more than that of large bank, there will be a sharp increase in the loan-security spread for the small banks compared with large bank, leading them to favor securities in its portfolio relative to loans. The movements in securities holding are apparently in contrast with the prediction that may be valid when the loan supply effects are operating.

Another testable hypothesis just in line with the first one is to exploit the implication that the sensitivity of the lending volume to monetary tightening is greater for banks facing tighter liquidity constraints in raising uninsured external finance and, if this is the case, the sensitivity should be more pronounced for small banks with weaker internal liquidity positions (Kashyap and Stein, 1997). But this hypothesis is not also completely free from some potential counterweight argument: if small banks face tighter liquidity constraints than large banks, it is expected that they would hold larger buffer stocks of liquid assets such as securities and short-term inter-bank market funds mainly to insulate their lending behavior from the impact of unexpected severe monetary tightening. This means small banks should not be necessarily more liquidity constrained than large banks all the time. Nonetheless, it may be quite possible to occur that the buffer stock of the typical small banks will not be sufficient enough to be shielded from the very severe monetary policy tightening and will be more subject to liquidity constraints in credit market than the large banks.

# _Econometric Specification_

To identify whether the loan supply effects are really important (i.e., whether bank lending channel has a distinctive role in monetary transmission mechanism), it may be worthwhile to test the cross-sectional implications of the prediction empirically. To this end, the test procedure should be of the following sort: we first need to divide banks on the basis of their total assets into small and large categories that would also potentially reflect differential in their costs of raising non-deposit external funds. The six largest commercial banks"<sup>0</sup> were classified as banks in the large category and ten regional banks" as banks in the small category. The next step is to compare the responses of primary assets (bank loans, securities) of each bank group to a monetary contraction using the impulse responses in the standard vector autoregression (VAR).

In our case, the VAR approach was applied to monthly Korean data from January 1993 to May 1998 ( 65 observations) because of the paucity of relevant data. The shorttern RP rate over which the Bank of Korea has direct leverage in the short-term may be a

- 10 The six largest commercial banks include Cho Hung Bank (39,551 billion Won), Commercial Bank of Korea (32,498 billion Won), Korea First Bank (31,771 billion Won), Hanil Bank (34,470 billion Won), Bank of Seoul (29,655 billion Won) and Korea Exchange Bank (38,594 billion Won). The amount in parenthesis indicates the total assets of relevant bank as of the end of 1997.

Ten regional banks include Daegu Bank (10,713 billion Won), Pusan Bank (10,168 billion Won), Chung Chong Bank (4,909), Kwangju Bank (6,182 billion Won), Bank of Cheju (1,475 billion Won), Kyungki Bank (8,258 billion Won), Jeonbuk Bank (2,532 billion Won), Kangwon Bank (3,435 billion Won), Kyongnam Bank (7,034 billion Won), Chungbuk bank (2,970 billion Won). The amount in parenthesis indicates the total assets of relevant bank as of the end of 1997.

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