Private Sector Indebtedness Across Euro Area Countries

ECB - CONFIDENTIAL
Agostino Consolo
Private Sector Indebtedness
European Central Bank
Directorate General Economic Developments
across euro area countries
Supply side, Labour Market and Surveillance Division
This is a joint work with Beatrice Pierluigi and has ADBI – Managing Private and Local
received comments from Wolfgang Modery and Isabel
Vansteenkiste. We also acknowledge excellent research Government Debt
assistance from Federica Malfa, Joan Piqueras and
Giacomo Pongetti. 30 Nov – 1 Dec 2017, Tokyo
The views expressed are those of the speaker and do not necessarily reflect those of the European Central Bank.
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.
Overview
Rubric of the talk
A. The European context:

– Macroeconomic imbalances
– Banking sector vulnerabilities
B. Measuring excessive private sector leverage

– Model-based deleveraging estimates and their relationship to economic outcomes
C. Vulnerability risks for private sector indebtedness

– A cross-country comparison of balance-sheet risks among households and firms
D. Policies supporting the deleveraging process

– The role of efficient insolvency frameworks
2 www.ecb.europa.eu ©
A.1 A bird-eye view on private sector indebtedness
Rubric
• Build-up of private sector debt in the euro area has been heterogeneous
and significant corrections are under way across both HH and NFC sector
Chart 1: Private sector debt across US, JP Chart 2: HH debt change, pre- and post- Chart 3: NFC debt change, pre- and post-
and four largest euro area countries crisis time (in pp of GDP) crisis time (in pp of GDP)
(in % of GDP)
Source: BIS database for long-term time series of Source: Eurostat national and sectoral accounts; ECB Source: Eurostat national and sectoral accounts; ECB
private non-financial sector debt. The grey area computation computation. Given the large changes, IE and LU are
shows the min-max interval across Germany, France, not shown in the picture
Italy and Spain. The median is computed across
these four euro area countries
A.2 The euro area context
Rubric
• The analysis of the private (non-financial) sector debt is very topical for the
euro area as a whole and for the convergence process across countries
• From a macroeconomic perspective, the European Commission (EC)

monitors private sector indebtedness across countries
– The EC’s Macroeconomic Imbalance Procedure Scoreboard defines a country-specific
threshold for excessive indebtedness in the private sector to be 133% of GDP
– Yearly reviews of country-specific stock imbalances aim at defining policies which can (i)
address a situation of excessive indebtedness and (ii) enhance economic resilience
• From a banking sector view, the stock of banks’ non-performing loans is

related to excessive indebtedness in the private sector
– From a micro-supervision perspective, the stock of NPLs across some euro area
countries is still a source of concern (about EUR 1 trillion or 10% of GDP)
– Looking forward, new macroprudential policy tasks and tools in the euro area rely on the
analysis of private sector indebtedness
Structure
Rubric of the talk and key takeaways
• The structure of the talk is based on the following three work streams
looking at macro, financial and framework conditions behind indebtedness
1. The economic effects of the deleveraging process are fading away

– Deleveraging pressures have largely faded away in the euro area as a whole, both
across households and non-financial corporation
– However, current deleveraging estimates are heterogeneous across euro area countries
and, in some countries, considerably large
– Across euro area countries, higher deleveraging estimates (measured before the crisis)
are associated with negative sequential effects on the economy and financial system
2. From a balance-sheet perspective, vulnerability risks are declining

– Based on a balance-sheet framework, a composite risk indicator shows that overall risks
stemming from the household and NFC balance sheet have significantly declined
– Looking forward, risks are expected to remain contained to the extent the cost of
servicing the debt evolves in line with the overall economic and financial conditions for
households and non-financial corporations
Structure
Rubric of the talk and key takeaways
3. Insolvency policies can further support a smooth deleveraging process

– More efficient insolvency frameworks (pre-insolvency regimes, overall legislation and
proceedings, judicial system) can better and swifter tackle debt restructuring problem,
especially across NFCs
– This would, in particular, contribute to higher exit rates from the stock of NPLs and the
clean-up of HH and NFC balance-sheet
– Better insolvency frameworks together with proper flanking policies, including regulatory
and supervisory policies, can thus address stock imbalances across euro area countries
and improve their economic and financial resilience going forward
Overview
Rubric of the talk




B.1 Measuring excessive private sector leverage
Rubric
• For each country in the euro area, the amount of deleveraging is computed
by comparing current debt levels with a robust benchmark debt level for
each sector (HH and NFC)
• A robust benchmark debt level is derived by model averaging across a set
of panel cointegration and unobserved components models
– In each model, the benchmark level of debt is defined as the underlying long-
term/permanent component. This is country- and sector-specific
– The main purpose of using this set of models is to identify the long-term drivers of debt
from the cyclical fluctuations, while going beyond purely statistical/filtering methods
– The set of the explanatory variables used in the empirical work is differentiated between
HH and NFC and accounts for macroeconomic, financial and balance-sheet variables
B.2 Deleveraging estimates and bank NPLs
Rubric
• Chart 6 shows the median deleveraging estimates across all models for HH and NFC
• Some countries display larger deleveraging estimates in certain sectors, although
strong co-movement
• Across countries, deleveraging estimates are related to higher banks’ NPL (Chart 7)
Chart 6: deleveraging estimates (2015) for HH and NFC Chart 7: deleveraging estimates for the private
across EA countries sector (2015) and the Texas ratio (2016) across EA
(in % of GDP) countries (both in terms of z-score)
NFC Deleveraging Estimates in 2015
Texas ratio in 2016
HH Deleveraging Estimates in 2015 Private Sector Deleveraging Estimates in 2015

Source: Eurostat national and sectoral account data. ECB house price and lending rate data.
Note: Explanatory variables used in the panel cointegration models and in the state-space model are GDP, disposable income, house price, unemployment,
lending rates, share of 35-55years in total population. The panel is estimated by means of FMLS and PMG estimators. The state-space models use two
unobserved states measuring potential GDP growth and cyclical debt fluctuations respectively
B.3 Deleveraging estimates and economic outcomes
Rubric
• Chart 8 and chart 9 show how deleveraging estimates measured in 2009 are
associated with subsequent economic and financial developments
• This aims at corroborating the importance of excessive leverage in the private sector
and the prolonged effects the deleveraging process can have on the economy
Chart 8: deleveraging estimates in 2009 and Chart 9: deleveraging estimates in 2009 and
change in core inflation from 2010 to 2015 change in HH bank lending from 2010 to 2015
Z-score of (2015-10) change in HH bank lending

Z-score of (2015-10) change in core inflation
Z-score of HH Deleveraging Estimate in 2009 Z-score of HH Deleveraging Estimate in 2009
Source: Eurostat national and sectoral account data. ECB bank balance-sheet (BSI) database
Note: Deleveraging estimates are displayed in slide 10. Core inflation refers to the HICP excluding energy index.
Overview
Rubric of the talk




C.1 Private sector debt vulnerabilities in the euro area
Rubric
• The previous macro-econometric approach is now complemented with a

balance-sheet framework to measure private sector debt vulnerabilities
• A composite risk indicator is built, both for HH and NFC, based on four
underlying factors to encompass different definitions of risk:
– Debt-to-GDP ratio (overall sustainability risks)
– Debt-to-asset ratio (balance-sheet leverage risks)
– Debt service-to-income ratio (liquidity/roll-over risks)
– Interest-growth differential (long-term dynamics risks)
• The composite risk indicator can be computed on a historical and forward-

looking basis
• For the forward-looking approach, a sector-specific dynamic debt equation

is used which accounts for macroeconomic projections and balance-sheet
information
C.2 Private sector debt vulnerabilities in the euro area
Rubric
Chart 10: HH indebtedness vulnerability index (HSIX)
• These charts show the HH (HSIX)
and the NFC (FSIX) Sector
Indebtedness index in 2006, 2009
and 2017
• Over time, vulnerability risks

across euro area countries
stemming from private sector
Source: ECB computation, Eurostat national and sectoral accounts.
Risk is measured on a 0-10 rating scale with higher values signalling higher risks. debt have receded compared to
Chart 11: NFC indebtedness vulnerability index (FSIX) pre-crisis levels
• Nevertheless, risks indicators

show higher vulnerability in the
NFC sector
Source: ECB computation, Eurostat national and sectoral accounts.

Risk is measured on a 0-10 rating scale with higher values signalling higher risks.
C.3 Contributions to private sector debt vulnerability risks
Rubric
Chart 12: Contributions to HH vulnerability index (HSIX)
• These charts show the composite
risk indicators and the contribution
from each of the four factors, in
2017
• Currently, vulnerability risks remain

mostly driven by the debt service
ratio (green bar)
Note: The contributions to the total composite index are (i) interest-growth differential,
(ii) debt service ratio, (iii) debt-to-financial asset ratio and (iv) debt-to-GDP ratio. The
relative weights are 0.15, 0.35, 0.25 and 0.25 respectively. • The improved economic conditions
Chart 13: Contributions to NFC vulnerability index (FSIX)
have also further reduced the
negative impact from the interest-
growth differentials (purple bar)
• The ongoing deleveraging process

has reduced the overall contribution
of the leverage ratio (red bars) in
some cases
Note: The contributions to the total composite index are (i) interest-growth differential,
(ii) debt service ratio, (iii) debt-to-financial asset ratio and (iv) debt-to-GDP ratio. 14 www.ecb.europa.eu ©
The relative weights are 0.15, 0.35, 0.25 and 0.25 respectively.
C.4 The incomplete pass-through of lower interest rates
Rubric
• The low-interest rate environment is gradually improving the interest coverage

ratio, but the debt service ratio has been slow in adjusting
• However, cross-country heterogeneity in interest payment-to-income ratio is larger
across NFCs than HHs; this is contributing to higher risks for NFC compared to HH
Chart 14: HH Interest payment-to-Income ratio, percentages Chart 15: NFC Interest payment-to-Income ratio, percentages
Source: Eurostat and ECB, Quarterly national accounts Source: Eurostat and ECB, Quarterly national accounts
Note: Range computed as the interquartile range across euro area Note: Range computed as the interquartile range across euro area
countries. Interest payment does not include FISIM fees. Income is the HH countries. Interest payment does not include FISIM fees. Income is the
gross disposable income NFC gross operating surplus
Overview
Rubric of the talk




D.1 Policies supporting the deleveraging process
Rubric
• Chart 6 shows that, across some euro area countries and sectors, the ongoing
deleveraging process is still incomplete; also, debt write-offs have had only a
marginal contribution until now
• Restructuring policies could have been more supportive of a smoother deleveraging

– Compared to the OECD frontier, insolvency frameworks across euro area countries have been a
major hurdle because of the ex-ante (legislation) and ex-post (procedures) inefficiency
– In fact, in the euro area, liquidation remains the most likely outcome compared to restructuring in case
of financial distress. But liquidation tends to take longer and to significantly reduce the recovery rate
– The prevailing framework conditions during the crisis have very likely had damaging effects for bank
asset quality and the need to reallocate NFC capital towards more productive investment
• In what follows, a synthetic indicator of the efficiency of the insolvency framework

(IFI) based on the World Bank (Doing Business) database is constructed and its
effects tested on the reduction of banks NPLs
• IFI is a weighted average of sub-indicators capturing the enforcement of legal and

contract rights, the time of insolvency and the recovery rate
D.2 Policies supporting the deleveraging process
Rubric
• In a panel of OECD and EU countries, the efficiency of the insolvency framework (IFI)
is found significant in supporting the reduction of bank NPL and favouring the
deleveraging process (annex)
• This is especially so when countries experience high unemployment gaps (crisis
times). IFI is more effective in reducing the stock of NPLs more than in limiting their
increase during the early phase of the crisis
Table 1: panel estimates across EU and OECD countries
Summary
Rubric and concluding remarks
• Summing up,
– the deleveraging process has strengthened and balance-sheet conditions are improving.
– some countries have adopted new legislations and procedures to upgrade their insolvency regimes
– The ongoing adjustment in private sector vulnerabilities and the convergence process in the euro area
remain supportive of the economic recovery
• The European sovereign debt crisis has further highlighted the importance of
vulnerabilities stemming from high private sector debt levels
• High private indebtedness has been either the main driver of country-specific
imbalances or the results of subdue growth and delayed balance-sheet repair
• In both cases, there is a need to have an analytical framework featuring “stock

variables” and their relationship with macro and balance-sheet information
• Finally, such a framework should preferably account for institutional features – e.g.
the insolvency framework – which can enhance the resilience of the economy, avoid
a prolonged deleveraging cycle and support the reallocation of resources.
Rubric
Thank You.
In case of questions:
agostino.consolo@ecb.europa.eu
Rubric
Annex – Empirical Models
Modelling
Rubric HH and NFC "equilibrium" debt levels
Purpose
• Derive an assessment of stock (private debt) imbalances
i. time varying
ii. country- and sector-specific
iii. structural/economic interpretation
• Encompass different information
iv. balance sheet information
v. macro variables
vi. interest rates
Modelling approach
• Based on the existence of a credit/debt cycle (fin. boom-bust cycle)
• Mean-reversion of debt ratios provides support for trend-cycle analysis
• Two approaches:
 Panel cointegration models
 Trend-Cycle decomposition (state-space models)
Data
Rubricdescription and caveats
Data description
• Country coverage: all EA countries
• Frequency: quarterly
• Sample period: 1999 - 2016 (unbalanced)
• Dependent variable (𝑫𝑫𝒕𝒕 ):
• HH loans (consumer and mortgage loans)
• NFC consolidated debt (consolidated loans + bonds)
• Explanatory variables (𝑿𝑿𝒕𝒕 ):
 Balance-sheet:
 HH: financial and non-financial assets
 NFC: equity, fin. assets, notional lev., liquidity ratio
 Macro:
 HH: income, house prices, unemp. rate, demographics, share of construction value added
 NFC: GDP, sector-specific investment, profits
 Interest rates: lending rates, US mon policy shadow rate, corporate bond premium
Caveats:
1. For some countries, NFC debt includes loans of foreign companies
2. Some explanatory variables include large revaluation effects
3. Sample period is not homogenous for all countries and, for some, it may capture only the most
recent leverage cycle
Panel
Rubric cointegration models
• The panel cointegration models assume that

 Long-run coefficients are equal across EA countries
 Deterministic (constant) coefficients are country specific (Caveat (1.))
• The long-run equation is estimated using pooled cointegration techniques
 This allows to account for cyclical variation in endogenous and exogenous variables
(Caveat (2.)); robustness check based on HP-filter variables
 By pooling, the estimation is affected by countries with longer time series with a view
to address (Caveat (3.))
• Several panel models are estimated for each sector by using different combination
of the variables (𝑿𝑿𝒕𝒕 ) based on statistical significance and economic plausibility
• For instance, for HH:
𝐷𝐷𝑖𝑖𝑖𝑖𝐻𝐻𝐻𝐻 = 𝛼𝛼𝑖𝑖 + 𝛽𝛽1 𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 + 𝛽𝛽2 𝑅𝑅𝑅𝑅𝑅𝑅𝑖𝑖𝑖𝑖 + 𝑒𝑒𝑖𝑖𝑖𝑖 1
𝐷𝐷𝑖𝑖𝑖𝑖𝑁𝑁𝑁𝑁𝑁𝑁 = 𝛼𝛼𝑖𝑖 + 𝛽𝛽1 𝑃𝑃𝑃𝑃𝑃𝑃𝑖𝑖𝑖𝑖 + 𝛽𝛽2 𝑅𝑅𝑅𝑅𝑅𝑅𝑖𝑖𝑖𝑖 + 𝛽𝛽3 𝑈𝑈𝑈𝑈𝑈𝑈𝑖𝑖𝑖𝑖 + 𝛽𝛽4 𝐿𝐿𝐿𝐿𝐿𝐿𝑡𝑡 + 𝑒𝑒𝑖𝑖𝑖𝑖 2
• and for NFC

𝐷𝐷𝑖𝑖𝑖𝑖𝑁𝑁𝑁𝑁𝑁𝑁 = 𝛼𝛼𝑖𝑖 + 𝛽𝛽1 𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖𝑖𝑖 + 𝛽𝛽2 𝐺𝐺𝐺𝐺𝐺𝐺𝑖𝑖𝑖𝑖 + 𝑒𝑒𝑖𝑖𝑖𝑖 1
𝐷𝐷𝑖𝑖𝑖𝑖𝑁𝑁𝑁𝑁𝑁𝑁 = 𝛼𝛼𝑖𝑖 + 𝛽𝛽1 𝐸𝐸𝐸𝐸𝐸𝐸𝑖𝑖𝑖𝑖 + 𝛽𝛽2 𝐺𝐺𝐺𝐺𝐺𝐺𝑖𝑖𝑖𝑖 + 𝛽𝛽3 𝐺𝐺𝐺𝐺𝐺𝐺𝑖𝑖𝑖𝑖 + 𝛽𝛽4 𝑀𝑀𝑀𝑀𝑀𝑀𝑡𝑡 + 𝑒𝑒𝑖𝑖𝑖𝑖 2
Where PYN is disposable income, RMP is the middle-total population ratio, URX is the unemp. Rate, LRX is the lending rate; EQN is NFC equity,
GOS is the NFC gross operating surplus and MPR is monetary policy rate.
State-space
Rubric models
• The state-space models, instead, keep a country-specific approach and include a

structure on how permanent and cyclical factors behave
• All coefficients are country specific (heterogeneity of the estimates across countries is
also affected by short sample period)
• The model jointly estimates the permanent component for GDP and the cyclical
component for debt. For each sector (𝒊𝒊 = HH and NFC) several specifications are
taken to the data – here some examples.
• Measurement equation:
𝐺𝐺𝐺𝐺𝐺𝐺𝑡𝑡 = 𝑠𝑠𝑦𝑦,𝑡𝑡 + 𝜖𝜖𝑦𝑦,𝑡𝑡 (3.1)
𝑖𝑖
𝐷𝐷𝑡𝑡𝑖𝑖 = 𝑐𝑐21 + 𝑐𝑐22 𝑠𝑠𝑦𝑦,𝑡𝑡 + 𝑐𝑐23 𝑋𝑋1,𝑡𝑡−1
𝑖𝑖
+ 𝑐𝑐24 𝑋𝑋2,𝑡𝑡−1 + 𝑐𝑐23 𝑠𝑠𝑙𝑙𝑙𝑙,𝑡𝑡 + 𝜖𝜖𝑑𝑑,𝑡𝑡 3.2
• State equation:
𝑠𝑠𝑦𝑦,𝑡𝑡 = 𝛼𝛼 + 𝑠𝑠𝑦𝑦,𝑡𝑡−1 + 𝜇𝜇𝑦𝑦,𝑡𝑡 (3.5)
𝑠𝑠𝑐𝑐,𝑡𝑡 = 𝑐𝑐61 + 𝑐𝑐62 𝑠𝑠𝑐𝑐,𝑡𝑡−1 + 𝜇𝜇𝑐𝑐,𝑡𝑡 (3.6)
𝑖𝑖 𝑖𝑖
Where 𝑋𝑋1,𝑡𝑡−1 and 𝑋𝑋2,𝑡𝑡−1 are a set of explanatory variable which are sector specific as for the panel model. 𝑠𝑠𝑦𝑦,𝑡𝑡 is the permanent component in GDP
which also drives the permanent component in HH or NFC debt. 𝑠𝑠𝑐𝑐,𝑡𝑡 instead is the cycle component in debt fluctuations. Only permanent effect
component will be used to compute the underlying benchmark level of sustainable debt
Rubric
Annex – Private Sector DSA
i. Forward-looking debt dynamic equation

ii. Composite risk indicators: HSIX and FSIX
2. HH and NFC debt dynamics
Rubric
The equation for Households (HH) and Non-Financial Corporations (NFC) debt dynamics
reads, for i = HH, NFC:
∗
𝐷𝐷𝑖𝑖,𝑡𝑡 = 1 + 𝑟𝑟𝑖𝑖,𝑡𝑡 𝐷𝐷𝑖𝑖,𝑡𝑡−1 + 𝐹𝐹𝑖𝑖,𝑡𝑡 + 𝐼𝐼𝑖𝑖,𝑡𝑡 − 𝛼𝛼𝑖𝑖 𝑆𝑆𝑖𝑖,𝑡𝑡
where, for each sector i:
• 𝒓𝒓𝒊𝒊𝒕𝒕 is the lending rate
• 𝑭𝑭𝒊𝒊𝒕𝒕 is financial asset transactions
• 𝑰𝑰𝒊𝒊𝒕𝒕 is gross fixed capital formation
• 𝑺𝑺∗𝒊𝒊,𝒕𝒕 is a function of (not including interest payments)
• HH: Gross Disposable Income (GDI) and Private Consumption (PCN)
• NFC: Gross Value Added (GVA) and Compensation of Employees (CoE)
• 𝜶𝜶𝒊𝒊 = parameter capturing the share of savings used for debt redemption
www.ecb.europa.eu ©
27
3. Key underlying drivers
Rubric
1. MPE projections are used until 2018

2. Potential output growth:
• NCB potential growth projections up to 2022
• Beyond 2022, convergence to the 2040-2060 average growth as from the
Commission Working Group on Ageing Population report
3. Dynamics of the output gap

• Outside the BMPE horizon, the output gap is expected to close smoothly 𝜃𝜃𝑋𝑋
• As a result, real GDP growth for the outer years is derived.
4. Real consumption and investment

• Balanced-growth path which assumes gradual convergence to real GDP growth 𝜃𝜃𝐵𝐵
5. Income, wages and employment

• Real GDI and real GVA also follow real GDP growth
• CoE is expected to follow labour productivity and consumption deflator
• Growth in num. of employees follows a simple “Okun law”: 𝜃𝜃𝑂𝑂𝑂𝑂 * real GDP growth
28
3.Rubric
Key underlying drivers (cont.)
5. Price deflators
• In the long term, inflation converges to the euro area historical average (99-14)
• Each deflator converges to the euro-area historical mean. Euro area real GDP,
investment and consumption deflator are, over history, different though
6. Lending rates
• Short-term and long-term lending rates are a function of the corresponding bond
yields. Yields come from BMPE capital market assumptions and the Public DSA
• A constant country-specific spread, as the one prevailing at the end of the forecast
horizon between lending rates and bond yields is used beyond the forecast horizon.
• The effective lending rate used in the debt formula is a weighted average accounting
for the share of floating loans and the composition of loan maturity
7. Financial asset transactions

• Net financial asset transactions follow the historical pattern with respect to income
(HHs) or GDP (NFCs).
29
4. Output of the Private Sector DSA Tool
Rubric
Sector-specific indebtedness indicators
1. Solvency: debt-to-income ratio
2. Leverage: debt-to-financial asset ratio
3. Liquidity: debt service-to-income ratio
4. Fundamental: interest rate-growth differential
The overall Private Sector Indebtedness Index (PSIX):

• Each of the four ratios is transformed in the percentile of its respective historical
distribution (MIP time-span: 1999-2007)
• The aggregation is then computed, for each sector, as follows:
1 1 1 1 1
𝑃𝑃𝑃𝑃𝑃𝑃𝑋𝑋𝑖𝑖 = ( �𝑺𝑺𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑜𝑦𝑦𝑖𝑖 + 𝑳𝑳�𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑖𝑦𝑦𝑖𝑖 ) + 𝑳𝑳�𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑖𝑖 + 𝑭𝑭
� 𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑢𝑙𝑙𝑖𝑖
3 2 2 3 3
� variable is the transformed indicator in percentiles.

where each 𝒙𝒙
• Similar indices can be computed for HHs (HSIX) and NFCs (FSIX) separately
30
Rubric
Annex – Regression with IFI
Effect
Rubric of IFI on the deleveraging process
• Higher IFI (more efficient insolvency framework) larger deleveraging
Table
Households NFC
(2) HH (4) NFC

(1) Change in HH deleveraging (3) Change in deleveraging
debt episodes NFC debt episodes
IFI (-1) -0.0107** 0.0150*** -0.0130 0.0173***

(0.00534) (0.00405) (0.00834) (0.00589)
Debt over income (D) (-1) -0.0401*** 0.00239 -0.00894 0.0312***
(0.00685) (0.00399) (0.0105) (0.00795)
Income growth 0.0548 0.694*** 0.113 0.443***
(0.175) (0.0840) (0.131) (0.0786)
D * IFI (-1) -0.00401 -0.0313*** -0.0324 0.0615***
(0.0111) (0.00693) (0.0253) (0.0178)
NPL Ratio (-1) -0.00323*** 0.00301*** -0.00211*** 0.00275***
(0.00116) (0.000511) (0.000805) (0.000729)
Constant 0.0908*** -0.0168** 0.000332 0.0155*
(0.0181) (0.00778) (0.0151) (0.00900)
Observations 410 130 443 175
Number of countries 38 32 40 39
R-squared 0.471 0.634 0.224 0.307
Time FE YES YES YES YES
Robust standard errors in parentheses
Source: Consolo, La Malfa and Pierluigi
Effect
Rubric of IFI on the deleveraging process
• Asymmetric effects of IFI (more efficient insolvency framework) on NPL

increases and reductions
Table
EU+OECD countries EU countries
NPL ratio 3yr NPL ratio 3yr
NPL ratio 3yr neg. change NPL ratio 3yr neg. change
pos. change (absolute value) pos. change (absolute value)
Unemp. Rate 0.490*** -0.123* 0.455*** -0.105

(0.108) (0.0636) (0.121) (0.0781)
Insolvency Framework
(IFI) 0.401 0.604** 0.677 0.767*
(0.358) (0.256) (0.559) (0.404)
Unemp. gap * IFI -0.410** -0.164 -0.473* -0.169
(0.198) (0.163) (0.243) (0.211)
NPL ratio (-3) 0.293* 0.614*** 0.268 0.600***
(0.167) (0.0550) (0.175) (0.0594)
Debt-to-Equity Ratio 1.023*** -0.503 1.518 -1.322**
(0.139) (0.486) (0.936) (0.521)
Constant -4.612*** 0.947 -4.904*** 1.722*
(0.851) (0.839) (1.199) (1.034)
Observations 213 212 174 158

R-squared 0.416 0.797 0.381 0.798
Time FE YES YES YES YES
Number of countries 37 34 28 26
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1
Source: Consolo, La Malfa and Pierluigi
Rubric
Annex – Charts & Tables
Annex:
Rubric NFC Debt-to-GDP vs Debt-to-Equity ratio
• This comparison helps to highlight different cross-country signals coming

from two commonly used indebtedness indicators for the NFC sector
Chart 3: Debt-to-GDP ratio, percentages Chart 4: Debt-to-Equity ratio, percentages
Source: Eurostat and ECB, Quarterly national accounts Source: Eurostat and ECB, Quarterly national accounts
Note: Peak (2005-2015) refers to the max value over the period Note: Peak (2005-2015) refers to the max value over the period
ARubric
simple decomposition of the Debt-to-GDP ratio
• Deleveraging across EA countries mostly occurred through GDP growth

and, to a lesser extent, via a reduction in debt or write-offs
Chart 5: change in the NFC debt-to-GDP ratio and related contributions over 2009Q3-2016Q4
Source: Eurostat and ECB, Quarterly national accounts

Note: LU real GDP contribution is -58pp ; IE NFC Debt change contribution is 116pp

Private Sector Indebtedness Across Euro Area Countries

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Private Sector Indebtedness Across Euro Area Countries

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ECB - CONFIDENTIAL

A. The European context:

B. Measuring excessive private sector leverage

C. Vulnerability risks for private sector indebtedness

D. Policies supporting the deleveraging process

• From a macroeconomic perspective, the European Commission (EC)

• From a banking sector view, the stock of banks’ non-performing loans is

1. The economic effects of the deleveraging process are fading away

2. From a balance-sheet perspective, vulnerability risks are declining

3. Insolvency policies can further support a smooth deleveraging process

A. The European context:

B. Measuring excessive private sector leverage

C. Vulnerability risks for private sector indebtedness

D. Policies supporting the deleveraging process

Texas ratio in 2016

HH Deleveraging Estimates in 2015 Private Sector Deleveraging Estimates in 2015

Z-score of (2015-10) change in HH bank lending

Z-score of HH Deleveraging Estimate in 2009 Z-score of HH Deleveraging Estimate in 2009

A. The European context:

B. Measuring excessive private sector leverage

C. Vulnerability risks for private sector indebtedness

D. Policies supporting the deleveraging process

• The previous macro-econometric approach is now complemented with a

• The composite risk indicator can be computed on a historical and forward-

• For the forward-looking approach, a sector-specific dynamic debt equation

• Over time, vulnerability risks

• Nevertheless, risks indicators

Source: ECB computation, Eurostat national and sectoral accounts.

• Currently, vulnerability risks remain

• The ongoing deleveraging process

• The low-interest rate environment is gradually improving the interest coverage

A. The European context:

B. Measuring excessive private sector leverage

C. Vulnerability risks for private sector indebtedness

D. Policies supporting the deleveraging process

• Restructuring policies could have been more supportive of a smoother deleveraging

• In what follows, a synthetic indicator of the efficiency of the insolvency framework

• IFI is a weighted average of sub-indicators capturing the enforcement of legal and

• In both cases, there is a need to have an analytical framework featuring “stock

Annex – Empirical Models

• The panel cointegration models assume that

• and for NFC

• The state-space models, instead, keep a country-specific approach and include a

𝑠𝑠𝑐𝑐,𝑡𝑡 = 𝑐𝑐61 + 𝑐𝑐62 𝑠𝑠𝑐𝑐,𝑡𝑡−1 + 𝜇𝜇𝑐𝑐,𝑡𝑡 (3.6)

Annex – Private Sector DSA

i. Forward-looking debt dynamic equation

• 𝒓𝒓𝒊𝒊𝒕𝒕 is the lending rate

• 𝑭𝑭𝒊𝒊𝒕𝒕 is financial asset transactions

• 𝑰𝑰𝒊𝒊𝒕𝒕 is gross fixed capital formation

• 𝑺𝑺∗𝒊𝒊,𝒕𝒕 is a function of (not including interest payments)

• HH: Gross Disposable Income (GDI) and Private Consumption (PCN)

• NFC: Gross Value Added (GVA) and Compensation of Employees (CoE)

1. MPE projections are used until 2018

3. Dynamics of the output gap

4. Real consumption and investment

5. Income, wages and employment

7. Financial asset transactions

Sector-specific indebtedness indicators

1. Solvency: debt-to-income ratio

2. Leverage: debt-to-financial asset ratio

3. Liquidity: debt service-to-income ratio

4. Fundamental: interest rate-growth differential

The overall Private Sector Indebtedness Index (PSIX):

� variable is the transformed indicator in percentiles.

IFI (-1) -0.0107 0.0150* -0.0130 0.0173***