The recent financial crisis has generated interests in how business cycle affect bank lending to SMEs. However, the effect of the business cycle on lending to SMEs in South Africa after the global financial crisis of 2008 has not been extensively explored. We examine this relationship and its effect in South Africa using Vector Autoregressive modeling. This paper employs monthly data from South Africa Reserve Bank (SARB) for the period 2008 to 2014. We adopt the regulatory-driven capital crunch hypothesis employing monthly data from South African Reserve Bank (SARB). Most of the variables display a very sensitive reaction to the coincident index and capital adequacy shock. The results show strong evidence of procyclicality in SME lending in South Africa. The result shows that business cycle has a positive and significant long-run impact on SME. However, the adjustment coefficient of the business cycle is also positive and significant in the short run. Any case of asset price misalignment or excessive growth boom may ultimately amplify the business cycle. The impulse response test shows the response of bank lending to SMEs to one standard deviation shock of the business cycle is negative and persistent for over 15 quarters before steadying. This result vividly indicates some strong evidence of credit procyclicality between the business cycle and SME in South Africa. Our results have interesting implications for credit availability to SMEs. Our results have several implications. Firstly, these may lead to many banks decreasing lending in bad times when they encounter loan losses and their capitalization drops. This may affect the real economy, as SMEs, which need to finance their small enterprises, may be cut off from credit. There is also a need to promote diversification of financing options for small firms and SMEs by providing various credit supporting policies in South Africa. There is, therefore, an urgent need to boost support to SMEs credit, especially during recessionary periods.


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