## Risky Business: Reading Credit Flows for Crisis Signals

_IMF Blog, April 10, 2018_

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**Canonical URL:** [Risky Business: Reading Credit Flows for Crisis Signals](https://www.imf.org/en/blogs/articles/2018/04/10/risky-business-reading-credit-flows-for-crisis-signals)

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## Bibliographic details
- Authors: Claudio Raddatz
- Published: April 10, 2018

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### Overview and research scope
- Authors: Claudio Raddatz Kiefer
- Date: April 10, 2018
- Research coverage: 25 years of data for nonfinancial companies in 55 emerging and advanced economies.
- Central question: How much of additional credit during booms flows to relatively riskier companies versus more creditworthy firms?

### Key findings on credit allocation and risk
- When credit grows rapidly, the firms where debt expands faster become increasingly risky relative to those with the slowest debt expansions.
- An increase in the riskiness of credit allocation points to greater odds of a severe economic downturn or a banking crisis as many as three years into the future.
- The buildup of lending to relatively less creditworthy companies adds an extra dose of risk on top of the dangers associated with rapid growth of credit overall.
- Lending to risky firms can be rational and profitable, but may also reflect poorer screening of borrowers or excessive risk-taking.
- Low interest rates can encourage a “search for yield,” leading banks and investors to extend credit to riskier companies that pay relatively higher rates of interest.
- The riskiness of credit allocation may serve as a barometer of risk appetite.

### Global pattern and historical evolution
- Riskiness was elevated in the late 1990s.
- Riskiness fell from 2000 to 2004, in the aftermath of financial crises in Asia and Russia and the dot-com equity bubble.
- From a historic low in 2004, riskiness rose to a peak in 2008, when the global financial crisis erupted.
- It then declined sharply before rising again to a level near its historical average at the end of 2016, the last available data point.
- Riskiness may have continued to rise in 2017 as market volatility and interest rates remained very low in the global economy.

### Policy implications and recommendations
- Supervisors should monitor both the total volume of credit and the riskiness of its allocation.
- When warning signals flash, regulators can:
  - require banks to hold more capital;
  - impose limits on bank loan growth to restrain risk-bearing capacity and increase buffers;
  - ensure the independence of bank supervisors;
  - enforce lending standards;
  - strengthen corporate governance by protecting minority shareholders.
- A period of rapid credit growth is more likely to be followed by a severe economic downturn if more of that credit is flowing to riskier firms; policy makers should take appropriate steps in response.

*Source: Risky Business: Reading Credit Flows for Crisis Signals (April 10, 2018).*

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## References

- [Global Financial Stability Report](http://www.imf.org/en/Publications/GFSR/Issues/2018/04/02/Global-Financial-Stability-Report-April-2018)
- [https://www.imf.org/wp-content/uploads/2018/04/eng-april-2-gfsr-3.jpg](https://www.imf.org/wp-content/uploads/2018/04/eng-april-2-gfsr-3.jpg)

_Source: https://www.imf.org/en/blogs/articles/2018/04/10/risky-business-reading-credit-flows-for-crisis-signals_