Credit expansion, bank liberalization, and structural change in bank asset accounts

• Published in: Journal of economic dynamics & control Vol. 124; p. 104066
• Main Authors: Liu, Keqing, Fan, Qingliang
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01.03.2021
• Subjects: Bank balance sheet; Bank liberalization; Business cycle; Credit expansion; Bank balance sheet; Business cycle; Credit expansion; Bank liberalization
• ISSN: 0165-1889; 1879-1743
• DOI: 10.1016/j.jedc.2021.104066

This paper studies the links among credit supply expansion, commercial bank asset account structures, and the housing boom preceding the 2007–2009 financial crisis. We propose a real business cycle model with a housing market and financial intermediaries (banks) subject to leverage constraints. In our model, banks channel funds to firms for production and provide collateralized loans to mortgage borrowers; thus, banks determine their asset account structures endogenously. We show that a credit supply expansion to banks can account for four key facts that characterize the housing boom: (1) an increase in real house prices; (2) an increase in the mortgage-to-GDP ratio; (3) a decrease in the real mortgage interest rate; and (4) an increase in the ratio of mortgages to firm loans in commercial bank asset accounts. In our model, a credit supply expansion to banks can also generate a boom-bust cycle through the collateral value channel via mortgage borrowers. Asset-side bank regulations that reduce excessive mortgage issuance during a credit boom can help to dampen the subsequent economic downturn.