1

Household Credit Growth In Emerging Market Countries

Ceyla Pazarbasioglu

Division ChiefMonetary and Capital Markets Department

2

Contents

• Motivation

• Composition and Factors Driving Household Credit Growth

• Potential Vulnerabilities

• Legal, Regulatory and Institutional Reforms

• Policy Implications and Conclusions

3

Rapid growth of household credit across EM

-20

0

20

40

60

80

100

120

Hun

gary

Pola

ndC

zech

Bul

garia

Turk

eyR

oman

iaR

ussi

aS.

Afr

ica

Kor

eaC

hina

Taiw

anTh

aila

ndPh

ilipp

ines

Mal

aysi

aIn

done

sia

Indi

aM

exic

oA

rgen

tina

Col

ombi

aC

hile

Peru

Bra

zil

Ven

ezue

laG

erm

any

Japa

nU

.S.

Aus

tralia

Fran

ceIta

lyN

. Zea

land

Spai

nIr

elan

d

46.634.5

13.8 10.2

Average for all countries: 24.8

Annual Growth of Real Household Credit, 2004-05(In percent)

4

Catching up?

Romania

Russia

Bulgaria

HungaryTurkey

China

Korea

TaiwanMalaysiaSouth AfricaThailandChile

Argentina

ColombiaMexico

PolandPeru

Brazil

Czech RepublicIndiaIndonesia

Venezuela

-20

0

20

40

60

80

100

0 10 20 30 40 50

Philippines

Household Credit: Level in 2000 and Real Growth Rates, 2000

Romania

Russia

Bulgaria

HungaryTurkey

China

Korea

TaiwanMalaysiaSouth AfricaThailandChile

Argentina

ColombiaMexico

PolandPeru

Brazil

Czech RepublicIndiaIndonesia

VenezuelaAve

rage

gro

wth

200

0-05

(I

n pe

rcen

t)

Household debt in 2000

5

Welfare gains

• Reduces consumption volatility

• Improves investment opportunities

• Eases constraints on small and family businesses

• Diversifies household and financial sector assets

6

...and pitfalls of rapid credit growth

Combination of rapid credit growth with:

• Weak macroeconomic environment

• Lax or insufficient prudential regulation

• Inadequate risk management

• Weak legal and institutional infrastructure

Can create systemic vulnerabilities

7

Composition and Factors Driving Household Credit Growth

8

The level of Household Credit varies widely across EM countries…

Household Credit in Percent of GDP, End-2005

0

10

20

30

40

50

60

70

80

90

100

Russ

ia

Rom

ania

Turk

ey

Polan

d

Czec

h Rep

ublic

Bulg

aria

Hung

ary

S. A

frica

Phili

ppin

es

Indo

nesia

Indi

a

Chin

a

Thail

and

Kore

a

Taiw

an

Mala

ysia

Vene

zuela Peru

Braz

il

Arge

ntin

a

Colo

mbi

a

Mex

ico

Chile

Italy

Fran

ce

Japa

n

Germ

any

Spain

Austr

alia

Irelan

d

N. Z

ealan

d

U.S.

Emerging Europe 12.1 Latin America 9.2

Emerging Asia 27.5

Mature Markets 58.0

Sources: IMF staff estimates based on data from country authorities, CEIC, and WEO.

Average for all countries: 29.2

9

Positive Relationship between Household Credit and Income

Chile

Mexico Czech Republic

Hungary

Poland

Romania

South Africa

Turkey

Korea

Malaysia

Taiwan

Thailand

Australia

France

Ireland

Italy

Japan

New Zealand

Spain

United States

ArgentinaBrazil

Colombia

Peru Venezuela

Bulgaria

Russia

ChinaIndia

Indonesia

Philippines

Germany

0

10

20

30

40

50

60

70

80

90

100

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000

GDP per capita(in U.S. dollars)

Hou

seho

ld D

ebt/G

DP

(in p

erce

nt)

Sources: IMF staff calculations based on data from country authorities, CEIC, and WEO.

Household Credit/GDP and GDP Per Capita in Selected Emerging and Mature Market Countries, End-2005

10

Other Drivers of Household Credit

• Financial liberalization

• Financial innovation

• Highly favorable global liquidity conditions

• Lower inflation, stable interest rates

• Corporate de-leveraging post Asian crisis

• Access to capital markets by corporates

• Increased retail lending by foreign banks

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Housing loans dominate in Mature Markets but less so in EM countries

Share of Housing Loans in Total Household Credit, End-2005 (In percent)

0

10

20

30

40

50

60

70

80

90

100

Russ

iaRo

man

iaTu

rkey

Bulg

aria

Pola

ndH

unga

ryS.

Afri

caBr

azil

Ven

ezue

laCo

lom

bia

Arg

entin

aPe

ruCh

ileM

exic

oIn

done

siaPh

ilipp

ines

Mal

aysia

Taiw

anIn

dia

Kor

eaCh

ina

Italy

Fran

ceSp

ain

Uni

ted

Stat

esG

erm

any

Japa

nIre

land

Aus

tralia

New

Zea

land

Emerging Europe27.9

Latin America 37.5

Emerging Asia 54.2

Mature Markets77.5

Sources: IMF staff estimates based on data from country authorities and CEIC.

Average for all countries: 52.9

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Assessing the nature of credit growth – type of borrower

• Households, individual businesses, corporates– purpose and use of the loans

• mortgage loans/loans for asset purchases/loans for consumer goods

– sectoral composition and concentration of the loans • for productive vs. non-productive activities

– currency denomination of the loans• FX-denominated (or indexed) vs. domestic currency denominated

– maturity of loans • short-term vs. long-term

– funding sources of the loans• Foreign/domestic banks, non-banks

– other loan conditions• collateral, interest rate conditions

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Potential Vulnerabilities

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Credit growth have fueled asset price inflation in some EM

House Price Indices (2000=100)

Selected Mature Market Countries

Ireland

Netherlands

Spain

New Zealand

United States

France

100

120

140

160

180

200

220

2000 2001 2002 2003 2004 2005Sources: ESRI, Ireland; Ministerio de Vivienda, Spain; OFHEO, USA; RBNZ, New Zealand; NVM, Netherlands; ODBP, UK; ABS, Australia, Central Bank of Malaysia, CEIC and Bloomberg.

Selected Emerging Countries

Thailand

Korea

Malaysia

Hungary

80

100

120

140

160

180

200

220

240

260

280

2000 2001 2002 2003 2004 2005

South Africa

China

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... contributed to current account deficits

Czech Republic

Hungary

Russia

Turkey

South Africa

China

IndiaThailand

Brazil

Chile

Venezuela

France

Bulgaria

Malaysia

Philippines

Argentina

Colombia

Mexico

Peru

AustraliaGermany

Ireland Italy

Japan

SpainU.S.

-20

0

20

40

60

80

100

0 5 10 15 20 25 30

Average Import Growth, 2000-05 (In percent)

Ave

rage

Gro

wth

of C

onsu

mer

Cre

dit,

2000

-05

.(I

n pe

rcen

t)

Nominal Consumer Credit Growth and Merchandise Import Growth, 2000–05

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• Foreign currency borrowing in EE, mainly for housing

• Taking advantage of low euro interest rates

• FX risks for households but there are mitigating factors:

- low share of such loans;

- policy convergence with EU;

- presence of well supervised foreign owned banks

• Authorities are taking action in several countries

...and to cross-border inflows and foreign currency lending

Share of Foreign-Currency-Denominated Household Credit, End-2005

(In percent of Total Household Credit)

0

10

20

30

40

50

CzechRepublic

Turkey Russia Bulgaria Poland Hungary Romania

Sources: IMF staff estimates based on central banks and CEIC.Note: Data for Bulgaria does not include overdraft .

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• EM countries with rapidly rising HH debt also have significant positive net financial assets

• HH also have non-financial assets i.e. housing

• Need for improved HH level data on the distribution of debt (e.g. Riksbank Sweden)

EM Household Balance Sheets indicate positive net worth but this may mask vulnerabilities...

Household Financial Leverage1 in Selected Countries, 2005(In percent)

0

20

40

60

80

100

Ital

y

Jap

an

Cze

ch R

epubli

c

Po

land

Fra

nce

Turk

ey

Colo

mbia

Unit

ed S

tate

s

Hun

gar

y

Au

stra

lia

Spai

n

India

New

Zea

lan

d

Sources: IMF staff calculations based on data from central banks and CEIC.Note: Data for Colombia, India and Japan is as of end-2004.1 Household leverage is defined as the ratio of household liabilities to household assets.

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• Well capitalized banking system – reported CARsranging from 11 to 20 percent;

• With low non-performing loans in most countries;

• But, these indicators are backward looking and often reflect market averages and mask pockets of weaknesses

EM countries appear to have sufficient cushion to absorb credit losses

Nonperforming Loans, 2005

Household Loan NPLs(In percent of total household credit)

0

5

0

5

Bulg

aria

Turk

ey

Czech

Republic

Pola

nd

India

Mala

ysia

Philip

pin

es

Spain

United

Sta

tes

Fra

nce

Italy

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Legal, Regulatory and Institutional Reforms

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Teething Problems in Securitization of EM household credit

• High liquidity and more than adequate regulatory capital

• Underdeveloped institutional investor base

• Regulatory constraints discouraging investment in securitized products

• Legal limitations

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Legal and Institutional Reforms Needed

• Directed credit still existing in some countries

• Need to upgrade supervisory capacity

• Weak creditor protection and enforcement

• Inadequate origination standards

• Weak risk management of HH loan portfolios

• Weak disclosure standards and lack of proper credit information

• Lack of a framework to analyze linkages between HH credit and macro-prudential variables

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Menu of Options

Macroeconomic Policy

Measures

Prudential Measures

Supervisory/ Monitoring Measures

Administrative Measures

Market Development

Measures

Fiscal measures

Monetary measures

Exchange rate policy response

- Fiscal tightening

- Avoiding fiscal/quasi fiscal incentives that may encourage certain lending.

- Interest rate tightening

- Reserve requirements

- Liquid asset requirements

- Sterilization operations..

- Increase exchange rate flexibility

- In general maintain a consistent policy mix

- Higher/differentiated capital requirements

- Tighter/differentiated

loan classification provisioning

- Tighter eligibility

criteria for certain loans

- Dynamic provisioning - Tighter collateral rules - Rules on credit

concentration - Tightening net open

FX position limits - Maturity mismatch

regulations, and guidance to avoid excessive reliance on short-term borrowing

Policy Options

- Closer onsite/offsite inspection/surveillance of potentially problem banks or those with aggressive lending portfolios

- Periodic stress testing - Periodic monitoring/

survey of exposure of banks and their customers

- Strengthening

coordination between supervision of bank and nonbank financial institutions

- Increased dialog

between domestic supervisors and home supervisors of foreign banks

- Increasing availability of hedging instruments to manage risks

- Increasing availability

of asset management instruments to deal with distressed assets

- Developing securities

markets to reduce dependence on bank credit and improve diversification of banks’ credit risks

- Improving credit

culture (establishment of credit bureaus, credit registry, stronger legal system, creditor rights, etc)

- Improving banks’ and

corporations’ accounting standards

- Overall or bank-by-bank credit limits

- Marginal reserve

requirements based on credit growth

- Controls on capital

flows: e.g.,

- control on foreign borrowing by banks and/or bank customers

- different reserve

requirements on domestic and foreign currency

- Taxes on financial

intermediation - Import restrictions

Promotion of Better Understanding of

Risks

- Strengthening banks’ ability to monitor, assess, manage risks

- Public risk

awareness campaigns, press statements, etc

- Discussions/

meetings with banks (“moral suasion” being an extreme version, to warn/persuade banks to slow down credit extension, etc).

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Risks associated with rapid credit growth

Aspects of Credit Growth Type of Risk Associated Speed of credit growth • Credit risk (from inappropriate loan assessments, strain on ability to

monitor and assess risks) • Macro risks

Main providers of credit (foreign versus domestic banks, etc.)

• Credit risk (from aggressive lending strategies) • Macro risks

Main borrowers of credit (households, corporates, etc.)

• Credit risk (greater sensitivity of repayment capacity of corporate loans to the economic situation, that of consumer loans to collateral values)

• Macro risks (likely impact of loans on the current account) • Market risks (sensitivity to economic activity and price changes)

Sectoral loans concentration/ composition of credit (mortgages, durable consumer goods, investments, etc.)

• Credit risk from concentration, collateral values for mortgages, etc.) • Macro risks (impact on the current account in the case of

consumer/investment loans, etc.) • Market risks (e.g., sensitivity to real estate prices)

Currency composition of loans • Direct (through banks’ net open positions) and indirect (via borrowers’) exposure to FX risks

Maturity of loans • Maturity/liquidity risks (longer term loans financed through shorter term borrowing by banks)

Sources of credit • Foreign exchange risk (loans funded by bank borrowing) • Maturity risks (when liabilities short-term, assets longer term) • Macro risks (from exposure to market sentiment)

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Measures taken by some EM countries

• Tightening prudential/supervisory policiesloan eligibility and amounts (LTV, debt service/income)

imposing differentiated risk weights based on credit type

higher capital requirements for FX loans and/or NPLs

tighter collateral requirements

• Use of dynamic (ex-ante) provisioning

• Targeted on-site inspections

• Elimination of tax deductibility of interest payments

• Limiting aggressive marketing campaigns

• Consumer protection laws and credit bureaus

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Policy Implications and Conclusion

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Policy Implications

• Macroeconomic and financial linkages complicate the conduct of monetary policy

Need to build a frameworkUnderstanding of implications on transmission mechanism

• Relatively few episodes of systemic distress from HH credit in EM countries

Low levels of household credit / “catching up process”Mostly untested risk from bank and regulators’ perspective

• Traditional crisis management may have limitsPolitical implications of household bankruptcyFormulate contingency plans

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Conclusion• Healthy development in household credit can foster

growth in EM countries

• In most EM countries, retail credit expansion from a low base does not seem to threaten financial stability

• To mitigate potential vulnerabilities:

Ensure sound macroeconomic policy environment;Implement sound prudential regulations; comprehensive legal, regulatory and institutional infrastructure;Enhance information disclosureDevelop contingency plans