Decomposing financial (in)stability in emerging economies

Abstract

The build-up of risks in advanced economies has seen a lot of research efforts in the recent years, while similar research efforts on emerging economies have not been so strong and, when undertaken, have focused mostly on its international dimension. Simultaneously, the financial system of the emerging economies has substantially developed and deepened. In our paper, we construct an index of vulnerabilities in emerging countries, relying solely on data available at international organisations. We group indicators around four poles: valuation and risk appetite, imbalances in the non-financial sector, financial sector vulnerabilities, and global vulnerabilities. On purpose, we depart from early warning models or any other kind of complex econometric constructs. Simplicity and usability are the two key characteristics we have tried to embed into our index of vulnerabilities. We use the results to try to create a narrative of the evolution of vulnerabilities in emerging economies from 2005 to the third quarter of 2015, using innovative data visualisation tools as well as correlations and Granger causalities. We complement our analysis with a comparison between our index of vulnerabilities and the Credit-to-GDP gap.

Are shadow banks a threat to the financial stability of EMEs?

“…In order to develop an overall measure of financial stability, an index measure was followed. The literature signifies the limitation of a single measure to proxy financial stability, and thus, FVI was constructed based on Aikman et al (2017), Lee, Posenau, and Stebunovs (2017) and Lepers and Serrano (2020). The index consists of 12 indicators from four sectors: banking sector, non-financial sector, external sector and valuation pressures.…”

“…Financial stability has been measured using different proxies in the literature such as bank Z score (Soedarmono, Machrouh, & Tarazi, 2011;Diallo & Mansour, 2017), bank NPA ratio (Ozili, 2018;Kellard et al, 2022) and stock market volatility (Akter & Nobi, 2018;Sui et al, 2022). In order to measure financial stability, several authors such as (Hawkins & Klau, 2000;End, 2006;Gadanecz & Jayaram, 2009;Roy, Biswas, & Sinha, 2015;Aikman, Kiley, Lee, Palumbo, & Warusawitharana, 2017;Lee, Posenau, & Stebunovs, 2017, Lee, Posenau, & Stebunovs, 2020Akosah, Loloh, Lawson, & Kumah, 2018;Lepers & Serrano, 2020) have developed an index to measure financial stability. Aikman et al (2017) point out the inability of a single measure to identify the risks emanating in a financial system.…”

“…They purported that their aggregate index has better predictive power of a banking crisis than sector-specific indices. Lepers and Serrano (2020) developed financial instability measure or FVI for 11 emerging nations. They deployed 32 indicators in order to holistically measure financial stability.…”

The SHERLOC: An EWS-Based Index of Vulnerability for Emerging Economies

“…Few papers have proposed a synthetic index of vulnerabilities for emerging economies. One of the most recent is the index of vulnerability for emerging economies proposed by Lepers and Sánchez-Serrano (2017). Contrary to our paper, they only focus on financial crises and do not evaluate the performance of their composite index.…”

Home, safe home: Cross-country monitoring framework for vulnerabilities in the residential real estate sector

“…Due to data shortcomings, the data on NPLs cover all loan exposures (residential real estate exposures and other loan exposures).18 This supports the interpretation of non-performing loans as an indicator of the consequences of a real estate bust, rather than an early warning indicator. For this reason, non-performing loan data is not part of our monitoring framework, but is instead used to validate the signals resulting from our monitoring approach.19 SeeAikman et al (2015) andLepers and Sanchez-Serrano (2017) for a discussion of the insights from a "narrative" approach to the understanding of the origins of risk, as well as the benefits of disaggregating indices by intuitive 'poles' of vulnerabilities. These papers take a broader perspective on financial stability, rather than focus on the real estate sector.ECB Working Paper 2096, August 2017…”