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Econometric Approach to Early Warnings of Vulnerability in the Banking System and Currency Markets for Hong Kong and Other EMEAP Economies

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Author Info
Matthew S. Yiu (Research Department, Hong Kong Monetary Authority)
Alex Ho (Research Department, Hong Kong Monetary Authority)
Lu Jin (Research Department, Hong Kong Monetary Authority)
Abstract

This study adopts an econometric approach to develop an early warning system of the vulnerability in the banking system and currency markets for the 11 EMEAP economies over the period from1990 to 2008. We identify a set of leading indicators of banking distress and currency pressure and investigate the causal and contemporaneous linkages between them by using separate panel probit models and a simultaneous probit equation system. Asset-price misalignments, default risk of commercial banks and the non-financial corporate sector, and growth of real credit to the private sector are found to be significant leading indicators for both banking distress and currency pressure. Economic growth, inflation and the ratio of short-term external debt to international reserves are found to be important determinants of banking distress, whereas growth of M2 relative to international reserves, total trade balance over GDP, real effective exchange rate over-valuation and trade integration with China are identified to be crucial indicators of currency pressure. Currency market pressure is shown to have strong leading and contemporaneous impacts on banking distress for the EMEAP economies but not vice versa. These findings imply that the policy measures aimed at sustaining exchange rate stability will have the additional benefit of lowering the likelihood of banking distress in the region. Lastly, China is found to play a stabilising role in the region, i.e. the greater the trade with China, the lower the chance of experiencing currency pressure.

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Paper provided by Hong Kong Monetary Authority in its series Working Papers with number 0908.

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Length: 32 pages
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:hkg:wpaper:0908

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Related research
Keywords: Banking distress; Currency crises; Twin crises; Asia Pacific economies; econometric model;

Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
F31 - International Economics - - International Finance - - - Foreign Exchange
F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation
G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Mortgages

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References listed on IDEAS
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  1. Graciela Laura Kaminsky, 1999. "Currency and Banking Crises - The Early Warnings of Distress," IMF Working Papers 99/178, International Monetary Fund.
    Other versions:
  2. Chang, R. & Velasco, A., 1999. "Liquidity Crises in Emerging Markets: Theory and Policy," Working Papers 99-14, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  3. Yin-Wong Cheung & Matthew S. Yiu & Kenneth K. Chow, 2009. "A Factor Analysis of Trade Integration: The Case of Asian and Oceanic Economies," Working Papers 132009, Hong Kong Institute for Monetary Research. [Downloadable!]
  4. Reinhart, Carmen & Goldstein, Morris & Kaminsky, Graciela, 2000. "Assessing financial vulnerability, an early warning system for emerging markets: Introduction," MPRA Paper 13629, University Library of Munich, Germany. [Downloadable!]
  5. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June. [Downloadable!] (restricted)
    Other versions:
  6. Francesco Caramazza & Luca Antonio Ricci & Ranil Salgado, 2000. "Trade and Financial Contagion in Currency Crises," IMF Working Papers 00/55, International Monetary Fund.
  7. Lestano & Jan Jacobs & Gerard H. Kuper, 2004. "Indicators of financial crises do work! An early-warning system for six Asian countries," International Finance 0409001, EconWPA. [Downloadable!]
    Other versions:
  8. Tuomas A. Peltonen, 2006. "Are emerging market currency crises predictable? A test," Working Paper Series 571, European Central Bank. [Downloadable!]
  9. Reinhart, Carmen & Kaminsky, Graciela, 1999. "The twin crises: The causes of banking and balance of payments problems," MPRA Paper 14081, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  10. McKinnon, Ronald I & Pill, Huw, 1997. "Credible Economic Liberalizations and Overborrowing," American Economic Review, American Economic Association, vol. 87(2), pages 189-93, May. [Downloadable!] (restricted)
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