Tightening Financial Regulation: The Impact on the Credit Cycle in the USA

The credit cycle is one of the most important elements of the business cycle. Credit expansion after the crisis is one of the key ways of economic recovery. The tightening of financial regulation in response to the crisis of 2007–2008 largely slowed down the credit expansion phase and was reflected in an abnormally prolonged phase of credit contraction for the non-financial private sector. The normal course of the credit cycle was disrupted by the increased demands of Basel III and the reform of theUSAfinancial system. The credit cycle after the crisis of 2007–2008 differs from previous crises: the recovery of credit activity was slower; the volume of credit to the non-financial private sector has not recovered even now. The article presents a comparative analysis of the behaviour of credit after crises from the point of view of the duration of recovery. In this article, the author presents the results of the research of the nature of the incident called “the credit paralysis” based on Minsky’s hypothesis of financial instability and Crotty’s theory of the endogenous formation of credit standards. It is assumed that bank credit standards are set in accordance with the level of macroeconomic variables — the level of GDP, interest rates, the volume of loans taken. Using the vector autoregressive model, the author analyzed the change in credit activity in response to changes in credit standards, as well as the process of forming credit standards depending on macroeconomic indicators. Therefore, the author concluded that the excessive increase in credit standards due to the introduction of Basel III requirements in response to the crisis that violated the normal course of the credit cycle. Based on the author’s econometric study, the author built a stylized model of theUSAcredit cycle, taking into account the influence of specific factors of the crisis of 2007–2008: pre-crisis financial innovation and post-crisis tightening of financial regulation.

1. Sherman M. A short history of financial deregulation in the United States. Center for Economic and Policy Research. Washington, D.C.; 2009.

2. Komai A., Richardson G. A brief history of regulations regarding financial markets in the United States: 1789 to 2009. National Bureau of Economic Research. 2011; w17443.

3. Bernanke B. S. Causes of the recent financial and economic crisis. Statement before the Financial Crisis Inquiry Commission, Washington, September. 2010;2.

4. Carmassi J., Gros D., Micossi S. The Global Financial Crisis: Causes and Cures. JCMS: Journal of Common Market Studies. 2009;47(5):977–996.

5. Bernanke B. Financial reform to address systemic risk. Speech at the Council on Foreign Relations; 2009;10.

6. Claessens S. et al. Lessons and policy implications from the global financial crisis. International Monetary Fund. 2010;(10–44).

7. Lessons of the Financial Crisis for Future Regulation of Financial Institutions and Markets and for Liquidity Management. International Monetary Fund. 2009; February 4.

8. Structural changes in banking after the crisis. Bank for International Settlement, Committee on the Global Financial System; 2018.

9. Drehmann M., Gambacorta L. The effects of countercyclical capital buffers on bank lending. Applied Economics Letters. 2012;19(7):603–608.

10. Peirce H., Robinson I. C., Stratmann T. How are small banks faring under Dodd-Frank? Mercatus Center, George Mason University. Working paper 2014;(14–05).

11. Minsky H.P. The financial instability hypothesis. Working Paper. 1992;(74). Annandale-on-Hudson, N.Y.: The Levy Economics Institute. May.

12. Crotty J. Are Keynesian uncertainty and macrotheory compatible. New perspectives in monetary macroeconomics. Michigan: University of Michigan; 1994.

13. Magnus G. The credit cycle and liquidity: Have we arrived at a Minsky moment. Economic Insights-By George. 2007;6.

14. Reinhart C. M., Rogoff K. S. Recovery from financial crises: Evidence from 100 episodes. American Economic Review. 2014;104(5):50–55.

15. Calza A., Gartner C., Sousa J. Modelling the Demand for Loans to the Private Sector in the Euro Area. ECB Working paper. 2001;(55).

16. Lown C., Morgan D. P. The credit cycle and the business cycle: new findings using the loan officer opinion survey. Journal of Money, Credit and Banking. 2006;38(6):1575–1597.

17. Ciccarelli M., Maddaloni A., Peydró J. L. Trusting the Bankers: A new look at the credit channel of monetary transmission. European Central Bank (ECB) working paper series. 2010;1228.

18. Hristov N., Hülsewig O., Wollmershäuser T. Loan supply shocks during the financial crisis: Evidence for the Euro area. Journal of International Money and Finance. 2012;31(3):569–592.