Testing for the Credit Crunch in Trinidad and Tobago Using an Alternative Method

This paper examines whether the decline in loans to the private sector in Trinidad and Tobago from mid-2009 was caused by a demand-induced or the credit crunch phenomenon. The study presents an alternative methodology for estimating the credit crunch. The new methodology emphasizes an aggregate banking model in which excess liquidity and interest rate spread are important stylized facts. The analytical framework is used to identify shocks to loans and deposits that are found to be empirically related to excess liquidity. Using Two-Stage Least Squares (TSLS), we estimate auxiliary regressions of random deposit and loan shocks. The results suggest that weak loan demand instead of a supply-induced credit crunch best explains the decline.