• The Procyclicality Phenomenon in Bank Lending Behavior: An Empirical Test of Institutional Memory Hypothesis

Abstract

The banking industry provides a variety of intermediary services to assist in economic developments and recoveries. However, many studies of different countries have explored the phenomenon that banks may amplify business cycle volatilities due to various reasons. This is the concept of “pro-cyclical”. This paper summarizes extensive literature regarding procyclicality, and examines this phenomenon from a new hypothesis that may help explain the procyclicality of Taiwan’s bank lending. The institutional memory hypothesis is driven by deterioration in the ability of loan officers over the bank’s lending cycle that results in an easing of credit standards, even the procyclicality of bank’s lending behavior. We test this hypothesis for the individual Taiwan banks over 1987-2007 and analyze the samples using panel data methods. The results show that the institutional memory hypothesis is able to explain the procyclicality of Taiwan’s bank lending behavior. It means that loan spread will reduce as well as the proportion of secured loans as time passes since a bank’s last bust. However, the robust test appears to provide no consistent evidence for loan growth. The findings also indicate that the institutional memory hypothesis explains better the lending behavior at small banks than large ones. Finally, as expected, the institutional memory hypothesis is more supported by soft-information-intensive loans than hard-information

-intensive loans.

Keywords: Lending Behavior, Institutional Memory Hypothesis, Procyclicality