Domestic banking systems in Hong Kong, China and Canada are signalling vulnerability to a crisis, warns the Bank for International Settlements (BIS). Additionally, property price developments are fueling more vulnerability in Hong Kong and Canada.
The BIS back-tested seven indicators and found that four composite indicators correctly predicted two-thirds of past banking crises:
- credit-to-GDP gap (difference between the non-financial sector's credit-to-GDP ratio and its long-term trend)
- debt service ratio (interest payments and amortization relative to income)
- household debt service ratio (difference between household sector DSR and its 20-year rolling average)
- cross-border claims to GDP (cross[border borrowing and foreign currency debt issued across borders and at home)
"Aggregate credit indicators point to vulnerabilities in several jurisdictions," says the BIS in a report. "Canada, China and Hong Kong SAR stand out, with both the credit-to-GDP gap and the DSR flashing red. For Canada and Hong Kong, these signals are reinforced by property price developments."
Credit-to-GDP gaps and/or the total DSR send amber signals in some advanced economies, such as France, Japan and Switzerland, according to the report. In Indonesia, Malaysia and Thailand, as well as some other countries, property price gaps underscore this signal.
In Korea, Russia and Thailand, the household sector DSR flashes red. Thailand, the red signal for the household DSR is underlined by the property price indicator. Property prices have also been in elevated in Sweden and Canada, which exhibit an amber signal for the household DSR.
Early warning indicatiors in domestic banking systems
The threshold for red (and for amber) cells minimizes false alarms conditional on capturing at least two thirds (90%) of historical crises with a cumulative three-year prediction horizon. Asterisks highlight a signal of the combined indicator when property price gaps were above 11 at some point during the last three years. Source: Bank for International Settlements
Words of Caution
These indicators need to be interpreted with considerable caution, says the BIS. "As always, they have been calibrated based on past experience, and cannot take account of broader institutional and economic changes that have taken place since previous crises."
"For example, the much more active use of macroprudential measures should have strengthened the resilience of the financial system to a financial bust, even if it may not have prevented the build-up of the usual signs of vulnerabilities. Similarly, the large increase in foreign currency reserves in several [emerging market economies] should help buffer strains."
"The indicators should be seen not as a definitive warning but only as a first step in a broader analysis – a tool to help guide a more drilled down and granular assessment of financial vulnerabilities. And they may also point to broader macroeconomic vulnerabilities, providing a sense of the potential slowdown in output from financial cycle developments should the outlook deteriorate."