Banks' wholesale funding and credit procyclicality: evidence from Korea

Credit procyclicality has recently been the focus of considerable attention, but what fuels the often excessive credit growth is rarely questioned. We investigate the relationship between the composition of banks' liabilities and their credit procyclicality. After examining the macroeconomic context where banks rely increasingly on wholesale funding (WSF), we estimate the effect of WSF on the banks’ credit growth using panel data for the commercial banks of Korea between 2000:1 and 2011:2. We find that a higher sensitivity of banks' WSF to the business cycle leads to an excessive response of credit growth to the business cycle, even with a low share of WSF on bank liabilities. This finding suggests that the regulation of banks’ WSF mechanism may contribute to financial stability through a bank credit channel of monetary policy. On the other hand, we find that overseas WSF has a more marked effect on credit procyclicality, which may additionally exacerbate the financial fragility of export-led emerging economies.