WizKey In Depth #1 – The Availability of Domestic Credit to the Private Sector

by Lorenzo Nunzella
Jan. 23, 2020
4 minutes

This article investigates the availability of domestic credit to the private second, focusing on a timeframe ranging from 2001 to 2018. Our findings are interesting, especially for Southern European Countries, such as Italy and Spain.

Graphs available at this link.

During the chosen period, the availability of credit displays a clear trend:Italy,Spain and the UK reveal an expansive trend that lasted until the outbreak of the US subprime crisis at the end of 2006.

It is possible to observe that the UK and Spain reached the peak of credit availability in 2009 (the latter thanks to government-backed investments in the real estate sector that created new credit for the private sector), while Italy in 2012. This is only true if we compare credit availability to GDP, but in absolute terms Italy was already experiencing a credit crunch since GDP diminished by 5% during the period from 2009 to 2012.

Difference of Domestic Credit to Private Sector as % GDP

In the UK, the trend was mainly influenced by a credit crunch from the banking sector, following the mortgage crisis which also involved some local banks and triggered a crisis in the UK banking sector as a whole. To exemplify this, the first bank that risked bankrupt during the financial crisis was Northern Rock, an English bank dealing with mortgages, that was eventually saved by the Bank of England in September 2007.

With regards to Spain, pressures to reduce credit had multiplied since the crisis, starting in 2009 and ending up with the Greek sovereign crisis, which inevitably had an influence on the whole Eurozone and especially on Italy, Portugal, and Spain.

Another important factor contributing to the general reduction of credit to the private sector was a significant increase in the unemployment rate, which went from 11.3% in 2008 to 24.8% in 2012.

In Italy, things were pretty much similar to Spain, although in a less traumatic way: local banks, mostly commercials and characterised by a lower level of innovation were less hit by the subprime crisis, compared to banking systems in other countries.

Nonetheless, the country was among the most affected by the European debt crisis: this had a significant impact on the availability of credit to the private sector as banks, which were highly exposed to the country’s foreign debt, had to reduce their general exposure towards the economy for regulatory reasons.

This had a rather negative impact on the overall economy, resulting in a contraction of GDP in 2008, 2009, 2012 and 2013, which caused banks to have high amounts of impaired loans in their balance sheet. In turn, this led banks to act on two fronts: on the one hand to strengthen their capital and on the other hand to further reduce the concession of credit to the economy.

An interesting trend is that of France and Germany, diametrically opposed to each other. In fact, the percentage of domestic credit to GDP kept growing in France, while, in Germany, the trend shows a continuous decline. If we also take into account the public sector contribution to the indebtedness of these two countries, it would be possible to notice that, even in this case, the ratio of French debt and GDP is growing significantly, while in Germany is declining.

Therefore, it would be fair to expect that the general economic growth of these two countries would be highly different during the time frame considered. However, this is not the case, for the growth of GDP was instead very similar, as it is possible to observe in the table below.

GDP growth by year in France Germany
2008 +0.3% +1%
2009 -2.9% -5.6%
2010 +1.9% +4.1%
2011 +2.2% +3.6%
2012 +0.3% +0.5%

This is actually counterintuitive since one would expect the opposite, given that Germany experienced a higher reduction of credit to the private economy.

The issue here is whether the overall amount of money circulating on the economy as a whole has dropped or not. In reality, even during those years of crisis, Germany has enjoyed large trade surpluses in its balance of payments, thanks to its exports. In percentage terms, the German trade balance grew of 6% in 2008, 4.95% in 2009, 5.2% in 2010, 4.9% in 2011 and 6.1% in 2012. It goes without saying that such a positive trade balance has brought a large amount of resources that has been used to finance the development of the German economy, even during a historical period of reduction of credit compared to GDP.

On the other hand, during the same period, France experienced a significant decline in its trade balance: it declined by 1.15% in 2008, 0.8% in 2009, 1.3% in 2010, 1.95% in 2011 and 1.3% in 2013. This exit of capital from the French economy was compensated both by the country’s banking and public system that as a result accumulated significant budget deficits.

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