Credit Growth: Enhanced Access or Higher Risk by Giovanni Majnoni IADB

1. Credit Growth: Enhanced Access or Higher Risk by Giovanni Majnoni IADB “XXIII Meeting of the Latin American Network of Central Banks and Finance Ministries” Washington, April 20-21, 2006

2. Credit grows faster than in other regions while interest rates have broadly converged Source: IMF WEO, 2006 1

3. Consumption remains strong while current account surplus and capital inflows increase liquidity Source: IMF WEO, 2006 2

4. No surprise that retail credit grows faster: consumer credit growth is generalized … 3

5. … while housing finance growth is not uniform 4

6. The private sector has resorted to self-financing and foreign lending but not to commercial credit 5

7. Consumer lending is still small when compared to East Asia … 6

8. … leaving room for further substantial growth (income inequality may represent a constraint) … 7

9. … but rapid growth in the supply of new products may generate new risks 8

10. A credit card crisis in Korea in 2003 highlighted weaknesses in risk management and governance • Severity: write-offs close to 30% in 2003 and 2004 • Causes: • Lack of adequate credit information (only positive info) on individuals • Imported models of credit scoring that did not screen high risk borrowers • Use for cash advances and not for transactions • High lending rates • The impact on retail credit was mitigated by the conservative LTV ratios in housing finance (between 60% and 70%) that have avoided a spillover. 9

11. Loans of different size require different risk management strategies Credit losses distribution in Chile for loans above and below US 21,000 10

12. Main lesson: credit growth translates into credit risk if risk management and governance is poor • + + + • CRVolume= f(i, risk governance, risk assessment) • + - - • CRRisk = f(i, risk governance, risk assessment) • Policy implication: Increased access to credit and bank solvency share a common reform and policy agenda. 11

13. Bring risk management and governance into the policy agenda • Limited attention to risk governance is a major shortcoming of Basel II: • Quantitative aspects of risk management (measurement of RWA) • Inadequate attention to capital requirements at a consolidated level (consolidation stops at the bank holding group not at the ultimate owners); • Cursory mention to internal risk control. • The new Basel Core Principles and BCBS documents on bank governance address previous issues 12

14. Toward an integrated approach to risk management and governance • From compliance with Basel to country’s specific strategies of risk management and governance. • From FSAP based “assessments” to a “Roadmap to credit risk management and governance” defined along four keydimensions: • Banks credit risk management • Banks credit risk governance • Risk based supervision • Credit information infrastructures (legal and technical) 13

15. Thank You gmajnoni@worldbank.org 14