The crisis has focused attention on mechanisms for ensuring that banks adjust their capital (or loan provisioning) countercyclically, building it up in good times and then drawing it down as stress materialises. Finding a good indicator that signals the time to build up and release the capital buffer won't be easy.
Here's what the BIS Annual Report has to say:
The following discussion covers three macroeconomic indicators: credit spreads, the change in real credit and a composite indicator that combines the credit/GDP ratio and real asset prices. The ideal macroeconomic indicator would reliably identify both the expansion and stress phases of the banking cycle. With that in mind, we present the variables as deviations from their respective neutral levels, measured here by a trend or long-term average; and the phases of the banking cycle are measured by deviations of the charge-off rate from its long-term average.
1) Loans and leases removed from the books and charged against loss reserves, as a percentage of average total loans. 2) Deviation of long-term BBB-rated corporate bond spreads from their long-term average, in basis points.
Narrowed credit spreads could be a signal of good times, and a significant widening may indicate the onset of a deterioration. However, the credit spread, measured here with BBB corporate bond spreads, is not a reliable indicator of banking system stress. For example, in contrast to the historical realities of banking stress, this indicator points to more serious financial strains after the collapse of the dotcom bubble than in the early 1990s.
3) Exponentially weighted five-year average real credit growth minus its 15-year rolling average, in percentage points.
The second candidate indicator is the change in credit, a choice based on the idea that banks tend to overextend credit before crises emerge and deleverage once strains materialise. However, credit growth exhibits considerable inertia, and it remains well above the neutral level even as banking strains begin to emerge. Hence, an indicator based on credit alone is likely to be late in signalling a release of the buffer.
4) Deviation of each variable from its one-sided long-term trend (that is, a trend determined only from information available at the time assessments are made); credit/GDP ratio in percentage points, property prices in per cent.
The third potential indicator draws on previous BIS research, which has found that when the credit/GDP ratio and real asset prices simultaneously deviate by large amounts from their respective trends, they provide a fairly reliable signal of impending banking crises with a considerable lead time. Because the composite indicator requires that a real asset price and the ratio of credit to GDP exceed thresholds at the same time, it avoids the late release of the buffer induced by the credit variable, but it may trigger it too early.
Go to page 133 of the report to read about choosing the formula that determines how the indicator will modify the minimum capital requirement.
related items:
Regulation and the Cylce, The Economist, Special Report
Here's what the BIS Annual Report has to say:
The following discussion covers three macroeconomic indicators: credit spreads, the change in real credit and a composite indicator that combines the credit/GDP ratio and real asset prices. The ideal macroeconomic indicator would reliably identify both the expansion and stress phases of the banking cycle. With that in mind, we present the variables as deviations from their respective neutral levels, measured here by a trend or long-term average; and the phases of the banking cycle are measured by deviations of the charge-off rate from its long-term average.
Credit Spreads
1) Loans and leases removed from the books and charged against loss reserves, as a percentage of average total loans. 2) Deviation of long-term BBB-rated corporate bond spreads from their long-term average, in basis points.
Narrowed credit spreads could be a signal of good times, and a significant widening may indicate the onset of a deterioration. However, the credit spread, measured here with BBB corporate bond spreads, is not a reliable indicator of banking system stress. For example, in contrast to the historical realities of banking stress, this indicator points to more serious financial strains after the collapse of the dotcom bubble than in the early 1990s.
Change in Credit
3) Exponentially weighted five-year average real credit growth minus its 15-year rolling average, in percentage points.
The second candidate indicator is the change in credit, a choice based on the idea that banks tend to overextend credit before crises emerge and deleverage once strains materialise. However, credit growth exhibits considerable inertia, and it remains well above the neutral level even as banking strains begin to emerge. Hence, an indicator based on credit alone is likely to be late in signalling a release of the buffer.
Composite Indicator
4) Deviation of each variable from its one-sided long-term trend (that is, a trend determined only from information available at the time assessments are made); credit/GDP ratio in percentage points, property prices in per cent.
The third potential indicator draws on previous BIS research, which has found that when the credit/GDP ratio and real asset prices simultaneously deviate by large amounts from their respective trends, they provide a fairly reliable signal of impending banking crises with a considerable lead time. Because the composite indicator requires that a real asset price and the ratio of credit to GDP exceed thresholds at the same time, it avoids the late release of the buffer induced by the credit variable, but it may trigger it too early.
Go to page 133 of the report to read about choosing the formula that determines how the indicator will modify the minimum capital requirement.
related items:
Regulation and the Cylce, The Economist, Special Report
Mahalanobis - am 2009-07-03 10:32
