In a previous report Fitch concluded that the evidence from earlier banking crises was both too sparse and too variable to suggest an obvious threshold above which real house prices could reliably be said to threaten country banking system problems. From the evidence of the current crisis, however, it seems that this threshold is relatively low. The median deviation of real house prices from trend ahead of all past crises is around 15% - similar to the 16% seen in Ireland - and this is the figure Fitch will now use as an additional trigger to determine when a country moves into the highest Macro Prudential risk category - MPI 3 (when accompanied by a rise in the credit/GDP ratio to more than 5% above trend). Such an updated model would have anticipated the US and UK banking crises, as well as Belgium and also Ireland (which was already MPI 3 due to an appreciated real exchange rate).
However, some countries which have seen house prices rise to more than 15% above trend - e.g. Denmark, France, New Zealand and Sweden - have so far escaped widespread banking system problems. And not all countries that have suffered banking crises had the highest Macro Prudential risk indicators, notably Germany, Switzerland and the Netherlands, suggesting that banking problems in these countries were more due to foreign lending than domestic lending.
By end-2008, well over one-third (32) of the 86 countries in Fitch's report were MPI 3. Nine of these were due to the new house price methodology and six were added since the last report based on the original methodology. A further quarter showed more moderate signs of excessive lending and asset price appreciation and/or real exchange rate appreciation (MPI 2) (unchanged since the last report). In regional terms, Emerging Europe continues to have the greatest proportion (68%) of systems in the highest risk category (MPI 3) but developed countries have the next highest proportion (41%).
Fitch's BSR methodology continues to focus mostly on trends in credit/GDP. However, the experience of Emerging Europe has shown that rapid credit growth can give earlier warning of potential problems, before credit/GDP rises above critical thresholds. Double digit real credit growth warrants close scrutiny anywhere - China's will be amongst the highest this year at over 20%, based on developments in Q1 alone, and if sustained will eventually place China in a higher risk category (currently MPI 1).
The global banking crisis has radically changed the landscape of global banking system strength, as summarised in Fitch's second systemic risk indicator - the Banking System Indicator (BSI). Whereas the typical developed country system used to be 'BSI B' (strong) - on a scale from 'A' (very strong) to 'E' (very weak) - a majority are now in the 'C' category (adequate), though twelve developed country systems remain 'strong' (BSI B). The typical emerging market system remains 'C' or 'D'.
