HOUSEHOLDS LENDING MARKET IN THE ENLARGED EUROPE

ECFin Workshop on “Housing and mortgage markets and the EU economy”, Brussels, 21st November 2005

Debora Revoltella and Fabio Mucci copyright with the author

New Europe Research

2

Stylized facts

Liquidity constraints and the role of credit

Sustainability and risks of retail lending growth

Conclusions

AGENDA

3

A SNAPSHOT OF HOUSEHOLD FINANCIAL BEHAVIOUR WITH SPECIAL FOCUS ON THE LIABILITY SIDE

Year 2004 data

Gross Disposable income per capita, €

Eurozone

15,871(1)

New Europe*

3,178

Household liabilities over GDP 12%

Households financial wealth over GDP 182%(2) 53%

50%

Home ownership 69%70%(5)

Note: (1) As of 2003; excluding Ireland and Luxembourg; (2) Proxy including all eurozone countries with the exception of Luxembourg, Ireland, Greece and Austria; unquoted shares, other equity and other accounts have been excluded from total wealth (3) Eurozone 2001; (*) New Europe includes 8 CEECs new EU members, plus other candidate or EU approaching countries (I.e. Bulgaria, Romania, Croatia and Turkey). Malta, Lithuania, Slovenia and Cyprus are excluded. Source: UCI New Europe Research Network, ECB, OECD, Federal Reserves and US Census Bureau

US

23,617

124%

277%

69%

4

EUROZONE VS NEW EUROPE: SAME PATTERN OF FAST GROWTH OF RETAIL LENDING MARKET, BUT FROM VERY DIFFERENT STARTING POINTS

� Very different market size and level of households indebtedness

� Similar trends in terms of accelerated growth

� Increasing relevance of retail lending over total bank lending (meaning increasing banking focus towards the retail sector)

7%12%

46% 50%

2000 2004 2000 2004

EurozoneNE(10)

Household Indebtedness [as a percentage of GDP]

EurozoneNE(10)

23%

38%43% 45%

2000 2004 2000 2004

Bank credit to individuals [ weight in tot. banking sector]

23%

7%

Household debt growth in nominal terms [CAGR ’00-’04]

EurozoneNE(10)

Source: UCI New Europe Research Network Database, based on National Central Banks and Eurostat

5

1%

4%

4%

5%2%

3%

2000 2004

29%34%

7%

7%

9%

9%

2000 2004

NE(10) Eurozone

RETAIL LENDING DRIVEN BY THE MORTGAGE MARKET, STILL WITH FAST GROWTH IN CONSUMER LENDING

7%

12%

46%50%

Household Indebtedness by type of instruments[as a percentage of GDP]

Mortgage

Consumer loans

Other loans(1)

Note: (1) In the New Europe, the aggregate other loans includes overdraft, revolving credit cards, other loans and financial leasing

Source: UCI New Europe Research Network Database and ECB

� Average annual mortgage growth in NE equal to 43%, vs 8% in Eurozone

� Average annual consumer lending growth equal to 12% in NE, vs 2% in Eurozone

6

MARKET STRUCTURE AND GROWTH BY COUNTRY

*CAGR ’04-’00

AustriaBelgium

Germany

Spain

Finland

France

Greece

Italy

The Netherlands

Portugal

Romania

Latvia

Bulgaria

Hungary

Estonia

CroatiaCzech R.

Slovakia

Poland

Turkey

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

0% 20% 40% 60% 80% 100%

Mortgage over total loans

(Mort

gage g

row

th -

Consum

er

loans g

row

th)*

Note: for Slovakia, loans granted by non-bank financial institutions excluded from total individuals liabilities while for the Czech R. CAGR ’04-’01

Source: UCI New Europe Research Network Database and National Central Banks for Eurozone countries

Prevalence of consumer credit Prevalence of mortgages

Prevale

nce

of consum

er c

redit

Pre

vale

nce

of m

ort

gages

7

Bul

garia

Rom

ania

Cro

atia

Pol

and

Tur

key

Cze

chR

.S

lova

kia

Hun

gary

Est

onia

Latv

iaF

inla

ndIta

lyG

reec

eA

ustr

iaG

erm

any

Irel

and

Spa

inP

ortu

gal

Bel

gium

Fra

nce

Net

herla

nds

0

5

10

15

20

25

30

35

Gap

A CLUSTER ANALYSIS FOCUSED ON CYCLICAL FEATURES OF RETAIL LENDING MARKET PROVIDES FIRST SIGNALS OF CONVERGENCE…

Cluster based on:

� debt over GDP (2004)

� weight of mortgages in total loans (2004)

� real credit growth

� change in fin.wealth

Source: UCI New Europe Research Network

8

…ALTHOUGH A CLEAR GAP REMAINS WHEN TAKING INTO ACCOUNT THE DEGREE OF MARKET DEVELOPMENT IN THE TWO REGIONS

Bul

garia

Rom

ania

Cro

atia

Cze

chR

.H

unga

ryP

olon

dE

ston

iaLa

tvia

Slo

vaki

aG

reec

eT

urke

yA

ustr

iaG

erm

any

Por

tuga

loF

inla

ndS

pain

aIta

lyIr

elan

dB

elgi

umF

ranc

eN

ethe

rland

s

0

10

20

30

40

50

60

70

80

90

100

Gap

Cluster based on:

� real GDP growth

� change in unemployment rate

� per capita GDP

� fin. wealth over GDP

� debt over GDP (2000)

� change in interest rates

� weight of mortgages in total loans

� real credit growth

� change in fin.wealth

Source: UCI New Europe Research Network

9

Stylised facts

Liquidity constraints and the role of credit

Sustainability and risks of retail lending growth

Conclusions

AGENDA

10

HIGHER VOLATILITY OF CONSUMPTION RELATIVE TO INCOME GROWTH PROVIDES FIRST EVIDENCE OF LIQUIDITY CONSTRAINTS, PARTICULARLY IN NE COUNTRIES

Consumption and real GDP volatility and Correlation between consumption and credit

Coeff. of variation of real GDP

Bulgaria 4.76% 3.39% 0.29Czech Rep 2.64% 1.76% 0.06Croatia 1.28% 1.14% 0.24Estonia 3.00% 1.94% -0.15 (0.08 three lags)Hungary 1.85% 0.40% 0.65Latria 1.80% 1.37% 0.2Poland 1.18% 1.59% 0.21Romania 4.83% 2.79% -0.37 (0.51 two lags)Slovakia 1.98% 1.01% -0.14 (0.11 one lag)Turkey 4.76% 3.90% 0.85simple avg NE 2.81% 1.93% -Belgium 0.77% 0.75% 0.05Germany 0.87% 0.76% -0.42Spain 1.00% 0.54% 0.34France 0.67% 0.72% 0.46Greece 0.67% 1.00% -Italy 0.68% 0.71% -0.07Netherlands 1.19% 0.92% -0.01Portugal 1.09% 1.08% 0.08simple avg EU 0.87% 0.81% -

Coeff. of variation of real consumption

Corr(cons, credit)

Note: own estimates based on UCI New Europe Research Database, ECB and Eurostat

11

ECONOMIC ANALYSIS OF CONSUMPTION GROWTH AND HOUSEHOLDS DEBT: A SIMPLE FRAMEWORK

� 3 GROUPS OF HOUSEHOLDS:

� (1-λ1-λ

2) not liquidity constrained - can choose their optimal consumption path, on

the basis of permanent income, having free access to credit markets� (λ

1+λ

2) liquidity constrained, thus consumption is a function of current income

�Among those liquidity constrained, λ2 can access credit markets

Δct= β’’ + (1-λ

1-λ

2) σ E

t-1 r

t-1 + (λ

1 +λ

2) Δy

t+ λ

2 ΔHC

t

� CREDIT EQUATION ΔHCt= a – bi1

t-1+ c (i1 * Δy)

t-1

� CONSUMPTION EQUATION Δct= β’’’+ (λ

1+λ

2) Δy

t+ λ

2 (a-bi1

t-1 + c (i1 * Δy)

t-1)

12

EMPIRICAL ANALYSIS FOR OLD EUROPE PROVIDES EVIDENCE THAT IN ITALY, BELGIUM AND UK ABOUT 50% OF THE CONSUMERS ARE LIQUIDITY CONSTRAINED (DE BONDT 1999)*

� Developed credit market should allow a smoothing of consumption patterns of individuals, in line with the life cycle theory

� Excess sensitivity of consumption to current income is frequently interpreted as evidence of liquidity constraints, that is the inability or unwillingness to use capital markets to smooth consumption

� The evidence provided by De Bondt shows that in most EU countries 80% to 100% of all consumers are liquidity unconstrained with the only exceptions of Italy, United Kingdom and Belgium where about 50% of the consumers are liquidity constrained

� Moreover, the empirical analysis tend to confirm that variations in credit market conditions as reflected by changes in the so-called external finance premium (the wedge between cost of internal and externalfinance connected to informal asymmetries, cost of borrowers monitoring etc) significantly impact private consumption growth in the case of Germany, Italy and the Netherlands

De Bondt (1999), “Credit channels and consumption in Europe: empirical evidence”, BIS wp no. 69

13

LIQUIDITY CONSTRAINTS PLAY A KEY ROLE IN THE NE (CORICELLI, MUCCI AND REVOLTELLA 2005)

� By estimating both consumption and supply equations on quarterly data for a sample of 10 New Europe countries over the period 2000-2004, the analysis reveals that:

� the effect of household credit conditions on individual consumption is highly significant. As expected tightening of credit conditions have larger effects during a slow-down, rather than during an upturn;

� supply effects have been very relevant in explaining the dynamic of consumer credit during the sample period.

� Moreover, the estimation results suggest that the value of the share of liquidity-constrained households (λ

1+λ

2) appears to be large at 53%.

� Among the liquidity constrained individuals, only 5% have access to credit.

� Important to note: the total share of households with access to consumer credit includes as well those households that are not liquidity-constrained.

Coricelli, Mucci and Revoltella (forthcoming), ‘The New Europe household lending market’

14

PROSPECTS: SIMULATION OF DEMAND AND SUPPLY EFFECTS

� Relaxation of supply conditions in the context of liquidity constraints behind accelerated growth of household lending in most NE and some old EU countries

� Interest rates decline potentially partly balanced by upward movements in the demand curve (with enlargement of clients pool)

Credit supply

Credit demand

Int. rate

Credit

15

Stylised facts

Liquidity constraints and the role of credit

Sustainability and risks of retail lending growth

Conclusions

AGENDA

16

RELATIVE LOW INDEBTEDNESS VS THE US. IN THE NE CONCERNS FOR FAST GROWTH …

Household debt as a percentage of GDP (2004)

Source: UCI New Europe Research Network Database, ECB, National Central Banks for Eurozone countries and Eurostat

5% 6%10% 12%12% 13%14%

19%20%24%25%

31% 32%35%

40%40% 40%46%

50%53%

64%

78%

Rom

ania

Tur

key

Slo

vaki

a

NE

(10)

Bul

garia

Pol

and

Cze

chR

ep.

Latv

ia

Hun

gary

Est

onia

Italy

Gre

ece

Cro

atia

Bel

gium

Fra

nce

Aus

tria

Fin

land

Ger

man

y

Eur

ozon

e

Spa

in

Por

tuga

l

Net

herla

nds

124%

US

17

… AND HIGHER VULNERABILITY TO ADVERSE SHOCKS GIVEN THE LOW LEVEL OF WEALTH

Data as of 2004

Note: (*) As of end of 2003.

Source: UCI New Europe Research Network Database, based on National Central Banks and Eurostat

Per capita debt

143

210

300

540

663

740

852

1,217

1,587

1,603

1,939

13,286

Romania

Turkey

Bulgaria

NE(10)

Slovakia

Poland

Latvia

Czech R.

Estonia

Hungary

Croatia

Eurozone

Household Debt over Fin. Wealth

13%

21%

22%

23%

24%

27%

28%

29%

31%

36%

46%

83%

Turkey

Czech R.

Slovakia

NE(10)

Poland

Eurozone

Bulgaria

Latvia

Romania

Hungary

Croatia

Estonia

(*)

18

ACCUMULATION OF “CORRECTED” NET FINANCIAL WEALTH PROVIDES A POSITIVE SIGNAL IN THE NEW EUROPE AND IN SOME EUROZONE COUNTRIES

“Corrected”(2) Net Financial Wealth 2000-2004

Note: (1) Latvia as of 2003; (2) Corrected Net Financial Wealth is calculated as Gross Financial Wealth minus the non-mortgage part of households debt. All divided by GDP. Source: UCI New Europe Research Network Database, Natianal Banks, ECB and Eurostat

0%

50%

100%

150%

200%

250%

300%

350%

Bu

lgar

ia

Cro

atia

Cze

ch R

.

Est

on

ia

Hu

ng

ary

Lat

via(

1)

NE

(10)

Po

lan

d

Ro

man

ia

Slo

vaki

a

Tu

rkey

Eu

rozo

ne

Bel

giu

m

Ger

man

y

Sp

ain

Fra

nce

Italy

Net

her

lan

ds

Po

rtu

gal

Fin

lan

d

20002004

19

NO EXCESSIVE GROWTH IN HOUSING PRICES SO FAR DESPITE THE POSITIVE CORRELATION BETWEEN DEMAND FOR MORTGAGES AND PROPERTY PRICES

HPRICE = 0.36 HLOAN + 3.229

-4

-2

0

2

4

6

8

10

12

14

16

0 10 20 30 40

Mortgage loans

House prices

Mortgage loans

House prices

Mortgage and House Prices Levels in the Eurozone

Mortgage and House Prices Levels in the New Europe

Source: UCI New Europe Research Network estimates on Eurozone countries and Mihaljek D. (2005) ‘Rapid expansion of credit in South Eastern Europe: a cause for concern?’, BIS for NE countries

� Housing market exposure represents a source of vulnerability in the context of fast expansion of debt and rising house prices

� Much debate concerns single eurozone countries� In the NE, despite the increasing demand for housing connected to expectations of rising

incomes in the catching-up with EU, better provision of housing credit and current demographic trends we do not see signals of potential real estate bubbles given the still limited supply of new homes

y = 1.19x + 32.3

0

20

40

60

80

100

-10 -5 0 5 10 15 20

Hou

sing

loan

s

20

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

2000

q01

2000

q03

2001

q01

2001

q03

2002

q01

2002

q03

2003

q01

2003

q03

2004

q01

2004

q03

-45%

-20%

5%

30%

55%trade balance/GDP - RXcredit cyclefactor2

Latvia

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2000

q01

2000

q03

2001

q01

2001

q03

2002

q01

2002

q03

2003

q01

2003

q03

2004

q01

2004

q03

-40%

-20%

0%

20%

40%trade balance/GDP - RXcredit cyclefactor2

Turkey

-4.0

-2.0

0.0

2.0

4.0

2000

q01

2000

q03

2001

q01

2001

q03

2002

q01

2002

q03

2003

q01

2003

q03

2004

q01

2004

q03

-20%

0%

20%trade balance/GDP - RXcredit cyclefactor2

Romania

-6,000

-3,000

0

3,000

6,000

2000

q01

2000

q03

2001

q01

2001

q03

2002

q01

2002

q03

2003

q01

2003

q03

2004

q01

2004

q03

-20%

0%

20%

trade balance/GDP - RXcredit cyclefactor2

IN THE NE SOME CONCERNS ON THE MACRO SIDE

Note: the series on real credits to individuals and trade balance have been seasonality adjusted using the census X11 additive method. The trend have been extracted using Hodrick and Prescott (HP) filter with a smoothing parameter of 1600. Factor 2 represents in all graphs the absolute threshold used to identify credit booms episodes (1.75 times std of the cycle). Consumption booms have been identified using the same criteria and are represented in all graphs by grey areas.

Sources: Trade data: IMF- DOTS based on country’s declarations of exports and imports and Eurostat. Credit Data: UniCredit New Europe Research Network database.

-30.0

-20.0

-10.0

0.0

10.0

20.020

00q0

1

2000

q03

2001

q01

2001

q03

2002

q01

2002

q03

2003

q01

2003

q03

2004

q01

2004

q03

-45%

-30%

-15%

0%

15%

30%

trade balance/GDP - RXcredit cyclefactor2

Romania Turkey Latvia

Estonia Croatia

-0.2

0.0

0.2

0.4

2000

q01

2000

q03

2001

q01

2001

q03

2002

q01

2002

q03

2003

q01

2003

q03

2004

q01

2004

q03

-30%

0%

30%

60%

trade balance/GDP - RXcredit cyclefactor2

Bulgaria

21

Stylised facts

Liquidity constraints and the role of credit

Sustainability and risks of retail lending growth

Conclusions

AGENDA

22

CONCLUSIONS

� Similar trends in the retail lending market, although NE starts from a much lower base. Fast growth, driven by the mortgage market, with decrease of liquidity constraints and improvement in supply conditions

� Evidence of liquidity constraints in some old EU and most of NE countries. Relaxation of constraints and increasing access to credit markets explain most of the current accelerated growth of household credit

� No major concerns for sustainability at the enlarged European level, but a number of issues to monitor

� Micro/Macro issues in few NE countries

� Real estate market pressures in the Eurozone