Credit Stagnation in the MENADec 1st, 2011 | By Bassam Aoun
Adolfo Barajas, Ralph Chami, Raphael Espinoza, and Heiko Hesse
International Monetary Fund Working Paper. 2010.
Prior to the global financial crisis, nations in the Middle East and North African (MENA) Region experienced remarkable economic growth. However, the region was not immune to the downturn. Non-resource sectors in oil exporting countries were hit particularly hard. While several academic studies have aimed to explain the linkage between credit downturns and economic activity, a recent report by the International Monetary Fund (IMF), Recent Credit Stagnation in the MENA Region: What to Expect? What Can Be Done?, analyzes the frequency of credit booms and busts in the region. Further, by juxtaposing pre- and post-financial crisis bank balance sheets, the report suggests possible determinants that affect lending on a macro-level.
When confidence in the fiscal structure of a country is shaken, in the MENA region as elsewhere, both creditors and borrowers are more reluctant to do business with each other. Fearing a bank will default on its payments, clients withdraw their deposits and divert funds toward investments with more stable returns, such as Treasury bonds or gold futures. Creditors also fear defaults by borrowers and, thus, charge a higher interest rate, decreasing the amount of borrowing in the market while also decreasing overall investment in the economy. This situation induces a credit market deadlock that can only be resolved by reviving confidence.
During the global financial crisis, MENA private sector banks experienced sharp declines in deposits, and cut their activities as their profitability decreased. External shocks, such as the Dubai fiscal crisis, further stagnated demand for credit. In addition, each bank’s relationship with its respective government and with foreign creditors impacted local credit markets.
The authors, Adolfo Barajas, Ralph Chami, Raphael Espinoza, and Heiko Hesse, find that an expansion of bank deposits are the primary catalyst to emergence from a credit slump. This influx of deposits is usually coupled with a significant spike in macroeconomic activity, leading to a heightened level of confidence in the financial system. Country-specific factors also play a role. For example, credit growth is most rapid in the United Arab Emirates, but slower in Egypt and Lebanon.
The report concludes that credit market recovery in the MENA region will lag global economic recovery. The authors predict economic shortfalls throughout the region and encourage policymakers to dampen adverse effects as much as possible by implementing policies and regulations, such as altering the interest rate or purchasing long term securities, that can ensure a more diversified business environment while acting as a buffer against future downturns.