The Interdependence of Housing Market and Banking Sector in Croatia

Abstract

The two-way causality between housing market and banking sector has been widely documented in housing economics literature. On the one hand, the volume of housing loans, interest rates and other terms of lending are often highlighted as significant determinants of demand for housing and therefore housing prices. On the other hand, variations in housing prices change the value of assets in banks’ balance sheets. This might influence their loan potential. The aim of the paper is to investigate the mentioned bidirectional relationship in the case of Croatia. The interdependence between housing market and banking sector is examined within Vector Autoregressive (VAR) model. Housing market is represented by housing prices and construction variables and banking sector by volume of housing loans and corresponding interest rates. The empirical analysis shows that the causal relationship in Croatia mainly goes from the banking sector to housing market. On the other hand, there is a weak evidence of reverse causality which largely depends on chosen housing price index. These results suggest that housing market in Croatia does not follow typical patterns implied by widely accepted theoretical models.