Foreign Booms, Domestic Busts: The Global Dimension of Banking Crises

Abstract

This paper provides novel empirical evidence showing that foreign financial developments are a powerful predictor of domestic banking crises. Using a new data set for 38 advanced and emerging economies over 1970-2011, we show that credit growth in the rest of the world has a large positive effect on the probability of banking crises taking place at home, even when controlling for domestic credit growth. Our results suggest that this effect is larger for financially open economies, and is consistent with transmission via cross-border capital flows and market sentiment. Direct contagion from foreign crises plays an important role, but does not account for the whole effect.

Foreign Vulnerabilities, Domestic Risks: The Global Drivers of GDP-at-Risk

“…These findings have some parallels with the early-warning literature, where faster global credit growth is found to be a significant predictor of crises (Cesa-Bianchi et al, 2019;Bluwstein et al, 2020). However, our results are more general, suggesting that this predictability arises specifically from the association between foreign variables and the left tail of the domestic GDP growth distribution.…”

“…We include the foreign-weighted counterparts of each of the indicators in the foreign variable set X * i,t . 6 This variable choice is, in part, motivated by evidence that global financial market indicators and credit quantities tend to predict domestic financial crises (Cesa-Bianchi et al, 2019;Bluwstein et al, 2020). For our baseline results, we construct foreignweighted variables using data on bilateral trade linkages.…”

Credit Growth, the Yield Curve and Financial Crisis Prediction: Evidence from a Machine Learning Approach

“…During the global financial crisis, and only then, by far the most important predictor is global credit. This may be partly driven by financial globalisation which has magnified the importance of international credit growth (Cesa-Bianchi et al, 2019). For example, Germany and Switzerland experienced negative domestic credit to GDP growth before the global financial crisis.…”

“…Kaminsky and Reinhart (1999); Bussiere and Fratzscher (2006) ;Drehmann et al (2011); Frankel and Saravelos (2012); Schularick and Taylor (2012); Drehmann and Juselius (2014); Babeckỳ et al (2014); Giese et al (2014)). This literature typically identified domestic private credit or credit-to-GDP growth and indebtedness as key predictors of financial crises, with more recent work (Alessi and Detken, 2011;Duca and Peltonen, 2013;Cesa-Bianchi et al, 2019) also highlighting the importance of global credit growth in predicting crisis after 1970. Our results are in line with these findings.…”

Findings of the recent literature on international capital flows

“…There is empirical support for this international banking channel and the associated global credit cycle. Cesa- Bianchi et al (2017) have found evidence of a common factor explaining up to half of the variance of domestic credit growth in 38 advanced and emerging countries in recent years and support for the transmission channels being mostly through the financial sector rather than trade and real effects. Baskaya et al (2017aBaskaya et al ( , 2017b have also found supporting evidence in the case of Turkey.…”