Monitoring banking sector fragility : a multivariate logit approach with an application to the 1996-97 banking crises

The authors explore how a multivariate logit empirical model of banking crisis probabilities can be used to monitor fragility in the banking sector. The proposed approach relies on readily available data, and the fragility assessment has a clear interpretation based on in-sample statistics. Also, the monitoring system can be tailored to fit the preferences of the decisionmakers, and the model has better in-sample performance than currently available alternatives. Despite these advantages, the monitoring system would have missed the 1997 banking crises in Indonesia, Malaysia, and the Republic of Korea, while it would have detected some weakness in Thailand and the Philippines. It would have clearly foreseen the 1996 crisis in Jamaica. Aggregate variables can convey information about general economic conditions often associated with fragility in the banking sectorbut are silent about the situation at individual banks or in specific segments of the banking sector - so crises that may develop from specific weaknesses in some market segments and spread through contagion would not be detected. The econometric study of systemic banking crises is a relatively new field of study. The development and evaluation of monitoring and forecasting tools based on the results of studies such as this are at an embryonic stage at best. The authors highlight elements that need to be evaluated in developing"ready-to-use"procedures for decision-makers and explore possible avenues for doing so. The monitoring system must be designed to fit the needs of policymakers, so systems must be developed as part of an interactive process involving both econometricians and decisionmakers.