Modelling the Demand for Bank Loans by Private Business Sector in Pakistan

The importance of studying demand for bank loan by private business sector stems from the fact the money supply is ‘credit-driven’ and demand-determined and at the rate of interest determined by the central bank the money supply function is horizontal as illustrated by Moore and Threadgold (1985), Coghlan, (1981), Moore (1979, 1983). The analysis of the demand for bank loan by private business sector is important for understating the monetary transmission mechanism and formulation of the effective monetary policy to achieve macroeconomic objectives. The study aimed to model the demand for bank loan by private business sector in Pakistan. We use Hylleberg, et al., (1990) seasonal unit root test for investigation of properties of data. The dynamic Autoregressive Distributed Lag (ARDL) model is used for long rung and the short run analysis of demand for bank loans by the business sector. For the testing long run relationship among the variables we used bounds test proposed by Pasaran and Shin (1995). Real rate of return on advances, economic activity, expectations about future state of economy, macroeconomic risk, inflation and foreign demand pressure are taken as the determinants of demand for bank loan by private business sector. Economic activity, real rate of interest, macroeconomic risk and inflation were found significant in affecting demand for bank loans while the estimated equation do not provide evidence for the role of foreign demand pressure and expectations about future state of economy in effecting demand for bank loans. The sign of the coefficients of real rate of return on advances, inflation and macroeconomic risk is negative whereas economic activity is directly related to demand for bank loans by private business sector. The short run model shows that the speed of adjustment is 8.5% quarterly. Therefore it takes three years to go back to the long run equilibrium level. In the short run change in rate of inflation, RRA and economic activity have negative impact. The short run equation explores that change in real rate of return (RRA) does not affect RDBL. It implies that in very short run business cannot change their demand for bank credit in response to changes in real interest rate. Changing in macroeconomic risk appears in the model in form against a priori expectations. Foreign demand pressure (FDP) has no long run effect and in short run has the coefficient having low value. The demand for bank loan by private business sector was found interest elastic and gives the provision to central bank to control credit in the economy through variations of interest rate.