Determinants of lending activity in the Euro area

Empirical estimations of the drivers for loan extension mainly apply the outstanding stock of bank credit as the dependent variable. This paper picks up the critique of Behrendt (2016), namely that such estimations may lead to misleading results, as the change of the stock is not only driven by extended loans, but also by repayments, write-downs, revaluations and securitisation activity. This paper specifically applies a variable of new credit extensions for eight Euro area countries in a simultaneous equation panel model to evaluate potential determinants for credit extension, and compares the findings with a conventional specification using the outstanding stock. It is found that the new lending variable performs exceedingly better in respect to the underlying theory than the stock variable. This result has vast implications for the conduct of monetary policy while looking at credit trends. As most determinants have different coefficients, not only by magnitude, but also by significance and sign, central banks might react in a different way to changing trends in lending when looking at the stock variable rather than the underlying credit extension.