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Identifying Threshold Effects in Credit Risk Stress Testing

Author

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  • Armando Méndez Morales
  • Jose Giancarlo Gasha

Abstract

Using data from Argentina, Australia, Colombia, El Salvador, Peru, and the United States, we identify three types of threshold effects when assessing the impact of economic activity on nonperforming loans (NPLs). For advanced financial systems showing low NPLs, there is an embedded self-correcting adjustment when NPLs exceed a minimum threshold. For financial systems in emerging markets in Latin America showing higher NPLs, there is instead a magnifying effect once NPLs cross a (higher) threshold. GDP growth apparently affects NPLs only below a certain threshold, which is consistent with observed lower elasticity of credit risk to changes in economic activity in boom periods.

Suggested Citation

  • Armando Méndez Morales & Jose Giancarlo Gasha, 2004. "Identifying Threshold Effects in Credit Risk Stress Testing," IMF Working Papers 04/150, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:04/150
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    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=17540
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    References listed on IDEAS

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    1. Hansen, Bruce E. & Seo, Byeongseon, 2002. "Testing for two-regime threshold cointegration in vector error-correction models," Journal of Econometrics, Elsevier, vol. 110(2), pages 293-318, October.
    2. Potter, Simon M, 1995. "A Nonlinear Approach to US GNP," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 10(2), pages 109-125, April-Jun.
    3. Maria Soledad Martinez Peria & Giovanni Majnoni & Matthew T Jones & Winfrid Blaschke, 2001. "Stress Testing of Financial Systems; An Overview of Issues, Methodologies, and FSAP Experiences," IMF Working Papers 01/88, International Monetary Fund.
    4. Mehmet Caner & Bruce E. Hansen, 2001. "Threshold Autoregression with a Unit Root," Econometrica, Econometric Society, vol. 69(6), pages 1555-1596, November.
    5. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-384, March.
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    Cited by:

    1. Grigori Fainstein & Igor Novikov, 2011. "The Comparative Analysis of Credit Risk Determinants In the Banking Sector of the Baltic States," Review of Economics & Finance, Better Advances Press, Canada, vol. 1, pages 20-45, June.
    2. Tom Pak-wing Fong & Chun-shan Wong, 2008. "Stress Testing Banks' Credit Risk Using Mixture Vector Autoregressive Models," Working Papers 0813, Hong Kong Monetary Authority.
    3. Zhang, Dayong & Cai, Jing & Dickinson, David G. & Kutan, Ali M., 2016. "Non-performing loans, moral hazard and regulation of the Chinese commercial banking system," Journal of Banking & Finance, Elsevier, vol. 63(C), pages 48-60.
    4. Grigori Fainstein & Igor Novikov, 2011. "The role of macroeconomic determinants in credit risk measurement in transition country: Estonian example," International Journal of Transitions and Innovation Systems, Inderscience Enterprises Ltd, vol. 1(2), pages 117-137.
    5. Marcucci, Juri & Quagliariello, Mario, 2009. "Asymmetric effects of the business cycle on bank credit risk," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1624-1635, September.

    More about this item

    Keywords

    Business cycles; Credit risk; Stress testing; business cycle; gdp growth; probability; normal distribution; growth rates;

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