Evaluating Early Warning Indicators of Banking Crises: Satisfying Policy Requirements

37 Pages Posted: 27 Feb 2014

See all articles by Mathias Drehmann

Mathias Drehmann

Bank for International Settlements (BIS)

Mikael Juselius

Bank for International Settlements (BIS) - Monetary and Economic Department; Hanken School of Economics - Department of Economics; University of Helsinki - Department of Political and Economic Studies

Date Written: August 2013

Abstract

Early warning indicators (EWIs) of banking crises should ideally be evaluated on the basis of their performance relative to the macroprudential policy maker's decision problem. We translate several practical aspects of this problem - such as difficulties in assessing the costs and benefits of various policy measures as well as requirements for the timing and stability of EWIs - into statistical evaluation criteria. Applying the criteria to a set of potential EWIs, we find that the credit-to-GDP gap and a new indicator, the debt service ratio (DSR), consistently outperform other measures. The credit-to-GDP gap is the best indicator at longer horizons, whereas the DSR dominates at shorter horizons.

Keywords: EWIs, ROC, area under the curve, macroprudential policy

JEL Classification: C40, G01

Suggested Citation

Drehmann, Mathias and Juselius, Mikael, Evaluating Early Warning Indicators of Banking Crises: Satisfying Policy Requirements (August 2013). BIS Working Paper No. 421, Available at SSRN: https://ssrn.com/abstract=2384447

Mathias Drehmann (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Mikael Juselius

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

Hanken School of Economics - Department of Economics ( email )

PO Box 479
FI-00101 Helsinki
Finland

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland

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