Make It or Break It? Assessing Credit Booms in Developing Countries

In this paper, we argue that the assessment of systemic risk associated with rapid credit growth should be conducted with different tools at different stages of financial development. In particular, using a signal detection framework, we show that, when the level of financial development is low, the most used leading indicator of banking crisis, namely the credit-to-GDP gap, has poor predictive performance, as it is unable to disentangle episodes of financial deepening from bubble-like credit booms. On the contrary, a new class of indicators, comparing credit levels to structural benchmarks, has good capacity to correctly predict financial crises in economies in the early stages of financial development.