Controlling Credit Booms

1
Controlling Credit Booms

• By
• Sony Kapoor
• Policy and Advocacy Advisor
• Tobin Tax Network
• International Finance, Development and
  Environment Consultant
• Jubilee Research and the New Economics Foundation
• November 2003

2
Structure

• Credit Booms and Busts, History
• Procyclicality of the financial system
• Dimensions of Risks
• Measurement of Risks
• Capital and Provisioning
• Lending and Supervision
• Policy Options
• Specific Policy Measures

3
Procyclicality of the Financial System

• Amplification of Macroeconomic Cycle
• Information Asymmetry
• Incentive Problems
• Risk Mis-Specification
• Collateral Problems
• Capital, Provisions Underestimation
• Correlation Underestimation

4
Dimensions of Risk

• Expected Vs Unexpected
• Relative Vs Absolute
• Idiosyncratic Vs Systemic
• Time Dimension of Risk
• Disaster Myopia
• Cognitive Dissonance
• Herding
• Prisoners Dilemma

5
Measurement of Risks

• Point in time, One year focus
• Credit rating, Through the Cycle
• Quant Models, Recent History
• Credit Transition Matrices
• Correlations, Loss given Default
• Macro prudential Indicators

6
Capital and Provisioning

• Cover Unexpected Losses
• Current Horizon is too short
• Capital adequacy for the system
• Market pressures
• Provisioning ex ante not ex post
• Provision for Life Cycle of loans
• Tax and Accounting Problems

7
Lending and Supervision

• Loan to Value Ratios
• Collateral Valuation
• Minimum Discount Factors
• Unscrupulous Practices
• Stricter Supervision and Penalties
• Government Support ?
• Cyclicality of Supervision

8
Policy Options

• Improved Understanding of Risk
• Discretionary Use of Supervision
• Regulatory, Supervisory, Accounting rules
• Monetary Policy ?
• Incentives, Type I and Type II errors
• Moral Hazard

9
Specific Policy Measures

• Risk Reports
• Stress Tests
• Risk Horizon
• Capital
• Provisions
• Loans to Value
• Interest Rates and Monetary Policy
• Stricter Legislation
• Interest Rate Ceilings (Usury)