Restoring credit market stability conditions in Italy: evidences on Loan and Bad Loan dynamics

In this paper we study the effect of credit deterioration on loan dynamics in the Italian non financial sector. The aim is to analyze, from a macroeconometric point of view, if credit growth rate is simply affected by bad loans stock variation or if there are other proxies of credit worsening that could have an influence on it. We use a factor model approach to capture all the pervasive factors that could affect the cyclical dynamics of the credit market, and we take into account the structural breaks induced by the Great Recession using quarterly data for the period 1998:4–2014:4. We reach the conclusion that new bad loans entry rate is the credit quality proxy that seems to express a signifi- cant and robust impact on lending dynamics. An increase of this ratio seems to cause a loans contraction after only 3 months and this evidence is useful in formulating some policy conclusions about banking system stability. We provide also results on new bad loans entry rate dynamics, finding a significant relation with GDP at infra-annual period (6 months)