Are bank loans to SMEs procyclical? Evidence from an analysis of the lending behavior of Korean banks

This paper investigates the procyclicality of bank loans to Small and Medium Enterprises (SMEs) and to Large Enterprises (LEs) using aggregated and cross-sectional data from major private, foreign, and state-owned banks in Korea in the period from 1999 to 2008. Based on previous studies, it is hypothesized that compared to LEs, banks loans to SMEs may be more vulnerable to external economic shock. Berger and Udell (1994) suggested that bank loans to SMEs are comparatively risky due to their relatively low collateral and heavy dependence on banks for raising funds. In this study, empirical tests are verified by applying the rolling vector error correction Model (VECM), panel generalized least squares model (GLS), and the Clustering Fixed Effect Model. Findings include robust support for the procyclicality of bank loan to SMEs, but not for LEs. The review of short-term dynamics among first differential variables such as loans and GDP provides evidence to support a related hypotheses: the profit-oriented motivation of commercial banks in enhancing relationships with SMEs, the characteristics of governance structure in three types of banks (private, state-owned, and foreign owned banks), and the large-bank barriers assumption.