The Great Banking Divide

Jayati Ghosh

The Great Recession of 2008 has become a marker for many turns of the tide, including the relative position of nations in the global economic hierarchy. Among the many ways in which emerging economic powers (like the BRICS) are supposed to be doing better than developed countries in patterns of bank lending. So while the credit crunch continues for many businesses and households in the US and Europe, banks in the developing world are said to be providing larger and larger amounts of credit to enable investment and economic expansion.

Between December 2008 and 2011, the BRICS countries expanded bank lending to businesses in their domestic economies by 62 per cent, whereas in the G-8 countries such lending fell by 4 per cent. Much of the increase in bank credit to business in the BRICS came from China, and much of the decrease in the developed countries came from troubled European economies.

Despite the tepid recovery, it has been harder and harder to get loans for business in the United States and Europe. This is particularly true for small businesses, which have been starved of credit ever since 2008, because they cannot really access other sources of financing their investments or even their working capital. Some of them have even gone under not because the business is no longer viable, but because they cannot access loans. Obviously, this has a knock-on effect, for when small businesses close, the market shrinks for all the suppliers and service providers who previously sold to them. And this makes it that much harder to generate some growth in the midst of the overall recessionary tendencies.

So is this difference in patterns of bank lending yet another sign of the overall economic decline of the hitherto dominant western powers and the rise of the new kids on the global block? Does it suggest that as the fulcrum of economic power shifts to the South (and East) this is being facilitated and accentuated by patterns in finance as well?

Maybe, but we need to be a little cautious before jumping to any such easy conclusion. The big expansion in bank credit need not be unadulterated good news, especially

Consider what is happening in the most dynamic countries of developing Asia, where the increase in bank lending has been most evident since 2008. It turns out that a large part of the expansion in domestic credit has actually been directed to households, for consumption purposes. And the businesses that have gained from that (such as construction and real estate as well as some consumer durables) are the ones that have been disproportionately getting bank loans for their own productive activity.

In the aftermath of the Great Recession of 2008, many Asian developing countries actually encouraged the growth of consumer credit bubbles as a means to more rapid recovery, accentuating a process that had already been eased by financial liberalisation in the earlier decade. This meant allowing excessive private credit expansion, especially for private retail credit for housing, automobiles and other consumption.

The result has been an explosion in heavily leveraged consumption as well as in residential real estate activity,. And the impact has been most strongly felt in the housing market. So house prices increased rapidly between 2007 and 2011 – by around 70 per cent in China and Hong Kong China, and by 30-50 per cent in Taiwan China and Malaysia. Even economies where wage incomes barely increased, like South Korea, witnessed big increases in house prices.

This created a positive wealth effect, so households went on buying sprees in other ways as well – increasingly financed by debt rather than past savings. There have been even larger increases in household debt than corporate debt in most of Asia – for automobiles, for student debt, for credit cards purchases, for other consumption based on EMIs. And the businesses that catered to this consumption are precisely the ones that availed of bank credit in increasing amounts. (Incidentally, even in this boom, small and micro enterprises have been underserved and deprived of bank credit even in developing Asia.)

All this is part of a well-known cycle – but the trouble is that such credit bubbles burst. We know what happened in the US, in the UK, in Ireland, in Spain and so on, when the music stopped. Ironically, countries in Asia have also been there and done that and lost their shirts before in a very similar process, in the Asian crisis of 1997-98.

And now the signs are that this particular credit-driven boom in Asia is also coming to an end. House prices have stabilised and even started falling in many countries; banks are becoming more wary of lending to households and individuals; companies are already reporting greater difficulties in accessing loans. In South Korea, Malaysia and Thailand, this is already acting as a drag on the economy, because households that find it hard to service their debts are forced to cut down on consumption.

So any euphoria about the banking boom in the South and especially in Asia, may turn out to be short-lived. Bankers in the BRICS have already put on their seat belts but that does not mean they can all avert a crash.

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