Rising debts might boost economic growth in the short-term but after a year or more they can drag on growth and build risks of a financial crisis, the International Monetary Fund has warned.
“An increase in the household debt-to-GDP ratio is typically associated with higher economic growth and lower unemployment, but the effects are reversed in three to five years,” the IMF said.
“Moreover, higher growth in household debt is associated with a greater probability of banking crises.”
Restoring credit growth has been a key plank of post-financial crisis economic policy, as banks closed their doors in the wake of the credit crunch.
Credit is relatively freely flowing in the US, UK and, to an extent, much of the eurozone, supporting consumer spending, business growth and asset prices.
But the IMF fears that too much lending growth can build up serious risks.
“Higher credit growth and credit to GDP signal greater downside risk to growth at horizons of one year and longer,” the institution said in its Global Financial Stability Report.
The warning was published on the eve of the IMF’s annual meeting in Washington DC.
“Higher household debt is associated with a greater probability of a banking crisis, especially when debt is already high, and with greater risk of declines in bank equity prices,” the report said.
The report looks at the global economy but also applies to Britain, where consumer debts are rising sharply and mortgage borrowing is on a steady upward trajectory.
The IMF said that house prices in particular should be studied for signs of instability or financial vulnerability
“The dynamics of house prices are particularly important in countries where either the share of homeownership and floating-rate mortgages is high (such as the United Kingdom) or the mortgage market is a key node that underpins pricing and activity in systemic funding markets (as in the United States),” the report said.
However the IMF added that sound banking regulation can help, as lenders are more stable if they are well capitalised and their loans are closely monitored.