Macroeconomic determinants of credit risk: Recent evidence from a cross country study

The study of financial stability has become the cornerstone of modern macroeconomic policy particularly for developed countries. The recent global financial crisis has underscored the importance of understanding financial instability especially in the context of managing credit risk with particular emphasis on the banking sector. The key motivation for this paper is to improve our understanding of credit risk modelling at the country level especially under the framework of Basel II capital adequacy standards. The aim of the study is to investigate the interaction between the cyclical implications of aggregate defaults in an economy and the capital stock of a bank. The approach used requires the construction of a macroeconomic credit model that provides the framework to perform scenario analysis. Within this framework, our study forms the basis of a comparative analysis of two countries, a relatively immune economy from the recent crisis-Australia and the worst effected economy-the USA. The key questions posed in the study are which macroeconomic variables are important for both countries in addition we examine the impact of adverse macroeconomic shocks on default rates in both countries. The results indicate that the same set of macroeconomic variables display different default rates for the two counties. Additionally the study finds that compared to Australia, the US economy is much more susceptible to adverse macroeconomic shocks.