Did Bank Indonesia cause the credit crunch of 2006–2008?

Bank lending in Indonesia slowed dramatically during the period 2006–2008 while, at the same time, the banks’ holdings of short-term public sector (and other riskless) securities increased substantially. For some, this provided clear evidence of a central bank-induced credit crunch arising from Bank Indonesia’s regulatory (with respect to risk-based capital and risk management requirements) and monetary policy tightening. This paper, based on Berger and Udell (Econ J 112: F32–F53, 1994) and Haselmann and Wachtel (Comp Econ Stud 49: 411–429, 2008), seeks to establish whether the credit crunch was primarily due to central bank action or to alternative supply/demand side factors for the period 2002–2008. The so-called ‘risk-based capital credit crunch’ and ‘loans examination and supervision credit crunch’ hypotheses are duly tested alongside the ‘voluntary risk-retrenchment credit crunch’ and the ‘macro demand-side’ and ‘secular decline’ hypotheses to address the question. The results, perhaps unsurprisingly, do not allow us to definitively reject any of the supply-side credit crunch hypotheses but, what little supportive evidence there is, appears to be relatively weak, especially in respect of the risk-based capital credit crunch hypothesis. Contrariwise, the ‘macro’ demand-side hypothesis secures the strongest support, with the other (i.e., the ‘secular decline’) demand-side hypothesis receiving little support. This suggests that a reduction in loan demand in the face of rising interest rates was the main reason for the sharp contraction in bank credit experienced in Indonesia during the period 2006–2008 rather than supply-side factors.