3. Possible explanations for increasing credit-to-GDP ratios
3.1. Supply side considerations: Financial liberalization, the likely explanation for the 1970s and 1980s
A first important reason for an increase in credit volumes can be found in an improved availability of credit. It is well recognized that quantity rationing is prevalent in credit markets.1
Technical innovation and regulatory changes have an impact on the extent of credit rationing and thus very directly on the volume of allocated credit. The financial liberalization of the 1970s and the 1980s and technical innovation in financial services that resulted are therefore natural and plausible explanations for the spectacular credit development observed internationally in the later part of the last century. Here, a permanent adjustment to a new plateau seems to be a viable explanation. This does not mean that such an adjustment process is innocuous from the perspective of financial stability, nor does it imply that the adjustment process cannot overshoot. Indeed, a higher credit-to-GDP ratio means a higher degree of leverage which, in all cases, is likely to increase the fragility of the financial system
3.2. Demand side developments
Second, structural changes in the demand for credit are also a conceivable driver of an increasing credit-to-GDP ratio. For example, an economy-wide perception of improved growth opportunities justifies a broad increase in borrowing to finance investment projects. One can thus rationalize an increase in the credit-to-GDP ratio in economies in the process of catching up with advanced economies. This is a plausible element of explanation for credit developments in the case of a country such as Japan in the 1960s and 1970s. It is, however, much less plausible in the case of mature countries such as Switzerland in the latter part of the period of observation (Figure 3).
Other structural changes in credit demand are also conceivable. For instance, it can be argued that the financial liberalization of the 1970s and 1980s (together with related sociological developments) has significantly affected the public attitude towards indebtedness making it much more socially acceptable, in particular with regard to consumption financing. Further structural changes on the demand side, such as demographic transitions or an increase in idiosyncratic income risk could lead to an increase of credit demand for consumption smoothing purposes. It is difficult, however, to connect these theoretical considerations with the realities of developed economies in the last decades. In particular the demographic trends observed in advanced countries (also in Switzerland) would imply a structural shift towards less rather than more borrowing.
3.3. The role of the interest rate
Third, the role of the interest rate deserves special attention when thinking about credit developments. The interest rate is of course an endogenous variable when examining the demand and supply for credit. Yet additional insights are possible when considering it separately. For instance, a structural low interest rate level such as typically observed in Switzerland can help explain a relatively high credit-to-GDP ratio in international comparison.
Similarly a prolonged period of exceptionally low rates such as the one we are currently experiencing is a potential explanation for an increase in credit volumes. At a superficial level this relation is obvious. Low interest rates reduce the cost of servicing a given credit which becomes affordable for a broader range of households. Alternatively, borrowers can afford higher credit lines. Moreover, low interest rates translate into higher asset prices and higher notional wealth. The increased collateral values support higher credit lines and decrease the amount of credit rationing. This is, in particular, relevant with
- Stiglitz, J. and Weiss, A. (1981) [↩]