Bank and Non-bank Capital Flows and The Sectorial Reallocation of Credit Away from the Household Sector

Abstract

Does foreign capital flows into non-banks and banks result in the sectorial reallocation of credit extension? First, the negative relationship between capital flows and the share of credit to households is indicative of weak sectoral credit reallocation. Second, evidence shows that there is significant reallocation of credit to households due to foreign direct investment bank and non-bank flow shocks as well as to portfolio bank flow shocks. Third, evidence shows that non-bank flows explain a larger proportion of movements in the share of credit to households other than bank flows. Fourth, the counterfactual and historical contributions show that the contributions from bank and non-bank flows to the share of credit to households is very small. But if the negative effects occur over a prolonged period, they can crowd out domestic credit to households, and this can create a significant change in the banks’ loan portfolios and concentration of risks. From a financial stability and macroprudential regulation perspective, the small magnitudes of the sectoral credit reallocation reinforce evidence that small and localised financial practices can mask severe threats to financial stability.