Contraction or steady state? An analysis of credit risk management in Italy in the period 2008-2012

TL;DR

This study analyzes credit risk management in Italy from 2008 to 2012, finding that credit fluctuations are primarily driven by default rates and fluctuate around a steady state, supporting Basel II's effectiveness and informing Basel III policies.

Contribution

It provides empirical evidence that credit fluctuations in Italy are explained by default rates and occur around a steady state, challenging procyclical interpretations.

Findings

Negative correlation between credit growth and default rates (r=-0.6903).

Credit supply fluctuates around a steady state with a significant parameter.

Credit variation is explained by default rate fluctuations, supporting Basel II effectiveness.

Abstract

Credit risk management in Italy is characterized, in the period June 2008 to June 2012, by frequent (frequency=0.5 cycles per year) and intense (peak amplitude: mean=39.2 billion Euros, s.e.=2.83 billion Euros) quarterly contractions and expansions around the mean (915.4 billion Euros, s.e.=3.59 billion Euros) of the nominal total credit used by non-financial corporations. Such frequent and intense fluctuations are frequently ascribed to exogenous Basel II procyclical effects on credit flow into the economy and, consequently, Basel III output based point in time Credit to GDP countercyclical buffering advocated. We have tested the opposite null hypotheses that such variation is significantly correlated to actual default rates, and that such correlation is explained by fluctuations of credit supply around a steady state. We have found that, in the period June 2008 to June 2012 (n=17), linear regression of credit growth rates on default rates reveals a negative correlation of r=minus 0.6903 with R squared=0.4765, and that credit supply fluctuates steadily around the default rate with an Internal Steady State Parameter SSP=0.00245 with chi squared=37.47 (v=16, P<.005). We conclude that fluctuations of the total credit used by non-financial corporations are exhaustively explained by variation of the independent variable default rate, and that credit variation fluctuates around a steady state. We conclude that credit risk management in Italy has been effective in parameterizing credit supply variation to default rates within the Basel II operating framework. Basel III prospective countercyclical point in time output buffers based on filtered Credit to GDP ratios and dynamic provisioning proposals should take into account this underlying steady state statistical pattern.