## Bad Debt in Emerging Markets: Still Early Days

_IMF Blog, November 9, 2015_

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## Bibliographic details
- Authors: John Caparusso, Yingyuan Chen, Evan Papageorgiou, Shamir Tanna
- Published: November 9, 2015

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### Emerging market growth and its drivers
- The fifteen largest emerging market economies grew by 48% from 2009 to 2014, a period when the Group of Twenty economies collectively expanded by 6%.
- Growth was driven in part by bank lending that fueled corporate credit expansion, strong earnings, and low defaults.
- The combination of the credit boom, falling commodity prices, and foreign currency borrowing has increased firms' vulnerability and put financial sectors under stress.

### Credit booms, credit gaps, and signals of vulnerability
- Credit booms can lead to excess investment, surplus production capacity, deteriorating corporate cash flow, rising default risk, and bank capital losses.
- The credit gap (a country’s increase in borrowing—credit to GDP ratio—relative to its historical average) highlights vulnerable countries.
- By the end of 2014:
  - China, Thailand, Turkey, Brazil, and Indonesia had credit gaps above 10%, a level often considered the benchmark for risky credit booms.
  - China’s 25% credit gap places the country in the 5% highest credit gaps across emerging markets since the 1970s.
- Other factors beyond credit gaps can cause stress; Russia, Argentina and India currently have low credit gaps but may face other pressures.
- Recent depreciation of corporates’ home currencies against the dollar and falling commodity prices are increasing stress on weaker borrowers; increased borrowing rates could exacerbate the situation.

### Emerging market bank buffers and the evolving bad debt cycle
- Emerging market banks are starting to see new non-performing loans at a faster rate, which is now above developed economy levels for the first time since the financial crisis.
- Aggregate Tier 1 capital ratio for emerging market banks is about 11%, well above the regulatory minimum, and has risen slightly since 2009.
- Advanced economy banks have collectively engineered a nearly 4 percentage points increase in Tier 1 capital adequacy ratios over the same period despite lower stated profitability.
- Rather than conserving capital during the boom, emerging market banks channeled essentially all earnings into underwriting further growth.
- As the credit boom ends, the need to build reserves against rising credit losses will strain future earnings and the ability of banks to maintain credit growth.
- Emerging market economies face the risk of rising credit costs, slowing bank earnings, decelerating credit growth, and weak economic performance—with potential global implications given their size.

### Policy implications and recommendations
- At this late stage in the credit cycle, policymakers should act to prevent further deterioration in financial sector conditions.
- Use a mix of microprudential and macroprudential tools to keep institutions and the financial system safe and to discourage further accumulation of excess borrowing and foreign indebtedness.

Microprudential measures:
- Consider higher risk weights (capital requirements).
- Consider caps on the most problematic exposures, including property developers, commodity producers, and companies with large foreign currency borrowings.
- Strengthen corporate insolvency regimes.
- Pay special attention to vulnerabilities created by borrowing from overseas and in foreign currencies.
- Monitor banks’ and borrowers’ foreign currency exposures, including derivatives positions.
- Introduce and strengthen stress tests related to foreign currency risks.

Macroprudential and broader market measures:
- Maintain sovereign investment grade-status.
- Accelerate measures to foster money market and corporate bond issuance to improve corporates’ access to funding pools that reduce dependence on capital-constrained banks and potentially flighty offshore creditors.

*Source: Bad Debt in Emerging Markets: Still Early Days (IMF blog, November 9, 2015).*

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## References

- [Global Financial Stability Report.](http://www.imf.org/External/Pubs/FT/GFSR/2015/02/index.htm)

_Source: https://www.imf.org/en/blogs/articles/2015/11/09/bad-debt-in-emerging-markets-still-early-days_