The Credit‐to‐gdp Gap and Complementary Indicators for Macroprudential Policy: Evidence From the Uk

Abstract

The financial crisis has demonstrated the need for a set of macroprudential policy tools that can be used to mitigate systemic risk. Focusing on the UK, our paper reviews the performance of the Basel III credit-to-GDP gap that, alongside judgement, is to be used as a reference guide in setting the countercyclical capital buffer. We find that this measure worked well in providing an advance signal of past UK episodes of banking system distress. But this does not guarantee future signalling success. We therefore evaluate some conceptual shortcomings of the credit gap and suggest complementary indicators. viewed as complementary: we discuss a subset of the indicators in Bank of England (2013) in more detail with a focus on indicators for which we have long time series available. We take the credit-to-GDP gap as a starting point, arguing that the gap as defined by the BCBS worked well in providing an advance signal of past UK crises. This is despite us using a real-time measure (see Edge and Meisenzahl (2011) for a contrasting discussion of this issue).But, as noted in Bank of England (2013), no single indicator can ever provide a perfect guide to systemic risks or the appropriate policy responses, given the complexity of financial interlinkages, the tendency for the financial system to evolve over time and time lags before risks become apparent. Policymakers will also need to monitor a wide and time-varying set of indicators, depending on the emerging risks. In this paper, we therefore discuss additional indicators that might complement the credit-to-GDP gap, both in the context of having been useful in past crises in the UK and elsewhere and in helping to address some of the credit-to-GDP gap's conceptual shortcomings. In particular, we argue that the sources and quality of credit are important, suggesting the need not only for an aggregate capital tool such as the countercyclical capital buffer but also sectoral tools such as sectoral capital requirements. Finally, we discuss indicators that might help determine when to release the capital buffers.In discussing other indicators, we take guidance from the literature on the basis of cross-country analyses (e.g. Kaminsky and Reinhart (1999); Drehmann et al. (2010); Drehmann et al. (2011); Borio and Lowe (2002, 2004) and Barrell et al. (2010)). Cross-country studies have the obvious advantage of relying on more observations that gives more rigour to understanding the indicators that have tended to signal banking crises in the past. However, they also have drawbacks. For example, there may be little gained by including countries with different institutional arrangements and financial structures in the same panel analysis. Moreover, data definitions may not be homogeneous across countries and time series employed in panel approaches tend to be limited. By taking the lessons from the cross-country literature but focusing on the UK only for our own analysis, we have the advantage of being less limited by data availability, can focus more closely on individual series and...

Monetary Policy and Cyclical Systemic Risk - Friends or Foes?

“…The most promising leading indicators of financial crises are gaps of the ratio of (private sector) credit-to-GDP and asset prices, especially property prices (Borio and Drehmann, 2009), as combining them appears to capture the link among the financial cycle, business cycle and crises. Borio et al (2012) and Giese et al (2014) show that financial cycle is effectively identified by the co-movement of cycles in credit and property prices aside from the creditto-GDP gap. The ESRB (2014) finds that the credit-to-GDP gap is the best single leading indicator for systemic banking crises associated with excessive credit growth for both…”

Calibrating Macroprudential Policy to Forecasts of Financial Stability

“…Note that we deflate both GDP and private credit by the GDP deflator since Giese et al (2014) found that real credit growth performs slightly better than nominal credit growth with respect to financial crisis notification. We model the transition between financial stability states based on changes in the underlying dynamics of real GDP growth, ∆ln(GDP t ), and real credit growth, ∆ln(C t ).…”

Optimizacija korištenja instrumenata monetarne i makroprudencijalne politike u svrhu očuvanja stabilnosti financijskog sustava

“…), što je u skladu s novijim istraživanjima, jer je jaz omjera kredita i BDP-a u odnosu na dugoro ni trend referentan pokazatelj Þ nancijske stabilnosti. Jaz omjera kredita i BDP-a koji premašuje svoj dugoro ni trend za više od 2 postotna boda, signalizira prekomjernu kreditnu aktivnost banaka te se tada u skladu s protucikli nom makroprudencijalnom politikom, aktiviraju dodatni kapitalni zahtjevi koji obvezuju kreditne institucije na ve a regulatorna izdvajanja i na taj na in stabiliziraju i vra aju trend u ciljane okvire (Giese et al, 2013.). Ve i regulatorni zahtjevi u vrijeme uzleta u poslovnim ciklusima smanjuju kreditnu aktivnost banaka, tako da smanjuju njihov kreditni potencijal, ime ublažavaju akumulaciju i taloženje rizika.…”