Banking Crisis and Macroeconomic Indicators
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1 Banking Crisis and Macroeconomic Indicators Steyr, Upper Austria, 18 th of May 2017 Webster University, Vienna
2 2 Outline 1. Introduction 2. Importance of the topic 3. Current state of the problem 4. Purpose of the research 5. Research question and methodology 6. Hypothesis 7. Results and final conclusion
3 3 1. Introduction In Central and Eastern European countries, bank financing plays a crucial role while public equity markets play a secondary role. Culturally and historically these countries have been in Austria s sphere of interest and it should come as no surprise that Austrian banks moved in when the Iron curtain fell in 1989.
4 4 1. Introduction Systemic banking crisis is an example of extreme turbulence in the financial markets. Researching systemic banking crisis is helpful, since it can lead to a higher level of predictability and better policy responses. The importance of predicting and mitigating systemic banking crisis cannot be underestimated given the impact on an economy in the form of falling aggregated output along with the problems it brings
5 5 2. Importance of the topic Importance: Banking crisis are very costly for society. Banking crisis are common. Most financial crisis has a banking component. Banks are universal and a policy pipeline (monetary policy). There is a need to understand the fundaments of banking crises.
6 6 3. Current state of the problem Systemic banking crisis happens regularly in developed economies as well as in emerging markets and middle income economies. Systemic banking crisis large number of defaults. Difficult too forecast systemic banking crises. So far regulation been unable to stop systemic banking crisis.
7 7 3. Current state of the problem Previous studies including Early Warning Systems (EWS)cover financial and banking crises based on the era. The empirical models follows 3 distinct different generations: Gen 1. Canonical model: Weak economic fundamentals, trade imbalances BOP and fiscal problems. Gen 2. Overinvestment: Self-fulfilling prophesy's of crisis and countercyclical policies. Gen 3. Advanced study of contagion, characteristics of banks, currency imbalances, maturity.
8 8 4. Purpose of the research The aim is to understand the fundamental causes of systemic banking crisis. The goal is to find leading macroeconomic indicators that increases or decreases the risk of a banking crisis. Understanding the riskiness of the Austrian banking system due to exposure to CEE countries.
9 9 4. Purpose of the research Limitations to the research: No bank specific factors, microeconomic factors, and corporate governance factors. Regulatory factors are not covered in the empirical testing, but can be explanation factor of the result. My research has a clear macroeconomic focus. Regulation, governance and microeconomic factors are nevertheless explained as they are important for the risk of systemic banking crisis.
10 10 5. Research question and methodology Contributes by creating knowledge by identifying macroeconomic indicators, increasing or decreasing the risk of a banking crisis. The core CEE countries are covered, Bulgaria, the Czech Republic, Hungary, Poland, Romania, and Slovakia and 10 macroeconomic leading indicators are included. The time period is from covering tranquil and turbulent times. All data is from The World Bank s Databank (data.worldbank.org) Multivariate linear regression with a dichotomous dependent variable.
11 11 5. Research question and methodology Banking crisis in CEE from Bulgaria Czech Republic Hungary Poland 1994 Romania had no crisis in the period Slovakia (Author s computation based on Laeven, & Valencia, 2013)
12 12 6. Hypothesis Summary of the hypothesis and the expected outcome: (a plus indicates increased risk of crisis, a minus the opposite) GDP, bc Banking crisis with value of 1 for the crisis n/a and 0 otherwise (1) gdp GDP Gross growth, domestic product of a country. Measured at purchaser's prices Inflation (CPI), (2) gdpg Growth of the economy measured with Real GDP exchange growth as the annual rate, percentage change in GDP in local constant currency Domestic credit in percent of GDP, (3) gdpc GDP per capita divided by midyear population. Data are in current U.S. dollars. Current account deficit in percent of GDP, (4) cpi M3 in Inflation percent as in change of in consumer GDP, prices measured with CPI in local constant currency Sovereign debt in percent of GDP, (5) rer The percentage change in the Exchange Rate. Year 2010 is the base year and set at External 100 debt in percent of GNI, (6) dc Domestic credit from financial sector in Central percent banks of GDP reserves percent GDP, Variable Leading indicators and definition Expected sign Result Indicator Expected n/a sign GDP, GDP growth, Inflation (CPI), + Real exchange rate, + or Domestic credit in percent of GDP, + Current account deficit in percent of GDP, M3 in percent of GDP, Sovereign debt in percent of GDP, + External debt in percent of GNI, Central (7) cagdp banks Current account reserves deficit surplus in Johan in Winbladh, percent Webster GDP, University, Vienna - of GDP + +
13 13 7. Results and final conclusion A disproportionate risk-taking in certain assets. Financial engineering. Two steps ahead of policy makers. External shocks. Currency crisis. Sovereign debt crisis. Subprime crisis, Great Recession. European sovereign debt crisis.
14 14 7. Results and final conclusion GDP is insignificant, larger economies like Poland do not have lower risk of a banking crisis. GDP growth should lead to less risk of a banking crisis since the economy is growing. The result is however insignificant. GDP per capita is also insignificant. Which is not surprising given the similarities of the tested countries. Inflation (CPI) increases the risk of banking crisis. Is the strongest leading indicator. Real exchange rate, was insignificant. Domestic credit is a leading indicator of a banking crisis. Current account deficit is also an indicator of banking crisis. The result was however insignificant.
15 15 7. Results and final conclusion Inflation remains a solid indicator of increased risk of systemic banking crisis for all the tested economies. It follows research developed by Englund,(1999) and Qian, Reinhart, and Rogoff,(2011). In several cases the systemic banking crisis followed a currency crisis, devaluation, or a move from fixed to floating exchange rate.
16 16 Bibliography Alesina, A. and Summers, L.H., Central bank independence and macroeconomic performance: some comparative evidence. Journal of Money, Credit and Banking, 25(2), pp Allen, F. and Gale, D., Bubbles and crises. The economic journal, 110(460), pp Buiter, W.H., Corsetti, G. and Pesenti, P.A., Financial markets and European monetary cooperation: The lessons of the exchange rate mechanism crisis (No. 2). Cambridge University Press. Da-Rocha, J.M., Gimenez, E.L. and Lores, F.X., Self-fulfilling crises with default and devaluation. Economic Theory, 53(3), pp Demirguc-Kunt, A. and Detragiache, E., The determinants of banking crises: evidence from industrial and developing countries. Demirgüç-Kunt, A. and Detragiache, E., The determinants of banking crises in developing and developed countries. Staff Papers, 45(1), pp Englund, P., The Swedish banking crisis: roots and consequences. Oxford review of economic policy, 15(3), pp Giavazzi, F. and Spaventa, L., Why the current account may matter in a monetary union: lessons from the financial crisis in the euro area. The Euro area and the financial crisis, p.199. Laeven, L. and Valencia, F., Systemic banking crises database. IMF Economic Review, 61(2), pp Marchetti, J.A., Ruta, M. and Teh, R., Trade imbalances and multilateral trade cooperation. Pan, F., Understanding the Argentine Peso s Devaluation in 2014 (Doctoral dissertation, Duke University Durham). Perry, G.E. and Forero, A., Latin America: The Day After. Is This Time Different?. Pettway, R.H. and Sinkey, J.F., Establishing On Site Bank Examination Priorities: An Early Warning System Using Accounting and Market Information. The Journal of Finance, 35(1), pp Reinhart, C.M. and Rogoff, K.S., This time is different: A panoramic view of eight centuries of financial crises (No. w13882). National Bureau of Economic Research. Reinhart, C.M. and Rogoff, K.S., This time is different: Eight centuries of financial folly. Princeton university press. Reinhart, C.M. and Rogoff, K.S., Growth in a time of debt (digest summary). American Economic Review, 100(2), pp Reinhart, C.M. and Rogoff, K.S., From financial crash to debt crisis. The American Economic Review, 101(5), pp Reinhart, C.M. and Rogoff, K.S., Recovery from financial crises: evidence from 100 episodes. The American Economic Review, 104(5), pp Sachs, J., Tornell, A. and Velasco, A., The Mexican peso crisis: Sudden death or death foretold?. Journal of international economics, 41(3), pp Santomero, A.M. and Vinso, J.D., Estimating the probability of failure for commercial banks and the banking system. Journal of Banking & Finance, 1(2), pp Sharpe, W.F., Portfolio theory and capital markets. McGraw-Hill College. Sinkey, J.F., A multivariate statistical analysis of the characteristics of problem banks. The Journal of Finance, 30(1), pp Tiruneh, M.W., An empirical investigation into the determinants of external indebtedness. University of Munich, Empirical Research Group, Munich and Institute of Slovak and World Economics Slovak Academy of Sciences, Bratislava, Slovakia. World Bank. (n.d.). Indicators. Retrieved February 09, 2017, from
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