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Tuesday, 5 August 2008

Who gets the credit?

A new paper provides some fascinating insights on household and firm lending across countries, especially on the relationship between credit access and GDP :

...this paper is a first attempt to decompose bank credit to the private sector into household and firm credit for a large sample of countries. The data show that household credit is an important part of the lending activities of banks. In fact, in many countries, banks lend more to households than to firms. This observation puts into perspective the large theoretical and empirical literature that has studied the determinants and effects of private credit from the standpoint of firm credit only.

We find that it is bank lending to enterprises, not to households, that drives the positive impact of financial development on economic growth. Further, the insignificant relationship between household lending and growth together with the increasing share of bank lending to households in economically more developed countries go some way towards explaining the nonlinear finance-growth relationship. Specifically, while total bank lending to GDP is not robustly linked to GDP per capita growth in high-income countries, the relationship between enterprise lending to GDP and economic growth is much more precisely estimated across our sample, with even many high-income countries showing a significant relationship.

What country characteristics explain the credit composition? On the demand side, we show that the share of the informal economy, the importance of manufacturing and urbanization play a role, proxying for the market that lenders can rely on for household credit. Furthermore, competition from other financial markets influences the distribution of bank credit, as the share of household credit is larger in countries where capital markets are relatively more important than banks. Interestingly, credit information sharing does not affect the two types of credit in different ways, while contract enforcement seems to be more important for firm than for household lending. While not significant in the cross-sectional analysis, we find that higher levels of banking sector development and lower inflation are associated with a higher share of household in total credit in a smaller panel over time. Neither banking market structure nor regulatory policies show any robust correlation with credit composition. These results suggest that the relative importance of bank lending to households and enterprises across countries is mostly driven by factors not immediately subject to policy decisions, but rather by differences in economic and financial structure. This also puts the previous finding of an insignificant impact of household lending on growth in a different light.

Our findings justify the focus of the existing finance and growth literature on enterprise as opposed to household credit. They add further evidence that financial systems foster economic growth by alleviating firms’ financing constraints. And they can partly explain the lack of a significant finance-growth link in high-income countries.

This exploration of enterprise versus household credit across countries is an initial assessment of the factors that drive credit composition and its effects. More research is needed. First, expanding the existing data towards panel data sets with a longer time-series dimension will allow more rigorous testing of both determinants and effects of credit composition. Second, relating credit composition to other financial and real sector outcomes, such as banking fragility and income and consumption volatility, seems a promising and important direction for future research.

I read these results with mixed feelings. In some respect it is good news to know that bank lending to business is significantly correlated to GDP. In Zambia, and many other African countries, household credit expansion is much more difficult to achieve due to issues about tenure security and so forth. On the other hand it did raise one or two questions. Its quite obvious that in many developing countries, household credit is largely synonymous with business credit - many households are running small businesses to survive. In developed countries this tends not to be the case. So transporting these results to the African context may therefore be meaningless. A more in depth study of this issue at the country level would be good to tease out some of these issues.

That also got me thinking about other areas where household credit may be useful in Zambia - that is investment in education. Household credit can be useful for achievieng education outcomes. Indeed according to the MDGs, we are led to believe education outcomes are strongly linked to GDP growth, etc. Are we really saying these investments in human capital funded by credit may also be negligible? Or is that just a function of their time series data? Perhaps they'll address that in their next piece. Still a fascinating paper though.

5 comments:

  1. Its quite obvious that in many developing countries, household credit is largely synonymous with business credit - many households are running small businesses to survive.

    I remember reading something about micro-credit saying that most of it financed consumption and not investments (and yes, in this case, education was consumption). I'm not sure that the houshold and entreprise credit are really synonymous. And scale propably skews the data towards bigger entreprises.

    That also got me thinking about other areas where household credit may be useful in Zambia - that is investment in education. Household credit can be useful for achievieng education outcomes. Indeed according to the MDGs, we are led to believe education outcomes are strongly linked to GDP growth, etc. Are we really saying these investments in human capital funded by credit may also be negligible?

    This relationship is not that direct.
    What you saying is that because household credit access can finance education, it can raise education outcomes which are corralated to GDP.

    But that's two "can", to work household credit has to finance education and that has to be related to educational outcomes.
    If you have a non-responsive education capacity or if credit is used to pay for a price increase without a quality increase, the increase in outcomes is not obvious. Plus how much of household credit is really used for education ?

    Beyond that, there's better ways to improve educational outcomes.

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  2. "What country characteristics explain the credit composition? On the demand side, we show that the share of the informal economy, the importance of manufacturing and urbanization play a role, proxying for the market that lenders can rely on for household credit."

    Don't forget that getting credit for consumption in Zambia is more widespread than official numbers would suggest. If you know the right people everything can be bought on credit from wigs to education or cars, with no bank involved. In the US and EU such, no matter how small, will be booked on your credit sheet...


    "Household credit can be useful for achievieng education outcomes."

    This wouldn't be wise in a third world context. Imagine a BA has to start his/her career in lsk with thousands of dollars in credit debts. That's asking for more corruption.


    "Beyond that, there's better ways to improve educational outcomes."

    It's a different discussion but... We should ask ourselves why Zambia still has a colonial education system. In Europe, SA, the US we get our BA is 3 to 4 y tops. At UNZA it's 5. Not to mention te burden of getting a MA in Zambia.

    So if a raise in educational outcomes is corralated to GDP, let's start with a reform of our system.

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  3. CF,

    It's a different discussion but... We should ask ourselves why Zambia still has a colonial education system. In Europe, SA, the US we get our BA is 3 to 4 y tops. At UNZA it's 5. Not to mention te burden of getting a MA in Zambia.

    I think the US system is:

    AA - 2 years (Associate Degree)
    BA - 2 years (Bachelor's Degree)
    MA - 2 years
    PhD- 2 years

    Which creates a lot of flexibility, in my opinion.

    Another thing I have noticed about the British system is that they specialize at a very early age. In much of Europe, you have humanities degrees that are a lot more generalist and give the student a broader understanding of many different subjects - which is ideal for anyone entering middle management positions - languages, economics, statistics, etc.

    So if a raise in educational outcomes is corralated to GDP, let's start with a reform of our system.

    I don't think it is necesserily cause and consequence, or if it were, which direction the causality is.

    Remember that Zimbabwe has the highest literacy rate (and forget all of the propaganda against Zimbabwe). :)

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  4. ” If you have a non-responsive education capacity or if credit is used to pay for a price increase without a quality increase, the increase in outcomes is not obvious. Plus how much of household credit is really used for education ?” - Random

    Point taken, but I guess the central question remains unanswered, and that is whether the long horizons of rewards from education investment weakens the “household credit” argument. In terms of how much household credit is really used for education, I think considering the sample included developed countries, I would have thought it was quite a bit.

    ”It's a different discussion but... We should ask ourselves why Zambia still has a colonial education system. In Europe, SA, the US we get our BA is 3 to 4 y tops. At UNZA it's 5. Not to mention te burden of getting a MA in Zambia. So if a raise in educational outcomes is corralated to GDP, let's start with a reform of our system.” - CF

    Its an important issue, and one I gather the Minister for Education is looking into. I have touched on this several times, including here. But also see the posts under the education tag .

    ” Remember that Zimbabwe has the highest literacy rate (and forget all of the propaganda against Zimbabwe). :) - Mrk

    Zimbabwe is a special case :)

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  5. Point taken, but I guess the central question remains unanswered, and that is whether the long horizons of rewards from education investment weakens the “household credit” argument.

    I don't know.
    There's too many issues with linkages, crowding out effects or estimated amounts for it to be a direct refuation.

    ReplyDelete

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