Forbearance and Broken Credit Cycles
Tomohiro Ota
Bank of England
15th December 2013
15th Macro Conference at the University of Tokyo
* The views expressed in this presentation are mine and not necessarily those of the Bank of England.
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: from crisis to post-crisis
•Low Productivity (except for US)
•Unusual fall in the level of productivity after the crisis
•Property Price Puzzle (except for US etc)
•Property price shows resilience after the crisis
•Slow Deleverage (except for US)
•Especially in less-performing sectors such as real-estate
•Broken Credit Cycle
•Especially in less-performing sectors such as real-estate
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: from crisis to post-crisis
10%
land price
Banking crisis
15%
Real GDP (old)
Real GDP (new)
5%
-5%
-10%
-15%
Market crash
0%
NPL resolved
•Broken credit cycle in Japan
•Correlation of land price and GDP (1st order difference) was 0.49
from 1956 till 1991, but -0.15 from 1991 till 2005.
•Looks like the correlation recovers after 2005
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: Can forbearance be an answer?
•Forbearance:
•Banks do not liquidate less-performing borrowers by revising
terms of the contracts
•Also called: Zombie lending, evergreening loans
•Why banks forbear
•Liquidating bad borrowers need capital (or bankrupt)
•Liquidation value could be higher in the future (gamble for
resurrection)
•Impacts to macroeconomy
•Production capitals are wasted on the hand of ‘zombies’
•Forbearance hinders new lending (and new investments)
•New entrants are especially penalised
•But forbearance can also boost investment if the financial
accelerator of the economy is high
Forbearance and Broken Credit Cycle
1. Introduction
Literature
•
Forbearance (theory)
• Kocherlakota and Shim (2007)
• Caballero Hoshi and Kashyap (2008)
• Philippon and Schnabl (2013)
•
Forbearance (empirical)
• Peek and Rosengren (2005)
• Saita et. al. (2003)
•
Relevant theories
• Credit Cycles:
• Kiyotaki and Moore (1997)
• Krishnamurthy (2003)
• Korineck and Jeanne (2011)
• Optimal bubbles:
• Martin and Ventura (2013)
Forbearance and Broken Credit Cycle
1. Introduction
Overview
1.
Introduction
2.
Defining baseline model
1. Mechanism of leverage and de-leverage
2. Financial accelerator and “crisis”
3.
Modelling forbearance
1. Impacts of forbearance
2. Banks’ incentive and coalition
4.
Policy discussions
1. Welfare analysis (simplistic)
2. Implementing efficient outcome
Forbearance and Broken Credit Cycle
2. Benchmark model
Assumptions
• 3 sets of players:
• Firms (atomless): better stochastic production technology at={aH, aL}
• Banks (many, but finite): collect deposit to lend or invest directly
• Dealers (atomless): with less profitable non-stochastic technology
Banks
Wealth ωt
Depositors
Collateral
land
Loans Dt
Liquidate
Seized collateral
Firms
Buy /sell
Dealers
kft
Asset
Market
(qt)
Buy /sell kbt
Forbearance and Broken Credit Cycle
2. Benchmark model
Timeline
Firms and banks sell land to outsiders at q2
They consume all the wealth and die
Land price q0 is determined
t=0
t=1
• Land (K) is supplied by outsiders
• Firms receive endowment ω0
• Banks receive endowed ‘capital’ W0
t=2
t=3
Forbearance and Broken Credit Cycle
2. Benchmark model
Firm’s problem
•
Budget constraint
•
Collateral constraint
•
Demand function
(constrained)
•
Harvest (at t+1):
firms obtain at+1 kft
at+1 = {aH, aL} with prob π and 1-π
•
Bankruptcy:
Firms cannot harvest any with Prob γ
•
Updating wealth ωt+1:
Forbearance and Broken Credit Cycle
2. Benchmark model
Firms’ problem: one more assumption
•
Do firms realise all capital gains from their asset holding?
•
Firms realise a fraction η of the capital gain
•
Firms’ demand function and financial accelerator
Forbearance and Broken Credit Cycle
2. Benchmark model
Dealers’ problem
•
Dealers’ payoff function
•
Dealers’ demand function (downward sloping)
•
Market Clearing condition
Forbearance and Broken Credit Cycle
2. Benchmark model
Banks’ problem
•
Banks determine loan size Dt and repayment Rt to maximise their next
period payoff
•
•
Each bank lends to many firms
Banks make a take-it-or-leave-it offer to firms and take all excess profits
•
Borrowing firms’ default risks are perfectly correlated:
• i.e. with probability γ, a bank receives no repayment
Forbearance and Broken Credit Cycle
2. Benchmark model
Equilibrium (when η is low)
Firms’ unconstrained demand fn
Firms’ constrained demand fn
qt
dealers’ demand fn
(horizontally inverted)
(1 – h)Et[qt+1]
ktf
ktb
K
Forbearance and Broken Credit Cycle
2. Benchmark model
Equilibrium with negative macro shock (at+1 = aL)
•
When η is small: Unique equilibrium
qt
Negative macro shock
(1 – h)Et[qt+1]
ktf
ktb
K
Forbearance and Broken Credit Cycle
2. Benchmark model
Equilibrium Price (output) Dynamism
qt
aH
aH
q0
aL
E0[q1]
aH
aL
E1[q2]
aL
t=0
t=1
t=2
t=3
Time
Proposition: In the baseline model, the asset price qt follows a process with
(nearly) zero drift.
Forbearance and Broken Credit Cycle
1. Introduction
Overview
1.
Introduction
2.
Defining baseline model
1. Mechanism of leverage and de-leverage
2. Financial accelerator and “crisis”
3.
Modelling forbearance
1. Impacts of forbearance
2. Banks’ incentive and coalition
4.
Policy discussions
1. Welfare analysis (simplistic)
2. Implementing efficient outcome
Forbearance and Broken Credit Cycle
3. Forbearance model
What happens to the ‘stricken’ banks under neg. shock
•
Asset price plunge creates loan loss of the banks
•
Banks with capital Wt below a regulatory threshold are penalised
•
Banks can ‘make up’ their capitals if they can contain the plunge
•
… but how?
Forbearance and Broken Credit Cycle
2. Benchmark model
Forbearance: a basic structure
failed
firms
Collateral
Banks
Depositors
repayment
Survived
firms
Buy /sell
Liquidate a fraction
Liquidate
– θ) of seized
Seized(1
collateral
collateral
Dealers
Asset
Market
Buy /sell
Forbearance and Broken Credit Cycle
3. Forbearance model
Forbearance: definitions
•
Renegotiation of terms and conditions of loan contracts
• LTV covenant breach
• Interest / debt service breach
• Maturity extension
• Payment holiday
•
Creating new loans to help borrowers service their debts
• “snowballing loans” (Japan)
•
Foreclosing borrowers, but not liquidating collateral assets
• Spanish banks till 2011
Forbearance and Broken Credit Cycle
3. Forbearance
Forbearance: assumptions
•
Bad borrowers (fraction γ)’ productivity is fixed at zero throughout
the periods
• Ie they do not recover, nor deteriorate further
•
The value of bad borrowers is measured by the value of their
collateral (ie banks have to write off all negative equities)
•
Banks can forbear only at t=1, and have to unwind at t=2
•
Banks have a chance to collude (not to liquidate bad borrowers)
Forbearance and Broken Credit Cycle
3. Forbearance model
Forbearance: impact on price and investment
•
bad borrowers stay at their land without producing any
• … and squeeze total available production capital
• Asset price should be pushed up in any equilibrium
q1
q1 s.t. W1=W
k1f
k1b
θγk0f
K
Forbearance and Broken Credit Cycle
3. Forbearance model
Equilibrium Price Dynamism
qt
aH
aH
aL
E0[q1]
q0
aL
aL
Time
t=0
t=1
t=2
Pre-crisis
crisis
Post-crisis
t=3
Forbearance and Broken Credit Cycle
3. Forbearance model
Equilibrium Investment Dynamism (when η is low)
kf t
aH
aH
aL
E0[kf1]
kf0
aL
aH
Time
t=0
t=1
t=2
t=3
Forbearance and Broken Credit Cycle
3. Forbearance model
Forbearance: impact on k1f
•
Firms’ demand function:
•
•
•
•
•
Higher land price lowers firms’ purchasing power directly
But the collateral value of land does not increase as the
unwinding of forbearance is expected
i.e. the ‘haircut’ of collateral land increases by forbearance
Higher land price increases firms’ wealth
Total supply of land decreases to K – θγkf0 .
•
θγkf0 is left unused
Forbearance and Broken Credit Cycle
3. Forbearance model
Forbearance (when η is high)
•
•
Forbearance could increase or decrease firms’ land holding k1f
• Depend on parameters, particularly higher η
• Difficult to solve analytically – numerical exercise needed
Increase of k1f is not the sufficient condition of higher output
qt
ktf
ktb
K
Forbearance and Broken Credit Cycle
3. Forbearance model
Forbearance: impact on k1f (new entrants)
•
Firms’ demand function:
•
Survived (incumbent) firms’ purchasing power is supported by the
wealth effect to some extent
• If we introduce new entrants with higher productivity
possessing ω0 at t=1, their land holding decreases further than
the incumbents
Forbearance and Broken Credit Cycle
3. Forbearance model
Incentive of Forbearance
•
•
•
Authorities monitor banks’ W1 and force banks to close if W1 < 0
Banks choose the fraction of zombie borrowers θ
Two symmetric equilibria:
• θ*=0
• θ* such that W1=Wbar: minimum deviation by a bank triggers
default
q1
q1 s.t. W1=W
k1f
k1b
θγk0f
K
Forbearance and Broken Credit Cycle
3. Forbearance model
Discouraging forbearance
•
•
If W1 is increased by the government (capital injection), or the
threshold Wbar is lowered, banks do not have to forbear
But if the injection is insufficient it could rather incentivise forbearance
q1
q1 s.t. W1=W
k1f
k1b
θγk0f
K
Forbearance and Broken Credit Cycle
4. Discussions
Provisioning and capitalisation: Japan and Spain
14
(JPY TLN)
(YOY %)
0%
-1%
12
public capital
injection (LHS)
10
-2%
land price growth
(RHS)
8
4
10
Deadline for new capital req.
2
House Price Index (% YoY, LHS)
8
0
7
-3%
-2
6
-4%
-5%
6
4
9
-4
-6%
-6
-7%
-8
-8%
-10
5
4
3
2
0
-9%
1992
1995
1998
2001
2004
2007
2
Capital Injection
(€ BLN, RHS)
1
-12
0
2008Q1
2009Q1
2010Q1
2011Q1
Forbearance and Broken Credit Cycle
4. Discussions
Policy implications
•
Externalities to healthy banks and healthy firms
• Forbearance reduces new lending from healthy banks to healthy
firms
• Healthy banks’ capital accumulation would slow down
•
Explains the international productivity gap
• The US: de-leveraging till 2010
• The UK: less de-leveraging in CRE sectors etc
Forbearance and Broken Credit Cycle
4. Discussions
Directions for further works
•
Social planner’s optimal θ (regulatory forbearance)
• Bank failure is currently costless in this model
• Surviving banks replace loans without friction
• Stricken banks do not internalise all negative effect on output
•
Another incentive of forbearance
• Expected price recovery in the future can lead to forbearance
• Externality creates a dynamic inconsistency
•
Endogenous interest rate
Forbearance and Broken Credit Cycle
4. Discussions
Summary
•
Banks do forbearance to avoid liquidating collateral assets in the middle
of the plunge of asset price (= realising a larger loan losses).
•
Higher asset price (than it should be) and expected price decline
tightens healthy firms’ credit constraint (negative externality), which
lowers the firms’ investments.
•
Healthy banks’ profit lowers as well, as they lose lending opportunities.
•
If financial accelerator effect is strong, higher asset price could boost
firms’ investment.
•
Policy responses would be non-monotonic
Forbearance and Broken Credit Cycle
5. Appendix
Appendix: revival of zombies?
•
•
During the “resolving NPL” stage from 2002 to 06, 10 tn Yen loans were
downgraded and 10tn Yen were upgraded
Banks choose the fraction of zombie borrowers θ (collectively)
NPLs based on the FRL (Financial Reconstruction Law)
(of which) Special attention Loans (3m arrears or renegotiated loans)
Increase factors
Newly generated loans due to weakened business activities
Upgrade from riskier categories
Improvement of business condition of borrowers
Establishment of restructuring plans
Decrease factors Return to normal claims
Improvement of business condition of borrowers
Establishment of restructuring plans
Downgrade to riskier categories
repayments etc
(of which) Doubtful and bankrupt/de facto bankrupt
Increase factors
Newly generated loans due to weakened business activities
Downgrade from safer categories
Decrease factor
Removal from B/S
cumulative chg
FY2002 - FY06
JPY TLN
-31.3
-12.6
12.3
2.6
1.4
1.2
-12.1
-9.7
-2.7
-10.3
-5.2
-18.7
15.0
10.3
-44.1
Forbearance and Broken Credit Cycle
2. Benchmark model
Competitive equilibrium (at t > 0)
•
When η is larger: No equilibrium (crisis)
qt
HIDDEN CHARTS
(1 – h)Et[qt+1]
ktf
ktb
K
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: from crisis to post-crisis
•Low Productivity (Hughes and Saleheen, 2012)
•Unusual fall in the level of productivity after the crisis (except for US)
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: from crisis to post-crisis
•Property Price Puzzle
•Residential property price experienced 250% increase from 2000
till 2007, the price dropped by only 20% after the crisis
400
(1991Q1 = 100, nominal price)
+137%
(‘00 – ’07)
350
300
-10%
(‘07 – ’12)
250
+62%
(‘00 – ’07)
200
150
100
UK House Price
50
0
1991 Q1
1995 Q1
1999 Q1
US House Price
2003 Q1
2007 Q1
2011 Q1
-19%
(‘07 – ’12)
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: from crisis to post-crisis
•Slow develerage (especially in less performing sectors)
Japan
UK
PNFC - non-CRE
1991 = 100
CRE
120
(Mar-08 = 100)
160
Construction
140
120
100
80
100
80
60
NPL resolved
Market peak
20
0
85
90
95
40
40
Banking crisis
80
60
00
05
10
NFCs - Non-property related
NFC - CRE
NFC-Property related (non CRE)
20
0
Dec-97
Dec-00
Dec-03
Dec-06
Dec-09 Sep-12
Forbearance and Broken Credit Cycle
1. Introduction
Motivations: from crisis to post-crisis
•Slow develerage (especially in less performing sectors)
Spain
35
US
(YOY %)
30
25%
25
20%
20
15%
15
10
10%
5
5%
0
0%
-5
-10
Corporates
Households
-5%
-10%
-15
-15%
-20
2000Q1 2002Q1 2004Q1 2006Q1 2008Q1 2010Q1 2012Q1
-20%
2000-01
Commercial and industrial
Resid real estate
Comm. real estate
Real estate
2003-01
2006-01
2009-01
2012-01
Forbearance and Broken Credit Cycle
3. Forbearance model
Forbearance: impact on price and investment
•
bad borrowers stay at their land without producing any
• … and squeeze total available production capital
• Asset price should be pushed up in any equilibrium
q1
q1 s.t. W1=W
k1f
k1b
θγk0f
K
Forbearance and Broken Credit Cycle
2. Benchmark model
Static Equilibrium (when η is high)
•
When η is larger: Multiple equilibria
• Demand curve becomes Z-shape
• Focus only on the stable equilibrium
qt
(1 – h)Et[qt+1]
ktf
ktb
K
Forbearance and Broken Credit Cycle
3. Forbearance model
Is forbearance good or bad?
•
Forbearance is rational for ‘stricken’ banks
•
Forbearance lowers investment (and output)
• Some production capital is wasted
• Productive firms reduce investment
• Healthy banks (and the stricken banks) reduce profit
•
Forbearance increases investment (and output)
• If the economy is highly leveraged, the positive ‘wealth effect’
outweighs everything else