Strong Credit Growth, Asset Price Hikes Can Signal Financial Risks

Knowing what drives rapid credit growth key to right policy response

Credit growth signals risk build-up for variety of countries

Helps countries identify and lessen risks to financial system

In the wake of the global economic crisis, which began as a financial crisis in the United States in 2008, this new research, part of the IMF’s Global Financial Stability Report, provides countries a practical framework to help them spot potential trouble on the financial horizon, and choose the best policy to respond.

Credit growth is the result of either a good shock to the economy, such as increased productivity, or a bad shock, such as real estate bubbles that led to the most recent global crisis. Other indicators need to accompany credit growth for policymakers to distinguish between the two types of shocks.

The same indicators also work across different exchange rate regimes, which means a wide range of countries are able to use the indicators to help spot a potential crisis. The IMF tested a variety of models across a large sample of countries, including advanced and emerging economies.

“We first try to better understand, through a model that accounts for the interaction between the financial sector and the economy, which indicators and what types of shocks give rise to systemic risk; then we use these insights to find indicators to help us predict when risks are building up,” said Laura Kodres, chief of global stability analysis in the IMF’s Monetary and Capital Markets Department, in a press conference to launch the study.

These latest findings are part of the IMF’s ongoing work on macroprudential policy to help countries identify risks to the whole financial system, not just individual firms.

Macroprudential policy helps countries lessen the chances of a crisis or soften its blow through a wide range of systemic risk indicators—that is, indicators that gauge risks to the whole financial system, rather than those affecting individual banks. These include areas such as the resilience of the financial system to shocks, the availability of money in financial markets, the connections between...