentially profitable. And a lack of detailed information about the
characteristics of these market segments has made it difficult for financial
institutions to correctly assess the costs and risk associated with expanding
access to credit.