Cross-Border Claims and Banking Crises: An Early Warning System for Small Open Economies

Posted: 7 Jun 2019

Date Written: May 21, 2019

Abstract

This paper presents an early warning system for predicting banking crises specifically tailored to developed small open economies. The model considers two sources of financial instability: Domestic macro-financial imbalances and exposure to foreign banking systems with high crisis risk. Exposure of small open economies is measured by their total cross-border bank claims against foreign countries relative to GDP and weighted by the domestic risk of banking crisis in the foreign economies. A combined system that captures both national and foreign-induced risks outperforms conventional domestic early warning models. Further, the system correctly predicts crisis incidence out-of-sample for every small open economy in the sample prior to the Global Financial Crisis. Low banking exposure to highly leveraged foreign economies explains the resilience of many small open economies during the recent crisis.

Keywords: early warning system, banking crises, small open economies, cross-border claims, financial stability, financial linkages

JEL Classification: C53, E44, F34, F37, G01, G17

Suggested Citation

Dieckelmann, Daniel, Cross-Border Claims and Banking Crises: An Early Warning System for Small Open Economies (May 21, 2019). Available at SSRN: https://ssrn.com/abstract=3374490 or http://dx.doi.org/10.2139/ssrn.3374490

Daniel Dieckelmann (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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