Research Discussion Papers, Bank of Finland
No 8/1996:
Theoretical Aspects to the Finnish Credit Cycle
Vesa Vihriälä
Abstract: The paper discusses the possibility that the workings of
the financial system contributed the boom-bust cycle in the Finnish credit
market since the mid-1980s. We begin with a review of the most prominent
theoretical arguments about the role of "financial factors". Also the main
findings of a vast empirical literature are summed up. This is followed by
a description of the salient features of the Finnish credit cycle and the
associated banking crisis. The evolution of credit stocks and interest
rates are then analyzed on a relatively high level of aggregation from the
perspective of the theoretical arguments discussed. The main conclusions
are: First, changes in the balance sheets of firms and households very
likely contributed to both the rapid growth of credit in the late 1980s and
its subsequent steep contraction. Second, the observations are also
consistent with the conjecture that supply of bank credit very likely
increased in the late 1980s and contracted in the early 1990 relative to
other sources of credit. Third, some differences observed in the behaviour
of different bank groups suggest that moral hazard related to underpriced
bank liabilities may have contributed to the growth of lending in the boom
period, and problems with capital adequacy may have constrained bank
lending in the early 1990s. Stylized facts are consistent with these
conjectures. However, to reliably infer about these moral hazard and credit
crunch hypotheses, in-depth analysis of bank behaviour with micro data is
required. Similarly, ascertaining the role of borrower balance sheets
requires analysis of borrowers of different characteristics.
Keywords: credit cycle; financial factors; lending policies; moral hazard; credit crunch; (follow links to similar papers)
66 pages, April 2, 1996
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