Firm-level data for 55 countries, 1991-2016: The riskiness of credit allocation, captured by Greenwood and Hanson (2013)’s ISS indicator, helps predict downside risks to GDP growth & systemic banking crises 2-3 years ahead

Working Paper No. 19/207 : The Riskiness of Credit Allocation and Financial Stability. Luis Brandao-Marques,Qianying Chen,Claudio Raddatz,Jérôme Vandenbussche,Peichu Xie. IMF Working Paper No. 19/207, September 27, 2019. https://www.imf.org/en/Publications/WP/Issues/2019/09/27/The-Riskiness-of-Credit-Allocation-and-Financial-Stability-48670

Summary: We explore empirically how the time-varying allocation of credit across firms with heterogeneous credit quality matters for financial stability outcomes. Using firm-level data for 55 countries over 1991-2016, we show that the riskiness of credit allocation, captured by Greenwood and Hanson (2013)’s ISS indicator, helps predict downside risks to GDP growth and systemic banking crises, two to three years ahead. Our analysis indicates that the riskiness of credit allocation is both a measure of corporate vulnerability and of investor sentiment. Economic forecasters wrongly predict a positive association between the riskiness of credit allocation and future growth, suggesting a flawed expectations process.