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Rapid expansion of credit in South Eastern Europe: a cause for concern?

Dubravko MihaljekBank for International Settlements*

Presentation at ICEG EC conference

South Eastern Europe after EU Enlargement and before Accession Budapest, 4 April 2005

* The views expressed are those of the author and not necessarily those of the BIS.

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Overview

1. Two views of credit expansioni. Benign view

ii. Reasons for concern

2. Composition of bank lending

3. Mortgage lending and housing prices

4. Real estate markets in SEE

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1. Two views of credit expansion

Basic facts:

• Cumulative expansion of bank credit to the private sector over 2002-04:

> 200% (nominal) in BG, RO, SCG

90-170% in AL, HU, TR, Baltic states

40-75% in BH, HR, MK, SI

• Real growth > 20% p.a. in 8 countries

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Bank credit to the private sector, 2002-04

3738

33

38

2826

1820

16

1012

53

2

34

13

0

50

100

150

200

250

300

SCG ROM BUL LAT LIT TUR ALB EST HUN BIH HRV SVN MAK POL SKA CZE EUR

0

5

10

15

20

25

30

35

40

45

Nominal growth (cumulative, in percent) (lhs) Real growth (compound rate, % per year) (rhs)

Sources: IMF, International Financial Statistics; national data; BIS estimates.

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Benign view of credit expansion

• Recent growth mostly reflects low base, low levels of financial intermediation

R (credit growth, credit/GDP) = -0.5

• Banking sector indicators improved

• Banking reforms advanced in SEE

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Developments in bank credit to private sector

In nominal terms2 In real terms2,3 Credit/ GDP

M3/GDP Countries1

2002 2003 2004 2002 2003 2004 2003, in per cent

Croatia 30.2 14.6 11.8 27.4 12.5 8.8 57.8 66.8

Slovenia 15.0 15.7 17.1 6.7 10.7 11.8 43.2 66.0

Hungary 21.9 34.3 17.7 16.3 27.1 11.6 41.7 47.3

Bosnia-Herzegovina 27.7 20.3 13.2 27.4 19.6 13.7 41.7 45.2

Poland 10.0 8.1 3.0 9.2 6.3 –1.4 32.4 41.7

Czech Republic –6.6 9.3 12.2 –7.1 8.2 9.1 31.0 69.2

Bulgaria 43.2 48.3 42.6 38.0 40.4 37.1 27.6 48.1

Slovakia 1.5 15.0 1.4 –1.7 5.3 –4.2 27.4 62.5

Macedonia 4.7 15.3 17.8 3.7 12.5 18.9 19.6 30.0

Romania 51.1 69.5 38.0 28.3 48.5 26.3 15.9 24.2

Turkey 19.4 31.8 49.3 –7.9 1.4 37.2 13.6 43.5

Serbia-Montenegro 64.7 31.9 64.1 43.5 22.6 46.8 10.3 10.7

Albania 41.0 31.0 23.4 38.6 26.8 20.7 6.8 60.2

Memo: Euro area 4.1 4.7 3.5 1.7 2.7 1.1 97.7 83.3 1 Ordered according to the private sector credit/GDP ratio. 2 Annual changes, in per cent. 2004 figures based on latest available data. 3 Deflated by consumer prices.

Sources: IMF, International Financial Statistics; national data.

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Benign view of credit expansion (cont)

• Banking sector indicators improved• Lower NPLs• Kept high capital adequacy• Increased profitability

• Banking reforms advanced in SEE (privatisations in AL, SCG; consolidation in BH; better supervision in MK,TR)

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Banking sector indicators

Non-performing loans1

Capital adequacy2

Return on equity Return on assets

1999 2003 1999 2003 1999 2003 1999 2003

Bulgaria 29.0 4.2 43.0 22.0 20.9 15.6 2.5 2.0 Croatia 11.8 5.1 20.6 16.2 4.8 14.5 0.7 1.6

Czech Rep. 22.0 4.9 13.6 14.5 –4.3 23.6 –0.3 1.3

Hungary 3.6 3.2 14.9 11.6 7.1 19.8 0.6 1.7

Poland 13.2 22.2 13.2 13.6 12.9 5.9 0.9 1.0

Romania 35.4 3.4 17.9 21.1 –15.3 15.6 –1.5 2.2

Slovakia 23.7 9.6 29.5 20.7 –36.5 13.8 –2.3 1.1

Slovenia 5.2 9.4 14.0 11.5 7.8 12.6 0.8 1.0

Turkey 10.5 11.5 8.2 31.0 33.1 14.7 3.3 2.2

Average 14.6 6.6 18.7 16.8 4.3 14.9 0.6 1.5 Memo: Austria 1.7 1.5 13.9 14.5 6.9 7.2 0.3 0.4 1 As percent of total loans. 2 Risk-weighted capital-asset ratio. 2 End-2000.

Sources: Central bank publications and websites; ECB (2004); Bank Austria (2004).

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But there are reasons for concern

1. In BG, HR, TR credit has expanded by 5% of GDP or more p.a. for 5 years(benchmark signalling potential for crisis; Demirguc-Kunt and Detragiache, 1997)

In the last two years credit growth has exceeded this benchmark also in BH, HU, and RO (and Baltic states)

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Bank credit to the private sector, 2000-04 (Increase in percent of GDP, annual average)

8.5

6.0 6.05.1

3.62.7

1.9

0.9 0.9 0.60.1

-3.1 -3.2

4.5 4.34.0 3.9

-5

0

5

LIT BUG TRK HRV EST ROM LAT HUN BIH SVN EUR ALB POL MAK SCG CZE SKA

Sources: National data; BIS estimates.

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But there are reasons for concern

2. Lending expanding faster than deposits

banks borrow from foreign HQs

rising foreign liabilities of banking system

external indebtedness

central banks in BG, HR, RO taking precautionary measures

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Commercial bank liabilities, 2002-04(annual pct change, quarterly average )

-20

0

20

40

60

80

100

ROM BUG SKA LIT HRV EST SVN LAT HUN POL TRK MAK CZE

Time, savings and foreign currency deposits

Foreign liabilities

Source: IMF; BIS estimates.

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Reasons for concern (cont)

3. Loans extended during the boom have yet to mature NPLs could increase

4. Rapid expansion of foreign currency lending bank customers exposed to FX risk, banks substitute credit risk for FX risk

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2. Composition of credit growth

• Much faster growth of credit to households than to enterprises

• Negative correlation:R (household, enterprise credit growth) = -0.75

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Real credit growth to enterprises and households, 2003–041

Albania Bosnia and

Herzegovina Bulgaria Croatia

Czech Republic

Estonia Hungary Latvia

Enterprises 35 64 72 7 2 57 21 63

Households 172 77 173 38 68 111 92 212

Lithuania Macedonia Poland Romania Serbia and

Montenegro Slovakia Slovenia

Simple average

Enterprises 68 19 -4 52 50 -16 34 35

Households 212 129 35 356 227 56 25 132 1 Cumulative percentage changes from 2003 to latest available data for 2004; deflated by consumer prices. Source: National data.

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Real growth of credit, 2003-04 (cumulative growth rate, in percent)

BUL

ROM BIHSCG

ALB SVN AVGTRK

HUNMAK

HRVCZE

POLSKA-15

5

25

45

65

85

Enterprises

ROM

SCG

BUL ALB TRK

AVG MAK

HUNBIH SKA CZE

HRV SVNPOL

0

50

100

150

200

250

300

Source: National data; BIS estimates.

Households

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Composition of credit growth (cont)

• Composition of lending still far from that in mature market economies (except in HR)

• Lending to households (after years of neglect) welcome, profitable

• But household indebtedness rising fast (84% of disposable income in HR)

central banks in HR, CZ, HU issued warnings

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Composition of commercial bank lending1

Government2 Corporate Household

1999 2003 2004 1999 2003 2004 1999 2003 2004

Bulgaria 21 8 –3 65 67 70 14 25 33 Croatia 21 8 8 65 68 42 14 25 50

Czech Republic 6 31 25 83 45 45 12 25 30

Hungary 43 13 9 49 57 57 8 30 32

Poland 5 6 7 62 53 46 33 31 46

Romania 35 9 5 62 68 68 3 23 27

Slovakia 29 49 49 64 37 34 7 14 17

Slovenia 22 22 22 52 57 55 26 21 23

Turkey 3 4 4 86 76 71 11 20 25

Average 19 16 12 66 59 56 15 25 32 Euro area … 11 11 … 41 41 ... 48 49 1 In percent of total credit, excluding interbank credit and credit to non-bank financial institutions. End of period or for 2004, latest available period. 2 Net claims on government for most countries.

Sources: Central banks, ECB; IMF.

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3. Mortgage lending and housing prices

• Mortgage lending fastest rising component of household credit in many countries

• No excessive growth in housing prices so far

• But where data exist, clear correlation b/w housing loans and housing prices

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Mortgage lending and residential property prices1

(annual percentage changes)

HPRICE =-2.4 + 0.14 HLOAN

R2 = 0.33

-10

-5

0

5

10

15

20

-10 10 30 50 70 90 110 130

Housing loans

Hou

se p

rice

1 Based on quarterly data for Croatia, Hungary and Poland, 2000-04.Sources: Central banks; BIS estimates.

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4. Real estate markets in SEE

• Still underdeveloped– high owner occupancy ratios– many properties do not have clean titles– supply of good quality properties constrained

• But property prices rising rapidly in big cities and coastal areas demand by non-residents how fast should SEE countries open up their real estate markets to EU residents