smaller, but still positive (Chart 12). This suggests that the Czech subsidiaries of foreign banks lend to the parent groups they belong to (Chart 13).<sup>5</sup>

**Chart 13. Lending of banks in the Czech Chart 14. Ratio of deposits to loans granted in Republic to parent groups (gross exposure of selected EU countries (2010; %) six biggest banks to parent groups, as % of assets)**

<!-- Start of picture text --> 6 EU<br>Euro Area<br>5 Denmark<br>Sweden<br>United Kingdom<br>4<br>Italy<br>France<br>3 Austria<br>Belgium<br>2 Latvia<br>Estonia<br>Lithuania<br>1 Hungary<br>Bulgaria<br>0 Romania<br>Poland<br>2000 2002 2004 2006 2008 2010<br>Slovak Republic<br>Czech Republic<br>Source: CNB. 0 20 40 60 80 100 120 140<br>Note: Lending to parent groups includes gross exposures to all Source: ECB<br>institutions in the group, both non-resident and resident in the Note: EU = average for all EU countries.<br><!-- End of picture text --> Note: Lending to parent groups includes gross exposures to all institutions in the group, both non-resident and resident in the Czech Republic.

Overall, the Czech economy experienced a credit boom similar to those in other CEE countries in the pre-crisis years. The features and quality of the boom, however, were quite different. First, fast credit growth was concentrated to the household sector, while the developments in the corporate sector lending were rather smooth. Second, the increase in lending was accompanied by an increase in the base of local deposits and was thus financed from domestic savings, not foreign sources (Chart 14). Moreover, the local deposit base is predominantly in domestic currency, so there was no incentive for banks to offer foreign currency loans to minimize possible currency mismatches on their balance sheets. Third, lending to the household sector was done in domestic currency only, and there was no additional risk except for the credit one associated with growing housing loan portfolio of the Czech banking sector. Finally, the boom in housing loans may have not been as fast as it seems. The increased demand for these loans in 2006–2007 was also due to an expected increase in value-added tax (VAT) on construction work from 5 percent to 19 percent as of 1 January 2008, as announced already in 2005.<sup>6</sup> All this suggests that there are particular factors behind the credit boom in the Czech Republic that explain its different quality. In the next section we describe how differences in macroeconomic policies were key among them.

# **3. The CNB’s Approach to the Credit Growth Issue**

> 5 There is a regulatory limit on lending to parent groups that amount to 25 percent of regulatory capital. This limit is however applied on the so-called adjusted exposure (for example, if the parent bank is a bank from another EU country, 80 percent of the gross exposure can be deducted when calculating adjusted exposure). Most banks in the Czech Republic are around the half of the regulatory limit.

> 6 Due to this factor, a number of creditworthy households shifted their plans regarding the purchase or building of housing and frontloaded the loans much earlier to take the opportunity of the still lower taxation.

8