Bank Credit in Argentina in the Aftermath of the Mexican Crisis: Supply or Demand Constrained?

Following the introduction of the convertibility regime in early 1991, domestic credit to the private sector in Argentina grew rapidly, in line with the marked expansion of banking deposits. This close relationship between banking deposits and credit to the private sector broke down in the wake of the banking crisis of early 1995. While deposits began to recover in the second half of 1995 and, by mid-1996, had risen to some 15 percent above their pre-crisis peak, domestic credit to the private sector still stood below end-1994 levels. Two hypotheses have been raised to explain this mismatch. One is that domestic bank credit was largely constrained by supply factors: increased adverse selection brought about by soaring interest rates during 1995 and the sharp rise in nonperforming loans, together with the loss of information on clients' creditworthiness resulting from the closing down of a number of financial institutions, enhanced perceived lending risk. As a result, even though banks. liquidity position improved substantially, they were more hesitant to extend new credit to the private sector. An alternative hypothesis is that credit was largely constrained by demand factors: caught with a relatively high level of indebtedness as interest rates rose in early 1995, households curtailed their demand for credit and remained reluctant to resume large-scale borrowing, as interest rates and unemployment remained high and the debt stock adjustment unwound slowly. This paper puts together the empirical evidence pertaining to these hypotheses and uses a simple econometric model of supply and demand for credit to test their validity. The results allow some inferences to be drawn about the likely pattern of bank credit and the strength of the economic recovery in Argentina in the near term.