Early warning indicators of banking crisis and bank related stock returns

- Credit growth is more informative to predict bank crisis than credit-to-GDP gap.
- Credit growth forecasts bank stocks in credit tightening periods.
- Credit growth predicts stock returns of bank dependent firms in tightening periods.
- Bank stocks are more predictable than stocks of bank dependent firms.

This study examines whether early warning indicators of banking crisis can predict the U.S. bank related stock returns in credit tightening periods. We use the credit-to-GDP gap and the credit growth as the early warning indicators of banking crisis. Using bank stock returns and stock returns of bank dependent firms, we find the credit growth forecasts both of the bank related stock returns better than the credit-to-GDP gap in periods of tightened credit conditions. Our results suggest that the credit growth is more informative in predicting bank sector crisis than the credit-to-GDP gap.