Monetary Sector Reforms and Credit Demand In India: an Empirical Analysis on Banking Relationship: Analyzing the Impact of Relationship Banking on Credit Demand in the Indian Monetary Sector

Abstract

Relationship bankingbased on Okun's "customer credit markets" has important implications formonetary policy via the credit transmission channel. Studies of LDC creditmarkets from this point of view seem to be scanty and this paper attempts toaddress this lacuna. Relationship banking implies short-term disequilibrium incredit markets, suggesting the VECM (vector error-correction model) as anappropriate framework for analysis. We develop VECM models in the Indiancontext (for the period April 1991- December 2004 using monthly data) toanalyses salient features of the credit market. An analysis of the ECMs(error-correction mechanisms) reveals that disequilibrium in the Indian creditmarket is adjusted via demand responses rather than supply responses, which isin accordance with the customer view of credit markets. Further light on theworking of the model is obtained through the "generalized" impulseresponses and "generalized" error decompositions (both of which areindependent of the variable ordering). Our conclusions point towards firmsusing short-term credit as a liquidity buffer. This fact, together with thegradual adjustment exhibited by the "persistence profiles" providessubstantive evidence in favor of "customer credit markets".