The Credit Cycle: How the Availability of Credit Passes Through Rates, Banks and Borrowers

The credit cycle is a fluctuation not in demand for goods but in the lender's willingness to part with money and in the terms on which the lender does so. It explains why one and the same business, with the same revenue and the same assets, is valued differently by the market in different years: what changes is not the company but the price and availability of borrowed money against it. For an investor, the credit cycle is neither a calendar nor a signal to trade; it is a framework that shows which part of a company's result belongs to management and which part belongs to the phase that credit is currently in.

What exactly fluctuates

The interest rate is the most visible variable, but not the only one. The terms of access move together with it: collateral requirements and the way collateral is valued, the set of covenants, the maximum maturity of a loan, and the bank's willingness to refinance what it has already lent. In an expansion the lender agrees to a long maturity, weak security and loose restrictions; in a contraction the same money costs more, is lent for a shorter period and comes with tighter obligations. The borrower may not feel any of this as a refusal: it will simply be offered a refinancing for a term that does not cover its investment horizon.

The second variable is the risk premium. On the bond market it is visible as the spread between the yield of an issue and that of a government bond of comparable maturity. This spread is the market price of that very credit risk: it widens when lenders begin to price in the probability of non-payment, and it narrows when competition to place money intensifies. The spread moves earlier than the issuer's financial statements do, because it reflects an expectation rather than an accomplished fact.

The self-reinforcing mechanism

The credit cycle rests on a feedback loop that runs through the value of collateral. Rising asset prices enlarge the collateral base: more money is lent against the same property, equipment or block of shares. Part of that money flows back into the same assets and pushes their price higher still, which widens the collateral base once again. This is the logic described by Minsky: sustained calm itself creates the conditions for instability, because it rewards those who borrowed more aggressively.

The reversal works symmetrically and usually faster. A fall in the valuation of collateral cuts the available credit limit, the borrower repays or sells, the sales weigh on the asset price, and the collateral valuation falls again. At no step does this require a crisis or anyone's ill intent — it is enough that credit is extended against a value which itself depends on the volume of credit.

The channels through which this reaches the Russian market

The primary channel is the monetary policy of the Bank of Russia: the key rate sets the cost of funding for banks and, through it, the cost of all rouble borrowing. The second channel is bank capital: the more provisions are charged against problem loans, the less capital is left to back new lending, and the contraction continues even without any further rise in the rate. The third is the bond market, where a company's redemption schedule turns into a refinancing problem if a maturity falls in an unfavourable phase.

For banks, the cycle is directly visible in the financial statements: cost of risk, the movement of provisions, net interest margin. The current multiples of a stock can be viewed on its instrument page — {{instrument:SBER}}, 3,77 — but interpreting them without regard to the phase of the cycle is pointless: with cyclical earnings, a cheap multiple more often signals an expected fall in earnings than undervaluation. For companies outside the financial sector, the cycle shows up in the cost of debt and in the schedule of its repayment: see issuers' financial statements and the corporate news feed on placements and put offers, and find the dates in the events calendar.

The credit cycle and the credit rating are not the same thing

A rating ranks issuers against one another by their ability to service debt; the phase of the cycle shifts the whole scale at once. In an expansion, an issuer with a mid-range rating borrows without difficulty; in a contraction it borrows only at a noticeable premium, with the rating unchanged. That is why a change in the spread on corporate bonds often runs ahead of a rating revision rather than following it. The distinction is examined in detail in the article on what a rating assesses and what it does not guarantee; the definitions are in the glossary.

What follows from this for a portfolio

The practical conclusion is not to guess the turn but to know where in the portfolio the dependence on cheap credit sits: with issuers that have short-dated debt and redemptions close at hand, with businesses that carry a high share of debt financing, and with banks — through the quality of the loan book. This dependence can be seen in advance from the redemption schedule and the interest coverage, whereas the moment at which it materialises cannot.