Which factor matters for financial crises: leverage level or leverage growth?

ABSTRACT

Prior studies have shown a significant impact of the leverage level on economic outcomes. This study extends the literature by examining the role of leverage growth in predicting the occurrence of financial crises. Based on a dataset of 42 economies over the period 1980–2017, the results indicate a positive and significant association between leverage growth and the likelihood of financial crises. Moreover, leverage level plays no relevant role in predicting the financial crises after leverage growth has been controlled for. Further analysis also confirms the contribution of relative sectoral leverage growth to financial crises. Specifically, both the difference between the private and the government leverage growth, and the difference between the household and non-financial corporate leverage growth are positively associated with the likelihood of financial crises. These findings suggest that we should pay much more attention to leverage growth and its impacts on financial crises.

KEYWORDS:

• Leverage growth
• leverage level
• credit growth
• financial crises

JEL CLASSIFICATION:

• E00
• F34
• G15

Acknowledgments

We are extremely thankful to the anonymous referees and the editor for valuable suggestions that greatly helped improve the paper. We also thank Yiping Huang, Harald Uhlig, Alfred Schipke, Bin Li, Bin Zhang, Yanliang Miao, Ge Wu, Qiang Gong, Xiaofen Tan, Qiyuan Xu, Feng Dong, Jinyu Liu, Xiang Li, Yan Liu, Yilin Zhang and Longmei Zhang for their helpful comments and discussions. Yang Ji acknowledges the financial support from the National Natural Science Foundation of China (No. 71803163 and No.71773005) and the Fundamental Research Funds for the Central Universities.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The non-financial sectors include the private sector (households and NPISHs, and non-financial corporates) and the government.

² We thank the referee for noting the issue..

Additional information

Funding

The work was financially supported by the National Natural Science Foundation of China [No. 71803163 and No.71773005] and the Fundamental Research Funds for the Central Universities [No. 20720181039].