Academic journal article East Asian Economic Review

Study on the Impact of the Private Credit Excess on the Credit Risk under the Massive Capital Inflows *

Academic journal article East Asian Economic Review

Study on the Impact of the Private Credit Excess on the Credit Risk under the Massive Capital Inflows *

Article excerpt

(ProQuest: ... denotes formulae omitted.)


One of the major structural changes in financial systems in recent decades has been the rapid growth in international financial integration (Lane and Milesi-Ferretti, 2007). Moreover, as emphasized by Lane and Milesi-Ferretti (2008), there is a strongly positive relation between the size of domestic financial systems and the scale of cross-border financial positions.

The recent Global Financial Crisis which originated in US credit markets, spread rapidly across borders, and highlighted that the high level of international economic integration and financial interdependence now characterizes the global economy. Two of the key contributory factors in spreading the crisis were the domestic balance sheet problems associated with rapid credit growth, and the excessive external imbalances associated with excessive international capital flows (Lane and McQuade, 2014).

Private credit, that is, Domestic credit to private sector refers to financial resources provided to the private sector by financial corporations, such as through loans, purchases of nonequity securities, and trade credits and other accounts receivable, that establish a claim for repayment.1 The Private Credit-to-GDP ratio could have both a positive and a negative interpretation, since it represents both the level of financial development and the aggregate private sector's indebtness.

Credit growth when it is abnormally rapid (credit booms), has come to the fore of academic and policy debate in the aftermath of the global financial crisis of 2008. Credit growth is often associated with financial deepening and beneficial to long-term economic growth (Levine, 1997). However, on the other hand, it is also closely related to boom-bust cycles and financial crises (Schularick and Taylor, 2012).

The crisis has thus led to a renewed interest in understanding the linkages between credit, international capital flows and the real economy. In particular, the extent of interaction between international capital flows and macro-financial stability is an important topic of debate which is still unsettled (Kose et al. 2009).

Capital flows act as a transmission channel of risks across borders and thus may lead to the build-up of financial sector imbalances. A significant cause of the rapid recuperation in credits in emerging markets is the surge in direct or indirect cross-border capital flows to these economies. The direct channel refers to the credits extended to the domestic private agents by foreign financial institutions. The indirect channel describes an intermediary, usually a bank, rising wholesale funding from abroad and then lending to local customers. Both channels functioned well for emerging markets in the aftermath of the crisis due to the permissive global financial conditions, raising concerns for domestic authorities.

Azis and Shin (2015) describe three recent phases of global liquidity for emerging Asia. The first phase is the period leading up to the 2008/2009 global financial crisis and the immediate aftermath of the September 2008 Lehman Brothers collapse. This phase is marked by an expansion in global banking and the transmission of financial conditions across borders through capital flows-intermediated by the global banking system. The second phase of global liquidity begins roughly in 2010, when several central banks in advanced economies began using quantitative easing (QE) and asset purchase policies. In emerging Asia, the result was the rapid growth of credit markets. Credit expanded through corporate bond markets open to international investors, both in local currencies and in those of advanced economies, particularly the US dollar. The May 2013 so-called taper tantrum-after the US Federal Reserve (US Fed) announced its intention to taper QE-and the financial squall that followed in emerging markets is the third phase of global liquidity. Large capital outflows from emerging Asia were linked to the impending end of easy money

And out of three phases, in phase two, the massive amount of inflows into emerging markets saw credit grow through corporate bond issuance by nonfinancial borrowers. …

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