Title: LENDING BOOMS, FOREIGN BANK ENTRY AND COMPETITION: THE CROATIAN CASE
1LENDING BOOMS, FOREIGN BANK ENTRY AND
COMPETITION THE CROATIAN CASE
- Evan Kraft Ljubinko Jankov
- Croatian National Bank
- The views presented here are the authors alone
and do not necessarily represent the views of the
Croatian National Bank.
2Outline
- Lending booms, banking and currency crises
- Foreign banks and lending booms
- The Croatian case
- features of the lending boom
- causes competition, liberalization, stock
adjustment, capital inflows - consequences
- policy measures
3Consequences of lending booms financial side
- Credit quality deteriorationlooser underwriting
standards (Gavin and Hausmann 1996), dilution of
relationships (Niinimaka 2001) - Financial accelerator followed by crisis
- Financial deepening, with positive long-term
effects on growth (Wachtel 2001, Levine, Loayza
and Beck 2000 )
4Policy dilemmas
- Difficult to measure extent of bad asset problem
in real time - Where is the trade-off between preventing crisis
by slowing down growth and slowing down
beneficial financial deepening? - speed limits view
- increased capital requirements view
- wait and see view
5Consequences of lending booms macro side
- Investment and/or consumption boom
- Increased volatility of GDP, recession and
currency crises
6What causes lending booms?
- Real business cycle theorypositive technology or
terms of trade shocks. Such booms would not be
problematic at all. - Financial liberalization
- Capital inflows
- Wealth shocks
7Lending booms and banking crises the evidence
- Caprio and Klingebiel (1996), Demirgüç-Kunt and
Detragiache (1997), Honohan (1997) and
Eichengreen and Arteta (2000) all find evidence
that rapid lending growth increases the
probability of banking problems - However, Eichengreen and Rose (1998) do not find
this, and Gourinchas, Valdes and Landerretche
(2001) find that only Latin American lending
booms are strongly correlated with crises.
8Foreign banks and lending booms
- Foreign banks less dependent on domestic funding
sources, above all deposits - Foreign banks subject to strong push factors
- Competition strong among foreign players
- Evidence from Latin America and Central and
Eastern Europe confirms these observations - Effect on instability foreign banks grow faster
but are more soundambiguous effects
9Croatias lending boom phase 1, 1995-1998
- Liberalization of banking laws in early 1990s
- Substantial entry by domestic banks
- Funding
- high deposit growth due to repatriation of
deposits held abroad after ending of hostilities - strong foreign borrowing after Croatia received
an investment grade credit rating in January 1997
10Croatias lending boom phase 2, 2000-present
- Large scale entrance of foreign banks, late 1999
and early 2000 - Recovery of household loans begins in second half
of 2000 - Recovery of enterprise loans is slower, beginning
slowly in the first half of 2001 and only
reaching 15-20 growth rates - improved enterprise liquidity in 2000 may have
slowed loan demand, but also improved balance
sheets
11Credit growth households
12Credit growth enterprises
13Causes of lending boom demand side
- Stock adjustment under communism, economy was
financially repressed - war and transition led to further write-offs and
credit contraction - but economy is relatively developed, and probably
the equilibrium level of credit/GDP is far above
the actual - Insider loans (in phase 1)
- Capital inflows
14Causes of lending boom supply side
- Liberalization and competition
- removal of restrictions on entry and interest
rate controls meant to stimulate supply - increasing competition also should increase
supply - Availability of funding
- deposit growth (especially 1995-97 and 2002)
- foreign borrowing (especially 1997, 2000 on)
- Foreign bank role
- t-tests show that both privatized and de novo
(greenfield) foreign banks increased lending
faster than domestic banks in 2000 and 2001
15Deposit growth
16Evidence of increased competition
- Number of banks decreases after 1998, and
Herfindahl index increases, but competition
actually increases - Narrowing spreads between lending and deposit
interest rates - Lower variation of market interest rates across
banks - Increased number of banks actually covering the
whole territory of Croatia - Panzar-Rosse h test
17Lending boom and banking crisis what is the
connection?
- Downgrade incidents
- definition greater than 4 percentage point
increase in bad assets (B to E) - 37 of 43 banks undergoing downgrades in 1998-99
grew faster than 30 yoy in at least 1 quarter
prior to downgrade - 30 of 40 banks that grew rapidly experienced
downgrades
18Lending boom and failure
- Early Warning System (EWS)
- best predictors of failure are deposit interest
rates and liquidity - loan growth a weaker predictor
- but loan growth may be correlated with other
problems - cannot conclude that rapid growth leads to failure
19Macro side of lending boom, phase 1
- 1995 1996 1997 1998
- Inflation, retail prices, 3,7 3,4 3,8 5,4
- Real GDP growth, 6,8 6,0 6,6 2,5
- Current Account, GDP -7,7 -5,5 -11,6 -7,1
- Sources Croatian National Bank and Central
Statistical Office.
20Macro side of lending boom, phase 2
- 1999 2000 2001 2002
- Inflation, retail prices, 4,4 7,4 2,6 2,3
- Real GDP growth, -0,4 2,9 3,8 5,2
- Current Account, GDP -6,9 -2,3 -3,8 -7,1
- Sources Croatian National Bank and Central
Statistical Office.
21Policy measures phase 1
- Tighter monetary policy introduced in mid-1997
- Chilean-style capital controls introduced in
April 1998 - Not clear whether capital controls or bank
failures and the Russian crisis slowed down
banks foreign borrowing and lending boom
22Policy measures, phase 2
- 16 rulebanks must buy low-interest rate
Croatian National Bank paper if growth of risk
assets exceeds 4 in a given quarter. - 35 rulebanks must hold liquid foreign
exchange assets equal to at least 35 of their
total foreign exchange liabilities - These measures are mainly aimed at slowing
growth, not at preventing asset quality problems
per se
23Why not just raise interest rates?
- Transmission mechanism based on fx market
- CNB bills rate would be most likely instrument
- Raising rates could trigger more capital inflows
- Rates would have to be raised very substantially
- Implications for public finance
24Prudential measures
- Banks that grow faster than 20 will be required
to form special reserves (0.10 of risk assets) - Like a temporary increase in capital requirements
- Banks will be exempt if they meet higher capital
standards (15 for growth between 20 and 30,
20 for growth between 30 and 40 etc) - Exceptions for new banks (first 3 years).
- Mergers growth based on sum of merged entities.