Macroprudential Policies in Southeastern Europe

Dilyana Dimova; Piyabha Kongsamut; Jerome Vandenbussche

doi:10.5089/9781498342872.001.A001

Jump to Content Jump to Main Navigation

Macroprudential Policies in Southeastern Europe

Author: Dilyana Dimova, Ms. Piyabha Kongsamut, and Mr. Jerome Vandenbussche

Contributor Notes

Author’s E-Mail Address: ddimova@imf.org; pkongsamut@imf.org; jvandenbussche@imf.org

Publication Date:: 15 Feb 2016

eISBN:: 9781498342872

Language:: English

Keywords:: WP; credit growth; FC lending; liquidity ratio; central bank; FC-indexed loan; lending following; liquidity requirement; mortgage lending; FC LCP measure; credit growth ceiling; tightening FC ELI measure; FC-indexed lending

Download PDF (1.9 MB)

This paper presents a detailed account of the rich set of macroprudential measures taken in four Southeastern European countries—Bulgaria, Croatia, Romania, and Serbia—during their synchronized boom and bust cycles in 2003–12, and assesses their effectiveness. We find that only strong measures helped contain domestic credit growth, the share of foreigncurrency- denominated loans provided by the domestic banking sector, or the domestic banking sector’s reliance on foreign borrowing during the boom years. We also find that circumvention via direct external borrowing often fully offset the effectiveness of these strict measures, and thatmeasures taken during the bust had no discernible impact. We conclude that (i) proper calibration of macroprudential measures is of the essence; (ii) only strong, broad-based macroprudential measures can contain credit booms; (iii) econometric studies of macroprudential policy effectiveness should focus on measures rather than on instruments (i.e. classes of measures) and in so doing allow for possible non-linear and state-contingent effects.

Abstract

I. Introduction

In the wake of the global financial crisis, interest in macroprudential policies (MPPs) and their ability to manage the financial cycle has grown tremendously. Such policies, aimed at reducing the risk and the macroeconomic costs of financial instability, are gaining a much more prominent role in policy frameworks, alongside fiscal and monetary policy. Given the limited experience in their implementation, finding out whether and how they can achieve their objectives is now high on policy-makers’ agenda in most advanced and emerging market countries.

In this paper, we analyze the experiences with MPPs of four neighboring Southeastern European emerging economies, Bulgaria, Croatia, Romania and Serbia, during their recent synchronized financial cycle (2003–2012). The four countries were to a large degree subject to a common external macro-financial environment and going through similar processes of economic convergence and financial deepening—even if Croatia was (and remains) more economically and financially developed than the other three countries. The four economies were at different stages of joining the European Union (EU)—Bulgaria and Romania joined in 2007, Croatia joined in 2013, and Serbia became an accession candidate in 2012. Their banking systems were dominated by subsidiaries of large Western European banks, and were euroized to a large degree (Table 1). They experienced strong capital inflows and credit growth during the boom period running up to the fourth quarter of 2008, and then a sudden stop, followed by a protracted recession. Prudential authorities in each country actively adopted macroprudential measures to try to counteract these trends. At the same time, initial conditions in these banking systems and monetary policy regimes differed, and the set of policy instruments employed often varied. We believe that the combination of many shared elements of context and heterogeneous policy responses makes it interesting to exploit synergies in a joint study of the four countries.

Table 1.

Bulgaria, Croatia, Romania, Serbia: Selected Macro-Financial Indicators, 2002–12

Sources: WEO, IFS, AREAER, Claessens and van Horen (2013), and IMF staff calculations

^{^1/}Data for Serbia is for 2003

^{^2/}Data for Croatia is for June 2012

The boom-bust cycle in Central, Eastern and Southeastern Europe (CESEE) between the early 2000s and the early 2010s has already been well documented (e.g. in Bakker and Klingen, 2012). A detailed summary of macroeconomic developments in the four countries during the period spanning 2003–2012 is provided in Appendix 1. During the boom years, monetary policy was mostly focused on inflation and exchange rate developments and did not explicitly target credit or asset price developments. Fiscal policy was generally pro-cyclical, at best acyclical. That left MPPs in the front line to manage the financial cycle. Macroprudential policy was implemented outside of a dedicated formal macroprudential policy framework. Rather, the monetary and prudential authorities—both part of the central bank in the four countries—interpreted their mandate to include macro-financial stability objectives. The choice of instruments varied over time as conditions changed. Seen in a broader European context, the four countries were pioneers in the use of MPPs.¹

We follow a case study methodology, and aim to provide a useful complement to the burgeoning econometric literature on macroprudential policy effectiveness. Indeed the bulk of the econometric literature does not capture well either the diversity in design of MPP measures or the strength of the measures taken. This latter flaw often leads papers to talk in terms of instruments (i.e. policy measures removed from their calibration and implementation context) and to make categorical conclusions about instrument effectiveness (i.e. an instrument is, or is not, effective) whereas we suspect that an instrument’s effectiveness crucially depends on its proper calibration. We therefore find it more useful to discuss measure effectiveness rather than instrument effectiveness. Furthermore the effect of MPPs can in principle be highly non-linear, but the econometric studies of which we are aware are all based on linear specifications and rarely attempt to capture the strength of MPP measures (they often simply use an indicator variable for tightening or easing). A case study methodology is flexible enough to address all these limitations and also allows for providing a richer context about policy motivation and implementation. Before addressing the question of measure effectiveness, we thus provide a rich discussion of the more than twenty instruments used and the more than a hundred measures implemented by the four countries, as well as their sequencing, in a cross-country comparative perspective. Furthermore, rather than analyzing indiscriminately the effect of all macroprudential measures taken on the same variable (be it credit growth, housing price inflation, or banking sector leverage), we match each type of instrument with a subset of five possible intermediate macro-financial objectives and analyze only the effect of a measure on those objectives with which it is matched. For the most part, the matching comes from publicly stated objectives when the measures were taken. In cases where the objectives may not have been spelled out as explicitly macroprudential, we still assess those measures using the macroprudential lens². This approach also helps us to distinguish the effect of measures that were taken concurrently, by taking into account their design features and relative strength.

This being said, assessing the effectiveness of MPPs is a challenging task fraught with many pitfalls. Policy measures are most likely endogenous to macro-financial developments and we do not observe policy-makers’ information set and/or expectations. More broadly, we cannot observe what would have happened had no measures been taken. In particular, it may be the case that the implementation of a policy measure prevents an increase in a financial stability risk metric (e.g. faster credit growth) and that as a consequence we observe no change in that metric and may conclude incorrectly that the measure was not effective. In addition, measures may have been anticipated to various extents, may work with different lags, may not be immediately binding, and may interact with each other. We note that these challenges have to be faced by econometric studies as well.

Against that background, we modestly aim to identify which measures are associated with a sign of effectiveness, i.e. that the intermediate macro-financial objective variable visibly moved in the intended direction within a window of four quarters around the implementation of the measure, taking into account the implementation of other relevant measures implemented concurrently within that same time window. Because we assess one measure at a time—rather than lump all measures of the same type together—we are easily able to discriminate across directions of policy change (tightening versus easing), conditions of implementation (e.g. boom versus bust), and strength (in levels and in changes). We acknowledge, however, that because several measures may have been taken in the same quarter or taken in consecutive quarters our inference remains tentative.

One aspect we only barely address in this paper is the choice of prudential instrument (see the Staff Supplement of IMF (2014) for a discussion of instrument choice). Rather, we take instrument choice as given and simply examine whether the implementation of a measure through the chosen prudential instrument had an effect on the intended intermediate objective. Somewhat relatedly, we do not examine how the exchange rate or monetary regime may or may not have conditioned the macroprudential response (see IMF [2013] for a discussion of the interactions between monetary and macroprudential policies).

Another important aspect we do not address is whether the MPP measures helped build sufficient capital and liquidity buffers to preserve financial stability during the bust. The banking systems of the four countries remained broadly stable during the severe recession and only a few small domestically-owned banks failed during the bust period we examine (2008:Q4–2012:Q4).³ However, this robustness was likely partially due to the fact that many foreign-owned parent groups received capital and funding support from their own government⁴ and that this support was in part needed because of the deterioration in the outlook of these groups’ operations in Central and Eastern Europe. Furthermore, in the case of Romania and Serbia, macroeconomic stabilization programs with external official financing were rapidly put in place, and helped shore up confidence.

Keeping all the caveats listed above in mind, our main general findings on measure effectiveness are that only strong measures helped contain the domestic credit growth, the share of foreign-currency-denominated loans provided by the domestic banking sector, or the reliance of the domestic banking sector on foreign borrowing during the boom years, but that the impact of several of the measures was weakened because of circumvention. Turning to the specifics, our findings for the boom period are that: (1) binding marginal reserve requirements related to credit growth (“credit growth ceilings”) helped contain domestic credit growth; (2) strong sectoral capital measures and (3) the introduction of meaningful loan-to-value and debt-service-to-income ceilings helped limit household credit growth; (4) targeted capital measures and (5) strong, targeted reserve requirements measures contributed to reduce the share of foreign-currency-denominated loans provided by the domestic banking sector; (6) heavy reserve requirements measures on banks’ foreign borrowing helped slow it down; however, (7) circumvention via direct external borrowing largely offset the direct effect of measures (1) and (6).⁵ A corollary is that the other, less strict measures (the vast majority) are not associated with a sign of effectiveness as defined by us. In a few cases, less-immediately-binding loan classification and provisioning measures were taken concurrently with the strong measures we deem effective and may have reinforced their effect. Measures taken during the bust had no discernible impact.

What do we mean when we say that only “strong” measures were effective? While calibration of optimal measures obviously depends on country circumstances, the quantitative details of a few measures we find effective can provide a sense of the magnitudes involved in the four countries we analyze, keeping in mind that the effect of some measures may have been reinforced by other measures taken concurrently or soon afterwards,. Credit growth ceilings involved marginal reserve requirements of 200 percent when quarterly credit growth exceeded 4 percent (Croatia, 2003:Q1). Risk-weights on mortgages with loan-to-value (LTV) ratio above 70 percent were increased from 50 percent to 100 percent (Bulgaria, 2005:Q3). An LTV ceiling of 75 percent was introduced (Romania, 2004:Q1). Risk-weights on foreign currency loans to unhedged borrowers were increased by 25 percentage points (Croatia, 2006:Q2). The rate of marginal reserve requirement (MRR) on foreign borrowing was raised to 55 percent (Croatia, 2006:Q1). The rate of reserve requirements (RR) on short-term foreign borrowing was raised to 60 percent (Serbia, 2006:Q2). These were not trivial measures by any reasonable standard.

Our study of the experience of these four countries suggests one lesson for policy-makers and two lessons for future researchers. The lesson for policy-makers is that only strong, broad-based macroprudential measures which address circumvention have a chance to truly contain credit booms. The first lesson for future researchers is that the focus of effectiveness studies should be placed on measures and their strength rather than on instruments (i.e. classes of measures) and their mere deployment. The second lesson is that the possibility of non-linear effects (e.g. the existence of thresholds or asymmetries between tightening and easing) and state-contingent effects (e.g. differences between good times and bad times) should be taken into account in econometric studies.

The rest of the paper is organized as follows. Section II contains a review of the relevant literature. Section III describes the policy instruments and objectives. Section IV describes the MPP measures taken during the boom period. Section V discusses the MPP measures taken during the bust period. Section VI analyzes the effectiveness of these measures. Section VII discusses the evidence that MPP measures were circumvented, and is followed by a summary and conclusions. Annex I provides a summary of the macroeconomic background against which the MPP measures were implemented. Annex II provides a comprehensive list of the prudential measures that were implemented in each country.

II. Literature Review

An analysis of the key aspects of macroprudential policy design and a review of the burgeoning literature on the subject can be found in IMF (2013b, 2013c and 2014). Our review centers on the smaller set of empirical studies devoted to the effect of macroprudential policy on bank lending and borrowing, whose focus is closest to our own. We start by reviewing econometric studies and then turn to case studies.

Econometric studies

Econometric studies covering relatively large samples of countries have focused on instrument effectiveness rather than measure effectiveness, thus largely ignoring the issue of instrument calibration. Lim et al. (2011) find that several instruments—LTV cap, debt-service-to-income cap (DSTI), credit growth ceiling, foreign currency lending ceiling, reserve requirements, dynamic provisioning, and countercyclical capital requirements—captured by a set of dummy variables, reduce the procyclicality of credit and/or bank leverage in a panel of 49 countries between 2000 and 2010. Focusing on the same countries and period and the same MPP dataset, but using bank-level data, Claessens, Ghosh and Mihet (2014) find that measures aimed at borrowers (LTV and DSTI), and at financial institutions (credit growth ceilings and foreign currency lending ceilings) are effective at reducing asset growth, and that countercyclical buffers are of little effectiveness through the cycle. Dell’Ariccia et al. (2012) find that a stricter MPP stance (measured as a count of macroprudential instruments in use or as an aggregate indicator variable) reduces the incidence of credit booms and decrease the probability that booms end badly. Zhang and Zoli (2014) find that LTV, housing-related taxes, and foreign currency-related measures have helped curb credit growth, and bank leverage in a set of 46 countries during 2000–2013. Examining MPPs in 119 countries over 2000–2013, Cerutti, Claessens and Laeven (2015) find that borrower-based policies and financial-institutions-based policies are associated with lower growth in credit to households in emerging market economies. However, they also find an association between the use of macroprudential policies and relatively greater cross-border borrowing, also documented in our paper. Exploiting data from 57 countries spanning more than three decades, Kuttner and Shim (2013) find that only changes in DSTI have a robust statistically significant effect on housing credit growth. Vandenbussche, Vogel, and Detragiache (2015) look at household credit growth in sixteen CESEE countries between the late 1990s and 2011 and find that, among a large set of instruments, only changes in the minimum capital adequacy ratio and credit growth ceilings had a significant effect. In contrast with the rest of this branch of the existing literature, their paper actually quantifies the strength of policy measures and can therefore speak to the issue of calibration.

Some studies have focused on a narrower set of instruments, or on a single instrument. Tovar Mora, Garcia-Escribano, and Vera Martin (2012) find that higher RRs lead to a modest and temporary reduction in private bank credit growth in five Latin American countries, while increased MRRs on liabilities have negligible short-run effects. Dassatti, Camors, and Peydro (2014)’s findings for Uruguay are similar, but also indicate that higher RRs leads to credit being given to the most risky firms. Ashvin and Malhar (2013) and Igan and Kang (2012) find that tightening LTV and DSTI together slow housing credit growth in Hong-Kong and Korea, respectively. Jasova and Gersl (2012) find no evidence that tightening DSTI limits in Poland was effective against household borrowing in foreign currency. Jacome and Mitra (2015) summarize the findings of six studies of the use of LTV and DSTI in selected emerging market economies (Brazil, Hong Kong SAR, Korea, Malaysia, Poland and Romania). Among several other dimensions of policy implementation, they discuss the issue of the calibration of these policy tools and find that, with the exception of Brazil, these countries did not conduct a formal quantitative analysis to set the level or change the limits. The evidence they review suggests that LTV limits were effective in reducing loan growth and improving borrower debt-servicing, and that targeting the tools towards the loan segment most at risk, (such as speculative properties, or specific regions), was more effective than aiming at overall credit or mortgage loans.

A few studies focused on a single instrument address the issue of calibration. Duca et al. (2011) quantify the impact of a change in LTV on housing prices in the United States, while Jacome and Mitra (2015) estimate the impact of tightening the LTV ratio on mortgage credit in a set of six emerging market countries. Jiménez et al. (2014) find that dynamic provisioning smoothed the credit supply cycle in Spain during 1999–2013 and quantify the effect of a policy-induced increase in bank capital on credit supply, firm employment and survival, both before the global financial crisis and during the crisis. Aiyar, Calomiris, and Wieladek (2014) estimate the quantitative effect of an increase in the capital requirement ratio on lending growth in the United Kingdom.

Turning now to available econometric evidence for our four countries, Galac (2010) finds that credit growth ceilings, MRR on foreign borrowing, foreign currency liquidity ratio (FCLR) measures, and high capital adequacy requirements were particularly useful in building liquidity and capital buffers, but less effective in slowing down credit growth and capital inflows. He concludes that MRRs on foreign borrowing were not successful in reducing the rate of growth of banks’ foreign liabilities. This is consistent with our own findings presented below: we find that this instrument was effective only once the rate had become extremely high. Finally, he finds that credit growth ceilings (the so-called credit growth reserve) were successful in reducing the rate of domestic credit growth, but were largely unsuccessful in reducing the growth of total private sector debt, particularly for corporations, due to widespread circumvention via external borrowing. This finding is broadly confirmed in our study. Kraft and Galac (2011) fine-tune Galac (2010)’s analysis and find that while the credit growth ceilings did nothing to the growth of total non-financial corporations’ debt, they did slow down the growth of total household debt. Neagu, Tatarici, and Mihai (2015) discuss Romania’s experience with DSTI and LTV in detail. They find, as we do, that the introduction of these instruments in 2004 slowed down household credit growth. They also discuss the circumvention of these measures via nonbank lending, and for DSTI, via low initial interest rates, and longer loan maturities.

Case studies

A range of case studies of CESEE economies during the latest boom-bust cycle argue that various types of MPPs helped build banking system resilience,⁶ although Frait, Gersl, and Seidler (2011) point out that credit growth in the Czech Republic was reined in by strict monetary policy, open communication and public warnings, rather than explicit MPP measures. Kruszka and Kowalczyk (2011) explain how Poland avoided substantial economic and financial imbalances by deploying higher than the minimum Basel II capital requirements for new banks and differentiated eligibility rules by currency. Celeska, Gligorova, and Krstevska (2011) explain that a combination of MPP measures on capital, restricted foreign exchange lending, and tightened liquidity requirements, tempered the credit boom in Macedonia. Kenc, Turhan, and Yildirim (2011) document that in Turkey, lower RRs and foreign currency (FC) RRs and higher limits for export rediscount credits helped limit the severity of the financial bust. Banai, Király, and Nagy (2011) document that, in Hungary, no significant MPP measures were taken during the boom period, while strong measures in the bust mostly in response to a greater awareness of the financial stability risks associated with FC mortgage lending stifled banking activity. Sutt, Korju, and Siibak (2011) discuss how stricter capital and liquidity requirements, together with fiscal buffers, did not fully succeed in limiting credit growth in Estonia during the boom, but buttressed banking system liquidity and capitalization enough to withstand credit losses.

Similarly to these papers, our case study also analyses the use of MPPs against the background of particular macroeconomic contexts but delves into the design of the MPP measures in greater detail and discusses their effectiveness in meeting specific policy objectives.

III. Policy Instruments and Objectives

A. Policy Instruments⁷

The key prudential instruments used by the Bulgarian National Bank (BNB), the Croatian National Bank (CNB), the National Bank of Romania (NBR), and the National Bank of Serbia (NBS) can be grouped into six broad categories:

1. CAP: capital regulation, such as minimum capital adequacy ratio, risk-weights, sectoral leverage ratio, capital eligibility;

2. LCP: loan classification and provisioning rules, including rules for specific provisions, rules for general provisions;

3. LRR: liability-based reserve requirements and liquidity ratios, such as average reserve requirements, marginal reserve requirements on foreign liabilities, foreign-currency liquidity ratio;

4. ARR: asset-based reserve requirements, for example marginal reserve requirements related to credit growth;

5. ELI: eligibility requirements, such as loan-to-value ratio, debt-service-to-income ratio;

6. NBK: non-bank regulation, for example of leasing/consumer finance companies.

The first four categories of measures affect various cost margins as well as capital, provisions and liquidity buffers. They work through the supply side of credit while the fifth category affects the demand side of credit. The sixth category works by constraining the activity of nonbank credit intermediaries, which can be a channel of circumvention of measures targeting banks only. A comprehensive list of measures is provided in Appendix II.

The four countries varied in their degree of interventionism. Figure 1 shows the dynamics of policy action. Generally, countries tended to tighten (red) the macroprudential policy stance during the boom period and loosen (green) during the bust period. During the boom, policymakers at times implemented various instruments simultaneously. This approach suggests that macroprudential authorities believed in instrument complementarity. Sometimes the intended effects would move in opposite directions (yellow). The progression observed over time also seems to reflect a sequential approach where the more intrusive measures were used only after less severe measures had been first tried and found not to have the desired impact. Some easing measures were implemented to harmonize national policies with EU regulations ahead of EU accession (shaded).

During the bust, the four countries reversed some of the tightening that had taken place during the boom in order to help banks withstand the global financial crisis and the ensuing recession and thus help avoid a credit crunch. The most aggressive measures had become redundant and were dropped early. However, and perhaps surprisingly, some tightening during the bust also took place, in particular in the area of loan eligibility criteria. This may reflect the realization that banks had failed to properly assess credit risk during the boom years and therefore that further regulatory constraints should be placed on their loan decision-making process.

B. Policy Objectives

Though all four countries were experiencing a similar financial cycle, policymakers’ perception of risks varied somewhat. Therefore, while their ultimate objective was financial stability—or, more precisely, a balance between supporting economic activity and financial stability⁸—their intermediate objectives in taking action also varied. Intermediate objectives are defined by the European Systemic Risk Board as “operational specifications of the ultimate objective.”⁹ For example, domestic credit growth that is deemed excessive could threaten financial stability, and policy measures can be taken to rein in credit growth, with observable effects. Our study evaluates the effectiveness of MPPs against the stated (intermediate) objectives of policymakers in the four countries where these are made explicit, but also in some cases against what is a natural objective given the nature of the instrument (for example, domestic credit growth as an objective for broad-based LRR measures). These objectives are reported in public documents (press releases, annual reports, financial stability reports, etc.), and suggest that concerns were focused on five main intermediate objectives (Table 2). During the boom period, rapid credit growth was a concern in all four countries. Strong household credit growth was being particularly targeted in Bulgaria, Romania and Serbia, therefore we also discuss household credit growth in the context of overall credit growth below. In those same three countries, the relaxation of lending conditions was also a concern. Constraining the rapid rise in the share of loans denominated in foreign currency was another objective in all countries except for Bulgaria, where the country’s currency board was seen as a key anchor of financial stability. Finally, concerns about the growth in foreign borrowing by banks were mostly prevalent in Croatia and Serbia.

Table 2.

Macroprudential Policy Intermediate Objectives and Use of Instruments

Notes: AC = acyclical; CC = countercyclical; CAP = capital regulation; LCP = loan classification and provisioning rules; LRR = liability-based reserve requirements and liquidity ratios; ARR = asset-based reserve requirements; ELI = eligibility requirements; NBK = regulation of nonbank credit institutions; FC = foreign currency

Table 2.

Macroprudential Policy Intermediate Objectives and Use of Instruments

MPP Intermediate Objectives	Domestic Credit Growth	o/w Household Credit Growth	Lending Conditions	Share of FC Lending	Share of Foreign Borrowing
MPP Instruments	CAP, ARR, LRR, LCP, ELI, NBK	CAP, LCP, ELI	ELI, CAP, LCP	CAP, LCP, LRR, ELI	LRR
Bulgaria	CC	CC	CC
Croatia	CC			CC	CC
Romania	partially CC	partially CC	partially CC, then AC	partially CC
Serbia	CC	CC	AC	partially CC	CC

Table 2.

Macroprudential Policy Intermediate Objectives and Use of Instruments

MPP Intermediate Objectives	Domestic Credit Growth	o/w Household Credit Growth	Lending Conditions	Share of FC Lending	Share of Foreign Borrowing
MPP Instruments	CAP, ARR, LRR, LCP, ELI, NBK	CAP, LCP, ELI	ELI, CAP, LCP	CAP, LCP, LRR, ELI	LRR
Bulgaria	CC	CC	CC
Croatia	CC			CC	CC
Romania	partially CC	partially CC	partially CC, then AC	partially CC
Serbia	CC	CC	AC	partially CC	CC

As Table 2 illustrates, the same instrument category was sometimes used for different intermediate objectives. For example, CAP and LCP measures were used for almost all objectives, from domestic credit growth to lending standards to FC lending. Other types of measures, such as LRR, were targeted toward more specific objectives of managing the foreign borrowing of banks.

As hinted above, policymakers generally aimed for countercyclical (leaning-against-the-wind) measures. This implies that the tightening measures taken to address the concerns described above were partially or fully reversed during the bust. However, some tightening measures were acyclical in nature and presumably reflected policymakers’ realization that stricter regulation was required to reduce systemic risk regardless of the position in the financial cycle. In addition, in the case of Bulgaria and Romania, some measures taken for countercyclical reasons during the boom were later reversed in the context of harmonization with EU regulation, thus limiting their overall impact.

IV. Macroprudential Measures Taken during the Boom

The cumulative strength of policy actions taken by each of the four countries in each of the six main categories during the boom years are summarized in Figure 2.¹⁰ Countries differed in the strength of the implemented measures. Bulgaria’s measures were relatively moderate, perhaps reflecting in part stricter initial conditions for the minimum CAR. Romania took measures to contain FC exposures by tightening loan eligibility criteria and liability-based reserve requirements but scaled back loan eligibility criteria and loosened its capital regulation upon EU accession. Croatia’s measures were relatively stronger, in particular in trying to curb banks’ external borrowing, mainly through raising considerably liability-based reserve requirements. The focus was on slowing down banks’ external debt growth and trying to manage the indirect credit risk inherent in banks’ FC/FC-indexed lending through capital requirements. Serbia was the most aggressive of the four countries, tightening policies particularly in the area of capital adequacy (after starting from relatively lower minimum requirements) and liability-based reserve requirements.

A. Capital Regulation (CAP)

The four countries resorted to somewhat different strategies when it came to using capital adequacy measures during the boom years, reflecting initial conditions of their banking regulation and of the size and composition of their banking sector’s loan portfolio. Most banks operated in a situation of excess capital over minimum requirements; therefore tightening measures had the goal of maintaining sufficient buffers rather than building them, and/or affecting the allocation of credit across sectors and currencies. The following measures were adopted:

Changes in minimum capital adequacy ratio (CAR). Serbia increased it in two steps (from 8 percent to 12 percent) in 2005, as the credit boom gathered pace.¹¹ Romania reduced the minimum CAR from 12 percent to 8 percent as the country joined the EU in January 2007 and the authorities took steps to harmonize their capital regulation with that of the EU even though the measure was clearly procyclical. In contrast, Bulgaria kept the minimum 12 percent CAR upon EU accession, in part because of the still vivid memories of the domestic 1996–97 banking crisis.
Changes in specific risk-weights (RW). In response to the fast growth of mortgage lending, Bulgaria tightened risk-weights on mortgages twice (in 2005:Q3 and 2006:Q2) by making them a function of the LTV ratio. Romania also increased risk-weights on high-LTV (75 percent and above) loans when it adopted Basel II in 2007:Q1. Croatia increased risk-weights on foreign currency loans to unhedged borrowers twice (in 2006:Q2 and 2008:Q1) by 25 percentage points each time. While the share of FC loans and FC-indexed loans had been historically high already in Croatia, these measures seem to have been motivated in part by the rise of the share of loans indexed to the Swiss franc, the exchange rate of which against the kuna was more volatile than that against the euro. Serbia increased by 25 percentage points the risk-weights on FC and FC-indexed loans to unhedged borrowers above 10 million dinars (about €100,000)—effectively mostly targeting corporate loans—in 2006:Q3, then increased risk-weights on household FC loans by 25 percentage points two years later. The presence of FC-indexed loans in Croatia and Serbia most likely reflects attempts to circumvent earlier prudential measures on FC loans.
Introduction of bank-specific minimum CAR that depend on credit growth. From January 2008, Croatia required banks to hold minimum levels of capital based on their rate of credit growth and their reliance on funding sources other than core deposits. Essentially, banks growing their loan portfolio faster than 12 percent per year had to keep their CAR above 12 percent plus 150 percent of credit growth above 12 percent.
Introduction of specific leverage ratios. As the boom in household loans persisted inspite of measures taken in 2005, Serbia capped household lending at 300 percent of share capital from September 2006 onward and tightened the thresholds to 150 percent a year later.¹² This instrument was fine-tuned in several instances during its first few months of existence.¹³ Concerned by the fast growth of FC loans to unhedged borrowers, Romania capped the ratio of this type of loans to own funds at 300 percent from 2005:Q3 onward. However this measure remained in place only a little more over a year as it was dropped in January 2007 when the country joined the EU.
Exclusion of current profits from the regulatory capital base. Bulgaria excluded interim profits from the calculation of own funds in 2005:Q3, a little more than a year after having allowed their inclusion. This measure was also implemented by Romania just before the cycle turned (in 2008:Q3).¹⁴

Initial conditions of bank regulation likely played a role in the use of capital-related instruments. When Serbia increased its minimum CAR to 12 percent in 2005, it merely caught up with the other three countries which had a regulation stricter than the Basel I minimum of 8 percent already: the minimum CAR had been 12 percent in Bulgaria and Romania since 1999, and 8 percent in Croatia since 1998.

Institutional factors also played a role. While still in the acute phase of the boom, Romania lowered its minimum CAR upon joining the EU by harmonizing it with the EU minimum of 8 percent. In early 2008, it also implemented the Basel II framework as embedded in the EU’s Capital Requirement Directive, which led to a reduction in risk weights for household exposures relative to the previously prevailing more conservative Basel I norms. Bulgaria took a different approach—it implemented Basel II but initially kept the Basel I risk-weights. As non-EU members Croatia and Serbia did not face similar institutional pressure. Croatia implemented Basel II from the start of 2010 while Serbia implemented it in December 2011.

Finally, initial banking sector conditions also mattered. The decision by Serbia to introduce a sectoral leverage ratio in 2006, rather than increase risk-weights on household exposures, likely reflects the fact that the CAR of Serbian banks was quite high at the time (26 percent at end-2005 and 24.7 percent at end-2006) and that a constraint on credit growth through the imposition of more conservative risk-weights would not be binding enough. By emphasizing share capital (as opposed to total regulatory capital), Serbia anticipated one of the lessons of the 2008–09 global financial crisis, i.e. the importance of the quality of capital. Romania’s decision to impose a similar ratio for FC exposures to unhedged borrowers also likely reflected the fact that banks had “excess” capital by the CAR metrics (20.2 percent at end-2005) and that a change in risk-weights might not have been sufficiently binding. In contrast, Bulgaria had a CAR of 16.6 percent at end-2004 and of 14.6 percent at end-2006, making an increase of risk-weights more likely to be immediately effective. Similarly, the CAR in Croatia was 13.4 percent at end-2005, just before prudential authorities increased risk-weights on FC loans for the first time.

B. Loan Classification and Provisioning (LCP)

The four countries also made their loan classification and provisioning rules stricter so as to require banks to build thicker provisioning buffers and provide greater incentives for more careful loan underwriting. All countries changed the rules governing specific provisions, i.e. those provisions made against loan exposures that do not meet the criteria to belong to the safest category. Two countries also introduced a system of general provisions, i.e. provisions that are contingent neither on the characteristics nor on the performance of the loan and have built-in countercyclical features. The following measures were adopted:

Loan classification and specific provisions. Romania introduced the debtor's financial performance as a criterion for loan classification in 2003, and introduced exchange rate risk as another criterion in 2005 as part of its strategy to contain the growth of FC loans. In early 2008, it set higher provisioning rates for loans to unhedged FC borrowers. In December 2004, Serbia started requiring higher provisioning if minimum DSTI and LTV requirements were not met. It tightened loan classification further in 2005 but relaxed it in 2006 by only prescribing percentage bands for the calculation of special provisions and giving banks greater independence in credit risk measurement. Croatia introduced exchange rate risk as a criterion for loan classification in 2006. Bulgaria tightened classification rules in 2004 and 2005, but part of that tightening was reversed in late 2006.
General provisions. Croatia introduced a system of dynamic provisioning in 2004 linking a bank’s general provisions to its annual rate of credit growth. The threshold was 20 percent initially and was revised downward to 15 percent in 2006:Q3. Serbia introduced a system of dynamic provisioning similar to Croatia’s (with a threshold of 15 percent) in mid-2008 just before the global crisis struck, before reversing course a few months later.

While tightening dynamic/general provisioning represents an immediately visible cost to banks, tightening specific provisioning rules during a boom does not necessarily do so, as in many cases the expense occurs only when the financial cycle has turned and asset quality starts deteriorating. Thus, it is likely that the former type of measure, if well calibrated, would be a more dissuasive measure than the latter.

C. Liability-Based Reserve Requirements and Liquidity Ratios (LRR)

The four countries also had different strategies with respect to the use of measures to manage the growth of liabilities. The following instruments were used:

Average reserve requirements (RR). In the two countries with a flexible exchange rate–Romania and Serbia–classical liability-based reserve requirements were a key instrument to manage credit growth but also to promote the use of the domestic currency. Both countries expanded the set of liabilities subject to reserve requirements and increased significantly the rate applicable to FC-denominated liabilities while keeping the rate on domestic currency deposits stable or even lowering it. In Serbia, the rate on short-term borrowing from abroad reached a peak of 60 percent during the second half of 2006. In the other two countries with no or limited exchange rate flexibility, the use of the instrument was much more limited and had a greater focus on traditional liquidity management¹⁵, and no differentiation by currency was ever introduced. In fact Croatia did not use the instrument for tightening purposes at all and in one instance it reduced reserve requirements rates when other instruments were tightened (Figure 3).¹⁶
Marginal reserve requirements (MRRs) on foreign borrowing. Rather than stocks, Croatia preferred targeting specific flows. From mid-2004 until the end of the boom, it applied marginal reserve requirements on new foreign borrowing. Their rate was adjusted upwards several times, reaching 55 percent at the end of 2005 and remaining at that level until the instrument was abolished. The explicit objective was to slow down foreign borrowing of the banking sector and therefore the increase in external debt. Foreign parent banks reacted to the measure by substituting deposits and debt financing with capital injections and increasingly resorted to extending credit cross-border to Croatian corporations. A variant of MRRs on foreign borrowing called special reserve requirements (SRR) was introduced in 2006:Q1 and applied to some types of securities that banks had issued to circumvent the MRRs.
Foreign currency liquidity ratio (FCLR). Entering the boom, Croatia and Serbia already had a regulation requiring that a large share of banks' short-term FC liabilities be covered by liquid FC claims. The purpose was to force banks to self-insure against the risk of a run on FC deposits. Croatia used that instrument during the boom by significantly reducing the rate while at the same time expanding its base. In particular, FC-indexed deposits were added to the base in late 2006 to close a circumvention channel that banks had been exploiting. Serbia marginally reduced the rate in 2004 and 2005 before dropping the instrument soon after the Serbian deposit insurance agency was created and depositor confidence got a boost. The FCLR instrument obviously interacted with the RR instrument as their rates and bases differed, making changes in one of the instruments not necessarily binding.

D. Asset-Based Reserve Requirements (ARR)

A more direct way to control credit growth is to target it directly. That is what Croatia and Bulgaria did when they resorted to marginal reserve requirements related to credit growth. In Croatia, a first “credit ceiling” measure (penalizing quarterly credit growth in excess of 4 percent) was implemented during 2003. A second one, with a stricter threshold but a lower penalty rate, was implemented starting in early 2007. Bulgaria instituted similar credit ceilings in early 2005. They were to be phased out after1 year initially, but were then extended until the end of 2006. Penalties were increased in late 2005, and reduced in mid-2006. In both countries, the ARR were partly circumvented through booking with parent banks and booking with nonbank affiliates. In the case of Bulgaria, circumvention also took the form of extra booking before the reference date as soon as the measure was announced, which led the BNB to change the reference date ex post.

E. Loan Eligibility Requirements (ELI)

Perhaps surprisingly, only Romania made use of instruments which constrain credit demand by placing caps on the amounts that can be borrowed. They were implemented because “the identification of possible flaws in commercial banks’ management of the main banking risks was a major concern of the supervisory authority.¹⁷” An LTV limit of 75 percent was introduced in 2004:Q1. DSTI limits by type of loans (30 percent on consumer loans, 35 percent on mortgages) were introduced at the same time, and a DSTI limit of 40 percent covering total indebtedness was implemented in 2005:Q3. Both types of measures remained in place until the country entered the EU in January 2007 and banks were then allowed to set ceilings based on internal models. In August 2008, just before the crisis struck, Romania started requiring banks to consider interest and exchange rate risk in setting the indebtedness ceiling.

F. Regulation of Nonbank Credit Institutions (NBK)

Partly as a result of the stricter regulation imposed on banks, nonbank credit institutions (leasing companies, consumer credit companies) began to thrive. Romania and Serbia brought these institutions into the regulatory perimeter in 2006:Q1. Serbia subjected them to a 10 percent reserve requirements on foreign borrowing, while Romania subjected them to the same loan eligibility requirements as banks.

V. Macroprudential Measures Taken during the Bust

The four countries reversed some of the tightening taken during the boom in order to avoid a credit crunch during the global financial crisis and the ensuing extremely severe recession. The most aggressive tightening measures had become redundant and were dropped early. Bulgaria and Serbia eased their capital regulation; provisioning rules were softened in all four countries. Croatia, Romania and Serbia reduced or altogether removed liability-based reserve requirements. Yet, and perhaps surprisingly, some tightening also took place, in particular in the area of loan eligibility criteria and capital requirements in Romania. This may reflect the realization that banks had failed to properly assess credit risk or to keep adequate buffers during the boom years and therefore that further regulatory constraints should be placed on their loan decision-making process. Overall, Serbia eased the most during the bust, just as it had tightened the most during the boom (Figure 4).

A. Capital Regulation (CAP)

Changes in minimum CAR. None of the four countries reduced its minimum CAR during the bust, although three out of the four countries technically had regulatory space to do so (relative to the relevant Basel minima). In fact, as the crisis struck and Romania entered an IMF-and-EC-supported program, the National Bank of Romania asked all banks to maintain capital ratios above 10 percent, i.e. 2 percentage points above the statutory minimum. This requirement was still in place at end-2012. Croatia increased its minimum CAR from 10 percent to 12 percent in 2010:Q1 to compensate for the reduction in risk-weights on certain exposures at the time it implemented Basel II and which led to a mechanical increase in CAR by 2 percentage points.¹⁸
Changes in specific risk-weights: In 2010:Q1, Bulgaria provided capital relief to banks through a cut of risk-weights on household exposures to the minimum required by the European Capital Requirements Directive (CRD, i.e. the EU version of Basel II). A higher risk-weight for high-LTV housing loans was retained but the threshold was increased from 50 to 70 percent. Croatia and Serbia reduced risk-weights on household exposures and abandoned the risk-weight surcharges on foreign currency loans when they adopted Basel II in early 2010 and late 2011 respectively. Both countries also introduced a higher risk-weight for high-LTV loans with a threshold set at 75 percent. Therefore at the end of the period, all four countries had LTV-contingent risk-weights on mortgages, in line with the “substantial margin” requirement set in the EU’s 2006 CRD.
Changes in bank-specific minimum CAR that depend on credit growth. Croatia dropped this measure in 2010:Q1. The measure was far from binding at the time.
Changes in specific leverage ratios. Serbia relaxed the quantitative limit on household lending by increasing the ceiling of the maximum ratio of household loans to share capital from 150 percent to 200 percent in 2009:Q1, and abandoned the measure altogether in the following quarter as “all objectives … were met … and it was no longer necessary to set a limit on bank household lending.”¹⁹
Inclusion of current profits in the regulatory capital base: Romania and Bulgaria reversed the measure taken during the boom and allowed the recognition of current profit or profit from the previous year as a capital base element in 2009:Q2 and 2010:Q1 respectively. ²⁰

B. Loan Classification and Provisioning (LCP)

Loan classification and provisioning requirements were loosened in all four countries.

Loan classification and specific provisions. Bulgaria, Romania and Serbia loosened the loan classification and provisioning rules in various ways during 2009–2011. Bulgaria first slowed the rate of downgrades by increasing the number of days within each category of the loan classification, and later extended the allowed term of realization of real estate collateral. Romania allowed a fraction of the collateral to be deducted from the amount of exposures. Serbia first removed low down payments as a trigger for classification in the worst loan category, and later relaxed the DSTI thresholds triggering classification in one of the worst three categories.
General provisions. Very early in the bust, Serbia and Croatia revoked the regulation requiring holding general provisions related to credit growth.

C. Liability-Based Reserve Requirements and Liquidity Ratios (LRR)

These measures were among the earliest to be loosened to help relieve liquidity pressures in banking systems.

Standard reserve requirements. Countries reduced their reserve requirements both in terms of rates and in terms of base to relieve liquidity pressures in the banking system. In Bulgaria, the two-point reduction of reserve requirements early in the bust also allowed local affiliates of foreign banks to repay the liquidity support that had temporarily been provided by their parents soon after the onset of the global financial crisis. Romania and Serbia, which had increased significantly the rate on the foreign currency base during the boom, decreased it by an equivalently significant amount during the bust, although less so in the case of Serbia. At the end of the 2012, only in Serbia did the rates differ radically across currencies and reflected the explicit “dinarization” strategy pursued by the authorities in the post-crisis period (Figure 5).²¹
Figure 5.
Reserve Requirement Rates on Demand Deposits
(Percent, 2008:Q3–2012:Q4)
Citation: IMF Working Papers 2016, 029; 10.5089/9781498342872.001.A001
Source: Vandenbussche, Vogel, and Detragiache (2015), central bank websites and publications.Note: FCLR=foreign currency liquidity requirement
Download Figure
Download figure as PowerPoint slide

Figure 5.
Reserve Requirement Rates on Demand Deposits
(Percent, 2008:Q3–2012:Q4)
Citation: IMF Working Papers 2016, 029; 10.5089/9781498342872.001.A001
Source: Vandenbussche, Vogel, and Detragiache (2015), central bank websites and publications.Note: FCLR=foreign currency liquidity requirement
Download Figure
Download figure as PowerPoint slide
Figure 5.
Reserve Requirement Rates on Demand Deposits
(Percent, 2008:Q3–2012:Q4)
Citation: IMF Working Papers 2016, 029; 10.5089/9781498342872.001.A001
Source: Vandenbussche, Vogel, and Detragiache (2015), central bank websites and publications.Note: FCLR=foreign currency liquidity requirement
Download Figure
Download figure as PowerPoint slide
Marginal reserve requirements. Croatia’s MRR were completely revoked in October 2008 at the onset of the bust. SRR were lifted a few months later.
Foreign currency liquidity ratio. Croatia reduced the FCLR rate from 28.5 percent to 20 percent in 2009:Q1 in the second half of 2008 at the onset of the recession. This was followed by a further reduction in 2011:Q1 to 17 percent with the aim of freeing foreign currency liquidity and stimulate investment.²² The set of eligible assets to meet the FCLR was expanded in 2012:Q2 to include 50 percent of the amount of loans granted in the context of the “loan program for the development of the economy” sponsored by the Croatian Bank for Reconstruction and Development (HBOR, in local spelling).²³

D. Asset-Based Reserve Requirements (ARR)

Croatia dropped the credit growth reserve at the end of 2009 in the context of anemic credit growth.

E. Loan Eligibility Requirements (ELI)

As noted, this is one of the few areas in which some requirements were actually tightened during the bust period.

Romania amended the rule it had introduced in August 2008 only two quarters later by removing the requirement to take into calculation interest rate risk and currency risk when setting the indebtedness ratio for clients taking loans backed by mortgages within city limits. In 2011:Q4, it then introduced a maximum LTV ratio by type of loan currency denomination and required specific FC shocks to be applied to determine borrowers’ maximum indebtedness levels.
In 2011:Q2, Serbia introduced a maximum LTV for foreign-currency-denominated or foreign-currency-indexed loans. The ceiling was set at 80 percent for mortgages and 70 percent for other loans.

F. Regulation of Nonbank Credit Institutions (NBK)

In 2009:Q4, Romania reversed the rule allowing nonbank institutions to include interim profits in the calculation of own funds. This followed a similar easing rule for banks half a year earlier.

In addition to these measures, the four countries encouraged banks to implement conservative profit retention policies in 2009 and 2010 to fight the erosion of capital cushions because of the ongoing deterioration in asset quality. They also sought comfort letters from parent banks pledging adequate liquidity and capital support for their subsidiaries. In the case of Romania and Serbia, this was achieved in the context of the so-called Vienna Initiative (see Box 1).

Box 1.

The Vienna Initiative and the IMF-EC Stabilization Programs

The Vienna Initiative was launched in early 2009 as a coordination platform for multinational banks, their home and host country supervisors, fiscal authorities, and international organizations. The goal was to safeguard a continued commitment of parent banks to their CESEE subsidiaries in the five CESEE countries with International Monetary Fund or joint International Monetary Fund—European Commission stabilization programs: Bosnia and Herzegovina, Hungary, Latvia, Romania, and Serbia. In these countries substantial amounts of external debt were maturing and external financing gaps were opening up. A significant part of this debt was held by multinational parent banks and insufficient roll-overs would have compromised the success of the stabilization programs.

A total of 17 parent banks pledged, via so-called commitment or comfort letters, to maintain their exposures and to keep their subsidiaries adequately capitalized for the duration of the programs. As the crisis subsided, the pressure to maintain cross-border exposures was reduced and in some cases roll-over commitments were lowered by early 2010.

VI. Were the Measures Effective?

This section assesses the measures’ effectiveness by analyzing the evolution of the specific target variables these measures were meant to affect. By contrast with the other four targets, data on lending conditions are not publicly available, therefore we cannot assess effectiveness in that area. We find evidence that intermediate objectives moved in the intended direction according to the criteria used following the implementation of a handful of measures targeting them (see Table 3 for a summary assessment on credit growth and Table 4 on foreign borrowing and foreign currency lending). The other measures were likely too weak to have a measurable impact, or were implemented too close to the onset of the global financial crisis to be properly assessed.

Table 3.

Summary of Effective Measures on Credit Growth

(Including household credit growth)