Who gets the credit? And does it matter? Household vs. firm lending across countries

Thorsten Beck, Berrak Buyukkarabacak, Felix Rioja, Neven Valev, 9 July 2009



An extensive literature has documented the positive effect of financial development on economic growth and poverty reduction (Rajan and Zingales 1998; Beck, Levine and Loayza, 2000; Beck, Demirguc-Kunt and Levine, 2007). The theoretical literature underlying these empirical explorations makes a clear distinction between the roles of enterprise and household credit – most theoretical models with endogenous financial intermediation focus on an enterprise in need of external finance for investment or production purposes (see Levine, 2005 for an overview). The empirical cross-country literature, however, has mostly used aggregate measures of overall bank lending to the private sector. A new disaggregate dataset enables us to assess the separate effects of enterprise and household credit on real sector outcomes as well as to explore what drives the composition of credit across countries.

What do theory and previous empirical evidence say?

While theory has suggested ample mechanisms through which enterprise credit helps economic growth, it provides ambiguous predictions about the effect of household credit on economic growth. Jappelli and Pagano (1994) argue that alleviating households’ credit constraints reduces the savings rate, with negative repercussions for economic growth. Specifically, they show for a sample of 25 middle- and high-income countries that lower liquidity constraints on households, proxied by the loan-to-value ratio for mortgages, are associated with a lower savings rate and lower GDP per capita growth. On the other hand, Galor and Zeira (1993) and De Gregorio (1996) argue that household credit can foster economic development if it increases human capital accumulation. De Gregorio (1996) shows, for a sample of 20 OECD countries, that higher loan-to-value ratios are associated with higher secondary school enrolment, though not with economic growth. Both theory and previous empirical work thus provide ambiguous predictions, with the effect of household credit on economic growth mainly depending on the use of the credit. Unlike our paper, most previous empirical work has been limited to OECD countries.

Recent cross-country comparisons have shown that countries with higher levels of financial intermediary development experience faster reductions in income inequality (Beck, Demirgüç-Kunt and Levine, 2007), thus confirming theories that predict that financial development helps the poor by both accelerating aggregate growth and reducing income inequality. Theory, however, points to different channels through which this relationship can work. On the one hand, there might be a direct impact by enabling the poor to invest in their human capital and in microenterprises by gaining access to credit, an effect that is more likely to be captured by household credit (Galor and Zeira, 1993; Banerjee and Newman, 1993). On the other hand, financial deepening might result in a more efficient capital allocation across incumbent and new enterprises, fostering structural change, higher growth, and lower income inequality, an effect that is more likely to be captured by enterprise credit (Gine and Townsend, 2004; Beck, Levine and Levkov, 2007). Disentangling the exact mechanisms requires more detailed data on the use of credit. Here we aim to provide tentative evidence showing whether credit to enterprises or credit to households contributes more to reductions in income inequality.

A third aspect addressed by our study is whether higher levels of household credit lead to consumption smoothing by easing the credit constraints that households face. While the permanent income hypothesis states that consumption is determined by permanent income and not by transitory changes to income, empirical work shows that consumption varies with output in an economy. The extent to which changes to consumption are explained by changes to income is referred to as the “excess sensitivity” of consumption to income. Theory points to a positive impact of household credit on relaxing liquidity constraints on households, thus resulting in lower excess sensitivity of household consumption to business cycle variations (Jappelli and Pagano, 1989; Bacchetta and Gerlach, 1997; Ludvigson, 1999). None of these papers, however, have focused on household credit for as large a set of countries as we do. Regarding the effect of enterprise credit on excess consumption sensitivity, a priori, there is no theoretical reason for a direct link.

Summarising, the effect of household credit on economic growth seems ambiguous, while theory suggests a dampening impact of household credit on the excess sensitivity of consumption to income fluctuations. Enterprise credit, on the other hand, can be expected to be positively related to economic growth, while there is no theoretical argument suggesting a relationship between consumption smoothing and enterprise credit. Also, theory makes ambiguous predictions as to whether enterprise credit, household credit, or both explain the negative relationship between financial sector development and changes in income inequality.

Cross-country variation in credit composition

We compile data from national central bank reports, annual bulletins, and other statistical sources where disaggregated credit data are available. Our dataset includes 45 countries spanning different time periods depending on data availability but with a significant overlap during the period from 1994 to 2005. In order to avoid discrepancies between different countries we standardised our data collection methodology by focusing on the collection of data on credit to non-financial corporations and/or private enterprises/businesses by deposit money banks, where available. If private credit is reported for various economic sectors, we define business credit as the sum of loans to industry, construction, services, agriculture, and trade. We then use the credit series from the Financial Structure Database of Beck, Demirgüç-Kunt and Levine (2000) to obtain the distribution of credit into enterprise credit and household credit as the difference between overall credit and enterprise credit. While we have annual data available, we use mostly averages over the period 1994 to 2005.

Figure 1 shows the large cross-country variation in credit composition. Whereas Canada, Denmark, and the U.S. had a household credit share well over 70% of total bank credit during 1994-2005, the household credit share was 10% in Malaysia during the same period. Across the 45 countries, credit to households averages 43%. Countries with higher levels of financial and economic development typically have higher shares of bank lending to households.

Figure 1. The share of household credit in total bank lending across countries

What is the effect of enterprise and household lending on real sector outcomes?

Using cross-country regressions, with data averaged over the period 1994 to 2005, we find:

  •  Bank lending to enterprises is positively and significantly associated with real GDP per capita growth, while the relationship between household credit and growth is insignificant. This finding is robust to the use of instrumental variables, sample composition, and controlling for a large array of other country factors. The effect of enterprise credit on economic growth is more accurately measured than the growth impact of overall bank lending.
  • Bank lending to enterprises is significantly associated with faster reductions in income inequality, while there is no robust link with household credit. Again, this finding is robust to the use of instrumental variables and alternative measures of income inequality.
  • We find a negative link between household credit and consumption smoothing, but no impact of enterprise lending on excess consumption sensitivity. This dampening effect of household credit on consumption smoothing, however, is not robust to the use of instrumental variables, which might be due to the small number of observations and weak instruments.

The positive impact of enterprise credit on economic growth is consistent with previous cross-country evidence on the aggregate, industry, and firm levels, while the insignificant relationship of household credit with growth is consistent with the ambiguous predictions by theory. The increasing importance of household credit for higher-income countries and its insignificance in growth regressions can also partly explain the non-linear relationship of overall financial development with economic growth documented by other studies (Aghion et al., 2005).

The fact that it is enterprise lending and not household lending that explains the negative relationship between financial sector development and income inequality sheds some light on the mechanisms of this relationship. Specifically, our findings are consistent with Gine and Townsend (2004) and Beck, Levine and Levkov (2007) and inconsistent with theories focusing on credit for the poor helping them to pull themselves out of poverty by investing in human capital or microenterprises (Galor and Zeira, 1993; Banerjee and Newman, 1993).


This exploration of enterprise versus household credit across countries is an initial assessment of the factors that drive credit composition and its effects. As longer time-series data become available, the construction of longer panel data sets will allow testing of more rigorous hypotheses.


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Topics: Development, Financial markets
Tags: credit constraints, enterprise credit, financial development, household credit, lending

Thorsten Beck

Professor of Banking and Finance, Cass Business School; Professor of Economics, Tilburg University; Research Fellow, CEPR

ssistant Professor at the Department of Economics, Robins School of Business, University of Richmond.

Associate Professor at the Department of Economics, Andrew Young School of Policy Studies, Georgia State University

Associate Professor at the Department of Economics, Andrew Young School of Policy Studies, Georgia State University