BIS Study Suggests Households, Companies Set to Reduce Debt

Households and companies will continue to reduce debt built up before the financial crisis, according to a report by the Bank for International Settlements.

A study of 20 systemic banking crises that were preceded by surges in credit showed that in 17 cases, debt relative to gross domestic product returned to levels seen before the crisis, economists Garry Tang and Christian Upper wrote in the Basel, Switzerland-based BIS’s latest quarterly review.

“If history is any guide, we should expect to see a much more significant reduction in private-sector debt, particularly of households, than has so far taken place after the recent crisis,” they wrote. “Lower house prices may induce households to reduce their desired level of debt. Similarly, a lower level of output and tighter financial conditions could put firms under pressure to reduce their leverage.”

While policy makers including European Central Bank President Jean-Claude Trichet have forecast fiscal consolidation measures to reduce debt may curb demand, the BIS report said such efforts don’t necessarily undermine recoveries. In most cases in the study, growth rebounded while debt ratios fell, provided banks took steps to recognize losses and build up capital.

“We take this as an indication that it is possible to reduce debt and still experience healthy growth,” according to the report. “For this to be the case, policy makers have first to fix the problems in the banking system that led to the financial crisis.”

The smallest amount of debt reduction by private, non- financial borrowers in the study was in Chile, where the ratio of debt to GDP fell by 10 percentage points from 1982-1983. That’s still more than what borrowers have achieved so far after the most recent crisis, according to the report.

The study showed the ratio in the 17 nations, which included Japan, Russia and Sweden, fell an average of 38 percentage points after a crisis because of defaults and repayments, inflation and economic growth.

To contact the reporter on this story: Jennifer Ryan in London at jryan13@bloomberg.net

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