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SAFE: An Early Warning System for Systemic Banking Risk

Advisory: This article is based in whole or in part on the CFSI (Cleveland Financial Stress Indicator), an indicator that was discontinued by the Federal Reserve Bank of Cleveland in 2016 due to the discovery of errors in the indicator’s construction. These errors overestimated stress in the real estate and securitization markets. As a result, readers should be cautious and interpret any analysis based on CFSI data with those errors in mind.

This paper builds on existing microprudential and macroprudential early warning systems (EWSs) to develop a new, hybrid class of models for systemic risk, incorporating the structural characteristics of the financial system and a feedback amplification mechanism. The models explain financial stress using both public and proprietary supervisory data from systemically important institutions, regressing institutional imbalances using an optimal lag method. The Systemic Assessment of Financial Environment (SAFE) EWS monitors microprudential information from the largest bank holding companies to anticipate the buildup of macroeconomic stresses in the financial markets. To mitigate inherent uncertainty, SAFE develops a set of medium-term forecasting specifications that gives policymakers enough time to take ex-ante policy action and a set of short-term forecasting specifications for verification and adjustment of supervisory actions. This paper highlights the application of these models to stress testing, scenario analysis, and policy.

JEL classification: G01; G21; G28; C22; C53

Keywords: Systemic risk; early warning system; financial stress index; microprudential; macroprudential; liquidity feedback

Suggested citation: Oet, Mikhail V., Ryan Eiben, Timothy Bianco, Dieter Gramlich, Stephen J. Ong, and Jing Wang, 2011. “SAFE: An Early Warning System for Systemic Banking Risk,” Federal Reserve Bank of Cleveland, Working Paper no. 11-29.

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