Identifying Indicators of Systemic Risk

Abstract

We operationalize the definition of systemic risk provided by the IMF, BIS, and FSB and derive testable hypotheses to identify indicators of systemic risk. We map these hypotheses into a two-stage hierarchical test which combines insights from the early-warning literature on financial crises with recent advances on growth-at-risk. Applying it to a set of candidate variables, we find that the Basel III credit-to-GDP gap does not serve the goal of coherently indicating systemic risk across the panel of G7 countries. A composite financial cycle measure does indicate systemic risk up to three years ahead, but its single components like credit growth or house price growth do not pass our test. Our results suggest that, by smoothing the financial cycle, pre-emptive countercyclical macroprudential policy may address vulnerability episodes in boom phases, which then mitigates systemic risk in the future.

Keywords: Systemic risk, macroprudential regulation, forecasting, growth-at-risk, financial cycles

JEL Classification: E37, E44, G17