1 Rapid expansion of credit in South Eastern Europe: a cause for concern? Dubravko Mihaljek Bank for International Settlements* Presentation at ICEG EC conference South Eastern Europe after EU Enlargement and before Accession Budapest, 4 April 2005 * The views expressed are those of the author and not necessarily those of the BIS.

2 Overview 1.Two views of credit expansion i.Benign view ii.Reasons for concern 2.Composition of bank lending 3.Mortgage lending and housing prices 4.Real estate markets in SEE

3 1. Two views of credit expansion Basic facts: Cumulative expansion of bank credit to the private sector over : > 200% (nominal) in BG, RO, SCG % in AL, HU, TR, Baltic states 40-75% in BH, HR, MK, SI Real growth > 20% p.a. in 8 countries

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5 Benign view of credit expansion Recent growth mostly reflects low base, low levels of financial intermediation R (credit growth, credit/GDP) = -0.5 Banking sector indicators improved Banking reforms advanced in SEE

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7 Benign view of credit expansion (cont) Banking sector indicators improved Lower NPLs Kept high capital adequacy Increased profitability Banking reforms advanced in SEE (privatisations in AL, SCG; consolidation in BH; better supervision in MK,TR)

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9 But there are reasons for concern 1.In BG, HR, TR credit has expanded by 5% of GDP or more p.a. for 5 years (benchmark signalling potential for crisis; Demirguc-Kunt and Detragiache, 1997) In the last two years credit growth has exceeded this benchmark also in BH, HU, and RO (and Baltic states)

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11 But there are reasons for concern 2.Lending expanding faster than deposits  banks borrow from foreign HQs  rising foreign liabilities of banking system  external indebtedness  central banks in BG, HR, RO taking precautionary measures

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13 Reasons for concern (cont) 3.Loans extended during the boom have yet to mature  NPLs could increase 4.Rapid expansion of foreign currency lending  bank customers exposed to FX risk, banks substitute credit risk for FX risk

14 2. Composition of credit growth Much faster growth of credit to households than to enterprises Negative correlation: R (household, enterprise credit growth) = -0.75

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17 Composition of credit growth (cont) Composition of lending still far from that in mature market economies (except in HR) Lending to households (after years of neglect) welcome, profitable But household indebtedness rising fast (84% of disposable income in HR)  central banks in HR, CZ, HU issued warnings

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19 3. Mortgage lending and housing prices Mortgage lending fastest rising component of household credit in many countries No excessive growth in housing prices so far But where data exist, clear correlation b/w housing loans and housing prices

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21 4. Real estate markets in SEE Still underdeveloped –high owner occupancy ratios –many properties do not have clean titles –supply of good quality properties constrained But property prices rising rapidly in big cities and coastal areas  demand by non-residents  how fast should SEE countries open up their real estate markets to EU residents