Unwinding of Pre-Crisis Credit Booms Versus Recoveries

By: Franziska Ohnsorge Senior Economist

By Franziska Ohnsorge, Yevgeniya Korniyenko and Philipp Hochreiter

Private sector credit growth continues to be subdued in most of EBRD’s countries of operation (COOs), despite a gradual recovery of trade, industrial production and capital inflows in the second quarter of 2010.

Two groups of countries stand out among the EBRD’s COOs:

• In some countries, deleveraging continues and private credit continues to shrink or stagnate. This group includes the Baltic countries and several countries in South-Eastern Europe (Montenegro, Croatia, Bosnia and Herzegovina, Bulgaria), but also Kazakhstan and—because of the household lending segment—Russia. In Kazakhstan, credit is stagnant as banks remain cut-off from foreign funding. In Ukraine, too, credit shrank until the presidential elections in February 2010, after which capital inflows returned and credit began to expand again.
• In others, the recovery is clearly underway and credit started to grow already in 2009. This group includes commodity exporters (Armenia, Azerbaijan) and those with state-directed or state–subsidized lending (Belarus, Serbia) or lending to state-owned enterprises (Slovenia). The recovery in Turkish credit growth benefited from strong capital inflows.

To isolate the key factors that differentiate countries, we run an OLS regression of the growth in private sector credit to date in 2010 on measures of pre-crisis banking system structures, macroeconomic vulnerabilities, and institutional environment. In addition, we add the size of the preceding credit collapse to control for any rebound effects, and the rise in unemployment during 2009 as a measure of the cyclical downturn that may affect credit demand today (using 2009 GDP growth instead leads to similar results). We limit the sample to the EBRD region.

As expected, the cyclical positions of countries at end 2009 help predict recent credit growth, and so does a rebound effect (where credit dropped most precipitously during the crisis, it is recovering faster). In addition, recent credit growth appears to be explained by at least three structural factors:

• Banking systems that were better capitalized before the crisis (2007/08) show stronger post-crisis (2010) credit growth (see chart. 1.1).
• Post-crisis credit growth is lower in countries that experienced larger pre-crisis credit booms (see chart 1.3).
• In the same vein, more financially integrated countries are experiencing slower recovery of credit (see chart 1.2.). Interestingly, this effect is present over and above the effect of pre-crisis credit booms.

All these effects are robust to the inclusion of institutional controls, such as cost of contract enforcement.

 In a simple correlation, the recovery in credit growth appears to be lower in countries with a higher stock of foreign currency loans (see chart 1.4), higher external debt to GDP, higher loans-to-deposit ratios, or bigger presence of foreign banks. These correlations, however, becomes insignificant once controlled for the cyclical positions of countries at end 2009 and level of financial integration before the crisis.

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