1. Early Warning Indicators FCCC4 by SHIN

2. Indicator must signal vulnerability to financial turmoil Search for indicators has been: Pragmatic: Focus on procyclicality of elements in financial system Eclectic: all kinds of factors (external, financial, real & fiscal, political, institutional, contagion) to improve goodness of fit Not trying to link different crisis types, BUT this focus may hide common threads between crises

3. Price-Based Early Warning Indicators Shin: until 2006, no indication of greater vulnerability Lehman bankrupt Sept 2008 Bear Stearns absorbed by JP Morgan March 2008

4. Credit/GDP vs. Trend Measures credit booms, BUT Trend GDP ?? GDP revisions are as large as gap to trend Much lending based on pre- existing lines of credit Credit/GDP rises during crisis as GDP falling Needs to improve: Basel III includes Credit/GDP United Kingdom

5. Shin’s Idea Banks may aggressively make loans using interbank funds (non-core liabilities) Core liabilities (deposits) stable – depositors don’t often withdraw Crisis more likely when banks use greater share of non-core funds Ratio non-core/core shows degree of bank risk-taking (Hahm, Shin and Shin, 2013)

6. Banks Borrow to Lend Barclays expanded assets by issuing either repos or CDs, nearly 1-for-1 Small rise in risk-weighted assets (blue) => Basel- measure of risk doesn’t rise in boom

7. Bank chain now more complex than traditional

8. Repos are short term but whether rolled over or not depends on collateral quality

10. Relation between liqudity & “coreness” Most dependable source of funds Undependable source of funds Covered bonds: similar to MBS but remain on issuer’s balance sheet

11. Lending Boom and Non-Core Liabilities If bank can’t use retail deposits to fund new loans, it must find other funds Hahm, Shin & Shin: capital inflows to banks: their foreign liabilities predicts both currency & credit crises

12. Hahm, Shin and Shin (2012): Non-core measures indicate currency crises Dependent variable: Currency crisis dummy Similar results show non-core variables significantly related to dummy variables for: Credit crisis Equity crisis

13. Which Liabilities are Non-core ? Find most pro-cyclical liability, may differ for different nations Developed economies: wholesale funding, sometimes foreign- denominated Korea (open capital market): wholesale funding China: corporate time deposits

14. Look for procyclicality to mark as “non-core”

16. Won Depreciation To settle previous $ borrowings, Korean banks need $, so sell Won for $ => Won depreciates Depreciation NOT caused by equity investors fleeing Korea

17. As non-core/core rises, Won per $ rises (i.e. won depreciates) Won per $

18. Non-core/core Similar to Credit/M1 Shin and Shin (2011) Borio and Lowe’s credit/M1 ratio also indicates financial stability: As banks shift from deposits (M1) to wholesale funds, credit/M1 rises (like non-core/core ratio) Bank wholesale’s Credit/M1 rises infinitely Bank Retail’s Credit/M1 rises

19. M1, M2 Poorly Indicate Financial Sector Liabilities; Shin & Shin (2011) M1 or M2 ignores risk in investment banks which don’t create deposits (and thus M1 or M2) M1 or M2 measure ignores that banks hold non-core deposits (non- money), e.g. liabilities to foreign creditors

20. Shin and Shin (2011) Regressions: Growth in non-core liabilities forecasts future depreciation Positive relation (more non-core => higher bank interest rates vs. risk-free rate) Non-core/GDP Spread: AAA-banks’ rate to risk-free

21. Conclusions Market P can only warn on concurrent market conditions, not in advance Credit/GDP is better, will be used in Basel III May not be useful in real time (GDP subject to data revisions) May not be applied uniformly across countries (Bank liability / M stock) approach promising like Credit/GDP but better in real time Link it to specific institutions of nation Include liabilities to other fin’l intermediaries (usually omitted)