Slowdown in Bank Credit Growth: Aggregate Demand or Bank Non-Performing Assets?

This paper tests the bank lending channel against the aggregate demand channel as an explanation for slow credit growth by estimating the determinants of credit and of non- performing assets (NPAs) using three types of data sets: a quarterly macroeconomic time series, a bank panel on advances and NPAs and a firm level panel. The results suggest demand was and remains the key constraint for credit. Only demand variables affected corporate credit for a broad set of firms-sales and inventory were the only significant variables. Only for a subset of indebted firms in a difference-in-difference type analysis, did lagged credit and assets reduce credit, even so sales remained the dominant variable. From the bank panel gross NPAs did not have a negative effect on advances but the Asset Quality Review did have a strong negative effect. NPAs fell with growth, increased with repo rates and with past advances. Therefore, while high interest rates and low growth raised NPAs, so did past credit. If the priority is to revive assets and get credit flowing again, the valuable deadline imposed by the new bankruptcy code must be supported by flexibility in restructuring, funds infusion in PSBs, and easing of macroeconomic conditions.