Banking Crisis and Macroeconomic Indicators

Banking Crisis and Macroeconomic Indicators Steyr, Upper Austria, 18 th of May 2017 Webster University, Vienna

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 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 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 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 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 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 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 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 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 1990-2015 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 5. Research question and methodology Banking crisis in CEE from 1990-2015 Bulgaria 1996-1997 Czech Republic 1996-2000 Hungary 1994-1995 Poland 1994 Romania had no crisis in the period Slovakia 1998-2000 (Author s computation based on Laeven, & Valencia, 2013)

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 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 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 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.

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