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Rapid rise in credit-to-GDP ratio 'a sign of looming crisis'

IMF report

Published 14/09/2011 | 05:00

CREDIT rising significantly faster than economic growth is a good indicator of a coming financial crisis, analysis by the International Monetary Fund (IMF) finds.

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The background work to the upcoming annual report on global financial stability analyses the experience of 36 countries. It finds that when the credit-to-GDP ratio increases by more than five percentage points per year and is accompanied by equity price rises of 15pc or more, there is a 20pc chance of a financial crisis within the next two years.

Although Ireland is not specifically covered in the report, statistics show that the credit/GDP ratio was stable until 2003, but rose by 20 percentage points a year from then until the 2009 crash. The report says that identifying and dealing with a potential financial crisis requires improved understanding of the sources of increased risk build-up.

"Good leading indicators should help decipher good shocks (like productivity gains) from bad shocks (such as asset-price bubbles)," the report said.

"Credit growth, at the heart of build-up in systemic risks, needs to be accompanied by other indicators, such as increases in asset prices and foreign bank liabilities, as well as real exchange-rate appreciations, to tell apart the two types of shocks."

The Irish bubble was accompanied by both rapid asset prices and foreign borrowing by the banks. Irish politicians and economists have criticised the IMF and the OECD for not sounding stronger warnings on the dangers of these trends.

The report also worries that the fears of risk after the global crash may make financial markets more unstable because big institutions will be unwilling to ride out future market downturns and will dump longer-term risky assets.

"Heightened risk awareness, and initiatives like Solvency II for European insurers may potentially dampen the positive impact of one class of 'deep-pocket' investors that are willing to hold illiquid assets through market downturns.

"As private investors are pushed to hold 'safer' assets, there may be a role for sovereign (government) asset managers to take on some of the longer-term risks that private investors now avoid," the report said.

The survey found that both asset managers and pension funds had increased their holdings of bonds and reduced those of equities since the crash. Managers were holding less cash than in 2008 but pension funds had increased theirs, although the total was small at 2.4pc.

Irish Independent

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