Tight Money, Tight Standards

This paper uses a structural vector autoregressive model (SVAR) to study the effect of monetary policy and bank lending standards on business loans. The results are consistent with a dynamic model of bank behaviour that explicitly considers a bank’s soundness position. According to the results of the empirical estimation and prediction of the theoretical model, increases in loans, particularly non-performing loans or delinquency rates due to a monetary policy shock, deteriorate a bank’s health, causing it to apply more stringent lending standards. Thus, the results show that banks raise their lending standards in response to the tightness of money, defined as increases in the demand for the bank’s loans while its resources (reserves or deposits) remain constant. Furthermore, lending standards dominate loan rates in explaining loans and output dynamics.