# **2.2 Evidence of lending responses to financial crises**

There is abundant empirical evidence that all these channels are operative in curtailing bank lending during financial crises, and that lending tends to fall immediately following crises. While this fact alone does not imply that scaling back lending is an unambiguously optimal response for banks, it would appear that such reductions are, at the least, a constrained optimal choice. This choice is also strongly supported by the empirical evidence.

For example, Eichengreen, Hale & Mody (2001) examine emerging market crises in the 1990s and find that credit contractions reflect, _inter alia_ , balance sheet considerations that impact the volume of lending. For the more recent crisis, Cetorelli & Goldberg (2011a) find the balance sheet effect operative for global banks. The recent crisis has also demonstrated that liquidity considerations came into play. Many U.S. banks experienced difficulties in rolling over their short-term obligations (Gorton 2009), which—coupled with unexpectedly large drawdowns on their revolving credit lines (Ivashina & Scharfstein 2010)—meant that banks’ liquidity needs rose sharply, which limited their ability to expand their lending activity, and in fact led to a curtailment of lending by these banks. Puri, Rocholl & Steffen (2011) examine U.S. bank lending during the 2007/08 financial crisis and find that liquidity-constrained banks did scale back more on lending to retail customers, relative to unconstrained banks; Cetorelli & Goldberg (2011b) also consider this channel in greater detail with regard to banks’ internal capital markets. In a slightly different context, Khwaja & Mian (2008) also demonstrate the importance of liquidity access for sustained bank lending following a (political) crisis.

From a practical perspective, surveys designed to measure changes in credit standards and terms on bank loans, along with perceived changes in the demand for bank credit, have been conducted in the U.S., Europe and emerging countries, notably during the recent financial crisis.<sup>4</sup> There is evidence that banks started to tighten a number of terms on loans to both businesses and households in the aftermath of the 2007/08 crisis. Participating banks reported that balance sheet constraints and expectations about future economic activity were the main reason for this behavior. The results of these surveys also show the practical restrictions on credit that firms and households are confronted with, and how they are implemented by the banks. To tighten access to finance, banks tend to reinforce the conditions to obtain credit, but they also exhibited higher rejection rates with respect to the potential borrowers. In particular, younger firms and households without significant collateral suffered from these restrictions. Information asymmetry also influences responding banks’ behavior, as they become more pessimistic about potential creditors’ prospects and decide that a larger share of them would not be able to meet loan requirements. The surveys show that both mechanisms were relevant in the recent 2007/08 crisis.

> 4For the U.S., this is the Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices (http://www.federalreserve.gov/boarddocs/snloansurvey/). The equivalent surveys for Western Europe and the emerging economies are, respectively, the European Central Bank’s Euro Area Bank Lending Survey (http://www.federalreserve.gov/boarddocs/snloansurvey/) and the Institute of International Finance’s Emerging Markets Bank Lending Conditions Survey (http://www.iif.com/emr/global/emls/).

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