Microsoft Word Thesis Gent (1). doc

3.2 Development of credit cycle and its impact in financial system 
Banking crisis in Czech Republic in 1999 affected the Czech economy for a variety of 
factors; however, the crisis was mostly caused by the development of credit crunch, 
(Pospioil & Singer, 1999). Nonetheless, Pospiol & Singerdid (1999) did not specifically 
define the term’ credit crunch’. In the meantime credit crunch referred to situations that 
were created because interest rates were incoherent with demand and supply of credit. 
Indeed, credit crunch regarding by authors was similar of credit rationing. 
In CEE (Central Eastern European) countries credit growth has been one of the major 
factor, which took attention of many authors in order to do studies. Studies mostly have 

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attempted to examine causes of credit growth as well as its level of equilibrium, (Otker-
Robe & Enoch, 2007). 
The transition economies were worrying about the credit crunch as there was 
development of credit growth massive growth of credit would risk macroeconomic and 
financial stability, 
(
Hilbers, Otker-Obe, Pazarbasioglu & Johnsen, 2005).
Macroeconomic and financial stability of a country can be threatened by the excessive 
credit growth in several ways. There are several ways how the excessive credit impacts 
the macroeconomic stability such as, the encouragement of consumption that comes as 
a result of lending and the overheat in economy that occurs because of the 
intensification of loans in private sector which falsely over-initiate aggregate demand 
beyond the real capacity of output, (Gersl & Seidler, 2011). Furthermore, this overheats 
the economy and has an indirect impact also on inflation rate, the interest rates, current 
account deficit and the real exchange rate. Meanwhile, in economic growth phase 
financial institutions may be very optimistic while predicting the borrowers’ future 
ability to return the loan. Hence, they increase giving “bad” loans to high-risk 
borrowers during the upward phase of the credit cycle. Moreover, there are cases that 
foreign investors finance the domestic credit boom, which increases the risk that the 
domestic banks will not have enough balance-sheet liquidity. This process occurred in 
several excluding Czech Republic, (Gersl & Seidler, 2011). 
Furthermore, as the interest rates in foreign markets were lower, thus the private loans 
were given in foreign currencies. As a result this may cause the domestic currency to 
depreciate thus the credit expressed in domestic currency increases, while the debt of 
servicing costs increases also and the risk of foreign exchange risk transforms into 
credit risk, (Gersl & Seidler, 2011). 
Many studies support the idea the excessive credit growth may be one of the earliest 
and more reliable signs that foretell future problems in the banking sector. Given that 
the serious banking sector problems start with the burst of credit bubble and negative 
macroeconomic development, which lead to non-performing loans (NPLs) and external 

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financing constrains. Also, according to IMF (2004) more than 75 percent of the credit 
booms have ended by banking or currency crises.