Política de precios

A number of hypotheses on the interest-based bank pro-cyclicality can be extracted from the literature. Theoretically, Gertler (1988) and Gertler and Gilchrist (1993 and

1994), supported by Kashyap and Stein (1994) and Bernanke and Gertler (1995) emphasise on the interest-based bank debt and the role of market imperfections. They used the bank debt and the role of market imperfections framework to estimate credit market equilibriums to test for the credit channel hypothesis and the relevance to a credit crunch incident.

Bernanke’s and Lown’s (1991) analysis of the United States credit crunch episodes, by controlling the stages of the business cycle and previous five recession occurrences from the 1960s, documents the decline in the supply of credit for the 1990-91 recession. They show that the causes for the interest-based bank to cut the loan supply of the 1990s are related to the combined effect of shortage of financial capital and decline in the quality of borrowers’ financial health. In their analysis, they compared the contraction in credit during 1990-91 recessions to those in the previous recessions and they concluded that there had been a credit crunch.

Through their survey, the total loans at domestically chartered commercial banks grew at an average of 7.1 percent during the previous five recessions, compared to the period during the 1990-91 recessions when it grew only by 1.7 percent. This reduction in lending activity according to Bernanke and Lown (1991), attributed to the supply and demand factors. The supply of credit had reduced because of a decline in the interest- based bank capital caused by severe loan losses during the recession. Concurrently, the borrowers’ balance sheets had been weaker than normal, thus, the borrowers became less creditworthy than usual. As a result, market loan demand started to decline.

Earlier, Guttentag and Herring (1984) emphasised on the ‘disaster myopia’ syndrome that made the interest-based banks tend to underestimate the probability of shocks over time. The interest-based bank might underestimate the risk exposure and ease the credit

standard during economic expansion and might increase the magnitude of losses when the economy contracted. They emphasised on the creditor behaviour in formulating, and acting on the shock probabilities rather than the business cycle as the mechanism through which the vulnerability of the system might increase. They also argued that an abrupt increase in the extent of credit rationing was the central feature of a financial crisis. They showed how risk premiums were set in competitive markets in response to subjective probabilities of credit shocks. They also demonstrated how the moral hazard could lead to the credit rationing and the imposition of minimum capital requirements.

Rajan (1994) hypothesised that the interest-based banks’ management was obsessed with short-term concerns and perception of reputation and this is relevant to the ‘herd behaviour’ model. His paper argues that rational interest-based bank managers with short horizons will set credit policies that influence and be influenced by other interest- based and demand side conditions. Evidence of the interest-based banking crisis in New England in the early 1990s was consistent with the assumptions and predictions of his theory. This leads to a theory of low frequency business cycles driven by the interest- based bank credit policies.

Asea and Blomberg (1998) provided another set of views. During strong economic condition added with low default rates, the interest-based bank had the inclination to enlarge their portfolios in business loans exceeding the prudent level. Their view held that the interest-based bank loans underlying quality might deteriorate during economic expansions. Excess levels of lending volume increased the problem of adverse selection of drawing in an unwarranted volume of bad loans. This positioned the bank of higher than expected default rates that subsequently brought about an unnecessary tightening of the interest-based bank lending. The economy then slowed down as credit tightened.

Van den Heuvel (2002), based on the hypothesis of an imperfect market for the bank equity mentioned that the bank capital channel contributed to the fluctuations of the bank profitability. He addressed the issue of the effect of bank capital and its regulation on the role of interest-based banks’ lending in transmitting the monetary policy. Following the bank capital channel view, the monetary policy will affect the interest- based bank lending through its impact on the bank equity capital. Increases in interest rates will lower the bank equity even further, causing some interest-based banks cut lending to reduce the risk of capital inadequacy.

Results from simulating the calibrated model, Van den Heuvel (2002) from the perspective of optimal monetary policy, suggested that the economic amplification size was large to moderate. Perhaps the dynamics of the effect and size were highly dependent on the distribution and initial level of capital among the interest-based banks. Van den Heuvel’s (2002) reasoning is that the capital requirement affects the interest- based bank behaviour more when the interest-based bank equity is low.

Another model explaining the pro-cyclical behaviour of the interest-based bank is the ‘unifying model’ by Bliss and Kaufman (2002). The model emphasises on two constraints to credit expansion and contractions, the capital requirement and reserved requirement. If either constraint is binding, earning assets could not grow further. During the period of economic recession and monetary expansion, capital constraint implication may become the binding constraints on the interest-based bank. Reserve requirements, which are under the central bank control, are the likely effective constraints on interest-based bank during periods of economic boom and restrictive monetary regime.

Berger and Udell (2003) through the ‘institutional memory hypothesis’ explained that the current loan officers ease of credit standards over time creates the pro-cyclicality of interest-based bank lending. Loan officers obtain the skills to identify poor loan risks of recession but as the recessionary economic environment recedes into the past, they gradually lose this skill. The previous loan bust is not remembered with loan officer turnovers. Deterioration in the capability of loan officers will result in an easing of credit standards. The loan officers’ attempt to lower the loan standard will deteriorate the loan quality and creating for high default rates when the economic condition reverses. Berger and Udell (2003) provided empirical analysis to support for the hypothesis. This view is consistent with the persistent weakness for the volume of business loans as the economy enters the recovery phase of an economic business cycle.

Bank for International Settlement (2001b) on the other hand, describes the contribution factor of the pro-cyclical manners of the banking sector and the financial system is the improper banks risk management policy. The failure of treating the time-dimension of risks correctly by the money market participants causes the pro-cyclical behaviour. The money market participants in general fail to assess the progression of risk over time accurately. The financial institutions even fail to act based on the appropriate assessment even though they are able to determine the time-dimension of a certain risk correctly. Bank for International Settlement (2001b) also explains that the incentives affect the attitude of market participants and the regulatory environment as well contributes to the pro-cyclical behaviour.

Laeven and Majnoni (2003) supported by many researchers such as by Bikker and Metzemakers (2005) and Bouvatier and Lepetit (2008) argued that the bank loan loss provision also played a part in contributing to the interest-based bank lending cyclicality. They empirically showed that many interest-based banks all over the world

delayed their provisioning for loan losses and bad loans until it was too late. When the economic condition reversed, it magnified the economic downturn impact on the interest-based banks’ returns and capital.

Bikker and Metzemakers (2005) and Borio et al. (2000) study shows that banks provisioning for loan losses turned out to be substantially higher when the real gross domestic product growth was lower. This reflected the increase in risk of the credit portfolio when the economic condition was at a downswing trend that increased the risk of a credit crunch. This observable interest-based bank pro-cyclical behaviour of upswings or downswings of business cycle are the progression of interest-based banks’ provisioning for loan losses policy (Laeven and Majnoni, 2003).

The banks’ ratio of loan loss provisions to total loans decreases in the economic upswing event with the increase in economic activities and consequently the costs of provisioning decreases. While during economic downturns, the ratio and costs increase quickly and significantly. Therefore, erosion of the interest-based bank earnings immediately accompanies the turning point in business cycles with an abrupt decline in banks’ inclination to take on risk. Then, this is followed by a decrease of credit supply. Then, banks’ began restructuring on their lending portfolios to increase security as well as an adjustment of banks’ risk pricing by increasing the interest rates.

Summarising all the hypotheses explaining the pro-cyclical behaviour of the interest- based bank lending is related to the misevaluation and misestimating of the credit risk and liquidity risk over the business cycle phases.

The hypotheses model of the pro-cyclicality behaviour of interest-based bank lending activity is summarised in Table 2.1 below.

Table 2.1: Interest-Based Bank Lending Pro-cyclical Behaviour Model

Researcher/s Model Bank Pro-cycle Variables

Guttentag and Herring (1984) Disaster Myopia Syndrome. Underestimate the probability of shocks and the risk exposure.

Economic Expansion: Ease the credit standard.

Economic Contraction: Increase the magnitude of losses Loan Supply Bernanke and Lown (1991) Credit Channel Hypothesis. Combined effect of shortage of financial capital and declining in the quality of borrowers’ financial health.

Economic Contraction: Borrowers’ balance sheets weaken; Loan demand weaker, borrowers less creditworthy than usual.

Decline in bank capital caused by severe loan losses during recession; Supply of credit reduced

Loan Supply and Loan Demand Rajan (1994) Herd Behaviour Model.

Manager’s with short horizons

Bank’s Manager short horizons set credit policies that influence and being influenced by other banks and demand side conditions.

Loan Supply and Loan Demand Asea and Blomberg (1998) Underlying Quality of Bank Loans. Business loan supplied beyond a prudent level.

Economic Expansion: Excess lending activity creates adverse selection problem inordinate volume of bad loans.

Economic Contraction: Sets higher- than-expected default rates when the economy slows. Loan Quality Van den Heuvel (2002) Bank Capital Channel Hypothesis. The imperfect market for bank equity.

Bank capital and its regulation affect the role of bank lending. Increase in interest rates lower bank equity, causing some banks to cut lending to reduce the risk of capital inadequacy.

Bank capital and profit- ability Bliss and Kaufman (2002) Unifying Model. Capital requirement and reserved requirement constraints on credit expansion and contractions.

Either constraint is binding earning assets cannot grow further.

Economic Expansion: Reserve are the likely effective constraints on banks.

Economic Contraction: Capital constraint implications may become the binding constraints on banks.

Bank Reserve and Capital Berger and Udell (2003) Institutional Memory Hypothesis.

The ability of loan officers deteriorate over the bank’s lending cycle

resulted in an easing of credit standard.

Economic Recession:

Loan officers gradually lose the skill to recognize poor loan risks as the recessionary economic environment recedes into the past.

Loan officers’ turnover, previous loan bust is not remembered. They begin lowering standards, and loan quality deteriorates, setting the stage for high default rates at some future date.

Loan Risk Quality

Table 2.1: Interest-Based Bank Lending Pro-cyclical Behaviour Model (continued)

Researcher/s Model Bank Pro-cycle Variables

Laeven and Majnoni (2003) Loan losses provisioning policy

Loan loss provisions to total loans ratio and costs of provisioning. Economic Expansion: decline

Economic Contraction: increases quickly and significantly

Provision for Loan Losses

Table 2.2: Islamic Bank Financing Behaviour Model Islamic Scholars View Based on Quran and Hadith – Divine guidance Shariah compliant instruments

Application of interest-based instrument that resemble the characteristics of usury.

Not free from exploitation and excesses brings unfairness and unjustness to parties involved financial transaction.

Involvement of speculative trading, ambiguous financial transaction and financial risk trading Unethical investments and consumption spending loans make the operations within immoral value structure.

Non-asset backing in financial transaction.

Financing supply