The Riskiness of Credit Origins and Downside Risks to Economic Activity

Abstract

We construct a country-level indicator capturing the extent to which aggregate bank credit growth originates from banks with a relatively riskier profile, which we label the Riskiness of Credit Origins (RCO). Using bank-level data from 42 countries over more than two decades, we document that RCO variations over time are a feature of the credit cycle. RCO also robustly predicts downside risks to GDP growth even after controlling for aggregate bank credit growth and financial conditions, among other determinants. RCO’s explanatory power comes from its relationship with asset quality, investor and banking sector sentiment, as well as future banking sector resilience. Our findings underscore the importance of bank heterogeneity for theories of the credit cycle and financial stability policy.

Keywords: Private sector debt, credit growth, credit origin, credit cycle, bank soundness, credit risk, financial vulnerability, investor sentiment, financial stability

JEL Classification: E44, E47, G01, G21, G28