Revisiting the credit crunch of 1990s: An empirical evidence

Several studies in the literature have tried to assess the impact of capital adequacy on credit crunch in early 1990s. They have either relied on the macro level banking data or regional data for their work. In this paper, we analyze the connection between the new risk based capital requirements (RBC) and the credit crunch using state-level panel data for 50 states and the District of Columbia (annualized) from 1979 to 1996. The data indicated that commercial banks in the US reduced lending from mid 1989 through first quarter of 1992. It is not apparent whether reduced bank lending resulted from a precipitous drop in loan demand exacerbated by the weakening state of the economy; or whether the loan decline was due to the credit crunch following the introduction of the new RBC requirements. We use both the fixed-effects model and the random-effects model on the longitudinal data. The empirical evidence shows the relationship between bank loans and new regulatory changes suggesting that supply side effects dominated the result.