Capital Inflows, Credit Growth, and Financial Systems

IMF Working Papers, August 19, 2015

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Exploiting a granular panel dataset that breaks down capital inflows into FDI, portfolio and other categories, and distinguishes between credit to the household sector and to the corporate sector, the paper investigates the association between capital inflows and credit growth.
Main finding: non-FDI capital inflows boost credit growth and increase the likelihood of credit booms in both household and corporate sectors.
For household credit growth, the composition of capital inflows appears to be more important than financial system characteristics.
For corporate credit growth, both the composition and the financial system matter.
Net other inflows are always linked to rapid credit growth regardless of sectors and financial systems.
Firm-level data corroborate these findings and hint at a causal link: net other inflows are related to more rapid credit growth for firms that rely more heavily on external financing.
Further explorations indicate that both demand and supply side factors play a role in how capital flows translate into more credit.

Non-FDI capital inflows boost credit growth.
Non-FDI capital inflows increase the likelihood of credit booms in both household and corporate sectors.
Composition of capital inflows matters more than financial system characteristics for household credit growth.
For corporate credit growth, both composition and financial system characteristics matter.
Net other inflows are always linked to rapid credit growth across sectors and financial systems.
Firm-level evidence: net other inflows are related to more rapid credit growth for firms that rely more heavily on external financing.

Subjects: Balance of payments, Capital inflows, Consumer credit, Credit, Credit booms, Financial markets, Financial sector development, Money
Keywords: Capital flows, Capital inflows, Consumer credit, Credit, credit boom, Credit booms, credit growth, exchange rate, FDI inflow, Financial development, Financial sector development, Financial structure, GDP ratio, Global, market capitalization, WP

Both demand-side and supply-side factors contribute to the transmission from capital inflows to increased credit.
Firm-level patterns suggest a potential causal channel: firms more reliant on external financing experience faster credit growth when net other inflows increase.

Monitoring the composition of capital inflows is important for assessing risks of credit booms, especially in household credit.
Financial system characteristics should be considered when evaluating corporate credit growth vulnerability to capital inflows.
Net other inflows deserve particular attention from policymakers due to their consistent association with rapid credit growth across contexts.

Source: IMF Working Paper "Capital Inflows, Credit Growth, and Financial Systems" by Deniz O Igan and Zhibo Tan, August 19, 2015.