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

The macroprudential policy monitors different systemic risks, which can be divided into two primary groups: structural and cyclical. Cyclical systemic risks depend on the phase of the financial cycle in which the economy is located. Therefore, to mitigate such risks and their eventual materialization, time-varying macroprudential instruments are applied in practice. One of the main instruments is the countercyclical capital buffer (CCyB), whose calibration is based on indicators that should reflect the accumulation of cyclical risks in the financial system. However, practice and research have shown that it is not enough to monitor credit dynamics alone for these purposes (Tölö et al., 2019). It is necessary to summarize and synthesize a large amount of information. Therefore, increasingly in the practice of central banks, some approaches try to synthesize information about the financial cycle from several indicators into one measure, given the increasing number of indicators considered in practice.

Therefore, macroprudential policymakers may benefit from the results of this research paper, given that the synthesizing of data in the form of composite indicators makes it easier to monitor the dynamics of the individual variables they comprise and given that it guides how to determine the level of the CCyB by taking into account the assessment of the level of accumulation of systemic risks in the system, i.e., the assessment of the position of the economy in the financial cycle. In addition, using such an indicator can contribute to at least mitigating, if not preventing, systemic financial crises that have resulted in significant losses in the past.

An extensive presentation of existing approaches and practices was made, in such a way that individual indicators, their ideas, methods of calculation, advantages, and disadvantages were examined. Table 1 provides a brief overview of some of the possible approaches.

Based on the discussion, the selected best indicator for the case of Croatia is analyzed in the second part of the research. A comparison of the composite indicator of the financial cycle, the cyclogram, the indicator of systemic cyclical risk, as well as the additional possibilities of data aggregation concerning the analysis of the main components, the overheating index, and several proposed variants of the way of data transformation and aggregation were made. The results suggest that the importance of certain categories of cyclical measures should be taken into account at the same time risks, but also the interpretation of the final result. Thus, based on the obtained results, it is concluded that currently, a variant of the composite indicator of cyclical systemic risk defined in Lang et al. (2019) adapted for the case of Croatian data is adequate for monitoring the cyclicality of systemic risk. Figure 1 shows the best composite indicator for the case of Croatian data based on the analysis.

The interpretation of the results in Figure 1 is quite intuitive, given that the values of individual risk categories and the final composite indicator itself move in intervals that include both positive and negative values. This facilitates communication with the public, as well as the very interpretation of risk accumulation or release. All indicators reached their highest levels during the economic boom that preceded the global financial crisis, to which all included indicators contributed. With the arrival of the global financial crisis and the entry of the Croatian economy into a multi-year recession, the value of both indicators is rapidly falling due to the slowdown in credit growth, falling residential real estate prices, and the reduction of external imbalances. The lowest value of the indicator was recorded at the end of 2016, after which the recovery began, which, with temporary setbacks, is present until today. The upward trend of both indices points to the recovery of the credit and financial cycle, characterized by a low perception of risk and the accumulation of systemic risks. The most significant contribution to the increase in the value of ICSR (Indicator of cyclical systemic risk) since 2017 is the growing overvaluation of residential real estate and the acceleration of credit activity.

The composite indicators analyzed in the research are a starting point in setting the level of the countercyclical capital buffer. Thus, several approaches were examined: one based on the distributional properties of the composite indicator, another based on the threshold values from the early warning models, and a third one, the “positive neutral rate” approach. Having several approaches available enables policymakers some flexibility in practice. The results are helpful because, on the one hand, synthesizing more information in the form of composite indicators facilitates the monitoring of the dynamics of the individual variables that make them up. On the other hand, guidelines are given on determining the level of CCyB concerning the assessment of the accumulation of systemic risks in the system, that is, the evaluation of the economy’s position in the financial cycle.