Modeling the Demand for Bank Loans by Private Business Sector in Pakistan

Modeling the Demand for Bank Loans by Private Business Sector in PakistanByFaiza HassanPhD Student at PIDE , Lecturer, Department of Economics, University of Malakand

Prof. Dr. Abdul QayyumJoint Director, Pakistan Institute of Development Economics

1Introduction The impact of bank credit on macro-economic fluctuations has always been a topic of interest in monetary economics (Meltzer and Brunner 1963)2Moore & Threadgold (1985) argued that

money supply is credit-driven and Demand-determined

at the rate of interest determined by the central bank the money supply function is horizontal.

Coghlan, 1981; Moore 1979, 1983 illustrated that Quantity of bank borrowing is largely demand determined 3 4567 Source: SBP, Financial Stability review 2009-10 page 1458Year(Amount in billion Rupees)BanksIPO*TFC*20025250.14.720036072.519.5200487321.70.0200510769.86.6200612703.03.0200715204.94.0200820166.912.6200920651.10.0Pakistans Private business sector preferences for bank Credit

Sources of Corporate Financing in Pakistan

Objectives of Study9The basic purpose of the study is to analyze the long run and short run dynamics of demand for bank loans by private business sector in Pakistan for the period 1971 to 2010.

To investigate whether increased economic activity have positive or negative impact on the demand for bank loans

To observe the effect of real rate of return on advances

To analyze the effect of inflation on demand for bank loans by private business sector

To examine the effect of macroeconomic risk, foreign demand pressure, future state of economy on bank loan demand by private business sector

10Literature Review 11First category: studies that estimate credit demand as system

Two reduced form equations are estimated one for credit demand and other of credit supply Meltiz and pardue (1973)

122nd category: studies which determine demand for bank loan under equilibrium conditions.

In this approach, a single equation is derived by simultaneously solving the demand and supply equation and by assuming that loans corresponds to a level where demand and supply are equal or are in equilibrium. Hicks (1979) and panagopoulos & Spiliotis(1998)13The Disequilibrium ApproachDemand and supply equations are estimated separately and following Maddala and Nelson(1974) derived the likelihood function. These studies assume that observed quantity of loans are minimum of demand for loans and supply of loans. Laffont & Garcia(1977), Blundell-wignall and gizycki(1992) and Ghosh & Ghosh (1999) followed this approach 14Estimation of demand curve in Isolation from supply side of Market

In these studies supply equation is not estimatedit is assumed that at a specific interest rate, credit to private sector is determined by demand in the market15Moore (1983), cuthbertson (1985)Moore and threadgold(1985), Arestis(1987-88), Arestis & Biefang-Frisancho(1995), Calza, Gartner, Suosa(2001), Qayyum(2002), Vera.V Leonardo(2002), Pandit & Vashisht(2011) 16Studies with reference to Pakistan

There is a single study over the topic in Pakistan by Qayyum(2002)

In the study short run and long run dynamics of demand for bank loans by private business sector are analyzedThe real rate of interest, inflation and industrial output were taken as the main determinants of demand for bank loan17

Theoretical Model18 RDBL = f ( RRA , EA, , FDP, INF , MER , EFSE)

19Interest rate charged on bank loans Interest rate is the variable included in every study of demand for bank loan

Hicks(1979), Moore (1983), Cuthbertson (1985), Ghosh & Ghosh(1999), Qayyum(2002) ................ each and every study included interest rate

20Economic ActivityIndustrial output index is used as indicator of economic activity

There are two distinct views in literature about relationship of demand for bank loans and economic activity21Kashyap, Stein and Wilcox, (1993)

Suggest positive relationship

22Friedman and Kuttner (1993) and Bernanke and Gertler (1995)Proposed a negative relationship

23 Foreign Demand Pressure

To see the effect of foreign demand pressure on demand for bank loans by private sector, indices for Volume of Exports are included in the model24InflationIf increase in inflation > increase in interest increase in inflation compensates the effect of increase in interest rate.

On the other hand

High level of inflation increases the riskiness of projects ( negative relationship)

25Macroeconomic RiskNegative relationship is expected between macroeconomic risk and demand for bank loans

Variance of Moving Average of Inflation is used.

Vera(2002) has used the same for measuring macroeconomic risk26Expectations about future state of the economyStock price indices give signals about expectations of most informed group about future situation of the economy.

Moving average of share price indices is used to approximate Expectations about future state of the economy.27Model of Demand for bank loans by private business sector 28Autoregressive distributed lag model (ARdl)

ARDL approach is found appropriate for data analysis

29 Short Run Dynamics (Error Correction model)

30Econometric Methodology31Univariate Analysis

In the first step of data analysis individual series has been checked for existence or non existence of unit root

Hylleberg, Engle, Granger and Yoo( HEGY) test is employed for the purpose

32Test of Cointegration

Estimation of ARDL Model Estimation of Short Run Model33Estimation Results34HEGY test results suggested that

RDBL, EA, FDP,EFSE, RRA, INF are I(1)

while

MER is I(0)

35ARDL model is estimated using 6 lags and general to specific rule is followed for eliminating the insignificant variables

Different diagnostic and stability tests are carried out to check the validity of the model36Test of Co-Integration( Bounds Test)

37Long Run Parameter Estimates

38

Short Run Dynamics 39 40Dependent Variable: D(RDBL)VariableCoefficientStd. Errort-StatisticProb.ECM(-1)-0.0854430.013298-6.4251110.0000D(INF)-0.0163260.002038-8.0092470.0000D(EA(-1))-0.0611950.028179-2.1716740.0317D(RRA(-3))-0.0182100.006408-2.8416780.0052D(INF(-3))-0.0181890.006611-2.7511440.0068D(MER(-3))0.0035700.0012332.8954900.0044D(FDP(-5))-0.0448280.020305-2.2077360.0290D(MER(-5))0.0049850.0014623.4094890.0009D(RRA(-6))0.0052600.0017672.9773900.0035D(FDP(-6))0.0413710.0204252.0255190.0448D(MER(-6))0.0032720.0014492.2570620.0256D(EA(-6))-0.1574070.031539-4.9908590.0000Policy Implications

Demand for bank loan by private business sector is found elastic to RRA so it can help the monetary authorities to formulate effective monetary policy

The results of MER, INF highlights the importance of bringing macroeconomic stability

The analysis suggests the need of stable government policies and macroeconomic stability41Thank you42RDBLt = + + + + + + + + RDBLt-1 + EAt-1 + RRAt-1 + FDPt-1 + INFt-1 + MERt-1 + EFSEt-1 + t

RDBLt = + + + + + + + + ECM(-1) + t

F-statisticsProbability

7.8431***0.0000

Significant LevelLower I(0)Upper I(1)

1%3.414.68

Pesaran et. al (1999)RDBL = 4.0238- 0.02974*rra + 1.3595*ea 0.1703*inf - 0.04181*mer (4.88) (-1.63) (3.49) (-4.41) (-2.92)