Bank Credit in Argentina in the Aftermath of the Mexican Crisis: Supply or Demand Constrained?


WP/97/32-EASummary


Following the introduction of the convertibility regime in early 1991, domestic
credit to the private sector in Argentina grew rapidly, in line with the marked
expansion of banking deposits. This close relationship between banking
deposits and credit to the private sector broke down in the wake of the banking
crisis of early 1995. While deposits began to recover in the second half of
1995 and, by mid-1996, had risen to some 15 percent above their pre-crisis
peak, domestic credit to the private sector still stood below end-1994 levels.


Two hypotheses have been raised to explain this mismatch. One is that domestic
bank credit was largely constrained by supply factors: increased adverse
selection brought about by soaring interest rates during 1995 and the sharp
rise in nonperforming loans, together with the loss of information on clients'
creditworthiness resulting from the closing down of a number of financial
institutions, enhanced perceived lending risk. As a result, even though banks.
liquidity position improved substantially, they were more hesitant to extend
new credit to the private sector. An alternative hypothesis is that credit was
largely constrained by demand factors: caught with a relatively high level of
indebtedness as interest rates rose in early 1995, households curtailed their
demand for credit and remained reluctant to resume large-scale borrowing, as
interest rates and unemployment remained high and the debt stock adjustment
unwound slowly.


This paper puts together the empirical evidence pertaining to these hypotheses
and uses a simple econometric model of supply and demand for credit to test
their validity. The results allow some inferences to be drawn about the likely
pattern of bank credit and the strength of the economic recovery in Argentina
in the near term.