Central banks, through their monitoring and analysis of monetary and credit developments, can provide early warning signals about the building-up of financial imbalances that may lead to excesses in the financial markets – through various channels involving an under-pricing of risk and an increase in market liquidity that can fuel asset price bubbles which will eventually be followed by market corrections.
And such corrections will be the more severe, the higher the degree of leverage and the more prolonged the period of excessive credit growth. There is substantial empirical evidence across countries and over different periods in support of this proposition.