Banking and Currency Crises: Differential Diagnostics for Developed Countries

44 Pages Posted: 23 Jun 2015

See all articles by Mark Joy

Mark Joy

Bank of England

Marek Rusnak

Czech National Bank (CNB); Charles University in Prague

Katerina Smidkova

Czech National Bank (Deceased); Charles University - Economics Department (Deceased)

Borek Vasicek

Czech National Bank (CNB); European Union - Directorate General for Economic and Financial Affairs (DG ECFIN)

Date Written: June 22, 2015

Abstract

We identify a set of “rules of thumb” that characterise economic, financial and structural conditions preceding the onset of banking and currency crises in 36 advanced economies over 1970-2010. We use the Classification and Regression Tree methodology (CART) and its Random Forest (RF) extension, which permits the detection of key variables driving binary crisis outcomes, allows for interactions among key variables and determines critical tipping points. We distinguish between basic country conditions, country structural characteristics and international developments. We find that crises are more varied than they are similar. For banking crises we find that low net interest rate spreads in the banking sector and a shallow or inverted yield curve are their most important forerunners in the short term, whereas in the longer term it is high house price inflation. For currency crises, high domestic short-term rates coupled with overvalued exchange rates are the most powerful short-term predictors. We find that both country structural characteristics and international developments are relevant banking crisis predictors. Currency crises, however, seem to be driven more by country idiosyncratic, short-term developments. We find that some variables, such as the domestic credit gap, provide important unconditional signals, but it is difficult to use them as conditional signals and, more importantly, to find relevant threshold values.

Keywords: Banking crises; binary classification tree; currency crises; early warning indicators

JEL Classification: C14, E44, F37, F47, G01

Suggested Citation

Joy, Mark and Rusnak, Marek and Smidkova, Katerina and Vasicek, Borek, Banking and Currency Crises: Differential Diagnostics for Developed Countries (June 22, 2015). ECB Working Paper No. 1810. Available at SSRN: https://ssrn.com/abstract=2621627

Mark Joy

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Marek Rusnak

Czech National Bank (CNB) ( email )

Na Prikope 28
CZ-11503 Praha 1
Czech Republic

Charles University in Prague

Celetná 13
Praha 1, 116 36
Czech Republic

Katerina Smidkova

Czech National Bank (Deceased)

Charles University - Economics Department (Deceased)

Borek Vasicek (Contact Author)

Czech National Bank (CNB) ( email )

Na Prikope 28
CZ-11503 Praha 1
Czech Republic

European Union - Directorate General for Economic and Financial Affairs (DG ECFIN) ( email )

BU-1 05/190
Brussels, Bruxelles B-1049
Belgium

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