Credit-to-GDP gap as an early warning indicator of banking stress in Albania

AuthorOdeta Koçillari
PositionBank of Albania
Vol. 1 No. 1
January 2017
European Journal of Economics, Law and Social Sciences
IIPCCL Publishing, Graz-Austria
ISSN 2519-1284
Acces online at
Credit –to- GDP gap as an early warning indicator of banking stress in
Odeta Koçillari
Bank of Albania
This paper investigates the performance of credit-to-GDP gap as a potential early warning
indicator of systemic banking distress in the case of Albania. Following the “signal extraction
approach” by Kaminsky and Reinhart (1999), we test the early warning abilities of indicators
of credit-to-GDP gap for total credit to private sector, credit to households and credit to rms,
computed using one sided HP lter with di erent smoothing parameters. These indicators
are tested upon various thresholds and time horizons. We nd that credit to GDP gap for total
credit to private sector, computed using HP lter 25000 or 400000 work best as EWI in terms of
our evaluation criteria and up to years ahead of a potential episode of distress or crisis.
Keywords: early warning indicators, credit-to-GDP gap, banking stress, signal extraction
The high economic costs associated with the late nancial crisis (2007-2008)
highlighted the need for a careful monitoring of systemic risks threatening nancial
system in general and banking sector in particular. Many central banks have already
included in their tasks the monitoring and assessment of systemic risk on a regular
basis, in order to prevent future crises. These assessments can provide early signals
of vulnerabilities build-up, known as "macro - nancial imbalances", thus helping
in obtaining timely preventive measures to reduce such imbalances and maintain
nancial stability in the country. Despite the di erent methods and instruments
developed by various institutions and researchers on this ma er, the identi cation
of a uni ed set of reliable indicators that can serve as “early warning indicators” has
been quite challenging. This because the ability of such indicators to predict future
crisis is closely related to a number of factors that vary signi cantly from one country
to another, such as: the structure of the economy and/or the nancial system, the
characteristics of the banking sector, crisis complexity, length and accuracy of the
data series etc. For this reason, an indicator that may result e cient in predicting
a particular crisis in a particular country may not result as such if these conditions
change. However, among various indicators investigated, most authors agree that
the indicators related to credit, especially credit-to-GDP gaps, are the most e cient
one and as history tend to repeat itself, they can be used to signal future episodes of
banking sector distress as well.
Taking guidance on the existing literature addressing this issue, this paper aims to
investigate the early warning properties of potential banking sector stress of the credit
–to-GDP gap, in the case of Albanian banking sector. Various transformations of this

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