The role of demand and supply in cyclical fluctuations of household debt in Croatia

1. The role of demand and supply in cyclical fluctuations ofhousehold debt in Croatia Ivana Herceg* *Views expressed in this paper are solely those of the author’s The 17th Dubrovnik Economic Conference, June, 2011

2. Motivation • "credit lies at the heart of the crisis" (Aikman, 2010) • theory of banks pro-cyclical behaviour typically associated with Minsky (1992): "from time to time, capitalist economies exhibit inflations and debt deflations which seem to have the potential to spin out of control. In such processes the economic system's reactions to a movement of the economy amplify the movement-inflation feeds upon inflation and debt deflation feeds upon debt deflation“

3. Motivation • recent evidence shows that fluctuations in the demand for loansrather than supply of loans, may be more important driver of aggregate householdborrowing (Calem et al, 2011) • AIM: to identifywhether recent fluctuations of household borrowing in Croatia were primarily caused by themore restrictive banks' lending policies or changes in household demand for loans

4. Methodology • two segments of lending policies are separately modelled in two steps: • criteria that households should satisfy in order to qualify for the loan (loan accessibility) • the highest loan amounts banks are willing to approve to the eligible households (loan amount availability)

5. Methodology – 1. step • AIM: estimation of the probabilities for existence of loan demand and loan supply for each household in the sample • methodological framework: • full information availability - binary dependant variable model • probability of loan existence intersection of observable demand and supply • non-existence of full information matrix - partial observability model

6. Methodology – 1. step • partial observability model (Poirier, 1980) • only dummy variable of the loan existence is observable • the probability distribution of the loan existence - normally distributed bivariate process representing binary choice of credit demander and supplier bivariate normal distribution correlation between and

7. Methodology – 1. step • partial observability model (Poirier, 1980) • and need to differ in at least one variable (the exclusion restriction)

8. Methodology – 2. step • AIM: estimation of the maximum loan amount that could be approved to the household that satisfies loan approving conditions • methodological framework • stochastic frontier analysis (SFA) • distributional assumptions • doesn’t allow correction for sample selectivity bias • difficult to disentangle the impact of the banks' credit policies changes from the improvement of the households' creditworthiness • quantile regression (QR) • alleviates all mentioned disadvantages imposed by the SFA

9. Methodology - conjunction of two steps • sample selection correction, i.e. probability ofloan existence, is incorporated into credit limit estimation (QR) • Heckman two-step correction procedure • Machado-Mata (MM) decomposition technique • separate the effect of improved households' creditworthiness from theeffect of changed banks' lending policies

10. Data • Household Budget Survey (2008 and 2009) • sample of newly indebted households • in 2009 percentage of newly indebted households decreased • in 2009 average amount of newly granted loans decreased • characteristics of the newly indebted households in both years –similar • change in type of newly granted loans

11. Results-only loan amount availability segment SFA approach QR approach • both the SFA and the QR analysis indicate that the credit limits generally increased between 2008 and 2009, with decreasing rise of credit supply in relation to the loan size

12. Results – only loan accessibility segment Demand Supply • probability for loan existence decreased in 2009 due to combination of both supply, i.e. more rigorous banks' loan approving standards in household selection process, and demand, i.e. impaired households' propensity to borrow

13. Methodology – conjunction of two segments • in 2009 banks have tightened their lending standards and made access to credit more difficult - pro-cyclical behaviour • on average higher maximum loan amounts were made available to creditworthy households - counter-cyclical behaviour • increase in creditworthiness of household that were able to obtain loan - fled to quality

14. Results-available credit limit usage 2008 2009 • in 2009 credit limits were used less compared to 2008 • as a reaction to recession, households changed their consumption patterns that led to reduced reliance on bank lending

15. Conclusions • as a reaction to adverse economic developments banks only partially tightened their lending policies • pro-cyclical behaviour was principally conducted via process of household selection, while at the same time the maximum loan amounts made available to credit-worthy households even increased • relatively smaller exploitation of the available credit limits in 2009 • household demand had the prominent role in cyclical fluctuations of household debt during 2009