The Bank of Korea: "Venture Capital Plays a Substitute Role During Bank Credit Crunch and Crisis"

VC Market Needs Political and Institutional Support

[Image source=Yonhap News]

[Asia Economy Reporter Seo So-jeong] An analysis has revealed that venture capital (VC) can play a substitutive role during bank credit crunches or banking crises. The negative impact of banking crises was found to be mitigated in regions where venture capital is more developed.

On the 10th, the Bank of Korea stated in its 'BOK Economic Research' report titled 'Banking Crisis, Venture Capital and Innovation' that "during banking crisis periods, the role of alternative financial instruments such as VC is likely to expand."

The report conducted an empirical analysis by combining banking crisis data and VC data based on panel data measuring innovation activities of manufacturers in 31 countries at the industry level (20 industries) from 1980 to 2012, using data from the US Patent and Trademark Office. It first examined whether innovation activities in manufacturing industries with high external financing dependence shrink during banking crises, then used interaction terms to investigate whether the negative effects of such banking crises are less severe in places where VC is more developed.

According to the research results, industries more dependent on external financing experienced a contraction in innovation activities during banking crises. During banking crises, for each one-unit increase in an industry's external financing dependence, the number of patent applications and citations decreased on average by 35.9% and 11.5%, respectively, while patent originality (higher when citing diverse fields) and generality (higher when cited by diverse fields) scores decreased by 17.6% and 26.6%, respectively.

The negative impact of banking crises was alleviated in regions where VC is more developed.

When a country's VC index exceeds the average of 3.786 (on a 7-point scale) by at least 1.458 points (0.848, 0.963, 1.701), the negative shocks of banking crises on patent applications (citations, originality, generality) were completely offset. This mitigating effect was especially pronounced in countries with well-established intellectual property systems and democratic political institutions.

Seong Won, head of the Micro-Institution Research Division at the Bank of Korea Economic Research Institute, said, "The role of VC is important in influencing technological innovation, and especially during bank credit crunches or banking crises, VC can play a substitutive role. However, even if the VC market expands, it should be noted that efficient investment support may be difficult without political and institutional backing."