Credit, capital and crises: a GDP-at-Risk approach

How can macroeconomic tail risks originating from financial vulnerabilities be monitored systematically over time? This question lies at the heart of operationalising the macroprudential policy regimes that have developed around the world in response to the global financial crisis. Using quantile regressions applied to a panel dataset of 16 advanced economies, we examine how downside risk to growth over the medium term, GDP-at-Risk, is affected by a set of macroprudential indicators. We find that credit booms, property price booms and wide current account deficits each pose material downside risks to growth at horizons of three to five years. We find that such downside risks can be partiall y mitigated, however, by increasing the capitalisation of the banking system. We estimate that across our sample of countries, GDP-at-Risk, defined as the 5th quantile of the projected GDP growth distribution over three years, on average deteriorated by around 4.5 percentage points cumulatively in the run-up to the crisis. Our estimates suggest that an increase in bank capital equivalent to a countercyclical capital buffer rate of 2.5% (5%) would have been sufficient to mitigate up to 20% (40%) of this increase in medium-term macroeconomic tail risk.