Credit Crunch and Saving Glut in Taiwan: Empirical
Evidences
Cheng-Few Lee
Distinguished Professor of Finance, Rutgers University, USA
Chiung-Min Tsai
Central Bank of the Republic of China (Taiwan)
Abstract

To indentify the developments for bank credit allocation in Taiwan

Using a disequilibrium model to evaluate whether



An excess demand, i.e. a credit crunch, or
Excess supply, i.e. a saving glut, during these periods
Major findings

A considerable excess demand, or credit crunch, during Asian
financial crisis

On the contrary, there were some periods experiencing an excess
supply from 2001 to 2004, or the “saving glut” as mentioned by
Bernanke (2005)

Furthermore, the saving glut was still prevailing during the periods of
global financial crisis
1
Outline

I. INTRODUCTION

II. A DISEQUILIBRIUM MODEL OF THE BANK LOAN
MARKET
A. Development of Disequilibrium Model for Bank Loan Market
B. Estimation Methods

III. TESTING THE EXISTENCE OF PRICE ADJUSTMENT
PROCESS IN TAIWAN’S COMMERCIAL LOAN MARKET
A. Model Specification
B. Empirical Results

IV. SUMMARY
2
I. INTRODUCTION

The concept of credit rationing is first developed by Jaffee (1971)
for a commercial loan market

One of the reasons for credit rationing is the existence of
bankruptcy costs, as proposed by Miller (1977)


As a result, some firms will not receive the loan regardless of the rate
they are willing to pay
Sealey (1979) extends the study and uses a generalized
disequilibrium model (DM) to examine whether there is an excess
demand in the commercial loan market

The empirical results show that models of commercial loan market
being unable to explicitly include the effects of market disequilibrium
are likely to yield inconsistent parameter estimate
3
I. INTRODUCTION

Nehls and Schmidt (2003) examine whether the Germany economy
is affected by a credit crunch in the early years of 2000

The empirical results suggest a supply-side restriction of loans is not in
line with market interest rates and profitability of investment projects

A considerable excess demand, i.e., a credit crunch, particularly in the
second half of 2002

Financial liberalization and deregulation reduce the magnitude of
disequilibrium; However, the risk of credit crunch can’t be ruled out

The global imbalance and financial crisis tell us that



Sometimes the price adjusts too slow to clear the market, and
Sometimes the government has to step in
The insightful value of DM should be explored widely in practice
4
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET
A. Disequilibrium Model

In general, markets are in equilibrium
Supply:
QS = α1 +α2P + α3X + εS (α2 > 0)
P
Supply
Demand:
QD =β1+ β2P + β3Y + εD (β2 < 0)
P*
Equilibrium
Demand
QS = QD = Q*

But, sometimes are not
Q*
Qd, Qs
5
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET

All disequilibrium models share the feature that prices do not fully
adjust to the market clearing level

The DM consists of the following equations:
(1)
QDt = α1 Pt + β1’XD,t + μt,
(2)
QS
(3)
Qt = min (QDt, QSt ),
t
P
Supply
= α2 Pt + β2’XS,t + υt ,
P*
(4) ΔPt = Pt - Pt-1 = γ(QDt - QSt ),
Demand
γ: price adjustment factor, 0<γ∞
Qd, Qs
6
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET

where the QDt and QSt are the quantities of securities demanded and
supplied, respectively

Qt is the actual or observed quantity of securities in the market; Pt is the
observed return rate of securities

XD,t and XS,t are vectors of exogenous or predetermined variables
including the lagged Pt-1



α1 and α2 are unknown parameters for Pt; β1 and β2 are vectors of unknown
parameters for exogenous variables
γ is an unknown positive scalar parameter; and
μt and νt are disturbance terms and assumed to be jointly normal and
independent over time with distributions N(0, σ2μ) and N(0, σ2υ)
7
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET

In the equilibrium model, the existence of supply effect is the core
issue

In the DM, the parameter of the most interested is γ in (4)

If γ = 0, then, there is no price adjustment in response to an excess
demand, and

If γ is infinity, price adjusts instantaneously

In other words, if one assumes there is price rigidity in response to
an excess demand, γ should equal to zero

i.e., the most important test of the disequilibrium model is to
examine whether the price adjustment parameter is zero
8
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET
B. Estimated Methods
 One can reformulate the above model by considering periods of
rising prices ΔPt > 0 and periods of falling prices ΔPt < 0

The equations (1) to (4) can be reformulated and summarized as:
(5a)
Q
(5b)
Q
t
 a
 β
1 Pt
'
1
X
D,t
t
 a
1
Pt  β
'
2
X
S,t
where
Pt
Pt





 Pt

 0


  Pt

 0

1
g
1
g
 Pt   m
t
 Pt  u
t
if Pt  0
otherwise
if Pt  0
otherwise
9
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET
1. 2SLS Estimator

The equations system shown in (5) contains the jointly dependent
variables Qt, Pt, ΔPt+ and ΔPt-

The parameters in the above modified model can be consistently
estimated by the conventional 2SLS method

In the first stage, regress and on all of the exogenous variables,
XD, t and XS, t to obtain the estimations of and then,

ˆ P  in equation (5a),
In the second stage, regress Qt on XD, t and 
t
ˆ P  in equation (5b)
and regress Qt on XS, t and 
t

The estimators of â1 , â 2 , ˆ1 and ˆ2 could be consistent, but
are not asymptotically efficient in this model
10
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET
2. Maximum Likelihood Estimator

Quandt (1988) employs an appropriately formulated fullinformation maximum likelihood technique

He suggests one can use the log likelihood function represented as
equation (6) to find the ML estimator
(6)
L  T log | a 2  a 1 
where
1
g
| T log 2 
u t'  (Q t  a 1 Pt   1' X D,t 
T
1
log |  |   u t'  1ut
2
2 t
1
g
 Pt  , Q t  a 2 Pt   2' X St 
1
g
 Pt  )
11
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET

Amemiya (1974) suggests the MLE can be obtained by solving the
following equations simultaneously
a1,MLE  a1, LS
β1, MLE  β1, LS ,
(b)
a 2 , MLE  a 2 , LS
β 2 , MLE  β 2 , LS ,
(c)
 m2 
2

1
1
(Qt  a1 Pt  β1' X D ,t )   (Qt  Pt  a1 Pt  β1' X D ,t ) 2  ,


g
T  A
B

(d)
 u2 
2
1
1
2 ,
'
'
)
X
β

P
a

P


Q
(

)
X
β

P
a

Q
(


S ,t
2
2 t
t
t
S ,t
2
2 t
t

g
T 
A

 B
(e)
Tg 
(7) (a)
1
u
2
1
 (Q  g P  a
t
A
t
P  β'2 XS ,t )Pt 
2 t
1
m
2
1
 (Q  g P  a P  β X
t
t
1 t
'
1
D ,t
)Pt  0 .
B
12
II. DEVELOPMENT OF DISEQUILIBRIUM MODEL FOR
BANK LOAN MARKET

That is, the ML estimators of α and β are the same as LS estimators
given γ applied to equation (5).

Amemiya suggests the above parameters can be solved by using the
following iterative procedures
Step 1: Use 2LSL estimates of α, β, σ2μ and σ2υ as the
initial estimates
Step 2: Substitute â , ˆ , ˆ m2 and ˆu2 into (7e) and solve
for the positive root of γ, gˆ
Step 3: Use gˆ in (5) to obtain least squares estimates of
α, β, σ2μ and σ2υ
Step 4: Repeats step 2 and 3 until the solutions converge
13
III. TESTING THE EXISTENCE OF PRICE ADJUSTMENT
PROCESS IN TAIWAN’S COMMERCIAL LOAN MARKET
A. Model Specification

Demand Function
QDt = α1rt + β11 IPt + β12 Xt + μ1 t
where QDt is the demand for commercial loan (in DM, this can’t be observed)
rt is the observed commercial loan rate,
IPt is the index of industrial production, and
Xt is the growth rate of export

The 2nd variable, the index of industrial production, can measure
the firm’s expectations about future economics activity, and thus,
is used as a typical specification in many studies

In Taiwan, export sector has played a very important role in
economic performance. And thus, firms’ demand for commercial
loan is affected by the growth rate of export
14
III. TESTING THE EXISTENCE OF PRICE ADJUSTMENT
PROCESS IN TAIWAN’S COMMERCIAL LOAN MARKET

Supply Function
QSt = α2 rt + β21 TDt + β22 ORt + μ2 t
where QSt is supply of commercial loan,
TDt is the amount of total deposits, and
ORt is the interbank overnight interest rates

The TDt is used to capture the capacity of the banking sector to
lend, which is the major variable to the supply function

The 3rd variable, ORt, is used for two reasons

This rate can be seemed as an indicator of monetary policy
direction, and

It is also related to the banks’ profit margin indirectly as well
15
III. TESTING THE EXISTENCE OF PRICE ADJUSTMENT
PROCESS IN TAIWAN’S COMMERCIAL LOAN MARKET
B. Empirical Results

The expected signs of the coefficients should be as follows

The sign of α1and α2 should be negative and positive respectively since a
higher price (i.e. loan rate) means a decline in demand but encourages bank
to lend more

β11and β12 are expected to be positive since a prosper economic activities
boost demand for loan. And finally

β21 and β22 should be positive and negative respectively

For the former, an increase in total deposits gives the banking industry
more ability to lend

For the latter, a lower interbank overnight rate will increase one bank’s
profit margin and it also means an easing in monetary policy. Both of the
reasons will encourage banks to lend more
16
Table 1. MLE of Commercial Loan Market
Table 1 summarizes the MLE of the presented DM. From the table, the signs of the
estimated parameters are all in the correct direction and at a significance level of 5%
Parameter
Estimates
Std. Error
z-statistic
p-value
α1
-0.6720
0.2236
-3.00
(0.0027)
β11
0.3443
0.0703
4.90
(0.0000)
β12
1.3562
0.3796
3.57
(0.0004)
α2
2.9898
1.4670
2.04
(0.0415)
β21
2.2138
0.0838
26.42
(0.0000)
β22
-3.9260
1.8813
-2.09
(0.0369)
γ
0.0135
0.0009
15.55
(0.0000)
Data used are from 1994Q3 to the end of 2009. This is because though the banking industry was
deregulated in 1989, the number of institutions and branches was at peak around 1994. The
business of banking industry then becomes more stable and reliable
17
III. TESTING THE EXISTENCE OF PRICE ADJUSTMENT
PROCESS IN TAIWAN’S COMMERCIAL LOAN MARKET
B. Empirical Results

The parameter of most interest in the model, the market adjustment
parameter γ, is slightly larger than zero and significant

Both extreme values, zero and infinity, are excluded in a confidence interval
(even a fifteen times of the standard error)

This reflects the partial adjustment mechanism, the most special character of
a disequilibrium model

As we obtain the estimates of the parameters, we can trace back to find
out the real or the desired supply and demand for commercial loan

And then, using the difference between the desired demand and supply,
divided by supply, we can calculate the excess demand (Figure 1)
18
Figure 1. Excess Demand for Bank Loans
Excess demand ratio (in % of credit supply)
2 standard deviation
1.00
0.80
0.60
0.40
0.20
-0.20
-0.40
-0.60
-0.80
-1.00
M
ar
-9
De 5
c9
Se 5
p96
Ju
n9
M 7
ar
-9
De 8
c9
Se 8
p99
Ju
n0
M 0
ar
-0
De 1
c0
Se 1
p02
Ju
n0
M 3
ar
-0
De 4
c0
Se 4
p05
Ju
n0
M 6
ar
-0
De 7
c0
Se 7
p08
Ju
n09
-1.20
19
III. TESTING THE EXISTENCE OF PRICE ADJUSTMENT
PROCESS IN TAIWAN’S COMMERCIAL LOAN MARKET
B. Empirical Results


According the calculation, there are three periods of time in a situation of
credit crunch. They are 1996Q1, 1997Q1 to 1998Q1, and 2007Q2

The first one can be related to the Taiwan Strait tension in 1996

The second credit crunch is coincident with the Asian financial crisis

The third one is related to a near-bank-run event and a tension in
money market in early 2007
The figure also shows that there exists excess supply in some periods,
especially during the periods from 2001 to 2004

This may be reflecting the so-called saving glut as Bernanke (2005)
mentioned.
20
IV. SUMMARY


To indentify the developments for bank credit allocation in Taiwan
Using a disequilibrium model to evaluate whether



an excess demand, i.e. a credit crunch, or
excess supply, i.e. a saving glut, since 1994
Major findings

A considerable excess demand, or credit crunch, during Asian financial crisis



The main cause of this credit crunch can be contributed to the tightening in the
money market because of capital outflow
On the contrary, there were some periods experiencing an excess supply from
2001 to 2004, or “saving glut” as mentioned by Bernanke (2005)
Furthermore, the saving glut was still prevailing during the periods of global
financial crisis, this is probably due to

The aggressive and pre-empt policy actions taken by the financial and monetary
authorities to avoid a possible meltdown in credit market
21
IV. SUMMARY

Discussions



According to our specification of supply function, the overnight interest and
bank deposits are two major exogenous variables
The authorities lowered the interest rate fast enough and adopted the policy
of blanket guarantee on deposits in time had supported the banking sector
to resist the crisis
Debates

Though existing debates in the model specification

For example, lack of some variables such as the ROE or the profit margin etc.

However, all the coefficients estimated in both functions are at the expected
directions and are significant

Beside, the periods of excess demand/supply for bank loan are coincident
with those periods of some specific economic events

These evidences have showed the disequilibrium character in Taiwan’s bank loan
market successfully and are helpful in policy discussion
22