Greece Macro Monitor (11 Dec 2013): An Empirical Study on the Bank Lending Channel in Greece & the Euro area

Banking, Finance — By on December 12, 2013 at 7:36 PM

Platon Monokrousos

Bank credit supply in Greece: determinants, recent developments and outlook

This paper constitutes an update on our earlier study on the functionality on the monetary policy transmission mechanism and the bank lending channel in Greece and the euro area (see Monokroussos, M. and D. Thomakos, 2013a, Monetary Policy Transmission Mechanism and Bank Lending Channel in the euro area – Greece case study).

The paper presents a cross sectional study on the relation between bank credit and output in the Eurozone, tackling the endogeneity issue in a framework originally proposed by Driscoll (2004) and later applied by L. Cappiello (2010) to the euro area economy. In line with a number of earlier empirical studies, our results provide strong evidence supporting the existence of a banking lending channel in the euro area. Specifically, country-specific money demand shocks have a significant effect on the growth of loans, which effectively implies that the level of bank deposits is indeed a key determinant of loan supply.

Furthermore, the supply of bank loans has a significant effect of on GDP and other real economic variables. In more detail, a panel analysis of a group of five euro area countries that have been particularly hit by the sovereign debt crisis (Greece, Portugal, Ireland, Spain and Cyprus) shows that, a 1 percentage point increase in domestic bank loan growth relative to the cross-section average leads, after a quarter, to a rise of between 0.2ppts and 0.47ppts in Greece’s real GDP growth above the respective cross-sectional average (and vice versa).

Separately, our SVAR model estimates imply that a decline (increase) in the average Greek bank loan interest rate by 1ppt can lead to a cumulative boost (contraction) in real GDP growth by around 0.3ppts over a 4-quarter period.  By and far, our empirical results demonstrate the crucial role bank credit can play in the recovery of the Greek economy, following a 5 year-long severe recession.

Furthermore, our finding reinforce the need for a close monitoring of credit developments in the context of monetary authorities’ ongoing efforts to restore the proper function of the monetary policy transmission mechanism. In line with the said results, our analysis takes a closer look at the determinants and the outlook of bank credit in Greece and argues that, under certain conditions, a switch to positive credit creation is possible from 2015 onwards.

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