Are weak banks leading credit booms? Evidence from emerging Europe

Abstract

In an environment of brisk credit growth, supervisors tend to watch carefully whether weak banks are starting to expand rapidly. Sounder banks may have a competitive advantage in meeting the demand for credit owing to their larger capital cushions and better risk management, but weaker banks may have strong incentives to expand aggressively, in an attempt to grow out of problems by boosting their market share and profits. If the pace of expansion overwhelms banks' ability to manage risk, their asset quality would deteriorate over time. How sound are the banks that are driving credit expansion is a question that is particularly relevant for emerging Europe, where bank credit has been growing rapidly - at average annual rates of 25%-40% - during the last decade.