- <mark>The use of credit cards is much more widespread in the region than mortgage debt. However, credit card use has had a negligible effect on household income and investment during the crisis. It is unlikely therefore that credit card debt may jeopardize future economic activity in</mark> the region.

- <mark>FX mortgages hardly pose a threat to future household consumption and investment. Only a minor fraction of households in the region are exposed to foreign currency mortgages. Moreover those countries in which FX mortgages are most prevalent did not experience major exchange rate shocks during the crisis.</mark>

# **_4.3 Debt Overhang in the Banking Sector_**

In this section we turn to the supply side of credit and examine which countries‟ banks are more likely to face debt overhang problems and which customer group might be more affected from these. First, we relate the quality of banks‟ loan portfolios to their profitability and their lending activities. Second, we review the literature on foreign banks‟ lending behavior during the crisis to assess whether they have contributed to the transmission of a shock that evolved unrelated to the local economic environment.

# <u>Non-Performing Loans</u>

Throughout the transition region non-performing loan (NPL) ratios increased substantially in 2009. Figure 4.3 illustrates the increase in NPL ratios between 2007 and 2009 by country and relates to bank performance and bank lending structure. NPL ratios in Ukraine increased by nearly 50 percentage points in just two years, while banks in Georgia, Lithuania, Latvia and Moldova also experienced NPL increases of more than 10 percentage points.

The very high level of the NPL ratio in Ukraine compared to the Baltic countries, which also experienced substantial economic contraction during the crisis, has been attributed to the large exchange rate depreciation in Ukraine and a subsequent rise in defaults on FX loans (see De Haas and Knobloch (2010)). The household-level and firm-level survey data presented in sections 4.1 and 4.2 cast doubt on this exchange rate explanation: Only 51% of household loans in Ukraine are denominated in FX, while a mere 8% of the loans extended to firms in Ukraine are unhedged FX loans. At the aggregate level corporate (household) loans account for 60% (40%) of all bank loans in Ukraine, suggesting that in total roughly one-quarter of all bank loans in the country are denominated in FX<sup>12</sup> . Moreover, the LITS data suggest that in Ukraine only 16% of household mortgages denominated in FX were in default in 2010. Income shocks as well as a drop in house prices are thus more likely to have spurred the strong increase in nonperforming loans.

How well banks are able to cope with the credit losses they accumulated during the crisis should depend on their profitability. Figure 4.3.a relates the increase in NPL ratios between 2007 and 2009 to pre-crisis profitability of banks, measured by the 2005-2007 average return on assets (ROA) of banks in that country. The figure shows that, besides Moldova, those countries facing the highest increase NPL ratios did not have particularly profitable banks in the pre-crisis

> 12 See EBRD Transition Report 2010.

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