Assessing Policies to Revive Credit Markets

Policymakers in economies hit hard by the global financial crisis have been concerned about weak growth in credit, considered a main factor in the slow economic recovery. Many countries with near-zero or negative credit growth for a number of years sense that the strategy of very accommodative macroeconomic policies has been insufficient in reviving credit activity. Authorities have therefore implemented a host of policies to target credit creation (which are documented in an appendix to the chapter). 1 Effectively targeting these policies requires identifying the factors that underlie the weakness in credit. In credit markets, these factors center around the buildup of excessive debt in households and firms, reducing their credit demand, as well as excessive leverage (or a shortage of capital) in banks, restricting their ability or willingness to provide additional loans. The government could also usefully alleviate a shortage of collateral (perhaps resulting from large declines in asset values), which could constrain credit activity. To address such a technically challenging exercise, this chapter takes a stepwise approach. The first step is an attempt to identify the constraints to credit through the use of lending surveys—trying to disentangle whether banks are unwilling to lend (on the supply side) or whether firms or households are reluctant to borrow (on the demand side). This distinction helps narrow down the set of policies to consider, which differ depending on the side of the market that faces the major constraint. A more challenging second step—which is hampered by the lack of sufficient data for many countries—is to identify the individual factors that are constraining credit, specifically what makes banks unwilling to lend or households and firms reluctant to borrow. Using this approach for several countries that have sufficient data, the analysis finds that the constraints in credit markets differ by country and evolve over time. This reinforces the importance of a careful country-by-country assessment and the need for better data on new lending. In many cases, demandand supply-oriented policies will be complementary, but their relative magnitude and sequencing will be important. For example, relieving excessive debt in firms will help only if the banking sector is adequately capitalized. Policymakers should also recognize the limits of credit policies and not attempt to do too much. Because many policies will take time to have an impact, assessment of their effectiveness and the need for additional measures should not be rushed. When credit policies work well to support credit growth and an economic recovery, financial stability is enhanced, but policymakers should also be cognizant of longer-term potential risks to financial stability. The main risks center on increased credit risk, including a relaxation of underwriting standards and the risk of “evergreening” existing loans. Mitigation of these risks may not be necessary or appropriate while the economic recovery is still weak, as it could run counter to the objectives of the credit policies (which are often designed to increase risk taking); still, policymakers will need to continually weigh the near-term benefits against the longer-run costs of policies aimed to boost credit.