Colombian policy makers are monitoring credit indicators to ensure that the lowest interest rate in Latin America doesn’t lead to excess risk-taking that could jeopardize the stability of the financial system, central bank board members said yesterday.

The central bank will study the quality of household credit, and the amount of debt that consumers are taking on, when it decides on the future direction of interest rates, bank co-director Cesar Vallejo said in an interview in Medellin.

“Credit risk would be generated if interest rates are excessively low, or if low interest rates induce debtors to take on more debt than they can handle, or creditors in the financial system fall into the temptation of offering more credit,” Vallejo said, on the sidelines of a conference of the country’s banking association Asobancaria.

In a separate interview at the same event, central bank board member Carlos Gustavo Cano said that leaving borrowing costs low for a prolonged period when inflation accelerates to its target and growth rises to its full potential rate, could generate financial risks.

The central bank has cut its policy rate two percentage points since June, to 3.25 percent, the lowest among major economies in the region, as growth cooled and the inflation rate fell to a six-decade low. Even as the economy has slowed, home prices have risen to record highs and credit growth has begun to pick up after slowing for more than a year.
‘First Tool’

Vallejo’s and Cano’s remarks came after central bank Governor Jose Dario Uribe told the banking association that policy makers could set interest rates higher than would be necessary to hit the inflation target, in order to prevent “financial imbalances”.

Speaking to reporters after his presentation, Uribe said the “first tool at hand” if there were excessive risk-taking would be regulatory measures such as higher capital requirements for banks.

Home prices rose 71 percent in the third quarter from a decade earlier, according to the bank’s inflation-adjusted housing price index, while the delinquent payment rate fell to a record low 2.3 percent last year. Home prices are rising faster than nominal gross domestic product, Uribe said.

The central bank repeatedly expressed concern with the pace of credit growth when it raised interest rates nine times between February 2011 and February 2012. Annual credit growth accelerated for a second straight month in January, to 15.4 percent, from 14.6 percent in November.
‘No Guarantee’

The central bank wants annual inflation back at the 3 percent midpoint of its target range, and doesn’t want it to remain at its current levels, Cano said. Vallejo forecast that inflation will return to 3 percent in the first half of 2014.

Inflation accelerated to 1.99 percent last month, according to the median forecast in a Bloomberg survey of 19 analysts, from a six decade-low of 1.83 percent in February. The statistics agency is scheduled to report March inflation today.

The central bank unexpectedly stepped up the pace of rate cuts in March, with the first half-point reduction in three years. The move was intended to speed up the elimination of the economy’s excess capacity, Vallejo said.

“We hope and expect that with this interest rate we can close the output gap, though there’s no guarantee that this is the interest rate that will do it,” Vallejo said.

Both Vallejo and Cano said that the level of the real, or inflation-adjusted, interest rate played a key role in the decision to cut rates by half a percentage point last month.

“One of the main reasons the bank decided to cut 50 basis points was that inflation has been falling faster than nominal rates, which means that instead of real interest rates falling, they were stable or went up,” Cano said.

Source: Business Week