Banking Stability and the Financial Cycle: The Spanish Experience

Abstract

This paper defines the special characteristics of the financial cycle of Spain during the period 1995-2016 and investigates to what extend the stability of the banking system attenuates or exacerbates the financial cycle. The findings of these two empirical analyses highlight that the financial cycle in Spain is accurately defined by the credit-to-GDP ratio, credit-to-private non-financial sector and residential property prices. Moreover, the credit-to-GDP gap represents a good early warning indicator of the banking crisis in Spain. Finally, an exogenous deviation of actual loan loss provisions-to-total loans ratio from its potential value leads to smoothing of the cycle. Thus, the Spanish dynamic provisions regulation seems to be a good instrument for use as a macroprudential tool to deal with the pro-cyclicality of the financial system.