Procyclicality of Financial and Real Sector in Transition Economies

Abstract

Financial sector is prone to cyclical movements and procyclicality of the financial system may endanger financial stability, which depends on asset prices and loan losses due to the fact that the deterioration of bank assets through non-performing loans is characteristics of banking distress. This was the case during Japan's lost decade and the Nordic banking crises. Even the classic banking panics of the Great Depression are being revised in the light of new evidence on the fundamental deterioration of bank assets. Much empirical evidence supports the view that balance sheet variables, such as net worth affect investment and produce business cycle dynamics. In an upswing, the greater availability of credit leads to higher asset prices, which then serve as collateral for more borrowing. Relatively unstable development of share prices on the capital market increases equity risk. This paper is based on the presumption that the stability of macro economic environment, less pronounced cyclical movements and insignificant procyclicality between GDP and equity (used as collaterals for credit insurance) lower equity risk. There was proved no significant procyclicality between collaterals and GDP according to low stock market capitalization. And due to the relation that equity risk (as a part of market risk) is determined by unstable development of shares prices, I accepted the hypothesis of low equity risk in the analysed transition economies on the basis of tested procyclicality.