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Growth of bank credit in central and eastern Europe: housing markets and the role of foreign-owned banks Dubravko Mihaljek Senior Economist Bank for International Settlements Presentation at the 12th Dubrovnik Economic Conference Dubrovnik, 29-30 June 2006 The views expressed are those of the author and not necessarily those of the BIS. 1 Outline 1. Common trends in credit growth 2. Housing markets 3. Foreign-owned banks 4. Policy challenges 2 Rapid growth of bank credit to the private sector Bank credit to the private sector, 2002-05 700 600 500 50 38 38 38 40 35 40 34 33 30 400 17 17 20 13 300 15 20 14 6 3 200 6 4 10 0 100 0 -10 SCG ROM LAT BUL ALB LIT EST TUR HUN BIH Nominal growth (cumulative, in percent) (lhs) SVN HRV MAK SKA CZE POL EUR Real growth (% per year, compound rate) (rhs) Note: ALB=Albania, BIH=Bosnia-Herzegovina, BUL=Bulgaria, CZE=Czech Republic; EST=Estonia, EUR=Euro area; HRV=Croatia, HUN=Hungary, LAT=Latvia, LIT=Lithuania, MAK=Macedonia, POL=Poland, ROM=Romania, SCG=Serbia-Montenegro, SVK=Slovakia, SVN=Slovenia, TUR=Turkey. Sources: IMF, International Financial Statistics; national data; author's estimates. 3 Determinants of rapid credit growth in CEE GDP and income growth, greater macro stability Financial deepening Global and regional factors (EU accession, institutional reforms) Competition among banks Property markets in CEE/SEE started to develop 4 Macroeconomic setting (1) 5-6% growth on average since 2004 Main contribution from domestic demand (incl. investment) Table 1 Average New EU members Non-EU countries Memo: Euro area Real GDP growth in central and eastern Europe1 2003 2004 2005 2006 4.7 5.2 4.2 0.7 6.2 5.9 6.5 2.0 5.7 6.3 5.1 1.3 5.6 6.1 5.0 2.1 1 Annual percentage changes. Sources: European Commission, Economic Forecasts, Spring 2006; IMF, World Economic Outlook, April 2006. 5 Macroeconomic setting (2) Inflation declining but still relatively high on average; overall, greater price stability Table 2 Average New EU members Non-EU countries Memo: Euro area Consumer price inflation in central and eastern Europe1 2003 2004 2005 2006 5.0 2.9 7.2 2.1 4.9 4.3 5.5 2.1 4.7 3.3 6.0 2.2 3.8 3.2 4.5 2.2 1 Annual percentage changes. Sources: European Commission, Economic Forecasts, Spring 2006; national data. 6 Macroeconomic setting (3) Narrowing fiscal deficits (though still large in few countries); less crowding out of the private sector Table 3 Average New EU members Non-EU countries Memo: Euro area Fiscal balances in central and eastern Europe1 2003 2004 2005 2006 –3.3 –3.0 –3.7 –3.0 –2.1 –2.3 –1.9 –2.8 –1.5 –1.8 –1.3 –2.4 –1.5 –2.5 –0.5 –2.4 1 Percent of GDP. Sources: European Commission, Economic Forecasts, Spring 2006; national data. 7 Determinants of credit growth: financial deepening (1) Although increasing, levels of financial intermediation are still low, including in the new member states … Bank credit as a percent of GDP 100 Credit to the private sector Claims on central government 80 60 50 40 72 34 26 20 45 25 0 11 10 6 12 11 31 55 46 47 42 24 14 26 28 10 11 26 21 9 13 4 5 1999 2004 1999 2004 1999 2004 1999 2004 1999 2004 1999 2004 1999 2004 1999 2004 CZ HU SI LV EE SK PL LT Sources: IMF; national data; author's estimates. 8 Financial deepening (2) … and even more so in south-eastern Europe (except for Croatia) Bank credit as a percent of GDP Claims on central government Credit to the private sector 80 60 21 57 20 37 HR BH 10 BG 19 MK 2004 1999 2004 4 TR SCG 8 5 31 28 10 RO 2004 27 1999 26 2004 30 1999 24 6 2004 2004 1999 2004 10 21 2004 12 5 1999 11 1999 0 4 37 45 1999 46 20 1999 40 AL Sources: IMF; national data; author's estimates. 9 Global and regional factors Rapid convergence of interest rates to euro area levels 10 Competition among banks Narrowing of intermediation margins Representative commercial bank interest rates Lending rate End-2000 1 Deposit rate End-2005 1 End-2000 1 Interbank lending rate End-2005 1 End-2000 1 End-2005 1 Czech Republic Hungary Poland Slovakia Slovenia 6.9 12.7 20.9 13.4 15.8 5.6 8.0 6.2 6.7 7.7 3.2 9.5 15.0 6.9 10.1 1.1 5.5 2.5 2.3 3.1 5.4 12.3 19.4 8.1 12.2 2.2 6.5 4.6 3.1 4.0 Estonia Latvia Lithuania 7.1 13.2 11.3 4.8 5.5 5.8 4.2 4.4 3.4 2.1 2.5 1.5 6.1 8.7 5.4 2.6 2.5 3.1 Bulgaria Croatia Romania Turkey 11.6 10.8 53.2 … 7.1 11.1 15.7 … 3.1 3.5 32.4 68.2 3.0 1.7 4.2 20.5 2.7 4.5 49.1 65.0 2.1 4.4 5.2 13.9 Average 16.1 7.7 13.7 4.2 16.6 4.5 4.4 3.6 2.2 2.2 4.9 2.5 Memo: Austria 1 Or the latest period available. Sources: IMF; national data ; author’s estimates . 11 Housing markets in CEE Housing supply limited in many regions Housing demand rising • Domestic factors (income growth, housing finance, demographics) • External demand for second homes in SEE (EU demographics, low interest rates) • Investment demand (commercial property) Risks of strong growth in property prices exist; policies to focus on the supply side 12 Development of property markets Key contribution of housing loans to credit growth Housing loans and private sector credit growth, 2003–05 Table 2 Countries Growth of private sector credit 1 Contribution to growth of private 2 sector credit Household Corporate Total Bulgaria Croatia Czech Republic Estonia Hungary Latvia Lithuania Romania Serbia Slovakia Slovenia Average Household Housing Consumer Corporate Total Housing Consumer 28.7 8.4 11.1 40.7 12.3 16.4 27.6 30.8 25.2 3.7 40.0 63.3 16.7 32.3 56.8 28.5 53.2 67.1 64.8 61.4 35.4 105.0 114.8 23.3 39.6 64.2 26.1 60.0 68.9 67.8 … 34.9 … 51.5 13.7 23.3 34.2 44.2 42.4 3.3 42.9 … 15.6 … 50.5 22.4 10.7 45.4 40.8 43.0 59.0 50.7 48.4 27.0 78.0 49.5 62.7 89.3 54.6 59.2 57.0 41.0 49.3 51.6 73.0 22.0 17.3 24.9 69.9 47.5 43.9 35.5 40.7 46.1 … 51.7 … 32.1 37.9 19.4 7.0 15.8 6.4 0.3 3.2 … 15.2 … 22.3 53.1 55.5 30.1 43.3 55.4 41.9 15.3 1 Annual growth rate of private sector credit (excluding credit to financial intermediaries), 2003–05; in percent. 2 Data for 2005 are for the latest month available. Percentage contribution to the annual growth rate of private sector credit; average for 2003–05 (for Slovakia, 2004–05). Based on monthly data. Sources: Central banks; author’s estimates. 13 Is rapid increase in property prices a concern? Growth of housing loans and house prices closely correlated House prices and housing loans, 1997-05 1 (annual percentage changes) 50 40 y = 0.14x + 3.5 R2 = 0.20 House prices 30 20 10 0 -20 30 80 130 180 -10 -20 Housing loans 1 Annual percentage changes; data for Croatia, the Czech Republic, Estonia, Hungary, Lithuania and Poland. Sources: National data; author's estimates. 14 House price increases: is there a bubble? House prices1 2001 2002 2003 2004 2005 14.7 22.0 19.4 –2.5 … … 4.8 10.9 9.2 0.9 Poland –1.6 –9.5 12.3 … … Croatia –4.4 0.7 2.4 13.2 22.5 Estonia 34.0 30.7 14.0 28.0 21.3 Lithuania 24.0 10.1 18.3 10.1 45.3 Czech Republic Hungary 1 Annual percentage changes. Data refer mainly to house prices in urban centres. Sources: Central banks; real estate firms; author’s estimates. 15 Role of foreign-owned banks in credit expansion Impact on credit expansion – not as obvious as it seems Impact on credit allocation and bank efficiency – on the whole positive Macroeconomic effects – some undesirable consequences • Credit expansion funded by external borrowing • Foreign currency lending • Risk of overheating • Rising household indebtedness and widening external imbalances 16 Impact of foreign-owned banks on credit expansion Not as obvious as it seems Foreign-owned banks and credit growth in CEE, 1997, 2000 and 2004 Private sector credit as % of GDP 70 60 50 40 30 y = 0.075x + 25.02 R2 = 0.023 20 10 0 0 10 20 30 40 50 60 70 80 90 100 Market share of foreign-owned banks (% of total banking sector assets) Sources: Bank Austria - Creditanstalt; author's estimates. 17 Impact of foreign-owned banks on credit allocation Composition of bank lending has improved Composition of commercial bank lending1 Government 1999 Bulgaria Croatia Czech Rep. Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia Turkey Average Euro area 21 21 6 3 43 11 29 5 35 29 22 3 19 … 2003 8 8 31 6 13 10 20 6 9 49 22 4 16 11 2 Household Corporate 2004 –3 8 25 4 9 9 4 7 5 49 22 4 12 11 1999 65 65 83 71 49 76 62 62 62 64 52 86 66 … 2003 67 68 45 52 57 63 63 53 68 37 57 76 59 41 2004 70 42 45 50 57 59 70 46 68 34 55 71 56 41 1999 14 14 12 26 8 13 8 33 3 7 26 11 15 ... 2003 25 25 25 43 30 28 17 31 23 14 21 20 25 48 2004 33 50 30 45 32 32 26 46 27 17 23 25 32 49 1 In percent of total credit, excluding interbank credit and credit to non-bank financial institutions. End of period or 2 for 2004, latest available period. Net claims on government for most countries. Sources: Central banks; IMF; author’s estimates. 18 Impact of foreign-owned banks on bank efficiency (1) Prudential indicators have strengthened Prudential indicators (in percent) Countries Average High share of foreign banks7 Lower share of foreign banks8 Memo: Austria 2 Nonperforming loans2 Capital adequacy3 Loan-loss provisions4 Return on equity Return on assets 1999 2004 1999 2004 2000 2004 1999 2004 1999 2004 16.5 6.8 20.3 16.9 58.5 63.6 –0.7 14.7 –0.1 1.4 14.9 3.8 22.2 14.2 59.9 56.8 8.6 17.8 1.1 1.5 17.9 9.5 18.7 19.4 56.8 69.4 13.7 14.5 1.4 1.6 1.5 13.9 14.7 … … 6.9 9.3 0.3 1.5 1.7 3 4 Ratio of bank provisions for loan losses to Risk-weighted capital-asset ratios. As percent of total loans. 7 Average for the countries with a share of foreign bank ownership higher than or non-performing loans. 8 Average for the countries with a share of foreign bank equal to 70% of total banking sector assets. ownership lower than 70% of total banking sector assets. Sources: Central banks; IMF; author’s estimates. 19 Impact of foreign-owned banks on bank efficiency (2) Less interest income, more fee income 20 Impact of foreign-owned banks on bank efficiency (3) Lower operating costs 21 Macroeconomic effects (1) Clear role of cross-border loan flows in credit expansion But household indebtedness generally low 22 Macroeconomic effects (2) Foreign currency lending – risk of currency mismatches Foreign currency deposits and loans, 2005 Shere in total private sector deposits/loans, in percent 90 FX deposits 82 FX loans 77 80 72 70 65 60 50 72 49 48 48 52 52 48 40 31 30 20 28 15 10 0 BG HR RO SCG BH AL MK Source: Central banks. 23 Macroeconomic effects – risk of overheating? GDP growth rates not far from potential Investment rates at or below long-term averages Actual and potential growth rates in CEE New member states Potential growth rate Actual growth rate 2001-05 EU candidates and aspirants Potential growth rate Actual growth rate 2001-05 Czech Republic 3.6 3.6 Bulgaria 4.9 4.9 Hungary 3.4 4.0 Croatia 4.9 4.4 Poland 3.9 3.0 Romania 5.3 5.7 Slovakia 5.0 4.9 Turkey 6.7 4.5 Slovenia 3.5 3.4 Albania 6.2 5.4 Estonia 7.2 7.6 Bosnia-Herzegovina 5.4 5.0 Latvia 8.1 8.1 Macedonia 3.4 1.4 Lithuania 6.5 7.6 Serbia-Montenegro 4.7 5.1 Sources: European Commission (2006); IMF, WEO, April 2006; author’s estimates. 24 Is the widening of external deficits a concern? CA deficits in CEE due to factors characteristic for the stage of development (income level, high capital building) During 2000-03, the increase in deficits could be entirely explained by higher investment But during 2004-05, ¼ of the increase in CA deficits was due to higher consumption (especially SK and RO) 25 CA deficits for the most part due to higher investment Table 5 Changes in external balances, investment and saving, 2004–051 Current account balance Average Countries with wider CA deficit2 Countries with narrower CA deficit3 Gross fixed capital formation Domestic saving Budget balance –0.6 1.4 0.8 1.8 –3.1 2.4 –0.7 2.1 1.3 0.6 1.9 1.5 1 Cumulative changes during 2004 and 2005, in percentage points of GDP. Bulgaria, Latvia, Lithuania, Romania, Slovakia, Slovenia, Turkey. 3 Albania, Bosnia and Herzegovina, Croatia, Czech Republic, Estonia, Hungary, Macedonia, Poland, Serbia and Montenegro. Sources: European Commission, Economic Forecasts, Spring 2006; IMF, WEO, April 2006; author’s estimates. 2 26 Other mitigating factors Evidence of quick reversal of CA deficits without major growth slowdown (AL, BG, HR 2003-04; MK; SK 2002-03) Consumer credit booms tend to be self-correcting (build-up of the stock of consumer durables tends to level off) Purchasing power gains associated with RER appreciation were only used for additional consumption once the gains actually occurred, not in anticipation thereof (Deutsche Bundesbank DP 32/2005) 27 Composition of capital flows is changing (2) Composition of net capital flows (In percent of total net flows, average of country groups) 80 61 60 40 43 34 37 New member states 41 48 43 South-eastern Europe 55 51 48 31 22 20 2 5 11 6 5 21 12 20 14 18 0 -20 -14 -14 -40 2003 2004 2005 2003 FDI 2004 2005 2003 Equity flows 2004 2005 Bond issuance 2003 2004 2005 Cross-border bank loans Sources: IMF; author's estimates. 28 Policy challenges Maintaining financial stability Avoiding risk of overheating Preventing property price bubbles Containing current account deficits 29 Factors complicating policy responses in CEE Very small, very open economies Rapidly catching up with the EU (Balassa-Samuelson effect, RER appreciation) Banking systems mostly foreign-owned Strong capital inflows, easy global financing conditions 30 Policy responses so far Raise interest rates – Romania, Slovakia Tighten prudential regulations – Baltics, Croatia Strengthen banking supervision – Baltics, Hungary, Slovakia, Slovenia Moral suasion – Baltics, Croatia, Hungary Administrative measures (credit ceilings) – Bulgaria 31 Policy responses under consideration Raise interest rates – there are limits to domestic interest rate policy with low global interest rates, fixed ERs, free capital flows, but global rates are now rising Retain some capital controls (non-EU countries only) Allow capital outflows Clarify existing policies: • focus on disinflation • allow nominal ER to appreciate (managed and floating regimes) Tighten fiscal policy (already tight in many countries) 32