Drivers and Sustainability of Credit Growth in Paraguay

Paraguay’s financial system is bank dominated and currently liquid, profitable, and well capitalized. Credit growth has been strong in recent years—outpacing regional peers—in the context of robust economic activity. While it has moderated more recently, consumer credit continues to expand more rapidly, supported by digitalization, strong economic activity, and greater financial inclusion. Although NPLs remain close to historical lows, this raises questions about potential vulnerabilities, especially if combined with other shocks, such as droughts. For instance, in 2019 and 2022, Paraguay experienced two droughts, which coincided with periods of flat economic growth, owing to their negative impact on agricultural and hydroelectric production, as well as river navigation. The particularly severe drought in 2022 reduced agricultural output by 33.6 percent in the first half of the year and was followed by a significant increase in NPLs over the subsequent year. To examine these questions, this paper uses a macro financial modeling tool developed by the IMF Institute for Capacity Development customized for the case of Paraguay. Staff considered two shock scenarios: a drought calibrated to the experiences in 2019 and 2022, and an asset quality deterioration in addition to the endogenous deterioration due to the drought. The results suggest that Paraguay’s financial system is resilient to these scenarios, with buffers sufficient to sustain the provision of credit—and thereby supporting economic growth—even under combined shocks. However, more severe shock combinations could generate amplification effects, including as banks’ efforts to rebuild buffers would be associated with tighter financial conditions. These findings underscore the importance of close supervisory monitoring and strengthening the supervision of climate-related risks. Development of the macroprudential policy toolkit, especially of borrower-based tools (e.g., DSTI limits), would also increase the room of maneuver to contain vulnerabilities from the expansion of consumer credit.