lending booms, foreign bank entry and competition: the croatian case
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LENDING BOOMS, FOREIGN BANK ENTRY AND COMPETITION: THE CROATIAN CASE. Evan KraftLjubinko Jankov Croatian National Bank *The views presented here are the authors’ alone and do not necessarily represent the views of the Croatian National Bank. Outline. - PowerPoint PPT PresentationTRANSCRIPT
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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.
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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
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Consequences of lending booms: financial side
• Credit quality deterioration—looser 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 )
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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
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Consequences of lending booms: macro side
• Investment and/or consumption boom
• Increased volatility of GDP, recession and currency crises
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What causes lending booms?
• Real business cycle theory—positive technology or terms of trade shocks. Such booms would not be problematic at all.
• Financial liberalization
• Capital inflows
• Wealth shocks
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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.
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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 sound—ambiguous effects
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Croatia’s lending boom: phase 1, 1995-1998
• Liberalization of banking laws in early 1990’s
• 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
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Croatia’s 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
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Credit growth: households
Graph 1: Lending to households (corrected), yoy growth
0
10
20
30
40
50
60
70
80
90
100
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Credit growth: enterprisesGraph 2: Lending to enterprises (corrected) yoy growth
-10
-5
0
5
10
15
20
25
30
35
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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
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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
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Deposit growth
Graph 3: Growth rate of total deposits, yoy, %
-10
0
10
20
30
40
50
60
70
06.9
5.
09.9
5.
12.9
5.
03.9
6.
06.9
6.
09.9
6.
12.9
6.
03.9
7.
06.9
7.
09.9
7.
12.9
7.
03.9
8.
06.9
8.
09.9
8.
12.9
8.
03.9
9.
06.9
9.
09.9
9.
12.9
9.3)
03.2
000.
06.2
000.
09.2
000.
12.2
000.
03.2
001.
06.2
001.
09.2
001.
12.2
001.
03.2
002.
06.2
002.
09.2
002.
12.2
002.
03.2
003.
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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
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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
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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
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Macro side of lending boom, phase 1
1995 1996 19971998
Inflation, retail prices, % 3,7 3,4 3,85,4
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.
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Macro side of lending boom, phase 2
1999 2000 20012002
Inflation, retail prices, % 4,4 7,4 2,62,3
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.
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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
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Policy measures, phase 2
• “16% rule”—banks must buy low-interest rate Croatian National Bank paper if growth of risk assets exceeds 4% in a given quarter.
• “35% rule”—banks 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
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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
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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.