Information sharing, credit booms, and financial stability
Samuel Guérineau and Florian Léon
FERDI Working Paper Number 159, July 2016
Global financial crisis has shown the vulnerability of financial systems. It has consequently stressed the need for improving the management of financial vulnerability. The study seeks to improve the understanding of financial vulnerability in low-income countries to provide efficient tools for financial stability. Specifically, it studies the determinants of financial vulnerabilities, measured by annual change of the ratio of non-performing loans to loans, for a sample of 87 developing countries including 25 low-income countries.
Credit Growth and Financial Vulnerability
The financial stability issue is less studied in low-income countries (LICs), insofar as the risks they face are lower than in high and middle income economies. This is due to the smaller size and less interconnected nature of their financial system. However, a better understanding of financial fragility mechanisms in low-income economies remains crucial as they could still suffer sharp increases in non-performing loans and banking crises (see Leaven and Valencia, 2008). Confidence in the banking system in LICs is weak and a banking crisis may permanently hinder the development of banking services demand. As such, improving the understanding of financial vulnerability in LICs to provide efficient tools for financial stability is important. The dynamics of non-performing loans (NPLs), notably the NPL variations, is analyzed to identify the determinants of financial vulnerabilities. Also, it is examined whether the impact of credit growth on financial vulnerability depends on the existence of information sharing on credit.
The main results from the analysis are as follows:
- Credit growth is the main driver of financial vulnerability but its effect is mitigated by the presence of credit information sharing.
- This mitigation effect also exists in low-income countries, even if the credit growth direct effect is smaller.
- These results are not significantly different for Sub-Saharan African countries. These results are also robust to alternative measures of financial vulnerabilities.
First, a particular attention should be paid to the NPL variations. Second, the credit growth is a key variable to conduct macro-prudential policies in low and middle-income countries. Third, current efforts to develop information sharing schemes should be strengthened, since the latter allow a credit expansion without excessive increase in the overall credit risk. These results also suggest that the use of credit by sector may provide additional information on the relevant indicators to conduct macro-prudential policies. Early information on the rise of financial vulnerability might be extracted from the sectoral credit growth rate or concentrations of loans.