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LENDING BOOMS, FOREIGN BANK ENTRY AND COMPETITION: THE CROATIAN CASE

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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 ... – PowerPoint PPT presentation

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Title: LENDING BOOMS, FOREIGN BANK ENTRY AND COMPETITION: THE CROATIAN CASE


1
LENDING 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.

2
Outline
  • 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

3
Consequences 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 )

4
Policy 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

5
Consequences of lending booms macro side
  • Investment and/or consumption boom
  • Increased volatility of GDP, recession and
    currency crises

6
What 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

7
Lending 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.

8
Foreign 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

9
Croatias 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

10
Croatias 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

11
Credit growth households
12
Credit growth enterprises
13
Causes 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

14
Causes 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

15
Deposit growth
16
Evidence 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

17
Lending 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

18
Lending 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

19
Macro 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.

20
Macro 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.

21
Policy 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

22
Policy 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

23
Why 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

24
Prudential 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.
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