Composite indicator quantifies Italian financial cycle risk

The paper introduces the Cyclical Risk Indicator (CRI) as a weighted average of the best performing financial cycle indicators, offering a comprehensive assessment of systemic cyclical risk.

This new approach aims to overcome the limitations of the traditional credit-to-GDP gap, which often fails to capture the full spectrum of financial cycle dynamics.

Empirical analysis demonstrates that the CRI provides additional information for the early warning of financial distress and tail macroeconomic outcomes.

By adopting the CRI, the Italian macroprudential authority can gain a more nuanced understanding of financial cycle dynamics, enabling more informed and timely policy decisions.

This, in turn, is expected to foster a more resilient financial system and mitigate the impact of future financial crises, moving beyond a single, potentially misleading, indicator.

The countercyclical capital buffer (CCyB) traditionally uses the credit-to-GDP gap as its primary calibration guide.

However, its limitations in fully capturing financial cycle dynamics are well-documented.

Macroprudential authorities increasingly supplement this with additional indicators, recognizing that no single measure adequately reflects systemic developments.

Research consistently shows that multivariate models, combining various macrofinancial variables, significantly improve early warning capabilities for financial crises.

This growing consensus underscores the need for composite indicators to provide a more comprehensive and accurate assessment of cyclical risks, moving beyond the narrow focus of the credit gap alone.