Deleveraging after the burst of a credit-bubble

Introduction and Motivation
What happens to private leverage after the bursting of a banking-crisis-inducing credit-bubble? The obvious
answer would be simply that it falls. But the international experience shows that the process and consequences of a
systemic banking crisis (including those preceded or accompanied by credit bubbles) are actually quite heterogeneous
across different countries and even across different crises within the same country. Some recent literature has
concentrated on the effects of a banking crisis on economic activity, but few studies have explored the deleveraging
process itself.
How hard private leverage falls, how fast and what factors determine how severe is such a deleveraging
process? In this study we explore some tentative answers to these questions. In order to do this we assemblage a
rich database on the macro-financial dynamic preceding and following events of simultaneous occurrence of
credit-bubbles and systemic banking crises, and used it in the estimation of a simultaneous equation econometric
model able to explain and forecast the deleveraging dynamic conditioned to kind of events.
According to our results, the main determinants of the severity and speed of a deleveraging process after the burst of
a credit-bubble (following a banking crisis) are the growth rate of the credit ratio during the boom period and the fiscal position of the country at the peak of the credit boom, while the external position plays a more limited role.
The contributions of this note are illustrated by analyzing the consequences of a hypothetical burst of the current credit bubbles experienced by two economies, Canada and Thailand, in the case that they were suffering a systemic
banking crisis. We chose these two countries as examples since our Early Warning System of systemic banking crises
indicate that the probability of an event of this type in these countries is significant.

Fuente: BBVA Research

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