A composite indicator of systemic risk related to the Italian financial cycle

Financial cycles, i.e. the boom-bust dynamics that characterize modern decentralized economies, are a key driver of financial crises and subsequent economic downturns. Countercyclical macroprudential policy aims to mitigate these risks by strengthening the resilience of the financial system during the expansionary phases, mostly using the countercyclical capital buffer (CCyB) as an instrument. While the credit-to-GDP gap is the standard reference guide used for calibrating the CCyB, its limitations in capturing the full spectrum of financial cycle dynamics have become increasingly apparent. A growing number of macroprudential authorities are supplementing the credit gap with additional indicators to inform CCyB rate decisions, placing increasing emphasis on composite indicators of the financial cycle. This paper proposes a composite indicator of systemic risk related to the Italian financial cycle (Cyclical Risk Indicator, CRI). The CRI is constructed as a weighted average of the best performing financial cycle indicators, offering a comprehensive assessment of systemic cyclical risk. Empirical analysis shows that the CRI provides additional information for the early warning of financial distress and of tail macroeconomic outcomes relative to the credit gap. By adopting the CRI, the Italian macroprudential authority may gain a more nuanced understanding of financial cycle dynamics, enabling more informed and timely policy decisions. This, in turn, would lead to a more resilient financial system and mitigate the impact of future financial crises.