This paper aims to complement to standard Basel countercyclical capital buffer framework by suggesting additional measures for credit gaps that can be used to measure the financial cycle and to decide on countercyclical capital buffers for banks.
The paper concentrates on European Union countries with the data starting from 1970. The authors check whether the newly suggested buffers are in place and sizable before financial distress periods.
The new measures are: the change in the credit-to-GDP ratio over two years; the growth in credit compared to the eight-year moving average of growth in nominal GDP over two years; the growth in credit compared to annual nominal growth of 5% over two years; and growth in credit relative to the nominal GDP trend value over two years. They behave similarly to the gaps calculated with the standard Basel one-sided Hodrick–Prescott filter in long samples.
The main contribution of the paper is to suggest new alternative measures of credit cycles that can be used in short samples and in case of structural breaks. New measures correlate well with actual countercyclical capital buffers in place in 2018.
