Global Financial Stability Report, September 2006: Chapter II. Household Credit Growth in Emerging Market Countries

redit to households is growing rapidly,

albeit from a low base, across many

emerging market (EM) countries.

In most countries, the growth rates

of household credit outstrip those of corpo-

rate credit. The contributing factors include

lower inﬂation and interest rates, higher

income levels, higher asset (particularly hous-

ing) prices, ﬁnancial liberalization, reduced

corporate credit following recent EM ﬁnancial

crises and greater capital market access by EM

corporates, and increased presence of retail-

lending-oriented foreign banks. Given the likely

persistence of these factors and the current

low levels of household credit in EM countries,

these growth rates are likely to remain high.

Better access to credit reduces household

consumption volatility, improves investment

opportunities, eases the constraints on small

and family businesses, and diversiﬁes household

and ﬁnancial sector assets. The welfare gains

from such expansion can be sizable, making

further growth of household credit desirable.

Although we do not explore this dimension

in detail, greater access to consumer credit in

some emerging markets could also help allevi-

ate some of the current account imbalances.

At the same time, a rapid growth in house-

hold credit, especially in weak macroeconomic

environments that lack adequate prudential

regulation and are characterized by weak risk

management or legal and institutional infra-

structure, can create systemic vulnerabilities.

The key challenge for EMs going forward is

to ensure that the pace of household credit

expansion, while desirable, is consistent with

In this chapter, we focus on mortgages, credit cards,

auto loans, consumer durable ﬁnancing, and other

similar loans intended for some form of consumption.

Although credits may be used fungibly, we do not study

loans such as broker loans or margin lending for securi-

ties investment, because of data limitations.

the underlying macroeconomic, prudential, and

institutional infrastructure to avoid costly credit

boom-bust cycles.

Household credit has grown across the EM

universe during highly favorable global liquidity

and economic conditions; household balance

sheets may, therefore, come under greater pres-

sure when global interest rates rise or global

growth slows. Under more adverse circum-

stances, the weaknesses in household balance

sheets could affect the ﬁnancial sector as a

whole, weaken property prices, and reduce con-

sumption. Similar concerns about the sustain-

ability of household debt during the turning

credit and growth cycles, and possible implica-

tions for ﬁnancial and macroeconomic stability,

have been expressed for mature market (MM)

countries (BIS, 2006).

Within EM countries, several localized con-

cerns have emerged. In Korea, a rapid growth

of poorly structured household credit led to a

systemic rise in nonperforming loans (NPLs)

and massive personal bankruptcies in 2002. In

some emerging European economies, credit-

driven consumption has led to a deterioration

of external balances, and to high and unhedged

exposure to interest and exchange rate risks

by households. Also, rising house prices and

mortgage indebtedness in parts of Asia, South

Africa, and Hungary may need to be monitored

carefully.

The well-known weaknesses in some EM

ﬁnancial institutions, regulatory capacity, and

legal and institutional infrastructure may also

create vulnerabilities in an environment of

rapid credit growth. In some EMs, ﬁnancial

institutions’ skills in originating and monitor-

ing household credit are at an early stage of

development, and excessive competition may

lead to poor origination. Infrastructure (such

as credit bureaus) is often inadequate, and col-

lateral enforcement is frequently expensive or

CHAPTER II

HOUSEHOLD CREDIT GROWTH IN EMERGING

MARKET COUNTRIES

HOUSEHOLD CREDIT GROWTH IN EMERGING

MARKET COUNTRIES

ineffective. The legal framework for securitiza-

tion of consumer loans is also weak and inad-

equate in many EM countries. Frequently, the

EM regulators’ capacity to monitor the excesses

of such credit and their macroeconomic or

systemic impact is limited by availability of

data and analytical capacity. Such limitations

may also constrain policymakers from con-

ducting appropriate interest or exchange rate

policy if such policy affects a large number of

households.

Therefore, although household credit

expansion may be highly desirable for growth,

smoothing consumption, and improving

diversiﬁcation of credit risks across most EM

countries, EM policymakers should simultane-

ously act in four key areas to prevent a buildup

of associated vulnerabilities. These include

prudent macroeconomic management to mini-

mize income, exchange rate, and interest rate

shocks; introducing sound prudential norms

for household credit and encouraging good

origination standards and information sharing

by banks; developing a comprehensive legal and

regulatory framework and infrastructure; and

improving the availability of information that

enables better assessment of systemic risks and

their mitigation. If undertaken in a timely fash-

ion, these measures will allow EMs to reap the

substantial welfare beneﬁts of developing this

market, while minimizing the potential costs of

boom-bust cycles.

These considerations make it timely to

examine the beneﬁts and potential problems

of household credit at this juncture. This

discussion also complements the analyses in

recent issues of the Global Financial Stability

Report (GFSR) on EM sovereign debt, corpo-

rate ﬁnance, and corporate bond markets.

The next section in this chapter reviews the

factors affecting the supply and demand for

household credits, including macroeconomic

and ﬁnancial sector linkages, and related

literature. It is followed by a description of the

recent trends in household credit in a sample

of 23 EM countries, using data gathered from

a special country survey, recent IMF missions,

and existing literature and data. The last three

sections discuss approaches to managing risks

stemming from household credit and risk

transfer mechanisms, the legal and regulatory

framework, and some conclusions and policy

implications.

Macroeconomic, Financial, and

Policy Linkages

Greater access to a varied range of house-

hold credit products improves the consumption

and investment opportunities for households

and enables better diversiﬁcation of household

wealth. According to the life cycle income

hypothesis, the availability of credit allows

households to overcome liquidity constraints

and permits consumption to be smoothed over

periods of high and low income (Ando and

Modigliani, 1963). Availability of household

credit also frees household equity tied in hous-

ing and other consumer durables, and enables

its possible reinvestment in proprietary busi-

nesses, corporate bonds, or equity. Indeed, in

most EM countries, for small or family-owned

businesses, home mortgages may be the cheap-

est and most long-term source of funding avail-

able, and perhaps the only source of ﬁxed-rate

borrowing.

Household loans allow diversiﬁcation of

bank portfolios and the granular nature of

such loans may reduce systemic risks. Evidence

from mature market countries suggests that

household loans are subject to lower default

rates, and losses from such loans tend to be

smaller and more predictable than from larger

corporate loans. Thus, a balanced portfolio of

household and corporate loans may decrease

the overall risks of the banking system, relative

to risks from comparable portfolios dominated

by business loans.

Several recent studies (including BIS, 2006)

have identiﬁed macroeconomic performance,

ﬁnancial sector developments, and government

policies as the key factors that affect the supply

of and demand for mortgage and other house-

hold credits.

macroeconomic, Financial, anD Policy linkages

CH A P T E R II HouseHolD creDit growtH in emerging market countries

Macroeconomic Performance

Macroeconomic stability reduces uncertainty

about future incomes and consumption and

promotes ﬁnancial sector development and

intermediation.

Low inﬂation and interest

rates, combined with economic growth, stimu-

late the demand for credit. Lower interest rates

reduce borrowers’ debt service costs, enable

more borrowers to qualify for larger credits,

and lower the amount of future consumption

that borrowers must sacriﬁce to repay current

borrowings. Expectations of sustained growth

lead more households to borrow against future

income growth (Antzoulatos, 1996) and may,

in turn, inﬂate asset values that, by serving as

collateral, allow higher borrowing and spend-

ing. Higher incomes and low volatility of future

growth rates, inﬂation, and default rates enable

lenders to lend more to households, for longer

terms and at ﬁxed rates. Ample global liquidity

also augments funding to the banking sector

and thus the supply of credit.

Financial Sector Development

Financial sector development and liberaliza-

tion improve competition, efﬁciency, and access

to credit (Claessens, Demirgüç-Kunt, and Huiz-

inga, 2001; Clarke, Cull, and Shirley, 2005), and

lead to greater participation of foreign banks.

Cross-border ﬁnancial investment and the asso-

ciated transfer of know-how on consumer lend-

ing can improve risk management of portfolios

of household credit. Technology and ﬁnancial

innovation also contribute to the growth in

household credit. New consumer lending tech-

nologies permit lenders to reach more consum-

ers, better assess market and lending risks, price

loans more accurately, and reduce the cost of

lending. Complementary market developments

(e.g., in securitization and derivatives) enable

Favara (2003); King and Levine (1993); and

Levine (1997) provide evidence regarding the link

between macroeconomic stability and ﬁnancial sector

development.

better funding and risk management of house-

hold credit portfolios.

Government Policies

In many MM countries, government poli-

cies related to the housing market in the

areas of taxation, price and rent regulation,

land use, and construction have provided an

impetus to mortgage lending. Recent trends

in EM government policies have also facili-

tated greater allocation of credit to house-

holds. Directed credit requirements (generally

favoring industrial credits) and restrictions

on consumer credits have been reduced, and

interest rates are becoming more liberalized.

Greater openness to foreign banks has permit-

ted entry of many lenders with well-developed

consumer-lending strategies. Although EM

governments retain an important presence in

housing ﬁnance, restrictions on lending by

commercial banks and ﬁnance companies are

being lowered. In some countries (e.g., Brazil

and Malaysia), commercial banks are encour-

aged or required to make housing loans of a

certain amount, usually to low-income borrow-

ers, while others (e.g., Korea) have pursued

a policy of encouraging consumption and, in

turn, consumer credit.

Recent Trends, Issues, and

Potential Vulnerabilities

This section analyzes the recent trends and

potential vulnerabilities related to household

credit in a sample of 23 larger EM countries

that have widely varying levels and growth rates

of household credit. For comparison, we also

present data on nine MM countries. Availability

of data varies greatly across the EM sample. It

should be highlighted that there are differences

between countries in terms of coverage, types,

composition, and sources of household credit.

This makes it difﬁcult to make general obser-

vations across countries. The chapter Annex

provides details on the sample and data used in

the subsequent analysis.

recent trenDs, issues, anD Potential vulnerabilities

Level and Growth Rate of Household Credit

The average household-credit-to-GDP ratio

in EM countries is about 18 percent but ranges

widely from about 3 percent to 64 percent

(Figure 2.1). On average, household credit has

attained the highest levels in Asia, followed by

emerging Europe and Latin America. How-

ever, penetration rates for consumer credit,

housing loans, and usage of credit cards are

still well below those reached in MM countries

(Figure 2.2).

These differing trends can be explained by

several factors. In MM countries, consumer

credit has grown historically with income; there

is a positive relationship between the household-

credit-to-GDP ratio and per capita income

(Figure 2.3). Financial liberalization is another

important factor. In the United Kingdom, for

example, secured lending to individuals rose by

25 percentage points of GDP during the 1980s,

following the liberalization of the domestic

mortgage market, which had experienced

widespread rationing prior to 1981 (Muellbauer

and Murphy, 1997). Similarly, bank lending to

households grew by 98 percent in 2004 in Ice-

land, following the commencement of mortgage

lending by private commercial banks in early

2004. EM household credit growth has also

been encouraged by the restructuring of banks’

asset portfolios and business models following

recent ﬁnancial crises. In several Asian and

Latin American countries, postcrisis resump-

tion of bank lending has been led by household

credit rather than by corporate credit (Coric-

elli, Mucci, and Revoltella, 2006).

Interestingly, the share of private sector

credit allocated to households in total credit to

private sector (on average around 35 percent)

does not differ dramatically between EM and

MM countries (Figure 2.4), suggesting that the

lower levels of household credit to GDP in EM

countries are primarily a function of their lower

level of total private sector credit.

Among EM countries, growth rates have been

particularly high for countries starting from a

very low base in terms of household-credit-to-

GDP ratios (Figures 2.5 and 2.6). For example,

100

Emerging

Europe

12.1

Emerging

Asia

27.5

Latin

America

9.2

Mature

markets

58.0

Average for all countries: 29.2

Figure 2.1. Household Credit, End-2005

(In percent of GDP)

Sources: IMF, World Economic Oulook; CEIC; and IMF staff estimates based on

data from country authorities.

Russia

Romania

Turkey

Poland

Czech Republic

Bulgaria

Hungary

South Africa

Philippines

Indonesia

India

China

Thailand

Korea

Taiwan Province of China

Malaysia

Venezuela

Peru

Brazil

Argentina

Colombia

Mexico

Chile

Italy

France

Japan

Germany

Spain

Australia

Ireland

New Zealand

United States

CH A P T E R II HouseHolD creDit growtH in emerging market countries

as emerging Europe’s ﬁnancial sector develops

and converges with that of the EU, the growth

rate of household credit is very high (close to

50 percent per year in real terms), but the levels

are still signiﬁcantly below those within the EU.

In Latin America, the growth rate of household

credit has been accelerating in the last two years.

Composition and Structure of Household Credit

In MM countries, housing loans account

for about 70–80 percent of total household

credit, while the average share of housing

loans in total household credit is substantially

lower for some of the rapidly growing markets

(Figure 2.7). This low share in total household

credit reﬂects several factors such as a still-high

and volatile interest rate environment, in addi-

tion to hindrances such as an inadequate legal

framework for enforcing mortgages.

Consumer loans in EM countries are gener-

ally extended at ﬁxed rates, while housing loans

are extended at both ﬁxed and ﬂoating interest

rates (see Table 2.1). As in MM countries, this

reﬂects the large maturity differences between

these two types of loans.

Although limited information is available on

interest rates for household loans in EM coun-

tries (Table 2.2), it nonetheless indicates that

interest rates on EM household loans are gener-

ally higher than on their MM counterparts.

Higher nominal interest rates in EM countries

may reﬂect the higher risk-free rates, a larger

risk premium vis-à-vis comparable MM credits,

and possibly lower competition relative to MM

countries.

Although a signiﬁcant share of household

credit is denominated in foreign currency in

emerging Europe, it is almost entirely denomi-

nated in local currency in most of emerging

Asia and most of Latin America (except in

highly dollarized countries).

In emerging

Europe, the foreign currency exposure is

predominantly in the mortgage market, while

Data on household loans indexed to foreign currency

are not available.

100

1000

2000

3000

4000

5000

Emerging

Europe

Latin

America

Emerging

Asia

Mature

markets

Russia

Argentina

Mexico

Colombia

Brazil

Chile

Indonesia

India

China

Germany

United Kingdom

United States

Japan

Poland

Hungary

Czech Republic

Russia

Argentina

Mexico

Colombia

Brazil

Chile

Indonesia

India

China

Germany

United Kingdom

United States

Japan

Poland

Hungary

Czech Republic

Russia

Argentina

Mexico

Colombia

Brazil

Chile

Indonesia

India

China

Germany

United Kingdom

United States

Japan

Poland

Hungary

Czech Republic

Retail Loan Penetration

(Percent of GDP)

Emerging

Europe

Latin

America

Emerging

Asia

Mature

markets

Market Loan Penetration

(Percent of GDP)

Emerging

Europe

Latin

America

Emerging

Asia

Mature

markets

Credit Card Penetration

(Number of credit cards per 1,000 people)

Figure 2.2. Credit to Households: Market Penetration,

End-2005

Source: Merrill Lynch (2006).

recent trenDs, issues, anD Potential vulnerabilities

consumer loans tend to be denominated in

local currency. Even though some lenders offer

downside protection to borrowers against a

depreciation of the domestic currency, most

household loans in foreign currency remain

unhedged. The growth in the foreign currency

exposure in recent years (mainly in euros and

Swiss francs) could be attributed to the lower

interest rates in Switzerland and the euro area

and foreign banks’ access to cheap external

ﬁnancing. The share of foreign currency debt is

particularly high in Bulgaria, Hungary, Poland,

Romania, and Russia (Figure 2.8). With the rise

in MM interest rates in 2006 and some depre-

ciation of EM currencies, and as foreign banks

increase their deposit base in host countries,

these patterns could change.

Longer maturities for housing loans are

becoming more common in most EM countries.

However, loan tenors remain somewhat shorter

than is common in most MM countries, and the

tradition of short-term loans is strong in many

EM countries (notably in Korea) despite moder-

ate inﬂation expectations.

Providers of Household Credit

Banks are the largest providers of household

credit in most EM countries. Foreign banks

As an illustration, as of June 2006, a housing loan in

Hungary can be ﬁnanced at a 12.9 percent variable rate for

a forint loan, at a 4.8 percent six-month ﬁxed rate in euros,

or at a 3.3 percent six-month ﬁxed rate in Swiss francs.

0 10000 20000 30000 40000 50000

100

GDP per capita

(in U.S. dollars)

Household crredit/GDP

(in percent)

Malaysia

New Zealand

Ireland

Australia

Japan

Germany

France

Italy

Spain

Taiwan

Korea

Thailand

Bulgaria

Chile

South Africa

Hungary

Czech Republic

Mexico

Poland

United States

Figure 2.3. Household Credit/GDP and GDP per Capita,

End-2005

Sources: IMF, World Economic Outlook; CEIC; and IMF staff calculations based

on data from country authorities.

Note: The circled cluster of countries includes Argentina, Brazil, China, Colombia,

India, Indonesia, Peru, Philippines, Romania, Russia, Turkey, and Venezuela.

Table 2.1. Predominant Types of Household

Mortgage Interest Rates

Fixed Rate Variable Rate Mixed

France Australia Czech Republic

Germany Brazil Hungary

United States Ireland India

Korea

Italy

Malaysia

Japan

Spain

Thailand

United Kingdom

Source: Country authorities.

Most loans are ﬁxed in the initial period, most often, for one

to ﬁve years, and then ﬂoat.

Average for all countries: 37.5

Russia

Romania

Turkey

Poland

Czech Repulblic

Bulgaria

Hungary

South Africa

Philippines

Indonesia

India

China

Thailand

Korea

Taiwan Province of China

Malaysia

Venezuela

Peru

Brazil

Argentina

Colombia

Mexico

Chile

Italy

France

Japan

Germany

Spain

Australia

Ireland

New Zealand

United States

Figure 2.4. Share of Household Credit in Total

Private Sector Credit, 2005

(In percent of total private sector credit)

Sources: CEIC; and IMF staff estimates based on data from country authorities.

Private sector credit does not include credit to nonbank financial institutions.

Emerging

Europe

38.9

Latin

America

35.7

Emerging

Asia

31.4

Mature

markets

41.5

have played a particularly important role in the

expansion of household credit in EM countries

(Box 2.1 on p. 60, and Figure 2.9). Moreno and

Villar (2005) point to a strategic shift by foreign

banks from internationally active clients to

domestic retail clients. In several Asian coun-

tries, foreign banks still face important restric-

tions, including branch limitations. As a result,

foreign banks have focused on credit cards and

personal loans and, in many countries, have the

major share of these markets. In several emerg-

ing European economies, foreign banks

have

expanded their asset base faster than deposits,

resulting in rising external and foreign cur-

rency debt, and an accumulation of currency

risks by unhedged household borrowers.

Several EM countries have government-

sponsored lending institutions, particularly in

Foreign-owned banks (with parent banks from

Austria, Germany, and the Nordic countries in the lead)

accounted for 70 percent or more of banking sector assets

in Albania, Bulgaria, Croatia, the Czech Republic, Estonia,

Hungary, Lithuania, and the Slovak Republic in 2004.

–20

100

–20

100

120

Emerging

Europe

47.7

Average for all countries: 21.0

Average for all countries: 24.8

Average Annual Growth of Real Household Credit, 2000–05

Average Growth of Real Household Credit, 2004–05

Poland

Czech Republic

Turkey

Hungary

Bulgaria

Russia

Romania

South Africa

Taiwan Province of China

Malaysia

Thailand

Korea

Indonesia

India

China

Philippines

Argentina

Colombia

Mexico

Peru

Chile

Brazil

Venezuela

Japan

Germany

France

United States

Italy

New Zealand

Australia

Spain

Ireland

Poland

Czech Republic

Turkey

Hungary

Bulgaria

Russia

Romania

South Africa

Taiwan Province of China

Malaysia

Thailand

Korea

Indonesia

India

China

Philippines

Argentina

Colombia

Mexico

Peru

Chile

Brazil

Venezuela

Japan

Germany

France

United States

Italy

New Zealand

Australia

Spain

Ireland

Emerging

Asia

22.6

Latin

America

8.9

Mature

markets

8.9

Emerging

Europe

46.6

Emerging

Asia

13.8

Latin

America

34.5

Mature

markets

10.2

Figure 2.5. Annual Growth of Real Household Credit

(In percent)

Sources: IMF, World Economic Oulook; CEIC; and IMF staff estimates based on data

from country authorities.

Table 2.2. Average Household Loan Interest

Rates (in Local Currency)

(In percent)

2002 2003 2004 2005

(In nominal terms)

Bulgaria 14.8 14.0 12.3 9.8

Hungary . . . 18.1 16.1 13.8

Poland

. . . . . . 12.1 10.3

Romania . . . 27.4 26.7 12.9

Russia 21.3 22.0 20.5 20.4

Indonesia 20.2 18.7 16.6 16.8

Korea 7.1 6.3 5.5 5.6

Taiwan Province of China 4.6 2.9 2.8 2.8

(In real terms)

Bulgaria 9.0 11.8 6.0 4.8

Hungary . . . 13.5 9.3 10.2

Poland

. . . . . . 8.5 8.2

Romania . . . 12.1 14.8 3.9

Russia 5.5 8.3 9.6 7.7

Indonesia 8.3 12.1 10.3 6.4

Korea 4.4 2.8 1.9 2.9

Taiwan Province of China 4.8 3.2 1.2 0.3

Sources: IMF staff estimates are based on data from the CEIC

database, central banks,

International Financial Statistics (IFS),

and

World Economic Outlook.

Data for 2004 are end of period and for 2005 are for November.

CH A P T E R II HouseHolD creDit growtH in emerging market countries

the housing market. Over time, institutions

such as Thailand’s Government Housing Bank,

Mexico’s INFONAVIT, or the Philippines’ PAG-

IBIG are increasingly competing with com-

mercial banks, retaining their remit to provide

loans to low-income households that would

not be served by commercial banks. In some

instances, specialized secondary market insti-

tutions purchase or reﬁnance mortgage loans

from originators to provide them long-term

funding (e.g., Cagamas in Malaysia or National

Housing Bank in India).

In many developing countries, the nonbank

ﬁnance companies and, to a lesser extent, the

informal credit sector play an important role,

often as the only available source of house-

hold credit. In Mexico, following the “Tequila”

crisis and the retreat of commercial banks

from mortgage lending, nonbank mortgage

originators (Sofoles) have grown with fund-

ing from the Federal Mortgage Society and,

more recently, from mortgage-backed securities

(MBS). The informal sector in many EM coun-

tries is often an important source of credit to

low-income households. In the Philippines, for

example, limitations on banks to lend only to

taxpayers leave many households with no access

to the formal credit sector. In Chile, a signiﬁ-

cant share of credit is provided by department

stores. Such nonbank lending is not always

formally supervised or reported, leading to an

underestimation of aggregate credit growth to

households.

Potential Vulnerabilities

As with most forms of credit, a high level

or rapid development of household credit can

create vulnerabilities. In particular, if credit to

households grows too rapidly without adequate

infrastructure (see discussion below), household

debt may reach unsustainable levels and, if sufﬁ-

ciently large, can in turn jeopardize the stability

of the ﬁnancial system and overall economic

growth. Excessive mortgage lending could con-

tribute to the inherent vulnerability of property

markets to boom-bust cycles and the attendant

0 10 20 30

Household credit in 2000

(in percent of GDP)

Average growth in 2000–05

(in percent)

40 50

–20

100

Romania

Russia

Bulgaria

China

Hungary

Philippines

Thailand

Taiwan

Korea

Malaysia

South

Africa

Chile

Argentina

Colombia

Mexico

Brazil

Venezuela

Peru

India

Turkey

Czech Republic

Poland

Indonesia

Figure 2.6. Household Credit: Level in 2000 and Real

Growth Rates, 2000–05

Sources: IMF, World Economic Oulook; CEIC; and IMF staff estimates based on

data from country authorities.

100

Average for all countries: 52.9

Russia

Romania

Turkey

Poland

Bulgaria

Hungary

South Africa

Philippines

Indonesia

India

China

Korea

Taiwan Province of China

Malaysia

Venezuela

Peru

Brazil

Argentina

Colombia

Mexico

Chile

Italy

France

Japan

Germany

Spain

Australia

Ireland

New Zealand

United States

Figure 2.7. Share of Housing Loans in Total

Household Credit, End-2005

(In percent)

Sources: CEIC; and IMF staff estimates based on data from country authorities.

Emerging

Europe

27.9

Latin

America

37.5

Emerging

Asia

54.2

Mature

markets

77.5

recent trenDs, issues, anD Potential vulnerabilities

CH A P T E R II HouseHolD creDit growtH in emerging market countries

cyclicality in the banking system. Credit expan-

sion ﬁnanced by cross-border ﬂows can raise

concerns about sudden stops and contagion.

The rapid pace of credit growth can also lead

to macroeconomic imbalances such as a rapid

deterioration of the external current account

balances. This section discusses such vulner-

abilities in the context of the EM countries that

have experienced rapid growth in household

credit in recent years.

Household and Financial Sector Vulnerabilities

Deterioration in household repayment

capacity and net worth due to income, inter-

est rate, or exchange rate shocks may translate

into higher NPLs. In turn, a rise in NPLs may

impair the balance sheet of the ﬁnancial sector.

That said, the sustainability of household debt

depends upon the corresponding level of house-

hold assets as well as the steadiness of future

income (Box 2.2 on p. 61).

Data on EM countries’ aggregate household

balance sheets, net worth, and debt-servicing

costs are generally not available. Partial data,

however, suggest that many EM countries with

rapidly rising household debt also have signiﬁ-

cant positive net ﬁnancial assets (Figures 2.10

and 2.11; and Table 2.3). The ratio of household

debt to disposal income varies across EM coun-

tries and, except for some of the highest-income

EM countries (Korea and Taiwan Province of

China), it is generally still substantially lower

than in MM countries (Table 2.4). However,

debt-servicing costs in EMs could rise quickly if

interest rates go up.

Using macrolevel data to assess household

debt sustainability, however, has limitations.

A high level of indebtedness (household debt

to GDP) at an aggregate level may not mean

there is a risk to ﬁnancial stability, especially

if the distribution of debt is biased toward the

households that have a higher payment capac-

ity and a buffer to withstand shocks. Similarly,

low aggregate household indebtedness may

mask vulnerabilities if the debt accumulation is

skewed toward the low-income groups. Indeed,

most mature market countries undertake a

Czech

Republic

Turkey Russia Bulgaria Poland Hungary Romania

Figure 2.8. Share of Foreign-Currency-Denominated

Household Credit, End-2005

(In percent of total household credit)

Sources: CEIC; and IMF staff estimates based on data from central banks.

Note: Data for Bulgaria do not include overdraft.

2004

2000

Emerging Europe

38.8 (2000)

47.9 (2004)

Emerging Asia

10.8 (2000)

10.9 (2004)

Latin America

27.7 (2000)

27.2 (2004)

Russia

Romania

Turkey

Poland

Czech Repulblic

Bulgaria

Hungary

South Africa

Philippines

Indonesia

India

China

Thailand

Korea

Malaysia

Venezuela

Peru

Brazil

Argentina

Colombia

Mexico

Chile

Figure 2.9. Share of Foreign Bank Assets in Total

Bank Assets

(In percent)

Source: IMF staff estimates based on Bankscope.

Note: Dotted lines are regional averages for 2000 and 2004.

Foreign banks are all banks with combined foreign ownership exceeding

50 percent.

Table 2.3. Financial Assets and Liabilities of

Households, End-2004

(In percent of GDP)

Financial Financial Net Financial

Assets Liabilities Wealth

Bulgaria 42.2 12.0 30.2

Czech Republic 65.0 13.8 51.2

Hungary 55.0 20.0 35.0

Poland 55.8 13.2 42.6

Turkey 50.8 6.5 44.3

South Africa

260.6 33.8 226.8

Korea 144.6 76.6 68.0

Thailand 97.7 33.7 64.0

Mexico 32.1 11.6 20.5

United States 310.2 95.5 214.7

EU-15

185.0 63.0 122.0

Sources: UniCredit Group (2005); Aron and Muellbauer

(2006); and IMF staff estimates.

Data for Korea, Thailand, Mexico, and the United States are as

of end-2005.

Financial asset estimates for South Africa are based on

preliminary data from South Africa Reserve Bank.

Includes Austria, Belgium, Denmark, Finland, France,

Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands,

Portugal, Spain, Sweden, and the United Kingdom.

more detailed analysis of the household balance

sheets (Box 2.2).

A number of emerging European econo-

mies have a relatively high share of household

credit denominated in foreign currency. Such

loans are attractive in periods of local currency

appreciation and low foreign currency interest

rates but the risk of a large depreciation may

not be fully understood by unhedged house-

hold borrowers.

In several emerging European

countries, deposit growth has been lagging

and there is some evidence that credit growth

is being ﬁnanced mainly by foreign borrowing.

In its Bank Systemic Risk Report, Fitch (2006) has

warned that some countries now exhibit either

moderate or high vulnerability to potential sys-

temic stress due to rapid lending growth.

Although reported data suggest a sufﬁcient

cushion to absorb credit losses in many EM

See the Central Bank of Hungary’s April 2006 Report

on Financial Stability.

The countries ranked as highly vulnerable include

several MM countries (Iceland, Ireland, and Norway)

and Azerbaijan, Russia, and South Africa. Many of the

emerging European countries are ranked as moderately

vulnerable.

100

Figure 2.10. Household Financial Leverage in

Selected Countries, 2005

(In percent)

Sources: CEIC; and IMF staff calculations based on data from central banks.

Note: Data for Colombia, India, and Japan are as of end-2004.

Household leverage is defined as the ratio of household liabilities to household

assets.

Italy

Japan

Czech Republic

Poland

France

Turkey

Colombia

United States

Hungary

Australia

Spain

India

New Zealand

05040302012000

Figure 2.11. Household Financial Leverage in

Selected Countries in Emerging Europe

(In percent)

Sources: CEIC; and IMF staff calculations based on data from central banks.

Household leverage is defined as the ratio of household liabilities to household

assets.

Hungary

Poland

Turkey

Czech Republic

recent trenDs, issues, anD Potential vulnerabilities

CH A P T E R II HouseHolD creDit growtH in emerging market countries

countries, such indicators often reﬂect market

averages and mask pockets of weaknesses within

banking systems. Capital adequacy ratios in

banks in EM countries range between 11 and

20 percent, with an unweighted average of

13 percent (see Chapter I). The level of NPLs

varies across EM countries but the evidence

does not generally suggest sizable credit quality

problems in household loan portfolios (Fig-

ure 2.12).

However, NPL ratios are backward

looking and may not fully reﬂect the lending to

more marginal customers in the early stages of

rapid credit expansion.

Financial innovation in EM household credit

has created its own challenges. Easier access to

ﬁnancing by marginal customers through lower

origination standards may have ampliﬁed some

of the vulnerabilities. Product innovations, such

as lengthening the maturity of some of the

mortgages in Poland to 45 years and constant

payment loans in countries such as Malaysia

and Thailand, may result in larger interest

rate, reﬁnancing risks, or exposure to house-

hold income shocks. Households in the lowest

income brackets may be particularly vulnerable

to a “debt trap” as they have very little ﬁnancial

The criteria for classifying a loan as nonperforming

may vary across countries.

buffer and may face large penalties from delin-

quent payments. In Korea, the 2003 credit card

crisis led to a severe capital shortage for the

credit card industry and resulted in 10 percent

of the adult population becoming delinquent

on their debts (Box 2.3 on p. 64). For MM coun

tries, BIS (2006) has warned that lenders in

countries that are experiencing a rapid growth

of subprime markets may be underestimating

households’ probability and severity of default.

Macroeconomic Vulnerabilities

In addition to creating systemic problems

within the ﬁnancial sector, rapid growth of

household credit can lead to several macroeco-

nomic risks. These include fueling consumer

price inﬂation, property price inﬂation, higher

imports and thus current account deﬁcits, and,

as discussed above, if funded by capital inﬂows,

vulnerability to sudden stops.

It is worth noting

that past episodes of balance of payments or

banking currency crises were preceded by rapid

growth of corporate credit, most often in the

See Kaminsky and Reinhart (1999); Kaminsky,

Lizondo, and Reinhart (1997); Borio and Lowe (2004);

Mendoza (2001); Gourinchas, Valdes, and Landerretche

(2001); Mihaljek (2006); and Duenwald, Gueorguiev,

and Schaechter (2005).

Table 2.4. Ratio of Household Credit to Personal Disposable Income

(In percent)

2000 2001 2002 2003 2004 2005

Emerging Markets

Czech Republic 8.5 10.1 12.9 16.4 21.3 27.1

Hungary 11.2 14.4 20.9 29.5 33.9 39.3

Poland 10.1 10.3 10.9 12.6 14.5 18.2

India 4.7 5.4 6.4 7.4 9.7 . . .

Korea 33.0 43.9 57.3 62.6 64.5 68.9

Philippines 1.7 4.6 5.5 5.5 5.6 . . .

Taiwan Province of China 75.1 72.7 76.0 83.0 95.5 . . .

Thailand 26.0 25.6 28.6 34.3 36.4 . . .

Mature Markets

Australia 83.3 86.7 95.6 109.0 119.0 124.6

France 57.8 57.5 58.2 59.8 64.2 69.2

Germany 70.4 70.1 69.1 70.3 70.5 70.0

Italy 25.0 25.8 27.0 28.7 31.8 34.8

Japan 73.6 75.7 77.6 77.3 77.9 77.8

Spain 65.2 70.4 76.9 86.4 98.8 112.7

United States 104.0 105.1 110.8 118.2 126.0 132.7

Source: IMF staff estimates based on data from country authorities, CEIC, OECD, and Bloomberg.

context of ﬁxed-exchange-rate regimes; there is

limited evidence of systemic problems caused by

rapid household credit growth.

The experience of several industrial coun-

tries illustrates the complexity of the issues

revolving around credit booms, causes thereof,

and their interaction with other ﬁnancial sec-

tor and macroeconomic variables. In the latter

part of the 1980s, Finland, Norway, and Sweden

experienced a rapid increase in household debt,

driven in part by ﬁnancial liberalization.

All

three countries experienced higher consumer

spending, inﬂationary pressures, and rapid

growth, followed by large current account

deﬁcits, exchange rate pressures, and interest

rate hikes. The ensuing recessions exacerbated

household indebtedness and precipitated a

banking currency crisis. More recently, Iceland

experienced large short-term capital inﬂows

to a booming economy fueled by exceptionally

rapid credit expansion. Private commercial

banks entered the mortgage market in 2004,

which led to increased competition. The sharp

rise in house prices, the associated withdrawal

of housing equity, and the surge in consump-

tion contributed to the large current account

deﬁcit. The turning point was reached in early

2006, when the tightening of global liquidity

conditions triggered signiﬁcant capital outﬂows

and resulted in increased ﬁnancial volatility and

severe pressure on exchange rates.

In the sample of EM countries, there is some

evidence suggesting that the fast growth of

credit to households may be linked to increased

imports of goods and to deterioration in cur-

rent account balances (Figures 2.13 and 2.14).

Four countries—Bulgaria, Hungary, Romania,

and Turkey—had deﬁcits that exceeded 5 per

cent of GDP in 2005; all these countries experi-

enced large capital inﬂows and a rapid growth

in credit to households (at least twice as fast

as nominal GDP growth). Recent studies show

that the sharp increase in credit to households

explains in part the increase in imports and the

See Drees and Pazarbasioglu (1995); and Brunila

and Takala (1993).

Bulgaria

Turkey

Czech Republic

Poland

India

Malaysia

Philippines

Spain

United States

France

Italy

Bulgaria

Turkey

Czech Republic

Poland

India

Malaysia

Philippines

Spain

United States

Mexico

Bulgaria

Turkey

Czech Republic

Poland

Malaysia

Spain

Thailand

Mexico

Household NPLs

(In percent of total household credit)

Housing and Mortgage NPLs

(In percent of total housing

credit)

Consumer NPLs

(In percent of total

consumer credit)

Figure 2.12. Nonperforming Loans, 2005

Source: IMF staff calculations based on data from the World Economic Outlook

and data from central banks.

recent trenDs, issues, anD Potential vulnerabilities

CH A P T E R II HouseHolD creDit growtH in emerging market countries

deterioration in current account balances of

emerging European countries (Coricelli, Mucci,

and Revoltella, 2006; Hilbers and others, 2005;

and Menegatti and Roubini, 2006). Duenwald,

Gueorguiev, and Schaechter (2005) estimate

that a percentage point of GDP of additional

credit leads to a deterioration in trade balance

by about 0.4 and 0.7 percentage points of GDP

for Bulgaria and Romania, respectively.

Rapid credit growth to households can also

feed asset price inﬂation; rising asset prices

can encourage further credit growth by raising

collateral values, and an eventual decline in

inﬂated property prices may result in a boom-

bust cycle. While house prices have risen far

faster in MM than in EM countries, some EM

countries have seen substantial increases in

house prices over the last few years (Table 2.5

and Figure 2.15). Financial stability reports of

some emerging European countries that are

experiencing rapid growth in household credit

have already warned about house price inﬂation

and potential vulnerabilities for the ﬁnancial

system.

Risk Management and Risk Transfer

Depending on the terms of the loans, lenders

of household credit can face signiﬁcant inter-

est rate, exchange rate, reﬁnancing, and credit

risks. Nonetheless, risks in household credits

are more amenable to monitoring and manag-

ing than are commercial credits, which require

a more complex assessment of business ﬁnan-

cials, management, and industry trends. The

strong personal incentives of borrowers to pre-

serve their homes and to maintain future access

to credit generally reduces NPLs. Because of its

homogenous nature, a portfolio of household

credit is more stable and predictable. Moreover,

household credits can typically be repackaged

See the Financial Stability Report of the Czech

National Bank (2005); the Financial Stability Report of the

Central Bank of Hungary (April 2006); and the Financial

Stability Review of the National Bank of Poland (ﬁrst half

of 2005).

0 1 2 3 4 5

Average growth of private consumption expenditures

6 7 8 9 10

Average growth of household credit

100

120

140

Romania

Russia

Argentina

Brazil

Colombia

Poland

Korea

Czech Republic

Indonesia

Peru

Mexico

Chile

Thailand

Malaysia

India

ChinaVenezuela

Hungary

Bulgaria

Turkey

Philippines

Figure 2.13. Nominal Growth of Household Credit and

Private Consumption Expenditures, 2000–05

(In percent)

Sources: IMF, World Economic Outlook; CEIC; and IMF staff estimates based on data

from country authorities.

0 5 10 15 20 25 30

–20

100

Average import growth

Average growth of consumer credit

Russia

China

Bulgaria

Turkey

Hungary

Venezuela

India

Colombia

South Africa

Thailand

Chile

Spain

Mexico

Peru

Malaysia

Australia

Italy

Philippines

Czech Republic

Brazil

Japan

Germany

France

Ireland

Argentina

United States

Figure 2.14. Nominal Growth of Consumer Credit and

Merchandise Imports, 2000–05

(In percent)

Sources: IMF, Balance of Payments Statistics; CEIC; and IMF staff estimates based on

data from country authorities.

Note: Average merchandise import growth is based on 2000–04 data for Malaysia and

Argentina, and on 2001–03 data for India. Consumer credit growth is based on 2002–05

data for Turkey and on 2001–05 data for Indonesia, the Philippines, and Venezuela.

and sold to capital market investors, allowing

transfer of risks. This section discusses some

mechanisms for the management and transfer

of household credit–related risks.

Securitization

Securitization can play a particularly impor-

tant role in managing interest and rollover risks

of household credit. It allows banks to obtain

long-term funding and transfer the credit risks

of a pool of household credits to capital market

investors. It also allows originators to conserve

regulatory capital, diversify asset risk, and struc-

ture products to reﬂect investors’ preferences.

A related technique—mortgage bonds—allows

originators to obtain long-term funding at

competitive rates, but without reducing credit

risks. Box 2.4, on p. 67, compares the features

of these two alternatives for long-term ﬁnancing

of household credit portfolios.

Securitization is a complex structured ﬁnanc-

ing technique, and its implementation suffers

100

120

140

160

180

200

220

05040302012000

100

110

120

130

140

150

160

170

180

Spain

New Zealand

Netherlands

Hungary

Korea

Thailand

Malaysia

United States

Ireland

France

Figure 2.15. House Price Indices

(2000 = 100)

Selected Mature Markets

Selected Emerging Markets

Sources: Economic and Social Research Institute, Ireland; Office of Federal

Housing Enterprise Oversight, United States; Reserve Bank of New Zealand; NVM,

Netherlands; Australian Bureau of Statistics; Bank Negara Malaysia; CEIC; and

Bloomberg L.P.

Table 2.5. House Price Changes

(Year-on-year change in percent)

End-2003 End-2004 End-2005

Emerging Markets

Hungary 26.5 –5.6 7.5

Korea 5.7 –2.1 4.1

Malaysia 4.0 4.8 2.4

South Africa 16.2 25.0 34.9

Thailand 17.8 9.3 7.2

Mature Markets

Australia 19.4 0.2 2.2

France 12.4 16.0 14.8

Ireland 13.7 8.6 9.3

Japan

–10.3 –9.5 –7.0

Netherlands 1.7 3.6 4.2

New Zealand 25.0 11.6 15.4

Spain 18.5 17.2 12.6

United Kingdom 8.3 10.7 2.9

United States 7.9 12.0 13.3

Sources: Economic and Social Research Institute (ESRI),

Ireland; Ministerio de Vivienda, Spain; Ofﬁce of Federal Housing

Enterprise Oversight (OFHEO), United States; Reserve Bank of

New Zealand (RBNZ), New Zealand; Nederlandse Vereniging van

Makelaars (NVM), Netherlands; Ofﬁce of the Deputy Prime Min

ister (ODPM), United Kingdom; Australian Bureau of Statistics

(ABS); Central Bank of Malaysia; Central Bank of Hungary; Amal

gamated Banks of South Africa (ABSA); CEIC; and Bloomberg.

In Japan, year-on-year changes are as of September of each

respective year.

risk management anD risk transFer

CH A P T E R II HouseHolD creDit growtH in emerging market countries

Foreign banks have increased their pres-

ence in all emerging market (EM) countries

over the past several years. These banks have

spearheaded the growth of lending to house-

holds in several EM countries, attracted by

high margins and using the expertise they have

developed in this area in their home markets.

This box discusses the beneﬁts and challenges

of foreign bank participation in EMs and poli-

cies to manage such challenges.

The presence of foreign banks in a country

appears to be conducive to stability, efﬁciency,

and improved regulation and governance.

Claessens, Demirgüç-Kunt, and Huizinga

(2001) show that, in developing countries,

increasing the number (even more than

the market share) of foreign banks reduces

overhead expenses of domestic banks. Several

studies show that foreign banks tend to curtail

lending by less than domestic banks during

adverse economic times (De Haas and Lelyveld,

2002 and 2003). They also ﬁnd that foreign

banks’ credit growth is related positively to

the health of the parent bank and negatively

to the home country macroeconomic condi-

tions. During crises in Latin America and Asia,

foreign banks maintained higher loan growth

rates than did domestic banks, with lower

volatility of lending (Goldberg, Dages, and

Kinney, 2000).

For countries with rapidly growing house-

hold credit, foreign banks could present some

new challenges for surveillance and policy.

Potential contagion may arise if foreign banks

active in several countries in the same region

cut their exposure across the region follow-

ing a shock that affects their exposure in one

country. Buildup of exposures to common

risk factors in a region may also increase the

potential for contagion. During the Asian

crisis, for example, foreign banks signiﬁcantly

reduced their lending to countries that had

not been affected by the crisis, contributing

Note: The main authors of this box are Sean

Craig and Paul Ross.

to contagion. However, a large share of such

reduction can be attributed to Japanese banks

experiencing problems in their home market.

Host countries need to assess the potential for

such contagion and how to address contagion

if it occurs.

Foreign and local bank lending in some

countries is often denominated in, or indexed

to, a foreign currency. This may reﬂect exist-

ing practices in the host country or a legacy of

macroeconomic instability. Lending in foreign

currency transfers the foreign exchange risk to

borrowers, especially to households that often

lack income or assets in foreign currencies,

thereby contributing to a buildup of indirect

credit risk. The banks may not fully internalize,

and price and provision for this risk, especially

if they underestimate the risk of devaluation,

due to the expectation of joining a regional

currency bloc or a perceived guarantee of a

currency board.

Risk measurement and management systems

used in industrial countries may need to be

appropriately recalibrated when applied in the

EM context. In most EM countries, data qual-

ity is poor and, some countries have shorter

experience in lending to households. As expe-

rience is gained and the quality of information

gets better, risk management should improve.

In the meantime, home supervisors should

(and do) encourage parent banks to exercise

more conservative lending practices.

Strong cross-border supervisory cooperation

is needed to assess the vulnerability of foreign

ﬁnancial institutions and to minimize disin-

termediation in response to external shocks.

There are established mechanisms for coor-

dination that involve the exchange of infor-

mation and a structured dialogue between

home and host country supervisors. Regional

dialogue between host country regulators in

emerging Europe and home country regulators

from industrial European countries may be

particularly useful in cases where the exposure

of foreign banks to individual host countries

may be very small, but still be signiﬁcant for

host countries.

Box 2.1. Extension of Emerging Market Household Credit by Foreign-Owned Banks

Although the notion of sustainable house-

hold debt is conceptually tractable, a practical

formula is much harder to come by. Household

debt is “sustainable” if two broad tests (related

to the household’s balance sheet and income

position) are met over a relevant medium term:

(1) the borrower has positive net worth and

(2) the borrower can service debt at contractual

terms. Determinants include future income;

savings, interest, and exchange rates; access to

reﬁnancing; and whether loans are used purely

for consumption, durable assets (such as hous-

ing), or productivity-enhancing investments

(e.g., education). Household debt sustainability

assessment suffers from the difﬁculty of esti-

mating future variables, and from two addi-

tional problems. First, if debt is contracted to

increase assets, that is, net worth is maintained,

a wide range of debt levels may be sustainable.

Second, the reﬁnancing ability largely depends

on ﬁnancial market development and efﬁ-

ciency. The usual aggregation problem exists,

namely, the aggregate household debt level may

not fully represent the distribution of sustain-

able debt across households.

These difﬁculties imply that household

debt sustainability may not be amenable to

cross-country comparisons. For policymakers,

it may be useful to look at such comparisons

between “peers,” in addition to the trend in

key variables, and exercise judgment. It may be

that the sustainable household debt in emerg-

ing market (EM) countries might be lower

than in industrial countries, as in the case of

public debt, because of the higher volatility

and uncertainty of income, interest costs, and

exchange rates. Reinhart, Rogoff, and Savas-

tano (2003) show lower debt tolerance for EM

than for mature market (MM) countries, in

particular for previous defaulters. Empirical

work at the macro level has sought to link equi-

librium levels of private (household and cor-

porate) credit to economic fundamentals and

can be empirically estimated by using a matrix

of explanatory variables. However, parameter

instability of the estimated model is the main

constraining factor in using such frameworks

for EMs.

Using macrolevel data to assess household

debt sustainability, however, has limitations

because the aggregation may mask vulnerabili-

ties if the debt accumulation is skewed toward

a particular income group. Indeed, most MM

countries undertake a more detailed analy-

sis of household balance sheets. The central

bank of Sweden, the Riksbank, has been using

microlevel data to supplement the analysis

of the balance sheet of the household sector.

This approach also allows for stress testing of

the household sector’s ability to pay. We draw

on the forthcoming paper by Johansson and

Persson on how the Riksbank uses microlevel

data for analyzing household vulnerabilities. It

uses a detailed annual survey that covers house-

hold income, debt, and wealth. For the analysis,

households are divided into ﬁve categories

based on their level of disposable income. The

distribution of ﬁnancial assets, real assets, and

debt is obtained for each income category.

First, the debt-servicing capabilities and

indebtedness across income categories are mea-

sured by the ratio of interest expenditures to

disposable income and the ratio of debt to dis-

posable income. Second, the Riksbank supple-

ments the basic tools with measures to assess

the vulnerability of households to changes in

income or expenditure.

The Riksbank also conducts stress tests to

assess whether household indebtedness poses a

risk to the ﬁnancial sector. Different scenarios

are used to study the effects of

higher interest rates: this test ﬁrst analyzes the

short-term effects of a change in interest

rates, followed by the long-term effects that

arise if the entire stock of debt is affected by

the rate change, assuming that all the loans

are at the new higher rate; and

increased unemployment: based on Monte Carlo

simulation, the Riksbank assigned an equally

large probability of becoming unemployed

to all gainfully employed persons in order

•

Box 2.2. Using Macro- and Microlevel Data to Analyze Vulnerability of the Household Sector

Note: The main author of this box is Mangal

Goswami.

risk management anD risk transFer

CH A P T E R II HouseHolD creDit growtH in emerging market countries

from several regulation- and infrastructure-

related impediments across EM countries (some

of which are also present in the MM context).

Some of the serious problems include legal limi-

tations regarding true sale treatment of securi-

tization transactions, excessive transfer taxes,

an underdeveloped legal framework, require-

ments of borrowers’ prior consent to structure

securitized deals, lack of clarity in capital

adequacy requirements related to securitization

or pricing thereof, lengthy and cumbersome

approval process, and lack of standardization

(Box 2.4 on p. 67). Although a large number of

EM countries have introduced the basic legal

framework for securitization, the volume of

transactions still lags far behind that in MM

countries (Table 2.6).

A variety of economic factors, incentives, and

infrastructure gaps have also contributed to a

slow take-off of securitization in EM countries.

The current high liquidity and regulatory capi-

tal of the banking system make many EM issu-

ers eager to add and hold on to assets, while the

somewhat unsophisticated investor base prefers

plain bonds. Also, many EM countries have a

generally underdeveloped base of institutional

investors who would otherwise be the primary

investors in asset-backed securities. In addition,

institutional investors in some EMs face certain

regulatory constraints that may discourage

investment in securitized products.

See Gyntelberg and Remolona (2006).

These teething troubles are likely to be

resolved gradually and securitization of

household credit, particularly of mortgages,

is likely to grow. That said, the lack of stan-

dardization embedded in the current stock of

household credit is a more lasting hindrance.

It would be beneﬁcial to promote coopera-

tive efforts by banking associations or other

industry bodies to standardize such credit

in terms of maximum loan-to-value (LTV)

ratios, maximum debt-service-to-income ratios,

documentation requirements, and interest rate

conventions.

Payroll Deductions

In some countries, the collection of house-

hold credits has been linked to payroll deduc-

tions. Payroll deductions may help reduce

technical defaults, inculcate a habit of prompt

debt service, and adjust consumption to

post–debt service disposable income, thereby

enabling lenders to offer more household

credit. For example, credit to households

increased sharply in Brazil after the introduc-

tion of payroll-linked loans in 2004. Moreover,

interest rates charged on these loans are about

half of those charged on regular consumer

loans. The extent to which payroll deduction

can reduce delinquency, however, depends

on the degree of formal employment in the

economy, the use of bank account deposits for

salary payments, the availability of electronic

to derive the new estimates of disposable

income of all households in each category.

In sum, a range of analytical tools that

exploit both macro- and microlevel informa-

tion should be used to assess household sector

vulnerabilities in EM countries. Empirical

estimation of an equilibrium level of private

debt can provide a guide in determining

whether the level of debt is consistent with

economic fundamentals. This assessment can

be supplemented at the macro level by debt

sustainability analysis using aggregated data

for households to assess whether they por-

tend potential vulnerabilities to the ﬁnancial

system. It can be complemented by micro-

level information (where available) on the

distribution of household assets and debt to

assess whether a particular group or subset of

households is vulnerable and poses a risk to

the ﬁnancial system.

Box 2.2 (concluded)

or automated clearinghouse payments, and the

judicial treatment applied to such loans.

Credit Insurance

For mortgages, credit insurance may permit

transfer of risks to specialized institutions. Cer-

tain high risks in mortgages could be covered

through mortgage insurance. For example, in

Poland, such insurance is required for mort-

gage loans when the LTV ratio exceeds 70

percent, for bridge ﬁnancing (before a formal

mortgage is established), and for protecting

against unemployment. Mortgage insurance

provides incentives for borrowers to accept

a modest LTV ratio, and encourages fuller

assessment of the riskier credits by an unrelated

insurer. Such insurance still has considerable

potential for growth, possibly with some par-

ticipation of international ﬁnancial institutions

(IFIs) and government institutions together

with the domestic insurance industry and other

investors, and is a useful evolution for govern-

ment housing ﬁnance programs. However, as

with all forms of insurance, mortgage insur-

ance must be properly priced and monitored to

reduce moral hazard on the part of originating

banks.

Legal and Regulatory Framework

The development of household credit suffers

from several general weaknesses in the legal

and regulatory framework in EM countries.

In some countries, laws and regulations still

require directed credit to household sector,

especially for low-income housing. The laws and

legal systems in many countries often provide

excessive protection to borrowers, resulting

in time-consuming, expensive, or ineffective

enforcement of creditors’ rights, and a weak

credit culture. Pervasive under-reporting of

property values or income may also make it dif-

ﬁcult to adequately assess credit risk.

The prudential regulation of household

credit generally poses fewer problems than

corporate credit. Household borrowers may not

typically provide formal accounts, and their

antecedents may often be more difﬁcult to ver-

ify, especially in countries with underdeveloped

credit bureaus, small taxpayer populations, or

high levels of informal employment. On the one

hand, as a general rule, assessing a household

credit is far simpler than assessing a business

credit, which may require greater knowledge of

business, ﬁnancial analysis, and monitoring. On

the other hand, a large number of household

credits requires greater diffusion across branch

networks, and more laborious effort to process

loans, monitor delinquency, and collect delin-

quent accounts. Thus, it is important that banks

invest in adequate origination systems, risk

monitoring, and staff training.

Household credit requires the same broad

regulatory approach as does institution-speciﬁc

and systemic risk management. This entails

capital adequacy requirements and risk weights

Table 2.6. Gross Annual Issuance of Mortgage-

Related Securitization

(In percent of outstanding stock of housing and

mortgage debt)

2004 2005

Emerging Markets

Malaysia

1.1 2.6

Mexico 0.3 0.5

India 1.9 2.6

Mature Markets

United States

Agency-backed MBS 11.7 10.6

Private label MBS 5.1 10.1

Total 16.8 20.6

Europe

Private label RMBS 1.9 . . .

Of which: United Kingdom 3.6 . . .

Covered mortgage bonds 2.9 . . .

Of which: France (obligation

foncière et communale) 3.3 2.9

Germany (Pfandbrief) 14.1 15.0

Spain (cédula hipotecaria) 3.2 6.2

Total 4.8 5.7

Sources: Bond Market Association; European Securitisation

Forum; Dealogic Bondware; Thomson Financial Securities Data;

Structured Finance International; central banks of Mexico and

Malaysia; National Housing Board of India; European Mortgage

Association; and IMF staff calculations.

Note: MBS = mortgage-backed securities; RMBS = residential

mortgage-backed securities.

Data include RMBS issued by Cagamas Berhad (Malaysia)

only. No private label RMBS are considered.

legal anD regulatory Framework

CH A P T E R II HouseHolD creDit growtH in emerging market countries

Origins of the Crisis

After the 1997 crisis, Korea’s large indus-

trial groups sharply reduced their demand

for credit. Credit providers looked for new

growth areas. The government was seeking

to mitigate the impact of the information

technology bubble crash in 2001, expand

consumption, and broaden the tax base by

bringing the informal sector into the tax

net by replacing cash with credit card transac

tions. The authorities encouraged the creation

of a consumer-lending industry, with little

regulation and a somewhat unusual product

design. The credit card industry expanded

massively from 1999 to 2002. In this short

period, the number of cards issued by credit

card companies more than doubled to over

100 million, an average of three cards for

every adult. Annual card usage, including over

drafts and loans, increased sixfold to 114 per

cent of GDP.

Credit cards were provided with undemand-

ing requirements from borrowers; with little

regulation of the maximum limit with respect

to income; and with gifts, other incentives,

and ofﬁcial lotteries offered with credit card

purchases. The structure of the loans extended

on the cards was a problem. In Korea, credit

cards represented not a revolving loan, but

a credit repayable in full at the end of one

month. Moreover, borrowers who could not

repay (and should not have been issued a card)

found it rather easy, given the lack of good

information on borrower payments histories

and lax screening, to transfer balances between

different cards until limits were eventually hit.

This resulted in a large number of individuals

delinquent on multiple credit cards. Financial

supervisors, lacking experience with credit

card companies, also underestimated the risks,

especially as the companies appeared well

capitalized.

Already in 2002, delinquency rates had

begun to rise, as credit bureaus began accu-

mulating information about the debts of

clients to multiple credit card companies. In

response, the authorities tightened prudential

regulations and the companies began cutting

credit lines and selling impaired assets. The

industry’s problems were aggravated in March

2003, when the SK Global scandal triggered

a run on corporate bonds and a collapse of

the market for credit card company bonds. By

November 2003, total impaired assets, includ

ing rescheduled loans, reached 37 percent

(see the table), and 2.3 million card borrowers

were delinquent, representing 6 percent of the

population aged 15 or more—out of a total of

3.7 million persons delinquent on household

loans (10 percent of the adult population).

In December, the largest company, LG Card,

lost access to the capital market, creating a

liquidity crisis; the government-owned Korean

Development Bank rescued the company,

averting the threat of bankruptcy, which could

have cascaded through the entire credit card

company sector.

Resolution

The aftermath of the crisis implied severe

capital shortages for the entire credit card

industry. The resolution of the capital shortage

was made through (1) converting existing debt

to equity, in the case of LG Card; (2) capital

injection by afﬁliated industrial groups; and

(3) merging into parent banks. The authorities

further strengthened prudential regulations on

card issuance and cash advances, introduced

prompt corrective action clauses (to maintain

and improve capital adequacy ratios), and con-

cluded management improvement agreements

with remaining institutions.

As a result, the average impaired assets of six

existing credit card companies declined to 10.1

percent at end-2005, largely because of write-

offs; their capital adequacy ratio increased

from –3.3 to 19.0 percent between 2004 and

end-2005; and all six credit card companies

posted proﬁts in the ﬁrst quarter of 2006.

Box 2.3. Korean Credit Card Crisis and Its Resolution

Note: The main authors of this box are Edward

Frydl and Jack Ree.

The extent of the mismanagement of the

Korean credit card debacle is illustrated by

the fact that 6 percent of the adult population

became delinquent on their debts. Delinquen-

cies were concentrated among the young

borrowers. Half of the delinquents were under

40 years and almost 20 percent were under 30.

Many of these debtors were effectively insolvent

and incapable of servicing even rescheduled

debt. Resolution of delinquent debt is an ongo-

ing process and involves the following main

elements.

Credit Counseling and Recovery Service. CCRS,

a consortium of ﬁnancial companies, runs

the largest workout program. It serves those

with debts to more than two institutions of

not more than 500 million won (around

$500,000). Debt reduction of up to one-

third of total debt and waiver of past due

interest are obtainable when rescheduling is

agreed. By the end of May 2006, the CCRS

had provided restructuring to some 556,060

debtors.

Hanmaeum ﬁnance (the “bad bank”). In May

2004, the government-run Korean Asset

Management Corporation established

Hanmaeum to restructure small individual

debts (less than 50 million won or $50,000)

from creditor institutions. Qualifying

participants (about 211,000) have up to

eight years to repay written-off loan princi-

pals and can be instantly delisted as credit

delinquents.

Personal debtor recovery system. Effective

September 2004, rehabilitation procedures,

more ﬂexible than personal bankruptcy

•

procedures, were established. To qualify,

debtors must meet the insolvency criteria and

a least-cost principle requiring the value of

restructured debt to exceed its liquidation

value. Restructured debt is valued using a

court-supervised measurement of ability to

pay and participants have to surrender their

entire residual income to creditors for up to

ﬁve years.

These measures have contributed to a slow

decline in the number of total delinquent bor-

rowers to below three million. The fear that

the debt overhang would depress consumption

resulting in a deep recession did not materi-

alize, although credit card debts among the

poorest groups, which do not have regular

employment, remained unresolved. The bailout

of LG Card and small credit delinquents were

made under government initiatives. The moral

hazard implications of these programs remain

to be seen.

Lessons

The Korean credit card crisis demonstrates

some key lessons. Financial innovations should

be carefully introduced to promote efﬁcient

intermediation rather than achieve macroeco-

nomic policy objectives, and with adequate

regard to credit assessment and prudential

regulation. Credit cards could have been

introduced with better safeguards, and mea-

sures should have been taken to promote an

adequate infrastructure to assess creditworthi-

ness. An overly generous bailout of defaulting

borrowers can damage the establishment of a

responsible credit culture.

Impaired Credit Card Assets

(In percent of total assets)

2002 2003

________ ____________________________________________________

December March June September December

I. Overdue receivables 6.0 9.4 9.4 11.2 14.3

II. Rescheduled loans 5.2 8.0 13.2 20.7 22.3

III. Total distressed loans (I + II) 11.2 17.4 22.6 31.9 36.6

Sources: Korean authorities; and IMF staff estimates.

Credit card companies excluding Kookmin Card.

legal anD regulatory Framework

CH A P T E R II HouseHolD creDit growtH in emerging market countries

Table 2.7. Regulation of Household Credit in Selected Emerging Markets

Measure Examples

Residential Mortgages

Maximum loan-to-value ratio Thailand: 70 percent for property value exceeding 10 million baht;

Korea: Maximum ranges from 40 to 70 percent with tighter limits in “overpriced” areas;

Philippines: 70–80 percent.

Maximum debt-service-to-disposable- Korea: Debt service must be less than 40 percent of the household income for

income ratio high value apartments (with prices exceeding 0.6 billion won) in designated areas.

Minimum lending Brazil: Housing loans (individual mortgages and to construction sector) of minimum

65 percent of savings accounts, of which 80 percent at below-market rates.

Risk weight 50 percent for owner-occupied residential properties under Basel I.

India: Increased from 50 to 75 percent in December 2004;

Malaysia: Increased risk weight on NPLs for housing loans secured by ﬁrst charge

from 50 to 100 percent.

Credit Cards and Personal Loans

Maximum credit-to-income ratio Philippines: No loans without an income tax return (limits the potential applicants to

and eligibility rules 6 out of 55 million);

Thailand: Credit cards can only be issued to applicants with monthly income of at least

15,000 baht ($350), maximum loan ﬁve times the monthly income.

Minimum monthly repayment Emerging Europe:10 percent of outstanding balance;

Turkey: 20 percent of outstanding balance.

Maximum interest rate Malaysia: Interest rates on credit cards are capped at 18 percent;

Poland: Four times the Lombard rate;

Thailand: Interest rate on personal loans is capped at 28 percent and interest charges

and other fees on credit cards at 18 percent.

Risk weight Usually 100 percent. India: Raised to 125 percent in December 2004.

Auto Loans

Eligibility criteria India: Minimum gross annual salary of Rs. 100,000.

Qualitative and Other Measures

Loans in foreign currency Brazil: Prohibition on household credits in foreign currencies, but foreign-currency-

indexed loans allowed;

Chile: Approval by the regulator of internal policies to manage foreign exchange loans

required prior to commencing such business;

Croatia and Romania: Higher liquidity requirements for foreign currency loans;

Poland: 20 percent higher reserves for foreign currency loans as opposed to domestic

currency loans;

Singapore: Higher capital requirement of 10 percent for foreign exchange credits.

Stress testing Czech Republic, Hungary, and Poland: Regular stress tests to check robustness to

large exchange rate depreciations;

Thailand: Stress tests with respect to large fall in property prices.

Special reporting and analyses Korea: Special diagnostic report on mortgage lending practices and compliance with

tighter regulation;

Thailand: Quarterly reports on approvals of real estate loans of over 100 million baht.

Inspection and supervision Hungary: Increased risk management requirements for foreign currency lending,

enhanced supervision (more frequent off-site and on-site inspections) of banks with

dynamic foreign currency lending or banks in a weak ﬁnancial position.

Restrictions on aggressive marketing Thailand: Regulations on speciﬁc marketing strategies, hours during which prospects

may be approached, incentive gifts;

Korea: Street soliciting and signing gifts banned.

Moral suasion, education Croatia, Hungary, and Poland: Media campaigns to educate borrowers on risks of

foreign currency borrowing;

Malaysia: Credit Counseling and Debt Management Agency.

Sources: Country authorities; and IMF staff.

Household credit can be reﬁnanced in the

capital markets through either covered mort-

gage bonds or asset-backed securitization. The

former are simply bonds of the issuer (e.g., a

bank) but collateralized with a pool of mortgage

or other credits. Thus the issuer retains the risks

of the underlying loan, while bond investors

are exposed to the risk of the issuer. Under a

mortgage-backed securities (MBS) or an asset-

backed securities (ABS) transaction, the issuer

transfers mortgages (or other receivables) to a

special purpose vehicle (SPV) or a trust, which

then issues MBS or ABS to investors. An SPV is

structured to ensure “bankruptcy-remoteness,”

so that investors have a legal claim only on prin-

cipal and interest payments from the underlying

credits, and other creditors of the originator

cannot access such payments in case of origina-

tor bankruptcy. Typically, MBS transactions are

“tranched” in a subordinated structure, with

different tranches having different tenors, pri-

orities in debt servicing, claims on speciﬁc debt

service ﬂows, and thus ratings. Unlike mortgage

bonds, ABS permit issuers to shrink their bal-

ance sheets, reduce their capital requirements,

and divest the risks of the underlying credits to

capital markets, which can materially contribute

to systemic stability.

Given this potential for efﬁcient risk trans-

fer, most EMs have taken measures to develop

an adequate infrastructure for securitization.

This includes a complete law on securitization

and SPV and trust structures, elimination of

multiple transaction taxes on transfer of assets,

promotion of rating agencies, good practice

origination and standardization, and full

articulation of regulatory and tax treatment.

Nonetheless, a review of these initial attempts

reveals several important problems.

True Sale Treatment

In several countries, the current legal frame-

works do not achieve a full true sale treatment

for legal, regulatory, and accounting purposes.

Note: The main authors of this box are Andy Jobst,

Bozena Radzewicz-Bak, and Hemant Shah.

Complexities of bankruptcy and contracting laws

may allow creditors of the originators, under

certain circumstances (e.g., in case of fraud in

Colombia), to challenge, nullify, or override the

asset transfer, or permit an SPV to transfer the

assets back to the originator (e.g., in the Philip-

pines), thus threatening the debt service to ABS

investors. These weaknesses or uncertainties may

prevent securitization or make it risky.

Requirements to Notify Borrowers

Several countries (e.g., Indonesia, Thailand,

and Taiwan Province of China) have actual (or

legally unclear but potential) requirements for

notifying borrowers whose loans may be secu-

ritized and thus transferred to an SPV. These

requirements add to the costs and uncertain-

ties of the collection of securitized credits and

need to be judiciously removed while protect-

ing borrowers’ reasonable interests.

Excessive Transfer Taxes

In many countries, the underlying laws relat-

ing to taxation of transfer of assets generally

precede the advent of securitization. Thus,

without speciﬁc exemptions, they result in

multiple taxation of the same ﬁnancial inter-

mediation, making securitization unviable. For

example, in India, stamp duty varies between

0.1 percent and 8 percent depending on the

state and asset, which causes some geographical

concentration in SPVs and ABS. In Hong Kong

SAR, stamp duty is payable on transfers of land

and mortgages at up to 3.75 percent, but regula-

tions allow MBS structures to avoid such taxes.

Many countries (Malaysia, Poland, Russia, the

Slovak Republic, Taiwan Province of China, and

Ukraine) have exempted securitization transac-

tions from stamp duties. However, in Russia and

the Slovak Republic, tax implications depend

on the type of receivables and whether the

transaction is domestic or cross border.

Lack of Standardization

Standardization of underlying credits is

essential to minimize the cost of understand-

ing and assessing risks of ABS, but is frequently

Box 2.4. Securitization of Household Credit: Approaches and Problems

legal anD regulatory Framework

CH A P T E R II HouseHolD creDit growtH in emerging market countries

for normal and impaired loans, standards for

classiﬁcation and provisioning, and adequate

supervision. Several EM countries have sup-

plemented these measures with a variety of

approaches to limit imprudent household credit

extension (see Table 2.7). These include setting

interest rate caps, standards restricting loan

amounts and eligibility (e.g., debt-service-to-

income ratio, maximum lending limits, maxi-

mum LTV ratio, and maximum debt service

ratios), dynamic provisioning, documentation

requirements, guarantee requirements, prohibi-

tion of special promotion, and higher capital

adequacy requirements or risk-weights for

foreign exchange or nonperforming loans (see

Hilbers and others, 2005). Qualitative measures

may include setting limits on aggressive market-

ing practices, gaining prior approval of banks’

household credit risk management systems, and

establishing programs for consumer education

and protection.

There are no easily identiﬁable global “best

practice” parameters with respect to prudential

regulation of household credit. Nonetheless,

most regulators regard maximum LTV ratios

around 70–80 percent in property markets that

are not overheated, maximum debt-service-

to-income ratios of around 35–40 percent for

all household credit, a minimum repayment

rate of 10 percent of outstanding balance

for credit cards, and a maximum credit card

limit equal to three to four months’ income as

sensible benchmarks around which to design

country-speciﬁc rules. Regulators in EM coun

tries should also be vigilant about ﬁnancial

innovations such as interest-only or negative

amortization (where payment does not fully

cover interest) mortgages, which are obviously

lacking across most EMs. For instance, loan-to-

value ratios, and origination and documenta-

tion standards differ considerably, and such

variations are indeed used as marketing tactics.

In many EMs, there is no common interest rate

benchmark, with mortgages and credit cards

linked to a bank’s own lending rate or deposit

rate. These variations make it difﬁcult or

expensive to pool credits from different issuers

and price ABS.

Underdeveloped Legal Framework

In some EMs, such as Thailand and Tur-

key, the legal framework does not allow for

the securitization of future receivables and

does not fully ensure bankruptcy remote-

ness (i.e., the SPV and its assets are not fully

protected from attachment by the creditors of

the originator in the event of insolvency of the

originator). In some countries, basic trust law is

underdeveloped, requiring SPVs to be corpora-

tions, attracting many of the provisions of the

standard corporate law unsuitable or onerous

to securitization. In Thailand, a trust law is

awaiting parliamentary approval.

Lack of Clarity

As relatively new products, securitized assets

are often insufﬁciently recognized in exist-

ing law. For example, the risk weights for the

MBS and ABS have not yet been ﬁxed in some

EM countries, preventing investment by banks

in such products. In some countries (e.g.,

India), ABS products are inadequately deﬁned

as “security” for stock exchange listing pur-

poses. In most EMs, ABS are also infrequently

traded and hence lack daily quotations. In

the absence of well-developed rules for price

estimation or extrapolation, certain investors

(such as mutual or pension funds) subject to

mark-to-market ﬁnd it difﬁcult to invest in

such securities.

Lengthy Approval Process

In many EMs (e.g., Chile), securitization

issuance entails a somewhat lengthy process. In

some countries, such as Malaysia and Turkey,

the approval of both the bank supervisory

authority and the securities commission is

required when assets originated by ﬁnancial

institutions are securitized.

Box 2.4 (concluded)

more susceptible to speculative borrowings and

higher NPLs.

In some EM countries, margin lending to indi-

viduals for the purchase of stocks and bonds is

becoming an important form of noncorporate

credit. Although margin lending increases

access to securities markets, diversiﬁes the inves-

tor base, and contributes to make markets more

liquid, it may also exacerbate asset price ﬂuctua-

tions. These problems can be easily addressed

with prudent lending limits. Although not in

the same class of household credits as discussed

here, margin lending can be easily diverted to

personal consumption or housing and can have

similar effects as excessive household credit

growth.

Conversations with many EM banks suggest

that, under competitive pressures, lenders may

engage in practices that may prove to be impru-

dent in the long run. Thus, there may be much

to gain through a collaborative dialogue with

bankers’ associations and consumer advocacy

groups to promote the adoption of good prac-

tice origination standards, adequate sharing

of credit information, standard disclosure of

household credit terms, and avoidance of prolif-

eration of terms.

Foreign lenders can signiﬁcantly enhance

the efﬁciency of the EM domestic banking

industry through competition, technology

transfer, and new products; but they can also

present special regulatory and supervisory

challenges. As with any domestic institution,

EM regulators should take steps to adequately

regulate and supervise foreign bank afﬁliates,

especially because such afﬁliates may be of

marginal importance to the parent bank and

its supervisor, but of systemic importance to

the host country.

Several MM and EM ﬁnancial crises have

underscored the interactions between the ﬁnan-

cial sector and the macroeconomic conditions,

and regulators are paying increasing atten-

tion to such links. However, they also remain

handicapped by the lack of a robust conceptual

framework that links household credit and

macroprudential variables or ﬁnancial regula-

tion and monetary policy.

Nonetheless, central

banks of several EM countries have started to

incorporate ﬁnancial stability analysis in their

regular tool kits and publish ﬁnancial stabil-

ity reports that contain assessment of the risks

from a macroprudential perspective.

Conclusions and Policy Implications

The healthy development of household credit

is likely to generate important beneﬁts for bor-

rowers, lenders, the ﬁnancial system, and the

economy. It can also alleviate some of the cur-

rent global imbalances. The resulting welfare

gains could be substantial. Therefore, there is

a need to encourage the sound development of

this still-nascent market in EM and developing

countries.

In most EM—compared with MM—coun-

tries, retail credit expansion from relatively low

levels is desirable and does not seem to pose a

direct threat to ﬁnancial stability. Nonetheless,

minimizing risks that are frequently associ-

ated with high credit growth requires action

on four related fronts. In addition to ensuring

a sound macroeconomic policy environment,

authorities need to implement appropriate

prudential regulation, create or facilitate legal

and institutional infrastructure conducive to

sound household credit markets, and improve

their capacity to assess vulnerabilities and take

preventive action.

First, macroeconomic stability and the

resulting reduction in uncertainties related to

inﬂation, interest rates, and exchange rates are

indispensable for the healthy development of

all credit markets, including household credit.

In addition, rapid credit growth can compound

the problems of excessive consumption, cur-

rent account imbalances, and property boom-

bust cycles. If credit is predominantly ﬁnanced

by external capital ﬂows, it can heighten the

vulnerability to sudden stops and ﬁnancial

crises. These macroeconomic risks cannot be

minimized by measures to reduce credit growth

See Caruana (2005).

conclusions anD Policy imPlications

CH A P T E R II HouseHolD creDit growtH in emerging market countries

alone, and require appropriate ﬁscal and mon-

etary policies.

Prudential regulation is the second critical

element to ensure healthy growth of household

credit, for which EM regulators are generally

well equipped. The regulation of household

credit does not entail a fundamentally different

approach from that for other credits, and the

standard prudential apparatus—risk-weighting,

capital adequacy, classiﬁcation, and provision-

ing—should sufﬁce. Household credit is also

somewhat easier to evaluate and classify than

corporate credit. When household credit is

growing rapidly, consideration may also be

given to ex ante provisioning, recognizing the

procyclical nature of household credit. In addi-

tion, unlike corporate credit, household credit

is more amenable to speciﬁc guidelines to

ensure conservative origination standards such

as LTV ratios, debt-service-to-income ratios,

interest rate caps (e.g., for credit cards), docu-

mentation, and guarantee requirements. As a

general rule, regulators should refrain from

direct intervention in product design; it may be

appropriate to limit the riskier forms of credit,

such as negative amortization mortgages,

through more stringent capital and provision-

ing requirements. In addition, the large num-

ber of household credits may require regulators

to become better equipped to assess the banks’

overall retail business models, origination prac-

tices at branches, and quality and robustness of

credit scoring and other models used.

In countries where household credit is mate-

rially dependent on cross-border capital inﬂows,

such as in emerging Europe, prudent macro-

economic policies are of critical importance to

prevent boom-bust cycles. In addition, regula-

tors should improve their dialogue and coordi-

nation with home country regulators of large

foreign banks and other regional recipients of

such ﬂows to guard adequately against possi-

bilities of sudden capital ﬂow reversals. Direct

controls on lending are often circumvented

and distortionary, and should be considered

only on an exceptional basis in the face of large

systemic risks.

Third, authorities must take several steps

to improve the overall legal environment and

infrastructure conducive to the healthy growth

of household credit and risk management. As

discussed in this chapter, these include the

need to adopt enabling reforms in the regula-

tory and legal frameworks for (1) securitiza-

tion; (2) effective enforcement of collateral;

(3) provision and sharing of credit information;

(4) promotion of rating agencies and credit

bureaus; and (5) transparency in lending,

consumer protection, and consumer education.

The authorities must also be able to exercise

effective moral suasion and facilitate coopera-

tive efforts, for example, through dialogue with

industry associations on development of good

product standards, fair marketing practices,

and information sharing.

Fourth, a key building block to effectively

monitor and manage potential vulnerabili-

ties is improving data availability. In most EM

countries, there is a need to increase efforts

to monitor and assess the buildup of credit,

interest rate, rollover, and exchange rate risks

within the household credit portfolios at both

the aggregate and the individual levels. These

risks are closely linked to global and domestic

macroeconomic developments, property price

movements, and other variables. Thus, risk

measurement based solely on bank reporting

would need to be complemented with improved

measuring and monitoring of household debt

and net worth, asset prices, and stress test-

ing of speciﬁc shocks. In many EMs, this may

require a signiﬁcant upgrading of the analytical

skills that would support regulatory policy and

supervision.

Fifth, the authorities should recognize

the possible constraints on using traditional

policy measures (e.g., higher interest rates

and exchange rate depreciation) in the case

of systemic distress affecting a large number

of households. The political implications of a

massive household bankruptcy may be quite

different from that of large-scale corporate

distress. Accordingly, and depending on

country-speciﬁc circumstances, a high level of

reFerences

distressed household credit may require some

rethinking of conventional crisis management

tools (e.g., how to deal with large numbers of

delinquent debtors and how to realize col-

lateral). Countries in which households carry

large interest rate and exchange rate exposures

should maintain adequate reserves at the level

of both the authorities and the commercial

banks, and formulate adequate contingency

plans in the event of a large interest and/or

exchange rate movement.

To summarize, recent growth of household

credits in most EMs is a broadly welcome phe-

nomenon that needs to be encouraged and ren-

dered sustainable by appropriate policy actions

that would prevent excessive vulnerabilities.

Annex: Description of Data

This annex provides a summary of the data

used in the chapter. The data were obtained

from country authorities and public sources.

Due to limited data availability, the sample size

varies by year and variable; more complete data

exist for 2003–05 than for earlier periods.

Household credit data, mainly provided by

banks, were collected from 23 EMs and 10 MMs.

The EM country coverage was as follows:

Africa: South Africa.

Emerging Asia: China, India, Indonesia,

Korea, Malaysia, Philippines, Taiwan Province

of China, and Thailand.

Emerging Europe: Bulgaria, Czech Republic,

Hungary, Poland, Romania, Russia, and

Turkey.

Latin America: Argentina, Brazil, Chile,

Colombia, Mexico, Peru, and Venezuela.

The MM countries included Australia,

France, Germany, Ireland, Italy, Japan, New

Zealand, Spain, the United Kingdom, and the

United States.

Detailed data on the debt structure, such as

the types of household credit (and its composi-

tion by maturity, currency, and interest rate

structure), the sources (providers) of household

credit, securitization of household debt, and the

composition and liquidity of household assets

•

and delinquencies, were requested from country

authorities.

Complete data were not available for all coun-

tries; a summary of data obtained is provided

below. Data were collected on

the structure of household debt (credit product,

maturity, currency denomination, and inter-

est rate) for 21 EMs and 7 MMs;

the providers of household credit (by type of

lender) for seven EMs and six MMs;

the securitization of household debt for three

EMs and ﬁve MMs; and

the household assets and delinquencies for eight

EMs and seven MMs.

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