The determinants of long-term versus short-term bank credit in EU countries

In a new background paper prepared for the 2015/2016 Global Financial Development Report on Long-Term Finance, Haelim Park, Thierry Tressel and Claudia Ruiz analyze the growth of bank credit to firms in the emerging and advanced countries of the European Union.[1] By classifying loans according to their maturity, they document how long-term loans to enterprises in the emerging countries of the EU were growing substantially faster than in the rest of the region during the pre-crisis years.[2]

While there is a vast literature that examines the drivers of overall credit (Levine, 2005; Demirguc-Kunt and Detragiache, 1997; Beck and others, 1999; Barth and others, 2004; Cihak and others, 2012), fewer studies have analyzed the factors that contribute to the development of credit at different maturities. This is a very important area from a policy perspective since the growth of short, medium and long-term loans plays different roles. Whereas shorter-term credit allows firms to finance working capital and other short-term investments, firms need long-term loans to insure themselves against liquidity risks and afford longer-term investments that contribute more to long-term productivity growth (Aghion et al., 2005).

An interesting stylized fact that emerges from their analysis is that only in emerging countries long-term credit was expanding substantially faster than short and medium-term credit (see figure 1). In the advanced economies, loans of different maturities were growing at similar rates during the same period.

And then the crisis hit. As figure 1 shows, bank credit in the region stopped growing at the end of 2008, at the surge of the global financial crisis, and declined in 2009-2010. The decline of credit growth was much more significant in emerging economies than in high income countries.

Importantly, the contraction in total credit was initially mainly driven by a sharp decline of short- and medium-term loans. In contrast, long-term loans of maturity over 5 years in both advanced and emerging EU countries, experienced a more protracted growth slow-down but it was still very significant in emerging economies. The evolution of the long-term component of credit seems more consistent with an evolution of bank loans associated with lingering weaknesses in potential output.

In the emerging markets, which experienced a faster growth of longer-term credit in the years before the crisis, both domestic funding and foreign funding were significant drivers of bank credit to enterprises at all maturities, and foreign funding was more important to the growth of long-term bank credit than that of short-term credit. These patterns suggest that a self-sustaining process of financial deepening and increased use of long-term credit for fixed investments was at play.Using data at the country level over time on the volume of bank credit to firms, the authors then examine the macroeconomic factors associated with these patterns. They find that the cyclical determinants of the growth of credit at different maturities differed significantly between emerging markets and advanced economies in the EU.

Overall, credit growth was also positively influenced by the inflation rate and trade openness, suggesting that countries with booming demand conditions and with growing links to world trade experienced a more rapid growth of credit for fixed investments. The paper also shows that countries that established credit bureaus during the pre-crisis period experienced a faster growth of long-term credit.

As the crisis struck, some of these forces reversed.  The growth of credit in emerging economies decoupled from the growth of domestic deposits and of foreign funding. It also decoupled from the evolution of trade openness while countries with deeper banking systems experienced a faster decline of short-term bank credit.

In advanced EU countries, the relationship between credit growth and its cyclical determinants was less clear. The growth of deposits and of foreign liabilities was less strongly associated with credit to enterprises at various maturities. There is some indication that the relationship between inflation and initial banking sector depth on the one hand and credit growth on the other hand remained. There is also evidence that demand conditions – captured by real GDP growth – were a driver of credit growth before the crisis.

This paper documents and explores the factors behind several stylized facts on the growth of long-term bank credit to firms in the EU. Overall, this study suggests that more granular data on the composition of credit by maturity allows for a better understanding of the drivers of growth of overall credit in an economy.

References

Aghion, Philippe, Abhijit Banerjee, George-Marios Angeletos, and Kalina Manova. 2005. Volatility and Growth: Credit Constraints and Productivity-Enhancing Investment. NBER Working Paper 11349, National Bureau of Economic Research, Cambridge, Massachusetts.

Barth, James R., Gerard Caprio, and Ross Levine. "Bank regulation and supervision: what works best?." Journal of Financial intermediation 13.2 (2004): 205-248.

Beck, Thorsten, and Ross Levine. A new database on financial development and structure. Vol. 2146. World Bank Publications, 1999.

Cihak, Martin, et al. "Benchmarking financial systems around the world." World Bank Policy Research Working Paper 6175 (2012).

Demirgüç-Kunt, Asli, and Enrica Detragiache. The determinants of banking crises-evidence from developing and developed countries. Vol. 106. World Bank Publications, 1997.

Levine, Ross. 2005. "Finance and Growth: Theory and Evidence," Handbook of Economic Growth, in: Philippe Aghion & Steven Durlauf (ed.), Handbook of Economic Growth, edition 1, volume 1, chapter 12, pages 865-934 Elsevier.

Park, Haelim, Ruiz, Claudia, and Thierry Tressel, 2015, “Determinants of Long versus Short term Bank Credit in EU Countries”, Policy Research Working Paper 7436.

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¹ The countries examined are Austria, Belgium, Bulgaria, Croatia, Cyrpus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxemburg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden and the United Kingdom.

² The study classifies short, medium, and long-term loans as loans with maturity of: i) less than one year; ii) between one and five years; iii) and over five years.