CRITICAL LEVELS OF DEBT? Lenno Uusküla Peeter Luikmel Jana Kask* January 2005 Working Papers of Eesti Pank No 3, 2005

High credit growth in Central and Eastern European countries (CEEC) over recent years has sparked interest among many market analysts. Although banking supervision has improved, the continuation of such growth may cause concern about the threat of financial crisis. This paper is written with the aim of analysing the importance of debt factors as a potential cause of financial crises. First, a comparison is conducted of various debt indicators from episodes of crisis in banking across European countries since the 1970s. Second, a probit analysis is used to measure the probability of a crisis. Based on this analysis, it can be claimed that any direct link between debt indicators and financial crises is weak. However, there is some evidence that once the crisis occurs, greater indebtedness lengthens the crisis and raises costs in terms of GDP.
JEL Code: C23, E44, F34, G20
Key words: financial crisis, indebtedness indicators

* The authors would like to thank the participants of the seminars held at Eesti Pank for their valuable comments.

Authors' e-mail addresses: lenno.uuskyla@epbe.ee, peeter.luikmel@epbe.ee, jana.kask@epbe.ee

The views expressed are those of the authors and do not necessarily represent the official view of Eesti Pank.

Contents

Introduction

1. Literature Overview

2. Crises and Debt Indicators in Europe

2.1. Crises and Debt Developments

2.2. Linkages Between the Level of Debt, Debt Growth and Crises

3. Probit Model for Banking Crises in Europe

3.1. Theory and Data

3.2. Estimation Results

4. Other Effects of Debt and Estonia-Specific Questions

4.1. Levels of Indebtedness and the Severity of the Crisis

4.2. The Estonian Context

Conclusions

References

Appendix

Critical Levels of Debt?, Working Papers of Eesti Pank No 3, 2005 (PDF*)

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