Transcript What is a macroprudential policy?

Macroprudential policy – a framework
Jan Frait
Executive Director
Financial Stability Department
„ … in tracking systemic risk … we should avoid a false
sense of precision … it is better to be approximately
right than precisely wrong“
Claudio Borio, BIS (2010)
„ … dignity has never been photographed“
Bob Dylan, Dignity (1991)
2
I.
Concept of Macroprudential Policy
3
The birth of macroprudential“ policy
• Following the global financial crisis, on the global, the EU level as well as
on the national levels the ways how to establish the additional pillar for
financial stability – macroprudential policy framework – has been
discussed.
• Until the crisis, the concept of macroprudential policy was discussed
primarily within the central banking community under the leadership of
the Bank for International Settlements (BIS henceforth).
• After the crisis, the term “macroprudential” has become a buzzword
(Clement, 2010) and the establishment of effective macroprudential
policy framework has become one of the prime objectives of the G20,
EU, IMF and other structures.
• In the EU, such a desire has already been reflected in the decision to
create the European Systemic Risk Board as the EU-wide authority of
macroprudential supervision and by number of iniciatives focusing on
defining the EU-wide framework for macroprudential regulation.
4
The birth of macroprudential policy
• The EU-wide framework for macroprudential regulation including the
toolkit was created over 2012 and 2013.
• National competent or designated authorities in terms of
macroprudential policy were constituted.
• The CNB is the only institution responsible for macroprudential policy
in the Czech Republic.
• There are different models in the EU (CB only, FSA only, multi-agency
committees, more institutions, minister of finance).
5
What is a macroprudential policy?
• The term “macroprudential” as applied now is too embracive and
often used outside of the scope of its original meaning.
• The CNB looks at the concept of macroprudential policies from
relatively narrow perspective of the original BIS approach (e.g.
Borio, 2003, Borio and White, 2004).
• The objective of a macroprudential approach in the BIS tradition
falls within the macroeconomic concept and implicitly involves
monetary and fiscal policies (Borio and Shim, 2007, and White,
2009).
• In the BIS tradition, the phenomenon of financial market
procyclicality (mainly the procyclical behaviour in credit provision)
stands centrally (Borio and Lowe, 2001, or Borio, Furnine and
Lowe, 2001).
• The CNB‘s analyses are focused mainly on risks associated with
procyclicality, credit cycle in particular.
6
Two credit booms and one bust thus far in the CR
• Credit boom in early 1990s followed by sharp increase in credit losses and
major financial crisis.
• Credit “boom” of 2005-2008 had benign consequences.
• What made the difference?
Credit cycle in the Czech Republic
(1993-2012, v %)
GDP growth and credit risk in the Czech Republic
(1993-2012, in %)
30
25
65
35
60
30
55
25
10
8
20
15
6
4
10
50
20
2
5
45
15
0
40
10
35
5
30
0
0
-2
-5
-4
-10
-15
I/93
I/96
I/99
I/02
credit growth (MA)
I/05
I/08
I/11
-6
-8
I/93
I/99
%NPL
credit-to-GDP (rhs)
Source: CNB
Note: Credit growth is year-over-year increase in total bank credit.
% NPL is the share of nonperforming loans on total bank credit.
Data from the beginning of 1990s are based on authors' estimates.
I/96
I/02
I/05
I/08
I/11
GDP growth (rhs)
Source: CNB
Note: % NPL is the share of non-performing loans on total bank credit.
Data from the beginning of 1990s are based on authors' estimates.
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What is a macroprudential policy?
• Financial market structures matter as well.
• The other stream of macroprudential thinking is more micro-oriented and
focusing on individual institutions and their mutual interactions.
• By comparison with the BIS logic, in this approach systemic risk arises
primarily through common exposures to risk factors across institutions, i.e
canonical models of financial instability like Diamond and Dybvig (1983)
emphasizing interlinkages and common exposures among institutions.
• The analyses of this sort (common exposures among institutions, network
risks, infrastructure risks, contagion ...) has been intensively studied by the
IMF (see special chapters in some Global Financial Stability Reports).
• The ESRB analytical work also puts more emphasis on structural issues
than conjunctural ones.
• The reason is natural – financial cycles differ significantly within EU
economies, the ESRB started to operate during financial crisis characterized
by number of contagion risk channels.
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The CNB’s historical interpretation of financial stability
•
•
•
Consensus in the central bank community - the financial stability objective is to achieve
continuously a level of stability in the provision of financial services which will support the
economy in attaining maximum sustainable economic growth.
The CNB adopted a definition consistent with this way of thinking about the financial
stability objective back in 2004.
• It has defined financial stability as a situation where the financial system operates
with no serious failures or undesirable impacts on the present and future
development of the economy as a whole, while showing a high degree of resilience
to shocks.
Financial stability analysis as the study of potential sources of systemic risk arising from
the links between vulnerabilities in the financial system and potential shocks coming
from various sectors of the economy, the financial markets and macroeconomic
developments.
• The sources of systemic risks can be viewed as externalities associated with
behaviour of financial institutions (for details of such approach see Nicolò et al.,
2012), and financial markets and their participants (short-termism, myopia, risk
ignorance, herding).
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The CNB’s historical interpretation of financial stability
Sound financial system
Yes: resilience
No
Financial
stability
Yes
Financial
volatility
Shocks
• The CNB’s approach to financial
stability has historically been strongly
macroprudential.
• Its objective is to ensure that the
financial system does not become so
vulnerable in the course of cycle that
unexpected shocks ultimately cause
financial instability in the form of a
crisis.
No: vulnerability
Financial
vulnerability
Financial
instability
(crisis)
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The CNB’s current interpretation of financial stability
• Robustness is the key to avoiding vulnerability.
• For a bank-based system, robustness can be achieved via high loss
absorbency, strong liquidity, barriers to credit boom and plenty of luck.
• Loss-absorbency:
• expected losses – sufficient provisions (Frait and Komárková, 2009),
• unexpected losses – capital cushions,
• microprudential (Basel II) component,
• countercyclical component (Frait, Geršl and Seidler, 2011; Geršl and Seidler,
2011),
• cross-section SIFI component (Komárková, Hausenblas and Frait, 2012).
• Strong liquidity (buffers and stable funding) is essential way for
limiting fragility of liabilites (Komárková, Geršl and Komárek, 2011).
• Some macroprudential tools for creating barriers to credit booms,
excessive leverage are needed too.
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Financial stability vs. macroprudential policy
•
The CNB considers macroprudential policy to be an element of financial stability
policy (Frait and Komárková, 2011).
• the other part is microprudential oversight (regulation and supervision)
•
•
The main distinguishing feature of macroprudential policy is that unlike traditional
microprudential regulation and supervision (focused on the resilience of individual
financial institutions to mostly exogenous events):
• it focuses on the stability of the system as a whole;
• it primarily monitors endogenous processes in which financial institutions that
may seem individually sound can get into a situation of systemic instability
through common behaviour and mutual interaction,
• the objective of financial stability analysts is therefore avoid the risk of the fallacy
of composition – wrong assumption that the state of the whole is the sum of the
state of seemingly independent parts, for the trees the forest is not seen.
Hanson et al. (2011) mark the microprudential approach as partial equilibrium
conception while macroprudential approach as one in which general equilibrium
effects are recognized.
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Macroprudential policy components
• Macroprudential policy is comprised of application of
macroprudential regulation and macroprudential
supervision/surveillance for pursuing financial stability
objective.
• Macroprudential regulation – definition of rules and tools for their
enforcements for keeping systemic risk in reasonable level.
• Macroprudential supervision/surveillance – macro-off-site
supervision consisting of monitoring of systemic risk, setting
macroprudential instruments, issuing warnings and
recommendations for microprudential regulation and supervision,
or other policies.
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Macroprudential policy and systemic risk - objectives
• The macroprudential policy objective is to prevent systemic risk from
forming and spreading in the financial system.
• Systemic risk has two different dimensions:
• The time dimension (cyclical, conjunctural dimension) reflects the buildup of systemic risk over time due to the pro-cyclical behaviour of financial
institutions contributing to the formation of unbalanced financial trends.
• The second dimension is cross-sectional (structural dimension) and
reflects the existence of common exposures and interconnectedness in
the financial system.
• The experience commands that the time dimension of systemic risk
has to be regarded as more important.
• Cross-sector dimension cannot be ignored especially due to the risk of
contagion from domestic as well as foreign environment.
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Macroprudential policy and systemic risk - objectives
•
•
•
The time and cross-sectional dimensions to a large extent evolve jointly and so
cannot be strictly separated.
Shin (2010) argues that increased systemic risk from interconnectedness of banks is
a corollary of excessive asset growth and a macroprudential policy framework must
therefore address excessive asset dynamics and fragility of bank liabilities.
• In a growth phase of the financial cycle, rapid credit growth is accompanied by a
growing exposure of a large number of banks to the same sectors (usually the
property market) and by increasing interconnectedness in meeting the growing
need for balance-sheet liquidity.
• Financial institutions become exposed to the same concentration risk on both
the asset and liability sides. This makes them vulnerable to the same types of
shocks and makes the system as a whole fragile.
• When the shock comes, banks face problems with funding, their lending is
tightened and all market participants try to sell their assets at the same time,
which creates the downward spiral in both the financial and the real sectors.
The time dimension shows up in degree of solvency, while the cross-sectional
dimension manifests itself in the quality of financial institutions’ balance-sheet
liquidity. However, solvency and liquidity are also interconnected, as liquidity
problems often transform quite quickly into insolvency.
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Macroprudential policy and systemic risk - definition
• The objective of macroprudential policy cannot be to secure financial
stability at any point in time and prevent any stresses in financial system
(make sure it never happens again),
• pursuing such objective would lead to general elimination of risk-taking of
economic agents, innovations and economic dynamics.
• Macroprudential policy can be defined as the application of a set of
instruments that have the potential to
• increase preventively the resilience of the system, in the accumulation phase
of systemic risk, against the likelihood of emergence of financial instability in
the future by
• creating capital and liquidity buffers,
• limiting procyclicality in the behaviour of the financial system
• containing risks that individual financial institutions may create for the
system as a whole.
• mitigate the impacts, in the materialization phase of systemic risk, of
previously accumulated risks if prevention fails.
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II.
Financial Cycle and Systemic Risk
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Good times and virtuous cycle
• In good times the financial institutions and their clients may fail to price
correctly the risks associated with their decisions or may even be
incentivized to increase the extent of risk taken.
• In such periods, access to external sources of financing improves
significantly - such access is more dependent on current risk perceptions
on the side of both banks and their clients, which are strongly dependent
on current economic activity.
• If economic agents start to misconstrue a temporary cyclical improvement
in the economy as a long-term increase in productivity, virtuous cycle can
start to develop, supported by an increased willingness of households,
firms and government to take on a debt and use it to buy risky assets.
• This sets off a spiral (positive feedback loop) manifesting itself as a
decreasing ability to recognise risk, trend growth in asset prices, weakened
external financial constraints and high investment activity supported by
output growth, increased revenue growth and improved profitability.
• In the background of this cycle, credit picks up, financial imbalances grow
and systemic risk builds up unobserved.
18
Credit bust and vicious circle
• Systemic risk often shows up openly later on, when economic activity
starts to weaken as a result of a negative stimulus.
• Recession subsequently sets in, opposite processes take place, and the
spiral turns around.
• Economic agents realise that their income has been rising at an
unsustainably high rate, they are burdened with too much debt, their assets
have fallen in value and so they need to restructure their balance sheets.
• Both banks and their clients start to display excessive risk aversion and
vicious circle gains momentum.
• To a large extent, the processes described above are as natural as the
business cycle itself.
• However, the financial imbalances can sometimes get too big and, as a
result, a dangerous vicious cycle can arise in the contraction phase.
• If the desirable adjustment is combined with strong increase in general and
with fire-sales of overvalued assets, the downward movement can become
extremely rapid and destabilising.
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Conseptual approach to financial cycle
• The key concept describing the time dimension of systemic risk over financial
cycle is leverage (the indebtedness of economic agents, stocks of loans, the
ease of obtaining of external financing, the size of interest rate margins and
credit spreads, etc..).
• The leverage (can be to some extent approximated by credit-to-GDP ratio):
• increases until the financial cycle turns over, sometimes the turn is
disorderly and presents itself as the eruption of financial crisis.
• then starts to decline, although in the early phase of the crisis remains high
(given falling nominal GDP it can even rise in the initial post-crisis years).
• The deleveraging phase can therefore last several years, and in the event of
a deep crisis the leverage ratio can, after a time, fall below its long-term
normal value.
• Consequently, the leverage ratio adjusts to economic conditions after a
considerable lag, so stock measures have only a limited information value as a
guide for the macroprudential policy response during the financial cycle.
• For this reason, forward-looking variables are needed that can be used to
identify situations where the tolerable limit for systemic risk has been exceeded.
20
Leverage over credit cycle – a slow motion process
• Conduct of macroprudential policy changes throughout financial cycle.
leverage
Good times (systemic risk
accumulation):
leverage phase with
excess optimism
turning point (start
of crisis)
Bad times (systemic risk
materialization):
deleveraging phase with
excess pessimism
time
Normal level
of leverage
Signal for macroprudential tools
activation: forward-looking or
leading indicators (credit-to-GDP
gap, real estate prices gap …)
Discontinuity in marginal risk of
financial instability: e.g.financial
markets indicators (credit
spreads, CDS spreads) or
market liquidity indicators
Signal for termination of
supportive policies:
contemporaneous indicators
(default rates, provision rates,
NPL rates, lending conditions)
and financial markets indicators
21
Credit cycle and systemic risk – the case for forwardlooking approaches
• In a credit cycle, systemic risk evolves differently in two stages:
accumulation (build-up) and materialization (manifestation).
• Note the financial (in)stability paradox: a system is most vulnerable
when it looks most robust.
Build-up of systemic risk
period of financial
exuberance
Materialisation of systemic risk
period of financial
distress
period of low
current risk
time
period of high
current risk
time
normal conditions
marginal risk of
financial instability
degree to which risks
materialise as defaults, NPLs
and credit losses
22
Good booms, bad booms and systemic risk
• It is difficult to convince people of the system heading into a big mess, after
all a tranquil situation of this sort does not always mean that the financial
system accumulates systemic risk dangerously.
• A low level of risk indication can simply mean that a truly good and longlasting boom is under way.
• At any particular point in time it is likely that some indicators are giving
contradictory results.
• The financial instability paradox occurs only occasionally and irregularly.
• Still, the analysts have to keep in mind the risk of being trapped by the
financial instability paradox, i.e. that unusually good values of current
indicators signal a growing risk of financial instability.
• One can be rather sure that if credit and some asset prices are going up
quickly and moving away from historical norms, and both the quantitative and
qualitative evidence indicates excessive optimism and mispricing of risk, there
is a problem ahead, unless decision-making bodies take action.
23
Paradox in practice – the case of Irish boom and bust
• Remember Ireland – it looked so well in 2007:
• real-estate-price gap and credit-to-GDP gap indicated exuberance,
• sources of systemic risk may be increasing when banks and their clients
consider their business risks to be the lowest - non-performing loans ratio
close to zero “indicated“ resilience.
Ireland (end 2007 vs. June 2010)
(credit risk ratios in %)
80%
Leading Indicators of Systemic Risk
Accumulation in Ireland
Coverage ratio (provisions to NPLs)
60
40
20
0
-20
60%
40%
20%
0%
0%
-40
I/00
I/02
I/04
I/06
credit-to-GDP gap (IE, %)
real estate price gap (IE, %)
Source: IMF.
5%
10%
20%
25%
Non-performing loans ratio
Note: Size of the ring indicates relative volume of non-performing loans
Source: Central Bank of Ireland
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Paradox in practice – the case of Czech credit boom
• Bad loans are being created in good times.
• „Good“ information about it comes in subsequent bad times.
Procyklické chování ekonomiky
70
10
60
8
50
6
Opravné položky a úvěry v selhání (v mld. Kč)
(leden 2001-listopad 2011)
200
180
160
100
-2
80
-10
-4
60
-20
-6
40
-30
-8
20
opravné položky (mld. Kč)
I-11
I-10
I-09
0
I-08
tempo růstu úvěrů (mzr. v %)
tempo růstu cen bytů (mzr. v %)
tempo růstu HDP (mzr. v %)
I-07
I/99 I/00 I/01 I/02 I/03 I/04 I/05 I/06 I/07 I/08 I/09 I/10
I-06
0
I-05
0
10
120
I-04
2
20
140
I-03
30
I-02
4
I-01
40
úvěry v selhání (mld. Kč)
25
III.
Credit Risk and Cycle
26
Testing for credit risk determinants I
• The industry has a tendency to look at the credit risk level through the
ratio of non-performing low to total loans (NPL ratio).
• This itself provides a room for complacency in periods characterized by
increased economic activity and fast credit growth.
• NPL ratio is a variable that may suffer from financial instability paradox.
• Empirical studies on credit risk determination (Hardy & Pazarbasioglu,
(1998); Salas & Saurina (2002); Kalirai & Scheicher (2002), Delgado &
Saurina (2004), Louzis et al. (2010); Vogiazas & Nikolaidou (2011), for
example)), tend to confirm strong link between the phase of the
business cycle, credit defaults and NPLs.
• We apply panel data methods to examine the determinants of nonperforming loans (NPLs) in the Czech banking sector in order to
investigate the effects of both macroeconomic and bank-specific
variables on loan quality.
• The exercise is not intended to identify the determinants of credit risk but
to demonstrate the how the NPL ratio evolves over a business cycle. 27
Testing for credit risk determinants II
• We focus on the determinants of NPLs in the Czech banking sector and
use for estimation quarterly data for the period 1Q2001 – 1Q2014
including bank-by-bank supervisory data on NPLs and credit growth.
NPLi ,t  1,i   2 NPLi ,t 1   3GDPt   4UNEM t   5 IRt   6 NERt   7 LOANS i ,t   it ,
Variables:
(i)
macroeconomic: the growth rate of real GDP per capita (GDP), the
unemployment gap (difference between the unemployment rate and the longterm unemployment rate, UNEM); the spread between lending interest rate and
three-month interbank interest rate (IR), exchange rate gap (difference between
nominal rate and its Hodrick-Prescott trend, NER),
(ii) bank-specific: the ratio of non-performing loans to total loans (NPL), credit growth
(LOANS),
(iii) other: „t“ denotes time and „i“ the individual banks (15).
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Testing for credit risk determinants III
Variable/Method
NPL (-1)
GDP
UNEM
LOANS
SIR
NER
CONS
R-squared
FE1
GMM2
0.6997***
0.7454***
(0.0773)
(0.0677)
-0.0137
-0.0166**
(0.0088)
(0.0075)
0.1000**
0.0963***
(0.0357)
(0.0338)
-0.0014
-0.0011
(0.0011)
(0.0009)
-0.0200
-0.0244
(0.0648)
(0.0564)
0.0049*
0.0052**
(0.0024)
(0.0025)
0.0466**
0.0422***
(0.0163)
(0.0161)
0.953400
No. of observation
780.000000
No. of groups
15.000000
Note: the first-differences used, ***, **, and * denote significance at 1 percent,
5 percent, and 10 percent, respectively. Standard errors are below coefficient
estimates in brackerts. 1We tested the panel data for non-stationarity using
the Hadri panel unit root test. 2Sargan test of overid. restrictions:
chi2(6)=34.58, Prob>chi2=0.000, AR(1): z= -1.55, Pr>z=0.120, AR(2): z=1.26,
Pr>z=0.207.
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Testing for credit risk determinants IV
• Variables representing economic activity dominate while bank-specific
variables do not appear significant.
• The macroeconomic variables have both expected signs (GDP
negative and UNEM positive).
• An increase in the real GDP growth leads to a decline in NPLs.
• With respect to unemployment, the impact is also the one expected: an
increase in unemployment affects households’ ability to service their
debts.
•
Strong role of state of business cycle and its dynamics confirmed.
• Once recession strikes, credit risk goes to the light.
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IV.
Systemic Risk Indicators
31
Prevention and forward-looking indicators
• The main task of financial stability analysis as regards prevention is timely
identification of the risk of financial instability – the marginal contribution of the
current financial environment to the build-up of risks of a future financial crisis.
• In this phase, macro-prudential analysis must be focused primarily on the
identification of hidden risks to financial stability being generated in the balance
sheets of financial intermediaries and their clients.
• Analytical attention, however, must also be paid to the quality of cash flows, as
financial institutions with structural problems in their balance sheets, weak balancesheet liquidity and long maturity transformations are naturally far more prone to
cash-flow problems.
• Authorities need a set of forward-looking indicators providing information on the
possibility of materialisation of systemic risk in the future as a result of currently
emerging financial imbalances.
• This refers mainly to “gap” indicators based on the assessment of deviations of
factors determining the degree of leverage from their equilibrium or normal values.
• As regards the possibility of using forward-looking indicators to construct earlywarning systems, we feel that their information value and practical applicability
remain limited.
• Beware of financial markets‘ data signals – IMF, ESRB …..
• Analytically, it is also possible to use the FS paradox – extremely good values of
parallel indicators tell us that something strange is going on in the system.
32
Mitigation and identification of discontinuities
• In the systemic risk materialisation phase, the macroprudential policy focus
must be shifted to mitigating the impact of the crisis.
• In this phase it is vital to assess the scale of the risk materialisation problem and
the resilience of the financial system.
• Stress tests of the financial system’s resilience are a suitable analytical instrument
for performing this task.
• Macroprudential analyses must take into account the high degree of
discontinuity in the evolution of systemic risk – the potentially sharp transition
from good to bad times.
• To this end it is necessary to construct indicators characterising the start and end of
the materialisation of financial instability.
• In a small open economy, financial or informational contagion resulting from the
links between an economy and its institutions and the external environment can
be a major source of materialisation of systemic risk and of discontinuity in the
evolution of such risk.
• The analytical approach will differ significantly from country to country (share of
foreign ownership of financial institutions, dominance of subsidiaries or branches of
foreign banks, share of foreign currency loans, net external and foreign exchange
33
position of the banking sector and entire economy...).
Countercyclical capital buffers – the example of policy
• Policy of countercyclical capital buffers should follow the developments of
leverage over financial cycle and associated risk for financial stability.
Credit-to-GDP over financial cycle
period of financial
exuberance
Credit dynamics (e.g. y-o-y growth)
period of financial
exuberance
period of financial
distress
period of financial
distress
CCB set to zero
again
time
long-term „normal“
level of credit-to
GDP
time
CCB set at
maximum 2,5 %
turning point (start of
crisis): credit-to-GDP
still very high, but policy
has to change sharply
CCB set to zero
turning point (start of
crisis): credit growth
falls, lending conditions
tighten
34
How to Tell Normal Times from the Not So Normal Ones
• The key feature of a financial exuberance period, in addition to the
availability of cheap credit, is the emergence of overly optimistic
expectations about future income and asset prices leading to extra
risk appetite and excessive risk-taking.
• Financial distress period - in addition to the limiting the availability of
credit, economic agents become over-pessimistic.
• To identify the onset of or exit from not so normal times - the gaps
based on the indicators‘ level relative to their long-term average or
trend reveal the story:
•
•
•
•
•
•
credit growth, credit-to-GDP;
debt-to-income, debt-to-assets dynamics;
money market risk premia, credit spreads and CDS spreads;
financial investors’ lever length;
length of maturity transformation by banks;
lending standards, credit risk gauges, ...
• Bad news: systemic risk cannot be measured/predicted precisely!
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Financial Stability Indicators Matrix
Phase
Dimension
Risk accumulation
Time (cyclically induced risks)
Cross-sectional time (structurally
induced risks)
Risk materialisation
Time
Cross-sectional
Note: The table contains a list of selected indicators. Many of these tools can be directed at both
the time and cross-sectional component of systemic risk. The table gives the predominant target.
Sector abbreviations: H – households, C – corporations, F – financial institutions, P – property
market, M – financial markets, G – government. No abbreviations are shown next to indicators
that are valid for the economy as a whole. Underlined indicators are ones that we consider
important for CNB analysis.
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Financial Stability Indicators
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Indicators – Accumulation, Time
credit-to-GDP (deviation from long-term trend or normal)
rate of growth of loans and asset prices
gaps in asset prices and yields (deviations from long-term trend or normal)
leverage ratio (F)
default rate, NPL rate (F)
level and adequacy of provisions (loan-loss provision rate, coverage ratio, F)
credit conditions and characteristics of new loans from BLS (F)
credit spreads and risk premia (F)
haircuts on collateralized lending (F)
debt-to-assets ratio (H,C)
debt-to-income ratio (H,C)
interest-to-income ratio (H,C)
price-to-income ratio (P)
loan-to-value ratio (P)
price-to-rent ratio (P)
market liquidity in the form of market turnover (P)
macro stress tests of markets and credit risks (F)
early warning systems (F)
composite indicators of financial stability or leverage level (F)
macroeconomic imbalance indicators (government deficit and government debt,
current-account deficit and external debt, national investment position, foreign
exchange reserves, external financing requirements, currency under- or overvaluation)
37
Financial Stability Indicators
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Indicators – Accumulation, Structural
quality of liquidity structure (loans-to-deposits ratio, customer funding gap, ratio
of funds acquired on interbank market, F)
ratio of non-core liabilities to total funding (F)
maturity transformation ratio (maturity mismatch indicators, F)
capital quality structure (F)
liquidity stress tests (F)
composite liquidity index (F)
indicators of scale of activity within financial system, including network analyses
(e.g. flows between institutions, F)
degree of asset and liability concentration (F)
share of large exposures in balance sheet (F)
share of riskier loans in within specific classes (interest-only mortgages, F)
scale and structure of off-balance-sheet items (F)
bank foreign debt to bank foreign asset ratio (net external assets of banks, F)
currency mismatch indicators (open foreign exchange position, share of foreign
currency loans, F)
composite volatility index (M)
macroeconomic imbalance indicators (capacity for external contagion shock)
38
Prevention and indicators
• When assessing systemic risk during the accumulation phase, the authorities
have to build upon a comprehensive analysis of a set of indicators.
• they must first of all reach a general consensus on the normal or
sustainable values of the relevant indicators (the ones deemed highly
relevant for the CNB are underlined)
• and then continuously assess whether the deviations of the actual values
from their normal levels are becoming critical.
• they also have to pay attention to recognition of the types of likely shocks,
estimating their probabilities and potential impacts.
• The difficulties in reaching a consensus create a risk of delayed activation,
leading to an insufficient and inefficient policy reaction.
• imprecise timing of activation can result in overshooting or undershooting of
macroprudential objectives.
• It is therefore crucial to assess, on a continuous basis, the position of the
economy in the financial cycle.
• This is the crucial determinant in guiding the activation and release of
macroprudential tools in both stages of the cycle (preventive activation,
deactivation of preventive tools if possible, release of buffers and other tools
plus activation of anti-crisis measures, deactivation of anti-crisis measures).
39
Scenarios for the Activation and Release of Macroprudential
Instruments
Stage of financial cycle
Bust
With crisis
Boom
Other
macroeconomic
conditions
Strong
Tighten
Without crisis
No change or release
Release (if possible)
Weak
Tighten (only if
Release
necessary)*
* The case of the euro area in 2011–12 demonstrated that if banks end up without capital buffers and markets
lose confidence in their stability, the authorities may be forced to resort to requiring additional capital even
though this would normally constitute unwelcome tightening of policy during a crisis.
Source: CGFS (2012, p. 5)
No change or
tighten
The evolution of systemic risk and conduct of macroprudential policy over the financial cycle
Leverage
Good times (accumulation of
systemic risk): phase of
increasing leverage with
excessive optimism
Turning point (or
outbreak of crisis)
Bad times (materialisation
of systemic risk): phase of
deleveraging with
excessive pessimism
Normal leverage level
A case of cycle
without a crisis
Time
Signal to activate
macroprudential policy: forwardlooking indicators credit gap or
property price gap…
Discontinuous change in
marginal risk of financial stability:
e.g. financial market indicators
(credit spreads, CDS spreads) or
market liquidity indicators
Signal to end support policies:
current indicators (default rate,
NPL ratio, provisioning rate,
lending conditions) and financial
market indicators
40
Prevention and indicators
• It is undoubtedly quite difficult to distinguish normal cyclical
fluctuations and long-term trends from a dangerous financial cycle
in timely fashion.
• At any particular point in time it is likely that some indicators are
giving contradictory results.
• As to the build-up of systemic risk, one can be rather sure that if
credit and some asset prices are going up quickly and moving away
from historical norms, and both the quantitative and qualitative
evidence indicates excessive optimism and mispricing of risk, there is
a need to send out a clear warning and recommend that decisionmaking bodies take action.
41
Materialization and indicators
• If prevention is not sufficiently effective and a systemic risk
materialisation phase occurs, the macroprudential policy focus
must be shifted to mitigating the impact of the crisis.
• The easiest job for financial stability analysts may be to identify a critical
point (outbreak of crisis) in a simultaneous economic and financial boom
since the onset of a crisis tends to be clearly visible thanks to a sharp
deterioration in market variables (e.g. credit spreads or CDS spreads).
• In the systemic risk materialisation phase, it is vital to assess the
financial system’s ability to withstand the emerging risks.
• The analyses will have to extend their focus to the short-term risks
associated with adverse economic developments.
42
Financial Stability Indicators Matrix














Indicators – Materialization, Time
dynamics of default rate and NPL ratio (F)
dynamics of provisioning (coverage ratio, LLPR, F)
decline in profitability (F)
change in CAR (F)
macro stress tests of markets and credit risks (F)
credit spreads (H,C,G,M)
Indicators – Materialization, Structural
stress tests of liquidity (F)
changes in market liquidity measures (M)
activity and spreads on interbank money market and government bond market (F)
CDS spreads (F)
interbank contagion tests (F)
CoVaR (F)
joint probability of distress (F)
contingent claim analysis (F)
43
V.
Instruments of Macroprudential Policy
44
Macroprudential policy and systemic risk - tools
• True (genuine) macroprudential tools are those which can be applied in
the form of rules and can therefore take the form of built-in stabilisers.
• They should automatically limit the procyclicality of the financial
system or the risky behaviour of individual institutions.
• They should be explicitly focusing on the financial system as a
whole and endogenous processes within it.
• In addition to true macroprudential tools, various microprudential
regulatory and supervisory tools can be used for macroprudential
purposes.
• If these tools are applied not to individual institutions, but across
the board to all institutions in the system, they can be regarded as
macroprudential instruments.
• Measures of this type, along with monetary policy tools, fiscal policy
tools and tax measures, have been applied in many countries in the
past in an effort to slow excess credit growth.
45
Prevention vs. reaction in micro- and macro-approaches
• Microprudential approach (for example banking supervision):
• Prevention through enforcement of compliance rules and regulations
of prudential behaviour.
• Reaction when breaching of the rules/regulations is identified and
when prudential indicators got worse.
• Macroprudential approach:
• Prevention not based on rules and regulations, but on analyses and
indicators of systemic risk (as with monetary policy).
• Prevention can work only through timely and forward-looking action.
• Paradox of financial (in)stability - corrective action must therefore
occur in good times (as with monetary policy).
46
ESRB‘s key product of 2013 and 2014
• Flagship Report and Handbook on Macro-Prudential Policy in the
Banking Sector published in March 2014
• Flagship Report provides overview of the new macro-prudential policy framework
in the EU.
• Detailed handbook which is aimed at assisting macro-prudential authorities to
use the new instruments.
Objective: Address
Systemic Risk
Excessive credit growth & leverage
Indicators
Credit-to-GDP gap
Housing credit,
housing prices
Key Instruments:
Capital instruments:
- by sector (real
Counter-cyclical
estate, intra-financial)
Capital Buffer
- Systemic risk buffer
- Leverage ratio
LTV / LTI caps
Broad Transmission
channels:
Resilience of banks; contribute to
curbing excessive (sectoral) credit
growth
Resilience households,
mitigate pro-cyclicality
mortgage credit
47
Instruments of macroprudential policy
• A consensus regarding the key sources of systemic risks and
appropriate policy tools has emerged.
• Reflected in the ESRB‘s Flagship Report and Handbook on MacroPrudential Policy in the Banking Sector published in March 2014.









Source of systemic risk (of vulnerability)
Undue leverage
Excessive credit growth accompanied by lenient
lending practices
Shortage of quick liquidity
Maturity mismatches regarding asset and
liabilities
Unstable structure of bank funding
Excessive interconnectedness of financial
institutions
Complexity and opacity of financial sector
Reliance on bail-out of large and important
institutions
Excessive concentration in assets or liabilities of
financial institutions








Appropriate tool
Countercyclical capital buffer
Through-the-cycle provisioning
LTV and LTI (PTI) limits
Leverage ratio
Increased risk weights for specific sectors
LCR
NSFR
LTD ratio or core funding ratio


SIFI capital surcharges
Systemic risk capital surcharges

Large exposure limits
48
Macroprudential policy and systemic risk – tools I
49
Macroprudential policy and systemic risk – tools II
50
V.
Conclusions
51
The limits of macroprudential policy
• The preventive objective of macroprudential policy is not to sweep any
risk out of financial system
• it can only be to try to build barriers against the occasions when firms and
households take on risks that they are not able to identify or price correctly
owing to wide-spread exuberance in the financial system;
• such barriers may limit the potential for mass of occurrence of wrong
investment decisions leading to debt deflations etc.
• The central bankers may not be able to prevent from financial upswings
and imbalances
• but they can and set boundaries for prospective damages through applying
counter-cyclical tools.
• At the same time central bankers should not try to assist the agents to
get from their wrong decisions too easily – this would just provide the
incentive to excessive risk-taking in the next financial cycle.
• Paradox of financial instability thus sets clear limits for central bankers
too – the push for undue stability may produce destabilizing effects in
the long run.
52
Proper analyses, courage and luck needed
• The importance of the analyses of risks associated with current policies
and developments for future financial stability has been recognized.
• Owing to financial instability paradox, most indicators of actual credit and
market risks are not much useful for detecting probability of systemic risk
materialization in the future: they are not forward-looking.
• The analyses of financial stability risks must not be mechanical, relying
too much on formal EWS, DSGE-like models, indicators from financial
markets: deviations from equilibrium, non-linearities, discontinuities,
failures of efficient market hypothesis have to be taken into account.
• All relevant pieces of information have to be assessed through
fundamental analysis drawing upon economic theory and history: there is
a role for judgment by experienced experts in telling good booms from the
bad ones.
• The success in macroprudential policy-making will still require plenty of
courage, communication skills and luck.
53
References
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•
•
•
•
•
•
•
•
•
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