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Early Warning Tools for Financial System Distress: Current Drawbacks and Future Challenges
Abstract
In the last decade, economic literature has consistently and imperatively promoted the need to create and use early warning models to prevent the various types of crises, especially as the coverage of bank risks has widened, as a result of the financial liberalization process, innovation and cross border financial activity. Although several supervisory authorities and central banks have already in place different types of early warning systems (Austria, Czech Republic, France, Italy, Romania, UK), the recent global financial crisis has put into question the ability of these statistical tools to monitor financial or banking distress and make accurate predictions. The aim of the chapter is twofold: i) to review the existing typologies of EWSs, developed at micro prudential and macro prudential levels; and ii) to answer several questions related to the low predictive power recorded by early warning models with respect to the current financial crisis and to depict the main international approaches towards their future structural reconfiguration and role.
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