Relationship Banking and the Credit Market in India

Abstract

Relationship banking based on Okun’s ‘customer credit markets’ has important implications for monetary policy via the credit transmission channel. Studies of less-developed country (LDC) credit markets from this point of view seem to be scanty and this article attempts to address this lacuna. Relationship banking implies short-term dis-equilibrium in credit markets, suggesting the vector error-correction model (VECM) as an appropriate framework for analysis. We develop VECM models in the Indian context (for the period April 1992–December 2008 using monthly data) to analyse salient features of the credit market. An analysis of the error-correction mechanisms (ECMs ) reveals that disequilibrium in the Indian credit market is adjusted via demand responses rather than supply responses, which are in accordance with the customer view of credit markets. Further light on the working of the model is obtained through ‘generalised’ impulse responses and ‘generalised’ error decompositions (both of which are independent of the variable ordering). Our conclusions point towards firms using short-term credit as a liquidity buffer. This fact, together with the gradual adjustment exhibited by the ‘persistence profiles’ provides substantive evidence in favour of ‘customer credit markets’.