Abstract
This paper investigates the determinants of credit risk from a broad perspective. Particular attention is given to the role of housing affordability and household indebtedness. However, the impact of credit market developments and regulations is also closely examined. Using a large panel of countries it is found that housing affordability and household fragility significantly affect the risk of banks’ loan portfolios. In addition, an analysis of the conditional quantiles of non-performing loan ratios reveals that financial institutions in countries with greater levels of financial liberalization and less regulated markets also experience greater credit risk.
Highlights
Financial markets are fundamental institutions in any developed economy
The questions we address in this article are: Is there a sizable effect of the cost of housing on credit risk? In other words, does a reduction of housing affordability lead to an increase in default rates? the last few decades of economic growth have seen an enormous development in credit markets matched with a sharp increase in housing expenditure and household borrowing (see for example (Rinaldi and Sanchis-Arellano 2006))
The questions we address in this work are: Is there evidence that financial liberalization has affected the performance of banks’ loan portfolios? To what extent has the increase of ratio of credit provided to private sector affected the evolution of non-performing loans (NPL)? Is it the case that the risk appetite of financial institutions changes over the real estate cycle? As a corollary to our investigation we consider the impact of the regulatory system on the risk of banks’ loan portfolios
Summary
Financial markets are fundamental institutions in any developed economy. They play a crucial role in promoting economic growth by facilitating the channeling of saving decisions into productive investment (Gerlach and Peng 2005). A major concern for financial institutions is credit risk, because if not managed properly, it can lead to a banking collapse In this respect, the sub-prime mortgage crisis that started in 2005 in the United States demonstrated the devastating effect that a housing market collapse can have on the real economy. In this paper we distinguish between financial market regulations and the regulatory framework relating to the housing market With respect to the former, a large body of literature asserts that financial institutes are more driven by risk-taking behavior in a less-regulated financial environment (see for example (Favara and Imbs 2015)). With respect to the latter, regulations on property markets may constitute a legal impediment to collateral enforcement, affecting the risk of loan portfolios.
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