Credit at times of stress: Latin American lessons from the global financial crisis

BIS Working Papers No 370
February 2012

The financial systems in emerging market economies (EMEs) during the 2008-09 global financial crisis performed much better than in previous crisis episodes, albeit with significant differences across regions. For example, real credit growth in Asia and Latin America was less affected than in Central and Eastern Europe. This paper identifies the factors at both the country and the bank levels that contributed to the behaviour of real credit growth in Latin America during the global financial crisis. The resilience of real credit during the crisis was highly related to policies, measures and reforms implemented in the pre-crisis period.

In particular, we find that the best explanatory variables were those that gauged the economy's capacity to withstand an external financial shock. Key were balance sheet measures such as the economy's overall currency mismatches and external debt ratios (measuring either total debt or short-term debt). The quality of pre-crisis credit growth mattered as much as its rate of expansion. Credit expansions that preserved healthy balance sheet measures (the "quality" dimension) proved to be more sustainable. Variables signalling the capacity to set countercyclical monetary and fiscal policies during the crisis were also important determinants. Moreover, financial soundness characteristics of Latin American banks, such as capitalisation, liquidity and bank efficiency, also played a role in explaining the dynamics of real credit during the crisis. We also found that foreign banks and banks which had expanded credit growth more before the crisis were also those that cut credit most.

The methodology used in this paper includes the construction of indicators of resilience of real credit growth to adverse external shocks in a large number of emerging markets, not just in Latin America. As additional data become available, these indicators could be part of a set of analytical tools to assess how emerging market economies are preparing themselves to cope with the adverse effects of global financial turbulence on real credit growth.

JEL classification: E65, G2.

Keywords: Latin America, credit growth, currency mismatches, global financial crisis, emerging markets, financial resilience, vulnerability indicators.