According to a recently released working paper from the Hong Kong Monetary Authority (Central Bank), the key to predicting an impending banking crisis before it occurs is to watch the spread between LIBOR and OIS (Overnight Index Swap) rates. During normal times, the spread between the two rates is low, representing a healthy and liquid market. But during times of severe market dislocations, the spread starts to widen, which indicates liquidity problems in the interbank funding markets. The report goes on to say that if you had followed this indicator during the Fall of 2008, you would have been alerted to the market collapse and credit freeze a few days before they actually occurred. To be precise, the indicator flashed a warning signal on September 18th 2008, just days after Lehman's bankruptcy. At the time the market had not fully realized the dire consequenes. While the report mainly discusses how this is a useful tool for policy makers to anticipate and prepare for a banking crisis, I am more interested in this indicator as a trading tool. From the chart below you will see that the trigger for a banking crisis is when the spread is over 125 bps.
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