A Leading Indicator Model of Banking Distress - Developing an Early Warning System for Hong Hong and Other EMEAP Economies

Hong Kong Monetary Authority Working Paper No. 22/2007

46 Pages Posted: 27 Dec 2007

See all articles by Jim Wong

Jim Wong

Hong Kong Monetary Authority

T. C. Wong

Hong Kong Monetary Authority - Research Department

Phyllis Leung

Hong Kong Monetary Authority - Research Department

Date Written: December 18, 2007

Abstract

This study develops a probit econometric model to identify a set of leading indicators of banking distress and estimate banking distress probability for Hong Kong and other EMEAP economies. Macroeconomic fundamentals, currency crisis vulnerability, credit risk of banks and companies, asset price bubbles, credit growth, and the occurrence of distress of other economies in the region are found to be important leading indicators of banking distress in the home economy. The predictive power of the model is reasonably good. A case study of Hong Kong based on the latest estimate of banking distress probability and stress testing results shows that currently the banking sector in Hong Kong is healthy and should be able to withstand well certain possible adverse shocks. Under some extreme shocks originating from real GDP growth and property prices such as those that occurred during the Asian financial crisis, the model indicates a non-negligible risk of an occurrence of banking distress in Hong Kong. However, the chances of the occurrence of such severe events are extremely low. Simulation results also suggest that compared to the period before the Asian financial crisis, the local banking sector is currently more capable of withstan ding shocks similar to those that occurred during that crisis. The study also finds that banking distress is contagious, suggesting that to be effective in monitoring banking distress, close cooperation between central banks should be in place.

Keywords: Banking distress, Asia Pacific economies, econometric model

JEL Classification: E44, E47, G21

Suggested Citation

Wong, Jim and Wong, Tak-Chuen and Leung, Phyllis, A Leading Indicator Model of Banking Distress - Developing an Early Warning System for Hong Hong and Other EMEAP Economies (December 18, 2007). Hong Kong Monetary Authority Working Paper No. 22/2007. Available at SSRN: https://ssrn.com/abstract=1078765 or http://dx.doi.org/10.2139/ssrn.1078765

Jim Wong (Contact Author)

Hong Kong Monetary Authority ( email )

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

Tak-Chuen Wong

Hong Kong Monetary Authority - Research Department ( email )

55/F, Two International Finance Centre,
8 Finance Street, Central,
Hong Kong
Hong Kong

Phyllis Leung

Hong Kong Monetary Authority - Research Department ( email )

3 Garden Road, 30th Floor
Hong Kong
China

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