Assessing the risk of banking crises

Over the last two decades, banking crises have become more frequent and severe in both emerging market and industrial countries.2 Their cost in terms of output lost has been high, typically double digit percentages of GDP. For this reason, considerable efforts have been made recently to develop “early warning indicators” of crises that could allow policymakers to take remedial action in a more timely fashion. This special feature proposes a set of forward-looking indicators of banking distress. As in Borio and Lowe (2002) we argue that it may be possible recognise the build-up of one set of vulnerabilities that foreshadows banking distress with a reasonable degree of confidence, although the exact timing of the crises remains unpredictable. The corresponding indicators draw exclusively on ex ante information, are based on the interaction among a small set of variables, focus on the cumulative processes giving rise to distress and allow for variable horizons. Here we extend our previous work, which had mainly considered credit aggregate and asset prices, by examining the information contained in real exchange rate appreciations and the relative performance of indicators in industrial and emerging market countries. In the first section of this article we briefly discuss the origins of banking crises. In the second we motivate the choice of indicators and assess their performance. In the concluding section we note some caveats to the analysis and suggest areas for future work.