Particular emphasis is put on the credit-to-GDP gap (credit gap), defined as the difference between the credit-to-GDP ratio and its long-term trend. Where available, bank lending surveys contain valuable information about the risk perception of senior loan officers.<sup>28</sup> It is also worthwhile to monitor real estate prices closely, although in many emerging markets reliable real estate indexes are not available. As an alternative, transactional data on newly concluded mortgage loans can also contain valuable information, such as the LTV and DTI ratios. Rapid increases occurring in the upswing of the financial cycle reflect a relaxation of loan approval criteria and therefore signal increased risk of financial instability. Lastly, the net inflow of short-term speculative capital (portfolio investments) expressed as a share of GDP is also indicative of the financial cycle, with rapid increases occurring during the upturn.

- _The financial position of households_ : It is useful but often challenging to develop an index for the financial position of households, to complement the financial cycle index. The analysis of the household sector is often impeded by lack of data, often warranting the use of indicators from sources beyond the central bank, such as the statistical office, the credit bureau, or household surveys that some countries undertake annually. Drehmann and Juselius (2013) highlight the importance of debt service ratios for the nonfinancial sector, capturing the proportion of interest payments and mandatory repayments of principals relative to income for the household sector, which can be interpreted as an important indicator for the health of households’ balance sheets, and a harbinger of a deterioration of the financial stability outlook. Household indebtedness should ideally be defined in a comprehensive manner, covering residential mortgage debt, and the full range of consumer loans (including credit card loans, auto loans, and various kinds of consumer credit). The proportion of foreign currency–denominated loans and the share of adjustable interest rate loans are also worth monitoring, because households are usually not hedged against the risk of adverse movements in currencies and rates.<sup>29</sup> Where available, indicators for net household wealth (assets minus liabilities) are also relevant: the asset side covering financial wealth (such as savings, deposits, and securities) and real wealth (land and dwellings). Data availability permitting, the share of overindebted households whose debtto-disposable-income ratio exceeds a certain threshold may also be included.

- _The financial position of nonfinancial corporates_ : Similar to the analysis of households, it is important to assess the health of the balance sheet of nonfinancial enterprises. As is the case with the household sector, data coverage can be problematic, and external data sources may need to be consulted. A first relevant indicator is the debt service ratio for firms, wherein interest and mandatory principal repayments can be expressed as a share of turnover.<sup>30</sup> In addition, it may be worthwhile to monitor the proportion of foreign-currencydenominated loans, with particular focus on nonhedged corporate borrowers, data permitting. Profitability indicators, including the return on equity (RoE) and return on assets (RoA) for the corporate sector, sales growth, and the growth of inventories, can also contain

> 28 See for instance, the ECB’s bank lending survey

> <u>http://www.ecb.int/stats/money/surveys/lend/html/index.en.html).</u>

> 29 If data allow, it may also be useful to monitor the proportion of household loans that is subject to an interest rate adjustment within the next year.

> 30 Alternatively, if turnover data are not available, corporate indebtedness can be expressed as a share of GDP.

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