The views expressed in this presentation are the views of the author and do not necessarily reflect the

views or policies of the Asian Development Bank Institute (ADBI),

the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper
and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms.

Frameworks for managing private debt

Madhusudan Mohanty*
Bank for International Settlements
Representative office for Asia and the Pacific
Hong Kong

Asian Development Bank Institute 20th Annual Conference

Tokyo, 30 November-1 December 2017
*The views expressed are my own and do not necessarily reflect those of the BIS.

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 Outline of issues

 Recent debt accumulation

 Is there a framework for managing private debt?
 When is debt excessive?
 Potential triggers for policy actions
 Approaches to limiting risks from private debt

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 Recent debt accumulation in EMEs: a few facts

 Post -2008 crisis financial intermediation in EMEs:

 Large growth in total private debt as % of GDP:
- The boom driven by both household and corporate
sector,
- Rising house prices and corporate leverage at the firm
level,
 Strong growth in US dollar liabilities of the private non-
financial firms,
 And, significant reliance of banks on wholesale and non-
core funding sources to finance asset growth.

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 Outstanding credit to private non-financial sector
As a percentage of GDP

NFC = non-financial corporations; HH = households; Total = total private non-financial sector

Source: BIS credit statistics; BIS calculations.

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 Residential property prices and corporate leverage

EME residential property prices Corporate Leverage in EMEs1

Index, 2010 = 100 Ratio Ratio

1 Herwadkar (2017). Data for 10 EMEs using S&P Capital IQ database.

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 Debt securities issuance by non-bank corporations
Amounts outstanding, in trillions of US dollars

US dollar credit to non-banks outside US1 International debt securities issued by

non-bank private corporations in EMEs2

Vertical lines in the right hand panel indicate bankruptcy of Lehman Brothers on 15 September 2008, Federal Reserve announcements
of quantitative easing on 25 November 2008 and 3 November 2010 and FOMC hint on tapering on 1 May 2013.
1For more information, see R. McCauley, P McGuire and V. Sushko, “Global dollar credit: links to US monetary policy and leverage”, BIS
Working Papers No 483, January 2015. 2 Amount outstanding of international debt securities issued by the non-bank private
corporations in all maturities. Aggregate of Algeria, Argentina, Brazil, Chile, China, Colombia, the Czech Republic, Hong Kong SAR,
Hungary, India, Indonesia, Israel, Korea, Malaysia, Mexico, Peru, the Philippines, Poland, Russia, Saudi Arabia, Singapore, South Africa,
Thailand, Turkey, the United Arab Emirates and Venezuela.

Sources: BIS international debt securities and locational banking statistics by residence; BIS calculations.

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 Sources of funding of EME banks, end-2013
Corporate deposits Non-core financing1 Retail deposits
Percentage of total assets Percentage of total assets Percentage of total debt liabilities

AE = United Arab Emirates; AR = Argentina; CL = Chile; CO = Colombia; CZ = Czech Republic; DZ = Algeria; HU = Hungary; ID =
Indonesia; IL = Israel; IN = India; KR = Korea; MX = Mexico; MY = Malaysia; PE = Peru; PH = Philippines; PL = Poland; RU = Russia; SA =
Saudi Arabia; SG = Singapore; TH = Thailand; TR = Turkey; VE = Venezuela; ZA = South Africa.

1 Non-core financing comprises long-term debt securities (bonds), short-term debt securities and interbank claims. These interbank
claims refer to other liabilities than deposits from banks, as those are included in corporate deposits.

Source: BIS questionnaire.

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 Is there a framework for managing private debt?

 Compared to public debt literature, theoretical framework for

managing private debt is not well-developed: The key factors:
 Marginal role of debt in macro models.
 Representative agents and consumption smoothing.
 Limited role of capital structure of firms (the irrelevance
proposition).
 Aggregate perspective (emphasis on net liabilities of the
sector as a whole).
 Inadequate role of financial intermediaries.

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Is there a framework for managing private debt?
 Focus changed after the 2008 crisis:
 Excessive borrowing: the role of fundamental factors and
frictions ( eg. taxes, credit-constrained agents, incomplete
markets, irrational optimism, etc).
 Distribution of debt and assets.
 The role of collaterals and haircuts.
 Financial institutions’ capacity to intermediate credit.

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 Debt and the economy (Brazier 2017)

High debt Deeper economic

Big spending cut backs downturn

High level of debt

Cut backs on lending

Risk of losses at
High debt
banks
More defaults

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Is there a framework for managing private debt?

 What can we learn from frameworks for managing public debt?

 Single decision maker and clear mandates.
 Fiscal policy sets the current and future path of debt.
 Debt managers chose the optimal debt maturity to
minimize costs and refinancing risks.
 Enhanced objectives after the 2008 crisis: increased
recognition of macroeconomic stabilization role of debt
maturity.

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Is there a framework for managing private debt?
 Managing private debt is complicated by several factors:
 No single decision maker
 Imperfect instruments
 Pre-emptive policy intervention
 No clear accountability framework
 Involves more complex policy decisions
- Enhancing financial depth vs. limiting systemic financial
risks;
- Macro-economic stabilization vs. long run financial
stability;
- Political challenges from distributional impacts of
policies.

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Is there a framework for managing private debt?

 Managing private debt is likely to involve more encompassing

objectives:
 Managing the frictions
 Sources of the shock,
 And, the amplification mechanism.
 Also, multi-pronged measures involving;
 Lenders’ balance sheet
 Private borrowers’ balance sheet
 Public sector balance sheet (particularly explicit or implicit
guarantees that increase government’s eventual liabilities).

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 When is debt excessive?

 Recent studies have established a clear trade off between short

and long-run impact of household debt on growth.
 Mian, Sufi and Verner (2017): an increase in the household debt to
GDP ratio reduces consumption across countries with a lag of
three years.
 Lombardi, Mohanty and Shim (2017): Household debt boosts
growth in the short run, mostly within one year. By contrast, a 1
percentage point increase in the household debt to GDP ratio
lowers GDP growth in the long run by 0.1%.
 IMF (2017): The median three-year ahead impact of an increase in
household debt ratio on GDP is -0.5% for advanced economies
and -0.13% for EMEs.

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 Instantaneous and subsequent effects of debt
accumulation on consumption growth
Scatter plot of the change in the household Correlation between the three-year change
debt-to-GDP ratio1 and the average growth in household debt up to year t-1 and
rate of consumption2 subsequent consumption growth3

ratio between mid-2007 and end-2014

–0.225

Change in household debt to GDP

–0.300

–0.375

–0.450
t+1 t+2 t+3 t+4 t+5

1 In percentage points. 2 In per cent. 3 The growth rate is measured as the logarithmic difference of real consumption in year t and
that in year t+h, where h = 1, 2, 3, 4, 5.

Sources: IMF, World Economic Outlook; authors’ estimates.

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 When is debt excessive?

 The “tipping point” of household debt:

 Debt has non-linear effects on growth.
- Lombardi, Mohanty and Shim (2017): Negative effects of
household debt intensifies as the debt-GDP-ratio exceeds 70%.
Very low levels of household debt (20-35% of GDP) also
reduce prospects for growth.
- IMF (2017): estimates of upper threshold is much lower (30%).
Household debt to GDP below 10% has positive impact on
growth.
- IMF (2017): the negative effects of household debt is higher in
countries with an open capital account and fixed exchange
rate, lower quality of financial development and bank
supervision, and higher income inequality.

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 When is debt excessive?
 Similar analysis is lacking for corporate debt
 Optimal level of corporate debt for an economy is not well
defined.
- Corporate leverage influenced by firm-specific factors.
- Firms are more likely to maintain a stable leverage ratio in the
long run.
 However, the factors exposing firms to vulnerability are
clearly identifiable;
- Correlation of debt accumulation with global interest rate
cycles (IMF (2015), Herwadker (2017), Goyal and Packer
(2017)).
- Distribution of debt among firms with weaker balance sheets
- Accumulation of unhedged FX exposures
- Weak correlation of leverage with real investment (Bruno and
Shin, 2015)

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 Potential triggers for policy actions

 Frameworks for detecting credit booms

 Deviation of credit-to-GDP ratio from trend.
 Dell’ Ariccia et al (2012): annual credit-to-GDP ratio in excess of
20% (or when deviation from trend is greater than 1.5 times its
standard deviation and annual growth of credit-to-GDP exceeds
10%). One in three credit booms end in banking crisis.
 Borio and Low (2002) and Drehmann and Juselius (2014): deviation
of credit-to-GDP ratio from trend forecasts financial vulnerability
with a lead time of two to four years.
 Basel II counter-cyclical capital buffer: Buffers set at the maximum
2.5% with credit gaps exceeding 10 percentage points.

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 Credit-to-GDP gaps in EMEs1
As of Q1 2017, in percentage points

AR = Argentina; BR = Brazil; CL = Chile; CN = China; CZ = Czech Republic; HK = Hong Kong SAR; HU = Hungary; ID = Indonesia; IN =
India;
KR = Korea; MX = Mexico; MY = Malaysia; PL = Poland; RU = Russia; SG = Singapore; TH = Thailand; TR = Turkey; ZA = South Africa.

1 For a derivation of critical thresholds for credit-to-GDP gaps, see Drehmann et al (2011). Difference of the credit-to-GDP ratio from its
long-run, real-time trend calculated with a one-sided HP filter using a smoothing factor of 400,000, in percentage points.

Sources: National data; BIS; BIS calculations.

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 Potential triggers for policy actions

 Aggregate Debt Service Ratio (DSR)

 A clear indicator of over-indebtedness of households and
firms
 Interaction between leverage and DSR propagates credit
and output cycles (Juselius and Drehmann, 2015)
 Forecasting abilities of DSR dominate other early warning
indicators
- Maximum forecasting power in the four quarters
preceding the crisis (Drehmann and Juselius (2014):

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 Potential triggers for policy action
 Other indicators with useful early warning properties:
 Deviation of property price growth from trend, although
property prices may peak well ahead of the crisis (Borio and
McGuire, 2004).
 Debt build-up associated with an overvalued exchange rate
and large currency mismatches (Gourinchas and Obstfeld,
2012).
 Credit expansion driven by non-core liabilities of the
banking sector.
- Hahm, Shin and Shin (2012): credit and currency crises
associated with rapid expansion of banking sector’s
foreign liabilities.

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 Potential triggers for policy action
 Regulatory stress test of lenders’ balance sheets:
 Concurrent bank stress tests based on future risks than past
stress events.
 Incorporating financial cycles into the stress test (eg Bank of
England)
 Stress testing borrowers’ balance sheets:
 Particularly, when debt and assets are unequally distributed
 Stress events around the turn of capital flow cycles.

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 Approaches to limiting risks: some open questions
 How far does current regulatory framework addresses risks
from private debt?
 Overlay of counter-cyclical capital buffer and leverage ratio
 Macro-prudential regulation
 Should there be more regulation of liabilities?
 Levy on banking sector non-core liabilities (Shin 2013):
- acts as an automatic stabilizer (hits banks the hardest during
boom times when their non-core liabilities are rising rapidly)
- leaves banks’ assets funded by core liabilities unaffected
- Korea’s recent experience with leverage cap and macroprudential
stability levy.
 Regulation of non-financial corporate exposures (IMF, 2015)
 Hedging foreign currency exposures (mandatory or discretionary?)
 Markets for hedging (Is hedging cost- effective?)
 Speculative positioning in foreign exchange derivatives

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 Approaches to limiting risks
 How should macroeconomic and monetary policy respond?
 Incorporating debt and asset price developments in
monetary and fiscal policy
 Implicit insurance through liquidity assistance (moral hazard
risks?)
 Debt management policy to stabilise bond yields.
- Central bank bond market operations during May-June
2013 “taper tantrum”
- But potential distortion of the yield curve and fiscal
incentives

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 Approaches to limiting risks

 The role of macroprudential policies

 The number of macroprudential instruments proliferated
post-2008 crisis
 Instruments such as LTV, DTI, limits on foreign credit
growth, and reserve requirements can dampen debt and
financial cycles (Claessens, Ghosh and Mihet, 2014).
 Housing related instruments can be particularly effective
(Kuttner and Shim, 2013).
 Central banks’ views about the effectiveness of
macroprudential instruments – results from a BIS survey.

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Results from a BIS survey (Mohanty 2014).

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 Effectiveness and unintended consequences

 Effectiveness of macroprudential policies ( lags in

implementation, leakages and cross-border spillovers)
 Should the analyses of effectiveness of macroprudential policy
consider unintended consequences?
 Growth of shadow banking system;
 Discretionary policies increase distortionary costs (market
and investor uncertainty and lobbying efforts).
- Non-systematic (ad hoc) measures negatively affect the
economy (Boar, Gambacorta, Lombardo and Pereira da
Silva, 2017);
 Policy evaluation difficult without counterfactual evidence
(what would have happened had the authorities not acted?).

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 Conclusion
 The framework for managing private debt is underdeveloped
and requires careful analysis to understand and identify the
factors that cause credit cycles and the associated risks.
 Managing private debt is more challenging than managing
public debt given multiple objectives and the absence of a
single decision maker.
 Understanding when debt becomes excessive is important to
fostering financial development and limiting systemic risks.
 Given problems of imperfect instruments, frameworks to
manage private debt would require more research to
understand the relative effectiveness of various instruments.
 Monetary and fiscal policies along with a strong regulatory and
supervisory framework are likely to play a crucial role in limiting
risks.

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 References
Barzier, A (2017), “Debt strikes back’ or ‘the return of the regulator’, Speech at University of Liverpool, www.bankengland.co.uk.
Mian, A, A Sufi and E Verner (forthcoming), “Household debt and business cycles worldwide”, Quarterly Journal of Economics.
Lombardi, M, M S Mohanty and I Shim (2017), “ The real effects of household debt in the short and long run”, BIS Working
Paper 607.
IMF (2017): “Household debt and financial stability”, Global Financial Stability Report, Chapter 2. October
IMF (2015): “Corporate leverage in emerging markets – a concern?”, Global Financial Stability Report, Chapter 3.
Herwadkar, S S (2017): “ Corporate leverage in EMEs: did the global financial crisis change the determinants?, BIS Working
Paper (forthcoming).
Goyal, V and F Packer (2017): “Corporate leverage in emerging Asia”, BIS papers, 91, March
Bruno, V and H S Shin (2015): “ Global dollar credit and carry trades: a firm-level analysis”, BIS Working Paper, 510.
Dell’ Ariccia G, D Igan, L Laeven and H Tong (2012): Policies for Macrofinancial stability: dealing with credit booms and busts”,
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Borio, C and P McGuire (2004): “Twin peaks in equity and housing prices?, BIS Quarterly Review, March.
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