Early warning indicators of banking crises an empirical evidence from india

Abstract

Financial crisis causes heavy loss to economies and it takes a lot of tough measures and time by governments to bring the economy back to normal course. As the adage goes a stich in time saves the nine, early prediction of economic crisis can save a lot of money and hardships. Economists and policy makers have tried for long to discover a way that economic crisis could be predicted before their occurrence, but the task has not been finished yet. Efforts are being made to develop a framework that can timely forewarn against any impending financial crisis. Much emphasis has been given on identifying and exploring reliable Early Warning Indicators that can issue signal before the crisis event takes place. The current study is one more such attempt to identify and establish EWIs in Indian banking domain. newlineThe study aims at evaluating the performance of EWIs in Indian banking framework and explore new EWIs in Indian banking scenario. The study also aims to suggest preventive measures against false alarms that can be issued by EWIs. To evaluate the performance of leading indicators three basic parameters predictive ability, persistence of signal and lead time have been chosen. On the basis of previous studies done in other countries, a total of sixteen indicators that performed well were selected. These are debt service ratio, credit to GDP gap, inflation, lending interest rate, import, export, M1, credit to deposit ratio, government debt to GDP ratio, gross NPA, return on asset(ROA), foreign claims to GDP, ratio credit to nominal GDP, property prices, CRAR and household credit to GDP gap. newlineAmong these sixteen, a few has already been checked in Indian context whereas the rest are to be tested. Signal Extraction Approach was applied to determine the good signals and low noise ratio on three different threshold values. The study establishes that indicators which predicted the Indian banking crisis more effectively are ROA, export, DSR, credit to GDP, credit to deposit, import, foreign claims to GDP, lending interest rate