Investigating the early signals of banking sector vulnerabilities in Central and Eastern European emerging markets

Which factors, macroeconomic or financial, better predict crises in Central and East European countries (CEECs)? Are there differences between variables predicting potential troubles in the banking sector in new EU member states and in the rest of the CEECs?

The paper considers the joint role of macroeconomic and bank-specific factors in explaining the occurrence of banking problems in the twenty-one Central and East European emerging markets over the past decade. The authors anticipate that initially economy-wide problems will dominate as a cause of distress, while later the difficulties will become more bank- and regime-specific and hence more reminiscent of the experience in other countries. After the second shake out it appears that many of the CEECs have banking and regulatory structures similar to those of their Western European counterparts, assisted by considerable foreign ownership by Western European banks. After the authors provide a comprehensive literature review, they focus on the specification of the framework of the applied model. The next part is then devoted to the empirical study, which leads to presentation of the results and the authors’ comments.

The empirical part of the paper presents the estimates of macroeconomic and financial factors that would lead to crises. The results are:

• generally in CEECs, macroeconomic variables tend to perform better in predicting a couple of years ahead than financial variables
• generally in CEECs, financial variables have more to say about the crisis pattern, explaining how both the causes and the reactions, contribute to a crisis or its avoidance
• there are some interesting differences between ten new EU members and the rest of the observed CEE countries regarding the banking sector and its characteristics such as a high loan-to-assets ratio where a high loan-to-assets ratio in the EU banks sample was associated with problems, whereas the same characterized sound banks in the non-EU countries