Mr. Stals discusses the importance of credit extension for macroeconomic financial stability  (Central Bank Articles and Speeches, 29 Oct 98)
Central bank: sarb | Type: speech | Date: 1998-10-29

Mr.

Stals discusses the importance of credit extension for macroeconomic financial stability Address by the Governor of the South African Reserve Bank, Dr. Ch Stals, at a Breakfast Meeting of the Institute of Credit Management in Johannesburg on 2

## 1.

A 'credit' economyModern economies are often described as 'credit-based' economies.

This is a reflection of the functioning of modern, sophisticated economies in which money pla important part as a means of exchange, as an instrument of payments and as a store of vaThe availability and the use of credit facilitates the exchange of go services, the production processes and the growing importance in all modern econom financial services.

One can hardly visualize a modern economy that works without credit.The normal characteristic of credit is that one participant in the economy, individual, a corporate body or a governmental institution, denies himself the immedia purchasing power already in his possession, and makes this purchasing power on a tem basis available to another participant in the economy who has an immediate need for th the purchasing power.

This kind of transfer of purchasing power from savers (the len users (borrowers) will never create macroeconomic distortions in the economy.

On the c as already mentioned, it supports maximum economic growth and development in the countrThis basic form of credit extension encouraged the development over many ye of financial savings institutions, financial intermediaries, institutional investors, etc. that serve as useful conduits for transferring purchasing power from savers to u for consumption or for real or financial investment purposes.

The financial authori countries have a responsibility to oversee these financial institutions, mainly with th protecting the general public, be they lenders or borrowers, against exploitation that an unreasonably low remuneration for savers, exorbitantly high costs for borrowers financial losses for both.Together with the development of these specialised financial intermedi financial markets emerged where the transfer of savings from lenders to borrowers can t in a more competitive environment with greater transparency and more general partici These markets, such as the stock exchanges, bond markets, markets for derivative short-term money markets play a very important part in the optimum allocation of resources in modern economies.

Financial authorities also have a vested interest in o these financial markets to ensure orderly conditions, the effective and efficient tran from borrowers to lenders and the maintenance of orderly and stable conditions in the maA further development in this process of the transfer of purchasing power savers to users of funds, took place with the development of cross-border or inte transfers of purchasing power.

Savers in the more mature economies of the world whe demand for purchasing power is relatively low, found it increasingly attractive to mak the less-developed economies where they could earn much higher interest rates. cross-border movement of funds introduced a new dimension in the credit extension proc the form of exchange rates for foreign currency transfers.

The financial authorities o countries now obtained more than just an overseeing function in the credit extension Rightly or wrongly, governments were in the past seen to be responsible for the fixiexchange rate, and for ensuring that convertibility of national currencies into othe will at all times be possible.There is one further form of credit extension that has become of vital imp for macroeconomic financial management, and that is the extension of bank credi simultaneously also creates money.

Banks are not normal financial intermediaries tha funds from savers and then make loans out of these funds to borrowers.

Banks can create to make loans, and in the process can increase the total purchasing power in the economIn summary, therefore, the presence of credit facilities, financed out o savings, is an essential and necessary element of all modern economies.

The financial a should have no more than an overseeing function in the management, organisation and i administration of the whole process of credit extension.

As far as both financial int and financial markets are concerned, the authorities should restrict their interven creation of a protective and transparent legal and accounting framework within which in and markets can function effectively.However, the financial authorities have more than just an overseeing fun when it comes to international credit extension activities, and to the creation of banking institutions.

## 2.

Bank credit extensionExcessive bank credit extension lay behind many of the global financial pro of recent times.

In a number of the East Asian countries, controls on banking institu rather lax and enabled them to increase their total credit to governments and priv borrowers by substantial amounts over a protracted period of time.

In the process, int were kept artificially low and banks on an increasing scale relied on foreign borr supplement their liquidity base for the continuing expansion of total credit.In the end, when foreign investors became reluctant to continue to provi liquidity base for the credit extension by the banks, the financial systems crumbled.

I the final collapse was forced by:- A withdrawal of foreign deposits from banks and of foreign portfo investments from the capital markets of the affected countries.- Foreign credit previously extended to the East Asian countries was ther withdrawn.- A reduction in the amount of liquidity available within banking institut they lost foreign deposits and had to fund the withdrawal of other inves from the capital markets.- Forced reductions in the amount of credit banking institutions could available to their clients, many of whom were overborrowed and could meet the demand for the repayment of loans.- An unavoidable depreciation of exchange rates and sharp rises in interes which forced losses on borrowers of foreign and domestic fund Overborrowed institutions were forced into liquidation, and in the pr transferred their losses to their lenders.The consequences of this credit crunch are now well-known.

In many of the Asian countries, negative real economic growth rates are now experienced as p consolidations and reforms of banking and financial structures are taking place.The East Asian financial crisis, which quickly spread to other emerging ma to the smaller more stable developed economies of the world and recently also to major centres such as New York provided a stark reminder of how important sound credit manage is for the protection of macroeconomic financial stability in individual countries, world at large.No country can procure permanent and sustainable economic growth at a hi level if this growth is dependent on the creation of an increasing amount of credit, banking institutions.

Not only lenders (banking institutions) and borrowers (priva institutions and individuals) can be destroyed in the process, but also total financia even total economies can break down under the burden of too much credit.Central banks have the unenviable task of judging at all times what amou additional bank credit will in prevailing circumstances be reconcilable with the ob maintaining overall financial stability.

Economies normally provide early warning si excessive credit extension, such as rising inflation or unaffordable increases in imp withdrawal of foreign funds from the country.

It is important not to ignore such signal

## 3.

Other lessons from the global financial crisisThe recent turmoil in world financial markets provided important lessons only for central bankers, but also for credit managers in private sector financial ins following three lessons must have come to the notice of many a private sector f institution:- (i) Risk management models based on past experience or on rigid comput programmes do not necessarily provide adequate protection against poten losses in the new environment of financial globalisation.

Experience discretion cannot be replaced by models and machines.- (ii) The value of collateral against credit extension can disappear overni the Russian example).- (iii) Excessive leveraging must be avoided at all times, and particularl present environment of volatile global changes (vide the example of Long-Term Capital Management Fund).Governments, central banks, market managers, private sector institutions private individuals all have learned once again from this experience that the excess credit sooner or later leads to disaster.

At this juncture, the world economy is paying in the form of depressed growth for being reminded of these basic truths.

## 4.

Credit extension and the South African economyAlthough the South African economy was also severely affected by the curr world financial crisis, a sound banking system, well-managed financial institutions and financial markets protected the country against the almost total collapse of the ec happened in a few other countries.The Reserve Bank has some concern, nevertheless, for the increasing use of credit to maintain expenditure levels.

The recent financial crisis forced exorbitantly rates on the South African economy and borrowers of funds could not avoid sharp rises cost of servicing existing debts.

The world financial crisis therefore hopefully also grim warning to all South African borrowers and lenders that excessive debt positions avoided.

Neither the Reserve Bank nor the Government can guarantee low interest ra overall financial protection in the new environment of a worldwide integration of markets.It will also be foolish for South Africa now to try to revive the domestic by creating an excessive amount of additional credit extended by banking institutions i global financial environment.

Such a policy could easily lead South Africa also on th overall economic disaster, as more than one country in the rest of the world experience past year.

## 5.

ConclusionI believe that members of this Institute of Credit Management are aware potent danger of excessive debt positions, be it for countries, governments or priv borrowers.

The discipline of controlling this dangerous element of modern, sophisticate economies, is not a responsibility only of the central bank.

It is not only a macroeconomic policy, but also one for institutions operating at the micro-level.

W make a contribution towards protecting our country from falling in the debt trap of borrowing by applying sound principles in the management of our debt positions.