IMF published a working paper that reviews the key limitations of the Basel Credit Gap (BCG) and proposes two alternative approaches that can complement the BCG when assessing credit excesses or deciding whether to activate the countercyclical capital buffer (CCyB). The analysis highlights that the BCG tends to become persistently negative after a pronounced credit boom deflates, implausibly indicating that credit should return to its cyclical peak. This poses questions about the usefulness of the BCG as a guide for macro-prudential policy setting over the full credit cycle.
The paper on measuring credit gap highlights that assessing when credit is excessive is important to understand macro-financial vulnerabilities and guide macro-prudential policy. The Basel Credit Gap (BCG)—the deviation of the credit-to-GDP ratio from its long-term trend estimated with a one-sided Hodrick-Prescott (HP) filter—is the indicator preferred by the Basel Committee because of its good performance as an early warning of banking crises. However, for a number of European countries, this indicator implausibly suggests that credit should go back to its level at the peak of the boom after the credit cycle turns, resulting in large negative gaps that might delay the activation of macro-prudential policies. The paper presents two different approaches—a multivariate filter based on economic theory and a fundamentals-based panel regression.
Each approach has pros and cons, but they both provide a useful complement to the BCG in assessing macro-financial vulnerabilities in Europe. The authors show that both methodologies yield credit gaps that turn positive ahead of crises (similar to the BCG) but, unlike the BCG, do not remain negative for an extended period following the burst of a large and prolonged credit boom. The study does not test the crisis early warning properties of these two measures because, as experience with the BCG indicates, focus on these properties may produce a measure that performs poorly in other phases of the credit cycle. Having an indicator that can produce a view of the position of the economy over the entire financial cycle may inform recommendations of broader macroeconomic policy, beyond the decision on the CCyB.
Related Link: Working Paper
Keywords: International, Europe, Banking, CCyB, Macro-Prudential Policy, Basel Credit Gap, Research, Credit Risk, BCBS, IMF
Previous ArticleBCBS Issues Reporting Instructions and Template for G-SIB Assessment
In a letter addressed to the industry, the Australian Prudential Regulation Authority (APRA) set out an updated schedule of policy priorities for the banking, insurance, and superannuation industries.
The European Commission (EC) adopted a comprehensive review package of Solvency II rules in the European Union.
The Office of the Comptroller of the Currency (OCC) issued Versions 1.0 of the "Earnings" and "Regulatory Reporting" booklets of the Comptroller's Handbook.
The European Central Bank (ECB) published results of its economy-wide climate stress test, which aimed to assess the resilience of non-financial corporates and euro area banks to climate risks.
The European Banking Authority (EBA) published a report on the use of digital platforms in the banking and payments sector in European Union.
The Hong Kong Monetary Authority (HKMA) published updates on the policy measures that were announced in context of the ongoing pandemic.
The International Swaps and Derivatives Association (ISDA), along with several other associations, submitted a joint response to the Basel Committee on Banking Supervision (BCBS) consultation on preliminary proposals for the prudential treatment of cryptoasset exposures.
BIS published the September issue of the Quarterly Review, which contains special features that analyze the rapid rise in equity funding for financial technology firms, the effectiveness of policy measures in response to pandemic, and the evolution of international banking.
The Basel Committee for Banking Supervision (BCBS) met in September 2021 and reviewed climate-related financial risks, discussed impact of digitalization, and welcomed efforts by the International Financial Reporting Standards (IFRS) Foundation to develop a common set of sustainability reporting standards
The Office of the Comptroller of the Currency (OCC) issued a Cease and Desist Order against MUFG Union Bank for deficiencies in technology and operational risk governance.