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Ending over-lending: Assessing systemic risk with debt to cash flow

  • Ramsay, Bruce A.

    ()

    (Cascadia Monetary Research, Alberta, Canada; and RiskLab Finland at IAMSR, Åbo Akademi University and Arcada University of Applied Sciences, Finland)

  • Sarlin, Peter

    (Center of Excellence SAFE at Goethe University Frankfurt, Germany, and RiskLab Finland at IAMSR, Åbo Akademi University and Arcada University of Applied Sciences, Finland)

This paper operationalizes early theoretical contributions of Hyman Minsky and applies these in the context of economic sectors and nations. Following the view of boom-bust asset cycles, depicted by the endogenous build-up of risks and their abrupt unraveling, Minsky highlighted the relationship between debt obligations and cash flows. While leverage is oftentimes linked to the vulnerability of a nation, and hence systemic risk, one less explored measure of leverage is the debt-to-cash flow ratio (Debt/CF). Cash flows certainly have a well-known, academically verified connection to the ability of corporations to service and repay corporate debt. This paper investigates whether the relationship between the flow of a nation's savings to its stock of total debt provides a means for understanding systemic risks. For a panel of 33 nations, we explore historic Debt/CF trends, as well as apply the same procedure to individual economic sectors. This assessment of systemic risk is arranged for presentation within a four-zone framework. In terms of an early-warning indicator, we show that the Debt/CF ratio effectively stratifies systemic risks, and offers a useful platform toward macro-financial sustainability.

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File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/BoF_DP_1411.pdf
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Paper provided by Bank of Finland in its series Research Discussion Papers with number 11/2014.

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Length: 26 pages
Date of creation: 03 Apr 2014
Date of revision:
Handle: RePEc:hhs:bofrdp:2014_011
Contact details of provider: Postal:
Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland

Web page: http://www.suomenpankki.fi/en/

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  15. Alessi, Lucia & Detken, Carsten, 2011. "Quasi real time early warning indicators for costly asset price boom/bust cycles: A role for global liquidity," European Journal of Political Economy, Elsevier, vol. 27(3), pages 520-533, September.
  16. Sarlin, Peter & Peltonen, Tuomas A., 2011. "Mapping the State of Financial Stability," BOFIT Discussion Papers 18/2011, Bank of Finland, Institute for Economies in Transition.
  17. Amir Sufi, 2009. "Bank Lines of Credit in Corporate Finance: An Empirical Analysis," Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 1057-1088, March.
  18. Mathias Drehmann, 2013. "Total credit as an early warning indicator for systemic banking crises," BIS Quarterly Review, Bank for International Settlements, June.
  19. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, 09.
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  23. Éric Tymoigne, 2011. "Measuring Macroprudential Risk: Financial Fragility Indexes," Economics Working Paper Archive wp_654, Levy Economics Institute.
  24. Farrell, Greg, 2014. "Countercyclical capital buffers and real-time credit-to-GDP gap estimates: A South African perspective," MPRA Paper 55368, University Library of Munich, Germany.
  25. Drehmann, Mathias & Juselius, Mikael, 2014. "Evaluating early warning indicators of banking crises: Satisfying policy requirements," International Journal of Forecasting, Elsevier, vol. 30(3), pages 759-780.
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