The Anatomy of Household Debt Build Up in Croatia: Enlisting More Creditworthy Households or Relaxing Lending Standards?

The goal of this paper is to determine whether the rapid accumulation of household debt in Croatia between 2005 and 2008 was driven by the improving creditworthiness of borrowers or their willingness to carry more debt due to optimistic expectations and the relaxation of banks’ lending standards. A new approach is proposed which uses decomposition techniques previously employed in the analysis of wage gaps to capture risks related to the dynamics of household lending. We find that improved creditworthiness can explain only a minor part of the rise in the debt of Croatian households over the observed period (2005–2008). It was, rather, more lenient lending standards coupled with households’ willingness to borrow in increasing amounts on the back of optimistic expectations that had a prominent role in the expansion of household debt. The role of more lenient lending standards was especially pronounced in the case of highly indebted households, whose creditworthiness improved only very slightly or even deteriorated. Also, banks provided access to credit to more risky segments of the population as the creditworthiness of indebted households deteriorated relative to the general population.