Credit Conditions and Recoveries from Financial Crises

• Author: Prakash Kannan
• Pages: 1-3

Page 1

As the worst of the 2008 global financial crisis appears to be behind us, the focus has shifted to the prospects of recovery. Commentary in the financial press has typically revolved around predicting whether the path of output following the trough of the recession will be U-shaped, V-shaped, W-shaped (a double-dip recession), or L-shaped (a very sluggish recovery).

Recent research at the IMF has examined the patterns of recovery from recessions associated with financial crises in a set of 21 advanced economies (IMF, 2009). The episodes were based on the combination of two databases of banking and financial crises-Reinhart and Rogoff (2008) and Laeven and Valencia (2008)-along with the dating of recession and recovery phases from Claessens, Kose, and Terrones (2009). Recoveries from recessions associated with financial crises were found to be slower relative to a typical recovery. The average time taken for output to return to its previous peak was about six quarters compared to three quarters for all other recoveries. One year after the trough of the recession, the average growth rate of output was only about 2 percent for these episodes compared with an average growth rate of about 4 percent for recessions that were not associated with a financial crisis.

"Policies aimed at recapitalizing financial institutions, resolving distressed financial assets, and ensuring adequate provision of liquidity are crucial to restore the health of the banking system"

One particularly striking finding from this research is that recoveries from recessions associated with financial crises in advanced economies feature a near absence of growth in domestic credit. Credit remains essentially flat even up to two years after the end of the recession, a pattern that is significantly different from all other recovery episodes. Although the demand for credit is generally lower in the aftermath of a financial crisis as households and firms deleverage, stressed credit conditions during these episodes suggest that restrictions in the supply of credit are also important.

Credit conditions become particularly stressed during recessions associated with financial crises due to the occurrence of two distinct events. First, episodes of financial crises are usually accompanied by systemic bank runs, a significant number of bank closures, or a widespread depletion of bank capital, all of which serve to reduce the effectiveness of the financial...