Research Discussion Papers, Bank of Finland
No 11/2014:
Ending over-lending: Assessing systemic risk with debt to cash flow
Bruce A. Ramsay ()
and Peter Sarlin
Abstract: This paper operationalizes early theoretical contributions
of Hyman Minsky and applies these in the context of economic sectors and
nations. Following the view of boom-bust asset cycles, depicted by the
endogenous build-up of risks and their abrupt unraveling, Minsky
highlighted the relationship between debt obligations and cash flows. While
leverage is oftentimes linked to the vulnerability of a nation, and hence
systemic risk, one less explored measure of leverage is the debt-to-cash
flow ratio (Debt/CF). Cash flows certainly have a well-known, academically
verified connection to the ability of corporations to service and repay
corporate debt. This paper investigates whether the relationship between
the flow of a nation's savings to its stock of total debt provides a means
for understanding systemic risks. For a panel of 33 nations, we explore
historic Debt/CF trends, as well as apply the same procedure to individual
economic sectors. This assessment of systemic risk is arranged for
presentation within a four-zone framework. In terms of an early-warning
indicator, we show that the Debt/CF ratio effectively stratifies systemic
risks, and offers a useful platform toward macro-financial
sustainability.
Keywords: debt-to-cash flow; debt-to-gross saving; systemic risk; four-zone framework; (follow links to similar papers)
JEL-Codes: E21; F34; G01; H63; (follow links to similar papers)
26 pages, April 3, 2014
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