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Mind the Basel gap

Petri Jylhä and Matthijs Lof

Journal of International Financial Markets, Institutions and Money, 2022, vol. 79, issue C

Abstract: The Basel credit gap, the difference between a country’s credit-to-GDP ratio and its estimated long-term trend, is used as a basis for setting countercyclical capital buffers under the Basel III regulatory framework. Using international data from the BIS, we show that the Basel credit gap, estimated by a one-sided HP filter, is nearly equivalent to a naive 16-quarter change in the credit-to-GDP ratio and performs equally well in terms of predicting banking crises. We demonstrate that the near-equivalence between deviations from trend and simple changes occurs when the one-sided HP filter is applied to a unit-root process. The goal of this paper is not to evaluate the performance of the Basel credit gap as an early-warning-indicator, but rather to demonstrate that its estimation method is unnecessarily complicated.

Keywords: Credit gap; One-sided Hodrick–Prescott filter; Systemic risk (search for similar items in EconPapers)
JEL-codes: C22 E58 G01 G28 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.intfin.2022.101605

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Journal of International Financial Markets, Institutions and Money is currently edited by I. Mathur and C. J. Neely

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