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

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  • Sarlin, Peter
  • Ramsay, Bruce A.

Abstract

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 e effectively stratifies systemic risks, and offers a useful platform toward macro-financial sustainability.

Suggested Citation

  • Sarlin, Peter & Ramsay, Bruce A., 2014. "Ending over-lending: Assessing systemic risk with debt to cash flow," Bank of Finland Research Discussion Papers 11/2014, Bank of Finland.
    • Handle: RePEc:zbw:bofrdp:rdp2014_011
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    References listed on IDEAS

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    More about this item

    Keywords

    debt-to-cash flow; debt-to-gross saving; systemic risk; four-zone framework;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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