The early warnings of banking crises: Interaction of broad liquidity and demand deposits

• The authors explore the fundamentals in the run-up to systemic banking crises.
• This paper presents a new early warning system for systemic banking crises.
• The interaction of liquidity ratio and loss of demand deposits improves the results.
• The out-of-sample forecasts demonstrate the strong predictive power of the model.

This paper explores the fundamentals in the run-up to systemic banking crises. It applies a visualisation approach that combines elements of an event study analysis and a fan chart technique. The approach helps identify potential leading indicators. A multivariate analysis follows. This paper presents a new early warning system for banking crises built upon these indicators. The interaction of liquidity ratio and loss of demand deposits is incorporated into the model and substantially improves the results. The selected factors are highly statistically significant and robust. The out-of-sample forecasts demonstrate the strong predictive power of the model.