However, the very fact that interest rates must – eventually – rise again implies that credit expansion based on low interest rates cannot be viewed as a shift to a permanent higher credit level. At higher interest rates, credit demand will decline once again. To the extent that the credit expansion was driven by miscalculations on credit affordability, this may even lead to a crisis. 3.4. Behavioral biases  The latter remark leads to a fourth potential explanation, that is, credit expansion driven by behavioral biases. As highlighted by Hyman Minsky7, the credit cycle appears to be driven by “waves of optimistic and pessimistic sentiment”8. In an upswing, expectations about future developments may turn erratically exuberant. Observing a long period of price increases, investors tend to believe that new circumstances justify the perpetuation of the upward trend and act on this belief. Overconfident lenders and borrowers are increasingly ready to take higher risks. Ever increasing prices become a necessary condition to enable borrowers to service their debts. Then the tide turns. A few investors fail to meet their obligations, confidence crumbles, asset prices stop increasing or begin to fall and optimism turns into a wave of pessimism. Clearly, credit expansion driven by such erratic beliefs is a cyclical phenomenon and no viable explanation for a sustainable increase in the credit-to-GDP ratio. As we have seen, there are various potential explanations for an increase in the credit-toGDP ratio, some suggesting a permanent, structural increase in this ratio, others hinting at a temporary, cyclical upswing.

However it would be clearly a less pronounced one than in the pure cyclical case. 2  BIS central bankers’ speeches  3. Possible explanations for increasing credit-to-GDP ratios  3.1. Supply side considerations: Financial liberalization, the likely explanation for the 1970s and 1980s  A first important reason for an increase in credit volumes can be found in an improved availability of credit. It is well recognized that quantity rationing is prevalent in credit markets.6 Technical innovation and regulatory changes have an impact on the extent of credit rationing and thus very directly on the volume of allocated credit. The financial liberalization of the 1970s and the 1980s and technical innovation in financial services that resulted are therefore natural and plausible explanations for the spectacular credit development observed internationally in the later part of the last century. Here, a permanent adjustment to a new plateau seems to be a viable explanation. This does not mean that such an adjustment process is innocuous from the perspective of financial stability, nor does it imply that the adjustment process cannot overshoot. Indeed, a higher credit-to-GDP ratio means a higher degree of leverage which, in all cases, is likely to increase the fragility of the financial system. 3.2. Demand side developments  Second, structural changes in the demand for credit are also a conceivable driver of an increasing credit-to-GDP ratio. For example, an economy-wide perception of improved growth opportunities justifies a broad increase in borrowing to finance investment projects.