The Capital Crunch: Neither a Borrower nor a Lender Be

Abstract

The dramatic reduction in the growth rate of bank lending associated with the 1990-91 recession, particularly in New England, has evoked claims by many observers of a credit crunch. However, because of the difficulty in determining whether the observed slow credit growth is a demand or supply phenomenon, convincing evidence of the practical importance of credit crunches for economic activity remains elusive. We overcome this obstacle by examining a cross-section of banks in New England that have experienced the same economic downturn, effectively controlling for changes in demand. We find empirical support for a capital crunch, whereby poorly capitalized institutions shrink to satisfy capital requirements. This alone is not a sufficient condition for a credit crunch. However, we find s6me additional evidence that the ca~~ital crunch may have limited credit availability in New England.~.:We thank Paul Charrette and Robert Chicoski for able research assistance and Richard Kopcke for valuable insights and discussions. Helpful comments were received from

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