Systemic indicators Developing inputs on system-wide risks for

Systemic indicators Developing inputs on system-wide risks for financial stability analysis and macroprudential policy Paul Van den Bergh Head of Information, Statistics and Administration Monetary and Economic Department IMF-FSB Users Conference, Washington DC, 8 -9 July 2009 Views expressed are those of the author and not necessarily those of the BIS or its associated organisations 1

What are systemic indicators? l Early warning indicators l Financial stability/vulnerability indicators l Financial soundness indicators l Macro-prudential indicators l Mixture of “individual” indicators and “composite” indicators 2

Commonly used variable in financial stability reports l Real economy: GDP, government fiscal position, inflation l Corporate sector: debt to equity, earnings (to interest and l l principal expenses), fx exposure, defaults Household sector: assets and liability positions, income, consumption, debt service levels External sector: (real) exchange rates, fx reserves, CA+capital flows, maturity/currency mismatches Financial sector: money, (real) interest rates, bank credit, bank leverage, NPLs, CDS premia, capital adequacy, liquidity ratio, credit ratings, sectoral/regional concentration of exposures Financial markets: stock index, corporate bond spread, market liquidity, volatility, house prices 3

Macroprudential policy/framework l Much work in Basel, still confusion over its definition l Two features 1. Focus on financial system as a whole 2. Treat aggregate risk as dependent on collective behaviour of financial institutions (endogenous) l Contrast with microprudential which focuses on individual institutions and treats aggregate risk as exogenous l For 1: think of financial system as portfolio of securities with each security representing financial institution l For 2: think of link credit extension to economic activity, to asset price inflation, to increase in valuation of collateral to credit extension … 4

Macroprudential policy/framework: dimensions l Risk distribution at a given point in time (cross-sectional) • Correlation of exposures across institutions (direct or through linkages) • Contribution of individual institution to system-wide risk • Likelihood of failure if others face distress at same time • Vulnerability to risk concentrations even if individual institutions are diversified l Risk evolution over time (time dimension) • How can system-wide risk by amplified by interaction financial system and real economy? • Procyclicality • Impact of macroeconomic sources of risk: asset prices, credit, leverage l Important implications for calibration of prudential tools 5

Macroprudential policy/framework: cross-sectional l Measure likelihood of systemic event at given point in time l Use techniques applied to portfolios of securities l Data required • Size of institutions • Institution’s probability of default • Loss-given default in each case • Correlation of defaults l Information can be collected from supervisory assessments, prices of bank equity and debt l Overall level of systemic risk increases with institutions’ exposures to common risk factors 6

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Macroprudential policy/framework: cyclical l Countercyclical capital requirements (CR) • Choose indicator that signals time to build up and release capital buffer • Choose formula to determine CR when indicator changes • Adjust actual CR (rule-based or discretionary) l Possible indicators • Credit spreads • Real asset prices • Composite indicator combining credit/GDP ratio and real asset prices • Example for US • Variable presented as deviations from long-term average 8

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Reprioritisation of Financial Soundness Indicators? l Significant statistical project developed with wide consultation l Large number of participating countries l Distinction core and encouraged sets? l Core set • various ratio’s of aggregate balance sheet items of deposit takers • concept of consolidation not clearly understood • difficult to integrate data with other banking datasets 10

Reprioritisation of Financial Soundness Indicators? l Encouraged set • Includes indicators on indicators for other sectors, financial markets and real estate price indices • More emphasis on non-bank financial sectors? • Financial positions of other sectors through financial account/balance sheet approach? • More emphasis on housing and housing finance indicators (methodology on residential real estate price indices being developed by IWGPS/Eurostat)? 11

Conclusions l Need to be clearer about what we want to measure (individual elements of “financial situation”, composites, leading indicators? ) l Specific set of information requirements for macroprudential policy/framework (cross-sectional and cyclical analysis of aggregate risk; mixture of micro and macro data) l Possible to improve FSI’s both in terms of methodology and content (distinction core vs encouraged, better coverage of non-bank sector, more “agile” methodology) 12