16 if it is connected with some instability.<sup>7</sup> But a very rapid growth in credit is one of the most robust common factors associated with banking crises (Demirgüc-Kunt and Detragiache 1997 and Kaminsky and Reinhart 1999). IMF (2004), for example, estimated that about 75 percent of credit booms in emerging markets end in banking crises. Typically, credit expansions are fueled by overly optimistic expectations of future income and asset prices, often combined with capital inflows. Over time, households and firms accumulate substantial debt while income does not keep pace. A decline in income or asset prices then leads to an increase in non-performing loans and defaults. If the problem is severe, the country experiences a banking crisis. In a recent paper, Drehmann, Borio and Tsatsaronis (2011) examine the performance of different variables as anchors for setting the level of the countercyclical regulatory capital buffer requirements for banks, finding that the gap between the ratio of credit-to-GDP and its long-term backwardlooking trend performs best as an indicator for the accumulation of capital, because this variable captures the build-up of system-wide vulnerabilities that typically lead to banking crises. An advantage of the excessive credit growth variable is that it is relatively easy to observe and monitor. Also, unlike some of the other measures (e.g., those that include nonperforming loan ratios), it is a forward-looking measure of instability. A disadvantage of this measure is that it does not, by itself, capture situations where financial sector problems have already crystallized in a full-blown crisis. In such situations, credit is declining in real terms rather than growing. It is therefore important to amend the excessive credit growth indicator, as an _ex-ante_ measure of financial instability, by including credit declines as _ex-post_ proxies for situations of financial instability.

For financial markets, the most commonly used proxy variable for stability is market volatility, although other proxies are also included in the database (Table 1). One of these variables is the skewness of stock returns, the reason being that a market with a more negative skewed distribution of stock returns is likely to deliver large negative returns, and likely to be prone to less stability. Another variable is vulnerability to earnings manipulation, which is derived from certain characteristics of information reported in the financial statements of companies that can be indicative of manipulation It is defined as the percentage of firms listed on the stock exchange that are susceptible to such manipulation. In the United States, France, and most other highincome economies, less than 10 percent of firms have issues concerning earnings manipulation; in Zimbabwe, in contrast, almost all firms may experience manipulation of their accounting statements. In Turkey, the number is close to 40 percent.

Other variables approximating volatility in the stock market are the price/earnings ratio (P/E ratio) and duration (a refined version of the P/E ratio that takes into account factors such as longterm growth and interest rates). These variables are based on the empirical fact that market prices contain expectations of future cash flows and growth instead of current fundamentals only, and therefore stock prices may be more volatile and negatively skewed in the future.

> 7 Ranciere, Tornell, and Westermann (2008), for example, find that countries that have experienced occasional financial crises have, on average, grown faster than countries with stable financial conditions.