Adverse selection and moral hazard in the Japanese public credit guarantee schemes for SMEs
Kuniyoshi Saito, Daisuke Tsuruta 14 November 2014
In Japan, loans with 100% guarantees account for more than half of all loans covered by public credit guarantee schemes, but banks claim that they do not offer loans without sufficient screening and monitoring even if the loans are guaranteed. This column presents evidence of adverse selection and moral hazard in Japanese credit guarantee schemes. The problem is less severe for loans with 80% guarantees.
Credit rationing caused by capital market imperfections is widely seen as an important phenomenon in the loan market, especially for small and medium enterprises (SMEs). Among various ways of alleviating the problem, credit guarantee schemes are one of the most important policy tools in many countries. An economic rationale for such public intervention is that it can enhance efficiency by providing additional funds for SMEs that are in fact healthy but unable to secure enough loans because of the informational gap between lenders and borrowers.
credit rationing, SMEs, credit, public guarantees, Japan, capital markets, asymmetric information, moral hazard, adverse selection, loan guarantees, insurance
EU bank deleveraging
Pierluigi Bologna, Arianna Miglietta, Marianna Caccavaio 14 October 2014
Following the financial crisis, European banks have taken steps to revise unsustainable business models by deleveraging. By this metric they have made substantial progress – but this column argues that improper management of the deleveraging process may threaten the recovery. The authors find that equity increases played a much larger role than asset decreases, and recommend increasing the disposal of bad assets.
Ever since the global financial crisis made it apparent that financial institutions had increased their leverage substantially (Figure 1), bank leverage has faced intense scrutiny. In the run-up to the crisis, the ballooning of banks’ balance sheets was primarily driven by both a significant increase in lending activities and an abundance of cheap funding. Many banks expanded dramatically, becoming too highly leveraged and ‘too-big-to-fail’, while at the same time accumulating substantial risks.
EU policies Financial markets Global crisis
deleveraging, leverage ratios, bank-sovereign link, EU banks, banking, credit, Eurozone crisis
Property debt overhang: The case of Irish SMEs
Fergal McCann, Tara McIndoe-Calder 23 September 2014
The role of credit-fuelled property booms in the Global Crisis has received much high-profile attention in recent years. Using data on Irish small and medium enterprises, this column highlights an additional channel through which such booms can impact post-crisis growth. Firms having difficulty repaying their property-related debts divert resources away from hiring and investment. Property booms thereby induce misallocation of resources in both the boom and the bust.
The detrimental impact of credit and property boom-bust cycles on consumption and growth has received much high-profile attention in the aftermath of the Global Crisis (Mian and Sufi 2013, 2014, Dynan et al. 2012). Separately, an empirical literature on non-financial corporates has shown that debt overhang can negatively impact firm investment (Aivazian et al. 2005, Cai and Zhang 2011, Coricelli et al. 2012).
debt overhang, debt, Ireland, Small and medium enterprises, capital allocation, credit booms, credit, asset price bubbles, housing bubble, property bubble
Banks, government bonds, and default: What do the data say?
Nicola Gennaioli, Alberto Martin, Stefano Rossi 19 July 2014
There is growing concern – but little systematic evidence – about the relationship between sovereign default and banking crises. This column documents the link between public default, bank bondholdings, and bank loans. Banks hold many public bonds in normal times (on average 9% of their assets), particularly in less financially developed countries. During sovereign defaults, banks increase their exposure to public bonds – especially large banks, and when expected bond returns are high. At the bank level, bondholdings correlate negatively with subsequent lending during sovereign defaults.
Recent events in Europe have illustrated how government defaults can jeopardise domestic bank stability. Growing concerns of public insolvency since 2010 caused great stress in the European banking sector, which was loaded with Euro-area debt (Andritzky 2012). Problems were particularly severe for banks in troubled countries, which entered the crisis holding a sizeable share of their assets in their governments’ bonds – roughly 5% in Portugal and Spain, 7% in Italy, and 16% in Greece (2010 EU Stress Test).
sovereign debt, financial crises, banking, banks, bonds, sovereign default, credit, bank lending, risk-weighting
Managing credit bubbles
Alberto Martin, Jaume Ventura 05 July 2014
There is a widespread view among macroeconomists that fluctuations in collateral are an important driver of credit booms and busts. This column distinguishes between ‘fundamental’ collateral – backed by expectations of future profits – and ‘bubbly’ collateral – backed by expectations of future credit. Markets are generically unable to provide the optimal amount of bubbly collateral, which creates a natural role for stabilisation policies. A lender of last resort with the ability to tax and subsidise credit can design a ‘leaning against the wind’ policy that replicates the ‘optimal’ bubble allocation.
Credit markets play an increasingly central role in modern economies. Within the OECD, for instance, domestic credit has risen from 100% of GDP in 1970 to approximately 160% of GDP in 2012 (as measured by the Bank for International Settlements). To be sure, this growth masks large variations across countries and over time, but there is a common feature to all these different country experiences that stands out. Credit has often alternated between ‘booms’ – periods of rapid growth – and ‘busts’ – periods of stagnation or significant decline.
Financial markets Macroeconomic policy
credit booms, lender of last resort, bubbles, credit, Leaning against the wind, collateral, financial accelerator
Do all firms have equal access to external financing?
Neil Kay, Gavin Murphy, Conor O'Toole, Iulia Siedschlag, Brian O'Connell 29 June 2014
Small and medium-size enterprises (SMEs) often report difficulties in obtaining external finance. Based on new research, this column argues that these difficulties are not due to greater financial risks associated with SMEs. Instead, they are the result of imperfections in the market for external finance that negatively affect smaller and younger enterprises. The same research has shown that these types of firms are also the most reliant on external finance to support their investment and growth.
The proportion of bank loan acceptances has fallen significantly following the crisis, along with the level of enterprise investment. The sharpest falls in both have been in countries hardest hit by the crisis. While in a number of countries – such as Finland, Malta, and Sweden – the declines have been modest, in others – such as in Bulgaria, Ireland, Denmark, Lithuania, Spain, and Greece – they have approached or exceeded 30%.
Figure 1. Percentage change in bank loan acceptances
EU policies Financial markets
investment, lending, credit, Finance, SMEs, credit rationing, borrowing, information asymmetries
Estimating the impact of changes in aggregate bank capital requirements during an upswing
Joseph Noss, Priscilla Toffano 06 April 2014
The impact of tighter regulatory capital requirements during an economic upswing is a key question in macroprudential policy. This column discusses research suggesting that an increase of 15 basis points in aggregate capital ratios of banks operating in the UK is associated with a median reduction of around 1.4% in the level of lending after 16 quarters. The impact on quarterly GDP growth is statistically insignificant, a result that is consistent with firms substituting away from bank credit and towards that supplied via bond markets.
The recent financial crisis and economic contraction that followed highlighted the crucial role that banks play in facilitating the extension of credit and enabling economic growth. This underlies the economic rationale for imposing regulations on the banking industry, including minimum capital requirements designed to mitigate risks banks would not otherwise account for in their behaviour.
regulations, bank regulation, banking, capital requirements, banks, BASEL III, credit, Macroprudential policy, bank capital
Tax evasion and austerity-plan failure
Francesco Pappadà, Yanos Zylberberg 03 February 2014
Greece’s austerity package included an unprecedented increase in the VAT rate, but the resulting increase in revenue was much lower than expected. This column links this disappointing result to the ‘transparency response’ of firms to higher tax rates. In countries like Greece with poor tax monitoring, firms face a tradeoff when deciding whether to declare their activity. Transparency is a necessary condition for accessing external finance, but it also means having to pay tax. Improving credit conditions for small and medium-size Greek firms might shift this tradeoff in favour of transparency.
Austerity plans in southern European countries (Greece, Portugal, Spain, and Italy) have so far yielded mixed results (Salto 2013). On the one hand, the primary budget balances of these countries have improved, and their risk premiums are now stabilised at a much lower level than during the crisis peak.
Financial markets Taxation
VAT, transparency, tax evasion, Greece, credit, austerity, European sovereign debt crisis
European bank deleveraging and global credit conditions
Erik Feyen, Ines Gonzalez del Mazo 12 May 2013
Before the global financial crisis, European banks had rapidly expanded their foreign-lending activities. However, this column argues that financial stress in Europe has put this process into reverse and negatively affected credit conditions in developed and emerging markets alike. As European banks repair their balance sheets and rethink their business models in a context of stricter regulatory requirements, financial fragmentation, and a deteriorating European economy, they continue to retrench to home markets.
In the run up to the global financial crisis, European banks significantly increased their lending activities both domestically and outside home markets driven by a procyclical spiral of cheap abundant funding, increasing profitability, and economic growth. European banks not only provided cross-border financing, but became increasingly involved in domestic financial markets via lending activities of their local affiliates.
Europe's nations and regions Global crisis
banking, Eurozone crisis, credit
Fact-checking financial recessions: US-UK update
Moritz Schularick, Alan Taylor 24 October 2012
Is the sluggish growth we see in the North Atlantic economies normal? This column updates the authors’ 5 October 2012 column to include an analysis of the UK. The original column looks at 14 advanced economies over the past 140 years and shows that larger credit booms during expansions have been systematically associated with more severe and prolonged slumps. Measured against the historical benchmark, the recent US recovery has been far better than could have been expected. The same cannot be said of the UK’s growth performance.
Debate on the “What should we have expected in terms of economic recovery?” question is raging on the internet (Reinhart and Rogoff 2012, Taylor 2012). Since publishing our widely-read column a few weeks ago, we have received several enquiries asking if we can apply the same benchmarks to evaluate the current performance of the UK economy. We now can.
Economic history Global crisis Macroeconomic policy
financial crises, recessions, credit