Introduction of the composite indicator of cyclical systemic risk in Croatia: possibilities and limitations

Published: 29/11/2022
Publication Working Papers
Issue W-68
Author Tihana Škrinjarić
Date November 2022
ISSN 1334-0131

Keywords

systemic risk, macroprudential policy, countercyclical capital buffer, composite indicators, cyclical risks

Summary

Macroprudential policy has the important task of monitoring the accumulation of cyclical systemic risks, using a wide range of indicators. Decisions on the use of instruments that seek to mitigate the pro-cyclicality of the system should be made according to properly defined and stable indicators that signal future trends in the cycle itself. In its Recommendation, the European Systemic Risk Board considers several important categories of indicators for monitoring cyclical risks. Since the credit gap, the main indicator of cyclical risks, has shown numerous shortcomings in practice over the years, composite indicators have been developed in the literature. As there has been no such composite indicator in Croatia so far, this research considers several popular approaches to constructing composite indicators of cyclical risks for Croatia. As there are several different approaches currently available, this research considers their characteristics, advantages and shortcomings, with special reference to Croatian data. Comparing the composite financial cycle indicator, the cyclogram, the systemic cyclical risk indicator, as well as additional possibilities of data aggregation in terms of principal component analysis and the overheating index, the results indicate that the issue of defining an adequate indicator for Croatia is a demanding task. This is due to the short time series, the absence of characteristics of other types of crises that are available for other countries, the instability of certain variables relevant for monitoring cyclical risks, complexity of communication with the public, etc. Finally, based on the discussion, the best indicator is chosen, and the possibilities of calibrating the countercyclical capital buffer are considered. This paper provides an overview of different approaches, with a special focus on a comparison of them, which has not been dealt with in the literature. It provides proposals for improving individual indicators and analyses the possibility of calibrating the countercyclical capital buffer.