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Credit is key to support healthy and sustainable economic growth but excess aggregate credit growth can signal the build-up of imbalances and lead to systemic financial crisis. Hence, monitoring the credit cycle is key to identifying vulnerabilities, particularly in emerging markets, which tend to be more exposed to sudden external shocks and reversal in capital flows. We estimate the credit cycle in Central America, Panama, and the Dominican Republic and find that the creadit gap is a powerful predictor of systemic vulnerability in the region. We simulate the activation of the Basel III countercyclical capital buffers and discuss the macroprudential policy implications of the results, arguing that countercyclical macroprudential policies based on the credit gap could prove useful to enhance the resilience of the region’s financial sector but the activation of macroprudential instruments should also be informed by the development of other macrofinancial variables and by expert judgment.

Banks and Banking --- Macroeconomics --- Money and Monetary Policy --- Industries: Financial Services --- Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) --- Financial Markets and the Macroeconomy --- Monetary Policy, Central Banking, and the Supply of Money and Credit: General --- General Financial Markets: General (includes Measurement and Data) --- Financial Institutions and Services: General --- Financial Institutions and Services: Government Policy and Regulation --- Business Fluctuations --- Cycles --- Banks --- Depository Institutions --- Micro Finance Institutions --- Mortgages --- Finance --- Monetary economics --- Financial services law & regulation --- Credit cycles --- Nonperforming loans --- Credit gaps --- Credit --- Countercyclical capital buffers --- Financial sector policy and analysis --- Financial institutions --- Money --- Financial regulation and supervision --- Business cycles --- Loans --- Asset requirements --- El Salvador