Procyclicality in Financial System: A Conceptual Study

Abstract

This paper examines the procyclical behavior of the financial institutions in the financial systems. The paper has highlighted the importance of banks and other financial institutions in the economy. The concept and various definitions of procyclicality have been discussed. The paper also discussed the mechanism of procyclicality –feedback effect which states that when economy is in recessionary phase, banks in response to this economic recession reduce the flow of credit to the economy. This leads to feedback effect in which decrease in credit towards economy negatively affect economic output and impacts back on the bank in the form of growth non-performing loans.