Lending booms and bank fragility : the South African experience
Thesis (PhD)--Stellenbosch University, 2020.
ENGLISH SUMMARY : This thesis empirically examined the link between credit booms and bank fragility in South Africa. Fundamentally, the thesis looked at how the current developments in the domestic credit market affect the banking system, and in particular financial system stability in South Africa. The past two or three decades have seen an unprecedented increase in the level of domestic credit to the private sector. We have used mostly South African Reserve Bank and World Bank time series data for the three empirical studies. The thesis applied the robust autoregressive distributed lags (ARDL) approach by Pesaran, Shin and Smith (2001) and the nonlinear autoregressive distributed lags (NARDL) methodology of Shin, Yu and Greenwood-Nimmo (2014). The thesis contains three empirical studies. The first empirical study investigated the aggregate drivers of credit booms in South Africa using the causality tests based on the ARDL and Error Correction Model (ECM). Credit growth was analysed in relation to economic growth, types of loans, composition of credit by economic sector, debt-to-income ratio and the business cycle phases. Statistical evidence showed that South Africa has had a strong persistent growth in domestic credit over the past three decades with evidence of procyclical credit provision. The ARDL and ECM results showed that foreign capital inflows, mortgage loans, real interest rates and GDP per capita were important drivers of credit booms in South Africa. The second empirical study investigated whether excessive credit growth signalled future vulnerabilities in the South African banking sector. The main objective was to examine the growth-risk nexus in bank lending, given the credit booms currently experienced in South Africa. The business cycle was included in the model to reinforce the growth-risk nexus by allowing the study to develop a tri-variate model. The study found that credit risk management was still backward-looking and procyclical even though there were strong moves towards countercyclical models as suggested by the Basel Committee on Banking Supervision (Basel III accord). The ARDL model revealed the presence of a long-run relationship between credit risk, credit booms and the business cycle while the NARDL model established the presence of an asymmetric cointegration between the three variables. Negative shocks on the business cycle have a higher and more pronounced effect on credit risk than positive shocks while positive shocks to credit have a negative effect on credit risk in South Africa. The third empirical paper explored the relationship between credit booms, banking sector finance sources and its implications for financial stability in South Africa. It was noted that it was important for the study to identify the sensitivity of the banking sector to funding sources in South Africa. It was established that, like all other banking systems around the world, South African banks also tapped into wholesale funds to satisfy growing local demand for credit. The empirical results revealed a strong presence of an asymmetric relationship between credit booms and banking sector funding sources. Specifically, the study revealed that in the long run, positive developments in the wholesale funds market had a positive effect on the ability of the banking sector to satisfy credit demand; however, statistical evidence revealed that wholesale funds were highly volatile and susceptible to negative public signals. On the other hand, the study established that in the long run, positive developments in the domestic deposit market had positive effects on credit booms, while in the short run positive developments also had a positive effect on credit booms. Finally, negative shocks in domestic deposits in previous years had negative effects on credit booms. Based on the above, the study believes that credit booms are too risky to be left alone, and that appropriate monetary policy is a major instrument that is capable of curbing credit booms and limiting over-indebtedness in South Africa. The increase in the level of indebtedness beyond sustainable levels is a potential trigger of financial fragility in the economy. Strong fiscal policy capable of stimulating the finance and the real sector is important if and when a credit bust occurs. It is also important to note that fiscal discipline is required during the upswing since credit booms do not only flatter the balance sheets of banks and consumers that they extend credit to, but they also flatter government financial accounts.
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