Mind the Basel Gap

39 Pages Posted: 10 Jan 2020 Last revised: 17 Jun 2022

Date Written: June 16, 2022

Abstract

The Basel credit gap, the difference between a country’s credit-to-GDP ratio and its estimated long-term trend, is used as a basis for setting countercyclical capital buffers under the Basel III regulatory framework. Using international data from the BIS, we show that the Basel credit gap, estimated by a one-sided HP filter, is nearly equivalent to a naive 16-quarter change in the credit-to-GDP ratio and performs equally well in terms of predicting banking crises. We demonstrate that the near-equivalence between deviations from trend and simple changes occurs when the one-sided HP filter is applied to a unit-root process. The goal of this paper is not to evaluate the performance of the Basel credit gap as an early-warning-indicator, but rather to demonstrate that its estimation method is unnecessarily complicated.

Keywords: Credit gap, One-sided Hodrick-Prescott filter, Systemic risk.

JEL Classification: C22, E52, G28

Suggested Citation

Jylha, Petri and Lof, Matthijs, Mind the Basel Gap (June 16, 2022). Available at SSRN: https://ssrn.com/abstract=3498165 or http://dx.doi.org/10.2139/ssrn.3498165

Petri Jylha

Aalto University ( email )

P.O. Box 21220
Aalto, 00076
Finland

Matthijs Lof (Contact Author)

Aalto University ( email )

P.O. Box 21210
Helsinki, 00101
Finland

HOME PAGE: http://sites.google.com/site/matthijslof/

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