Boštjan Jazbec: Reinvigorating credit growth in central, eastern and
southern European economies
Opening remarks by Mr Boštjan Jazbec, Governor of Bank of Slovenia at the IMF/Bank of
Slovenia high-level seminar on "Reinvigorating Credit Growth in Central, Eastern and
Southern European Economies", Portoroz, 25 September 2014.
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It is a great pleasure to welcome you all to the high-level seminar on reinvigorating credit
growth in Central, Eastern, and South European Economies organized jointly by the Bank of
Slovenia and International Monetary Fund. It is indeed a great honour to have a very
distinguished gathering of central bank governors and vice governors, senior officials of other
international financial institutions, former public officials and leading academics to discuss a
very critical issue that occupies the minds of policymakers in the region and elsewhere.
The objectives of the seminar are to learn about the diverse experiences of different
countries in the region and to exchange views on the policy challenges and possible
responses. The appropriate policy responses necessarily are country-specific and must take
into account the heterogeneity within the various sectors of the economy and the role of
idiosyncratic and institutional factors. Still, important lessons can be drawn from
crosscountry comparisons.
The presentations and discussion in the seminar will focus on four main themes: (1) repairing
balance sheets in the financial system and the corporate and household sectors; (2) the role
of foreign banks in fostering credit growth; (3) best practices for reviving credit markets and
the pitfalls; and (4) risks of a new financial crisis. I will now briefly touch on these themes in
general terms.
How the situation has changed! Not that long ago, policymakers in Central and Eastern
Europe were concerned about the issue of rapid credit growth. A key question then was
whether rapid credit growth should be seen as an endless boom or as an early warning.
As we all know very well, the boom turned to bust abruptly in 2008. The turmoil in
international financial markets and the consequent collapse in output in major developed
economies also adversely impacted the countries in central, eastern and southern Europe in
varying degrees through a combination of the trade, financial and domestic demand
channels.
A fallout of the global financial crisis was balance sheet recession in the region. The rapid
credit growth during the pre-crisis boom period was grounded in excessive borrowing and
risk taking by banks and enterprises. Banks relied heavily on external wholesale funding and
the rapid credit expansion took place against very limited equity capital in the corporate
sector. The global financial crisis exposed these balance sheet vulnerabilities. The onset of
the crisis caused a sudden stop in external financing, and countries in the region were
caught in a vicious cycle of reduced credit availability, deleveraging, rising non-performing
loans, and a cutback in corporate investment and output.
Much of the region is still suffering from the fallout of the global crisis. In a large number of
countries, economic recovery remains feeble and bank credit is still contracting. For these
set of countries, reviving credit growth is considered essential to achieving a strong and
durable output expansion. However, the task is complex.
Boosting credit growth without addressing the large sectoral and aggregate imbalances in
the economy that had built up during the credit boom years can be risky. Matters may
become worse if additional credit availability enables enterprises to postpone balance sheet
adjustment. In the wake of a balance sheet recession, the allocation of credit matters more
than its aggregate amount. It is important that good borrowers rather than the bad ones are
the main beneficiaries of credit growth.
It is not surprising that much of the CESEE region is experiencing a slow so-called credit-less
recovery. Balance sheet recessions are typically not very responsive to traditional demand
management measures. This is because the monetary policy transmission channel is
impaired by the weak balance sheets of banks and the corporate sector. As long as asset
quality is poor and capital is inadequate, banks will tend to restrict overall credit supply.
Liquidity may not be a binding constraint in such a situation. As has been argued by some
analysts in the context of an unexpectedly low take up in the recent first auction of liquidity
under the ECB's TLTRO programme, the profitability of borrowing very cheaply for the
central bank to lend to the private sector (especially SMEs) is not guaranteed if
nonperforming loans are high and banks would need to discount high expected default rates and
if lending to SMEs implies high risk weights and, consequently, capital charge.
Credit demand also is weak in a balance sheet recession. Bank lending surveys in the region
indicate that credit demand has decreased since the onset of the global crisis. An important
factor weighing down credit demand is the corporate debt overhang. The easing of monetary
conditions will not necessarily induce higher borrowing while highly indebted companies are
focused on deleveraging.
Thus, repairing the balance sheets of both the banking sector and corporate sector is a
priority for unlocking credit growth. A complicating factor here is that the maximum possible
speed for completing bank restructuring is typically faster than that for corporate
restructuring, even if all the enabling legislative and institutional frameworks for the latter are
in place. So, the resumption of credit growth may take a while. There also is a worrisome
aspect of the different restructuring speeds of the two sectors. Experience shows that, when
enterprise restructuring is lagging, non-performing loans continue to accumulate and erode
the capital buffer of banks created by their recapitalization, creating a likely need for another
round of capital injection.
Revival of credit growth is also difficult because of the tensions between monetary policy
considerations and financial stability considerations. The global crisis has demonstrated very
clearly the importance of having adequate safeguards in place to prevent unhealthy risk
taking and creation of credit bubbles. All central banks in the region are now in the process of
putting in place frameworks to strengthen bank supervision, enhance risk management and
governance standards, and increase transparency and statistical disclosure. National
authorities also are establishing the institutional framework for macroprudential oversight of
the financial system. These prudential aspects of the financial policy framework are meant to
reduce the amplitude of financial cycles. However, they also are likely to dampen the pace of
credit growth.
It also should be recognized that it will not be possible to achieve durable economic growth
underpinned by abundant credit in the same manner as that pursued during the pre-crisis
boom period. It will be necessary to limit the reliance on debt-financing and shift towards
more equity financing. Given the need to ensure fiscal sustainability, recourse to more state
funding for restructuring the economy and increasing investment is not a feasible option. An
appropriate business environment has to be created for attracting new non-debt capital
flows. This will require addressing the institutional and regulatory bottlenecks that currently
inhibit investment. In this context, increasing the efficiency of the legislative and judiciary
systems would be extremely important.
Not all CESEE countries have been equally hit by the crisis. Indeed, a few countries in the
region managed to escape the worst effects of the financial crisis, highlighting the role of
country-specific factors. Economic growth and strong credit expansion in these countries
have resumed after a brief pause. For them, an important question is whether the momentum
can be sustained. Based on the lessons from the crisis, a key priority for these countries
should be to prevent a build-up of imbalances that could threaten financial and
macroeconomic stability. The main tasks are to identify and implement on a timely basis
measures to curb the boom and to build the capacity to cope with a possible bust. An
advantage here is that, because of the differences in cyclical position, policy conflict between
monetary policy and prudential policy is absent, unlike in the case of countries suffering from
balance sheet recession.
Given the integration of CESEE countries in the world financial markets, credit growth in
these countries has acquired an international dimension. There is significant presence of
foreign-owned banks and external funding is an important source of bank liquidity. While
external bank funding for the region has been on a declining trend since the onset of the
global crisis and sizeable deleveraging has already occurred, parent bank funding still
represents a large share of bank funding in several CESEE countries. Thus, countries in the
region are highly vulnerable to changes in the external environment. If parent banks come
under pressure to deleverage and build up capital in the period ahead on account of the
results of the just concluded euro area asset quality review and stress tests or because of
tighter global financial conditions, the liquidity support for credit growth in the daughter banks
may not be forthcoming.
I would like to conclude by pointing out that central banks alone cannot succeed in reviving
credit growth and economic growth. Putting the economies in the region back on track will
require an integrated national policy strategy to restore the health of the financial sector,
restructure the corporate sector, reinforce the sustainability of the public finances, improve
the flexibility of product and labor markets, and reform the business environment. Because of
the complementarity of the measures, coordination between government agencies and other
stake holders is essential in policy implementation. Successful and timely policy
implementation will require political resolve and social consensus. If there is no determined
follow through on policies, the fragile recovery that is underway will come to an end and
economic problems will intensify.