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The credit-to-GDP gap and countercyclical capital buffers: questions and answers

  • Mathias Drehmann
  • Kostas Tsatsaronis

Basel III uses the gap between the credit-to-GDP ratio and its long-term trend as a guide for setting countercyclical capital buffers. Criticism of this choice centres on three areas: (i) the suitability of the guide given the objective of the buffer; (ii) the early warning indicator properties of the guide for banking crises (especially for emerging market economies); and (iii) practical measurement problems. While many criticisms have merit, some misinterpret the objective of the instrument and the role of the indicator. Historically, for a large cross section of countries and crisis episodes, the credit-to-GDP gap is a robust single indicator for the build-up of financial vulnerabilities. As such, its role is to inform, rather than dictate, supervisors' judgmental decisions regarding the appropriate level of the countercyclical buffer.

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Article provided by Bank for International Settlements in its journal BIS Quarterly Review.

Volume (Year): (2014)
Issue (Month): (March)

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Handle: RePEc:bis:bisqtr:1403g
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