Advanced Credit Risk Analysis and Management

24

Road to Credit Crisis

As we have seen in the Chapter 1, credit is akin to fire and if it gets out of control can be devastating and create catastrophic damage to the finances of individuals, organizations and governments. However, used reasonably, it is a great tool offering immense advantages and brings prosperity to all economic agents in an economy.

24.1 CREDIT AND GROWTH

Prosperity comes through increased production and exchange of goods and services and value addition. For instance, the backward economies of the Middle East experienced prosperity during the second half of the 20th century as they exchanged their newly found oil and gas with the rest of the world for goods and services. Similarly, China began its fascinating economic growth journey in the 1980s as the economy was freed from the tight control of government, who then encouraged private enterprises and risk taking. India started its accelerated growth path in 1991 when it abandoned its ‘licence raj’ and opened up its economy, allowing freer production and exchange of more goods and services among the various economic participants in the economy.

A high level of economic activity is often accompanied by a rise in domestic lending activity. Accordingly, the total loans extended to several sectors of the economy would record faster growth. The growth in loans would be supported by the banking sector's high liquidity levels – it allows banks high financial flexibility. The Loans-to-GDP ratio and Loans-to-Deposits ...