As the near-inevitable aftermath of China’s extraordinary government-led credit boom gathers pace, and the global deflationary risks mount, I thought it might be timely to have a look at credit growth in New Zealand in recent years.
I was partly prompted to do so by some reactions yesterday to my AUT Briefing Papers piece on housing. Several commenters at interest.co.nz were convinced that I was letting the banks off the hook, and that the creation of credit to finance house prices must be, in some substantial measure, to blame for high house prices (in Auckland).
In one sense, that reaction isn’t surprising. A similar model seems to have been implicit in the Governor of the Reserve Bank’s 2013 LVR restrictions and the new Auckland-specific investor finance restrictions he is consulting on at present. After all, prudential regulatory powers of the Bank should, as per the provisions of the Reserve Bank Act, be used only when action is need to promote the soundness of the financial system.
Without covering old ground in detail, I don’t believe that there is any such systemic threat. The Reserve Bank has not made a persuasive New Zealand-specific case, and the one piece of careful analysis that has been presented (the stress test results) suggest that the banking system would be robust to even some very severe shocks.
The international literature suggests that probably the single best (albeit not very good) predictor of crises is rapid growth in the ratio of credit to GDP. We had that in the years prior to 2007. China has had it, much more dramatically, in the last five years or so. Many countries have had periods of very rapid growth in credit, and no banking crisis I’m aware of was not preceded by a period of very rapid credit growth. New Zealand’s stresses from 1987 to 1991 are an example. But many, perhaps even most, episodes of rapid domestic credit growth have not ended in domestic systemic banking crises. New Zealand post-2007 was just one example.
The record suggests, unsurprisingly, that the quality of lending matters a lot. And the quality of lending tends to deteriorate a lot when, either
- Government agencies are directing that lending or setting up incentives that drive banks to undertake poor quality lending (the US housing finance boom of the 00s and the recent Chinese credit boom are good examples), or
- Where the regulatory shackles have just been taken off, and no one – banks or regulators – has much experience with a liberal market-based economy and appropriate credit standards (New Zealand, Australia, and the Nordics in the 1980s were good examples).
None of that looks to be the case in New Zealand at present. We have credit data to the end of June, and GDP data only to March, but for the rest of this I’ll just assume that seasonally adjusted nominal GDP showed no growth in the June quarter.
Since December 2007, just prior to the big recession, New Zealand’s nominal GDP has risen by just under 30 per cent, and the four different measures of private sector credit have risen by about 33 per cent. But the pre-crisis dairy lending boom went on well beyond the end of 2007 If we start our comparisons from December 2009, we find that nominal GDP since them has increased by around 26 per cent and PSC by around 21 per cent. Within that total, lending to households has increased by 22 per cent. Whatever the base period for comparisons, credit growth has been fairly subdued relative to GDP.
And it is not that nominal GDP growth has been rampant. In the seven years to March 2015, NGDP increased by 27.4 per cent, down from 55.1 per cent growth over the previous seven years. As is now well-recognised, given the inflation target, monetary policy has been too tight over the last few years, not too loose.
Annual nominal GDP growth fluctuates a lot, largely with fluctuations in the terms of trade. At present NGDP growth is slowing rapidly. Credit growth is currently growing faster than nominal GDP growth The strongest component of that is agricultural credit, up 7.6 per cent in the last year. But whatever the overall state of banks’ dairy exposure – and I suspect they will lose quite a lot of money, without it being a systemic threat – the current growth in dairy credit is not the sort of lending that is recklessly bidding up asset prices, it is a reflection of the severe drop in farmers’ income – if anything, a buffer rather than the initial source of any problem.
In short, when credit has been growing at only around the (rather subdued) rate of growth in nominal GDP for the last 6-8 years
(a) it is difficult to credibly blame bank lending policy for growth in specific asset prices (Auckland house prices) without independent evidence of a decline in lending standards (which neither the Reserve Bank nor anyone else has sought to demonstrate), and
(b) we just don’t have the basis for expecting any severe stress on or threat to the soundness of the strongly-capitalised financial system. Rising house prices certainly generate a demand for additional credit, but it is the rather more fundamental forces (driven by governments) – land use restrictions and policy-driven immigration flows – that are the source of the underlying pressure on prices. The same banks operate nationwide, and there is no sign of house price inflation in Invercargill, or even Wellington.
Of course, a rather nasty economic slowdown appears to be already underway, and that could worsen a lot yet. If so, that will put a lot of pressure on a lot of borrowers.