Dell’Ariccia et al (2012), drawing on a large sample of AEs and EMDEs, concluded that about one in three credit booms has been followed by a financial crisis within three years of its end. They used bank credit as the reference variable, which almost exclusively corresponds to private debt. Koh et al (2020), drawing on a large sample of EMDEs, concluded that around 40% of the identified periods of rapid private debt accumulation were associated with financial crisis.
Credit booms tend also to be associated with periods of prolonged subdued growth. Dell’Ariccia et al (2012) concluded that three out of five credit booms culminated in extended periods of subdued economic growth. Jorda et al (2013a) also show, for a sample of AEs, that private leveraged booms tend to be followed by slower recoveries, in terms of GDP growth, investment spending and credit growth. Verner (2019) shows that private debt booms are good predictors of GDP slowdown.
It is also the case that the intensity of the credit boom increases the likelihood as well as the adversity of unfavorable outcomes. Dell’Ariccia et al (2012) show that credit booms that start at higher levels of leverage are more likely to end badly, that meaning a financial crisis and/or a period of subdued growth. Jordà et al (2013a) conclude that the intensity of leveraging is statistically associated with the adversity of the post-boom period.
Credit booms are different from financial deepening, which is not associated with disruptive outcomes. Credit booms are most of the times driven by an expansion in credit supply, in a context of declining credit spreads and riskier borrowers reflecting an increasing willingness to lend. They tend to fuel asset prices (housing in particular) and a reallocation of credit towards the non-tradable sector (construction in most cases). Finally, they leave in their wake private debt overhang and banking sector distress.