Krzysztof Rybiński: Rapid credit growth in converging economies - the
challenges ahead
Closing remarks by Mr Krzysztof Rybiński, Deputy President of the National Bank of Poland,
at the National Bank of Poland International Conference of Central Bankers and Economic
Educators "Monetary Policy Challenges Resulting from the Rapid Credit Growth in
Converging Economies", Warsaw, 23 November 2007.
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Ladies and Gentlemen,
We have now come to the end of the conference on "Monetary Policy Challenges Resulting
from the Rapid Credit Growth in Converging Economies", and it is my honour to provide
some concluding remarks. Over the last two days, we have been discussing opportunities,
challenges and problems related to the rapid credit expansion in Central and East European
(hereafter: CEE) economies that find themselves in a convergence process towards more
advanced EU member states. In the following, let me briefly summarize the main conclusions
that emerge from all the presentations and discussions.
Before I proceed, I would like to thank you all for attending this conference, especially the
speakers and discussants for their valuable contributions. Most of all, I would like to thank
central bank governors from our region: Ms Júlia Király, Deputy Governor of the Magyar
Nemzeti Bank, Mr Andres Sutt, Deputy Governor of the Bank of Estonia, Mr Sławomir
Skrzypek, President of the National Bank of Poland, and Mr Zdeněk Tůma, Governor of the
Czech National Bank, for enriching this conference with their presence and their views.
Without any doubt, the distinguished economists and practitioners who have actively taken
part in this conference have been its most valuable asset.
*
Turning to the rapid credit growth that has been observed in CEE economies over the past
years, the first question that comes to an economist's mind is the following: do these
developments pose a threat to the macroeconomic stability of the countries of interest? In
order to answer that question, one has to ask another: what forces have been the decisive
factors behind the rapid credit expansion? Several papers presented at this conference have
sought to provide answers to these questions.
One approach, followed by the papers1 presented in the first session, has been to estimate
the equilibrium rate of credit growth and check whether the actual growth has been below or
above that equilibrium path. The decomposition of credit growth into a convergence and a
boom component has shown that for most of the CEE economies, the former component has
been dominant, i.e. the rapid credit expansion can to a large extent be attributed to a
continuous improvement in the macroeconomic fundamentals and the initial low credit
volume in these countries. However, there are notable differences across the region: the
Baltic states (especially Latvia and Estonia) and South-East European countries (especially
Croatia and Bulgaria) seem to have approached or even reached the equilibrium by 2004 or
2005, whereas in the case of the Visegrad countries (especially the Czech Republic and
Poland) the credit-to-GDP ratio seemed to remain below its estimated equilibrium level at
that time. Of course, it might well be that some of the CEE economies have overshot the
equilibrium only recently, but one has to wait for a while until the relevant data become
available before this overshooting can be captured in empirical analyses.
The general upshot of these papers is that the rapid credit expansion in CEE economies has
mainly been fuelled by demand factors: the buoyant economic growth and the ensuing
increases in disposable incomes, rising expectations with regard to future income prospects
related to EU accession, remarkable decreases in interest rates, and falling or low and stable
inflation rates. A similar message emerges from two papers presented in Session 3, which
have scrutinized the factors that contributed to the very rapid credit expansion in the specific
cases of Romania2 and Lithuania3, and from the World Bank report4 presented in Session 6,
which provides a detailed overview of the recent credit developments in all ten new EU
member states from Central and Eastern Europe. While stressing the demand factors that
have fuelled the expansion of credit to the private sector, these papers also point out that the
supply side has played a role too: the boost in credit volume was made possible by the
privatisation of banks, deregulation of financial systems, and the deepening of the financial
markets in the region.
Both the above-mentioned World Bank report and the paper5 prepared by International
Monetary Fund staff, also presented in Session 6, were aimed at identifying vulnerabilities
and risks that might threaten the financial stability of CEE countries. The former concludes
that these countries vary rather widely with regard to the sustainability of the credit growth.
While the largest new EU member states seem to be still on the safe side, the Baltic states
and, to a lesser extent, the emerging economies of South-Eastern Europe probably witness a
credit boom that leads to significant macroeconomic imbalances and might ultimately end in
a crisis. These conclusions reinforce the findings of the papers presented in Session 1, which
I have discussed before, that the Baltic states and the South-East European economies have
probably already reached or even overshot the equilibrium level of credit to GDP.
The paper prepared by IMF economists, in turn, addresses the issue of sustainability by
focusing on capital flows. Within a dynamic stochastic general equilibrium model, it analyses
the short- and mid-term risks arising from the opening up to capital flows and alleviating of
credit constraints for the case of a small converging economy. Both papers prepared by
economists from international financial institutions and presented in Session 6 offer
recommendations for policymakers in such economies, which can reduce vulnerabilities and
risks in the face of rapid credit growth. Under such circumstances, it is crucial that
macroeconomic policies do not add to the existing demand pressures - tightening fiscal
policies is often a must-do - and that steps are taken to strengthen the health of the financial
system. This can be achieved by tightening regulatory measures, raising prudential
standards and enhancing supervisory coordination and cooperation, as well as by supporting
a better understanding of financial risks by the general public, e.g. by means of public
awareness campaigns.
Similar policy recommendations follow from another paper6 prepared by IMF staff, which was
presented in Session 2 and sought to identify the features that distinguish "good" credit
booms from "bad" ones, i.e. such that probably eventually lead to a banking crisis. The
analysis has shown, inter alia, that better banking supervision lowers the probability of a
crisis. It has also established that booms that coincide with current account imbalances seem
less dangerous (a finding that may seem counter-intuitive at a first glance), that trade
openness is another factor that makes a crisis less probable, and that the more prolonged
booms as well as those accompanied by high inflation or slow economic growth are the "bad"
ones.
Another important topic raised during the conference was housing. This is hardly surprising
given that housing loans constitute the larger part of credit extended to households. Now that
the world economy is trying to shrug off the consequences of the liquidity crisis of late
summer and falling house prices in America, the question as to how sound housing finance
in converging CEE economies really is has become substantial. A reassuring answer to that
question comes out of the analysis in a paper7 presented in Session 4, which focuses on
house prices in the CEE economies. The analysis has shown that the very rapid house price
increases in our region have generally been based on fundamental factors: a boost in
housing demand due to rising per capita GDP, falling real interest rates and demographic
factors, coupled with the rapid development of housing markets and housing finance, virtually
non-existent in the era of central planning. All in all, the house price inflation in the region
seems to reflect a process of relatively fast convergence to a new equilibrium.
Again, however, the question remains open whether that new equilibrium has already been
reached or perhaps even overshot in some economies, and whether the rapid growth in
mortgage loans that is a natural consequence of the housing boom can be safely described
as sustainable. Experience has taught us that rapid credit growth cannot be ignored even if it
reflects nothing more than a convergence process, as it usually means that loans have been
extended to households with ever lower margins. Another paper8 presented in Session 4 has
focused on the changes in the margin of households who repay loans (the margin is defined
as the difference between disposable income and basic living costs as well as debt
repayment costs) for the case of Poland. Although the average margin has not declined
despite the rapid credit growth in recent years, stress tests have shown that households that
repay debt are rather vulnerable to adverse financial and real shocks. Specifically, economic
slowdown, monetary policy tightening or financial market turbulence would each bring about
a reduction in the households' average margin and cause a non-negligible percentage of
households to fall into a negative margin. This would probably lead to a deterioration of
banks' asset portfolio - a result that cannot be ignored by monetary policymakers and bank
supervision authorities.
Another result that is of high relevance to monetary policy is the substitution effect between
domestic and foreign currency denominated loans, which has been the focus of a paper9
presented in Session 2. The high percentage of foreign currency indebtedness, mostly
mortgage debt, that can be observed in many CEE economies shows that domestic and
foreign currency loans are treated as close substitutes in these countries. As households
generally do not hedge against foreign exchange risk, their debt servicing burden rises when
the home currency depreciates. Admittedly, depreciation of CEE currencies has hardly been
an issue in the recent past; the currencies in the region have either stable exchange rates
(when these are pegged) or tend to appreciate (when the exchange rate regime allows it).
However, concerns remain that under such conditions, domestic monetary policy cannot
effectively control the growth of credit due to the substitution effect: monetary tightening at
home does not lead to a slowdown of total credit growth, but rather to increased foreign
currency indebtedness. The analysis in the paper has identified the existence of this effect in
the case of three largest CEE economies.
Generally, most papers presented and discussed over the last two days have stressed the
necessity of prudential supervision of the banking system in the face of a credit boom. Even
though financial deepening and capital inflows bring about long-term benefits that can hardly
be overstated, in the short to medium run they can lead to imbalances and distortions that
pose a threat to the macroeconomic stability of a country. We have recently seen how badly
lax lending and improper credit risk management can end in developed countries. In the case
of converging economies, which are generally more financially vulnerable than fully-fledged
market economies, it is all the more important to closely monitor risks to the financial system,
enhance cooperation between financial institutions and supervisory authorities, and impose
prudential constraints on lending.
*
The ideas that I have summarized so far were expressed in the papers prepared and
presented by economists from academia, central banks, and international financial
institutions. We have also heard important voices of top commercial bank executives and
central bank governors during the panel that has just ended. Household credit, and
mortgages in particular, will remain an important source of revenues and profits for
commercial banks. At the same time central bankers and banking sector supervisors will
likely watch credit developments very closely to make sure that best lending practices are in
place.
In closing, I would again like to thank you all for attending the conference. I would like to
thank the organizing committee and the NBP staff for their excellent work. I hope to meet you
again at another conference organized by the National Bank of Poland.
Thank you.