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Financial Stability Reports:
What Are They Good For?
M. Čihák, S. Muñoz, S. Teh Sharifuddin, and K. Tintchev
June 20, 2012
FPD Academy
Comments from staff at IMF, the World Bank, and several central banks gratefully
acknowledged. Views expressed here are those of the authors and do not necessarily
represent those of the IMF, the World Bank, or any other organization.
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
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Financial Stability Reports: What Are They Good For?
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Motivation
“Banks are well prepared to withstand increased delinquency and loan
losses, which have been extremely low to date…”
“Nowhere has it been suggested that the banking systems of individual
countries should be subjected to size limitations…”
Iceland’s Financial Stability Report (2008)
“Low probability that in 2008 that existing
risks might materialize to the extent that it
will have an impact on bank performance…”
Latvia’s Financial Stability Report (2007)
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Financial Stability Reports: What Are They Good For?
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Introduction, objectives, and preview of results
Need for effective policy framework for financial stability
Wide range of instruments tools and devices are being considered
Background
Current financial stability framework includes financial stability reports (FSRs), which aim to
communicate key risks and vulnerabilities
Early reviews of FSRs experience have been mixed
Objective
Preview of
results
Ascertain to what extent and in what form FSRs should be part of the new framework
Simply publishing a report has no significant impact. However, higher quality reports tend to be
associated with a more stable financial environment.
Areas for improvement: forward-looking assessment, interconnectedness analysis, data issues
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Financial Stability Reports: What Are They Good For?
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Financial stability reports: what are they good for?
1. Trends in financial stability reporting
2. Case studies
3. Empirical evidence
4. Conclusions, further research
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FSRs: a growing “industry” (1996–2011)
Less rapid growth
in number of FSRs
published
Rapid growing “industry” of FSR
publications
90
80
Countries publishing FSRs
70
*Estimate: Newly published
FSRs in 2011 and assumed
all the central banks that
have published FSRs
previously will continue to
publish in 2011
60
50
40
30
20
10
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2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
0
Financial Stability Reports: What Are They Good For?
June 20, 2012
Global trends reflect the evolving experience with FSRs
and dynamics of financial stability communications
Ireland
• Ireland ceased to publish its
FSRs from 2008 onwards
United Kingdom
• Bank of England’s (BoE) FSR went
through a marked revamp in 2006
• Existing elements shortened and
new features added
USA
• US recently published
its first FSR
• Report is published by
the Financial Stability
Oversight Council
(FSOC)
• Central bank is
represented in the
publishing body, but
not the sole publisher
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
France
Israel
• Banque de France stopped
publishing its FSR in 2007
• Bank of Israel stopped issuing FSRs
as a stand-alone publication in 2005
• FSRs currently for internal
use only
• Financial stability issues are covered
as a chapter in its annual report
• Central bank website
contains a link to FSRs, but
the FSRs are a collection of
articles or conference
materials on a featured
topic
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Financial Stability Reports: What Are They Good For?
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General trends of FSR publication have not changed
dramatically in the last 15 years
Composition of FSRs in terms of
publication frequency
• Frequency, length and structure have not changed
dramatically
• Several countries have switched frequency of FSR
publication
Annual
• Average length of FSR has declined somewhat, but
marginally
Semiannual
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Other common trends observed in worldwide
FSR publication
Coverage
Market-based
indicators
Data
publication
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
•Coverage of issues in FSRs tends to increase over time
•Increasing use of market-based indicators such as credit-default swaps (CDS)
•Increasing number of central banks publishing underlying data
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Financial stability reports: what are they good for?
1. Trends in financial stability reporting
2. Case studies
3. Empirical evidence
4. Conclusions, further research
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Eight case studies of FSRs – Background
• Eight countries selected with a view to having a reasonably balanced coverage; geographically, advanced vs. emerging markets
• Analyzed based on “good practices” proposed by Čihák (2006) – CCC framework
Canada
Advanced
Minimal crisis in 2008
Iceland
Latvia
Advanced
Korea
Emerging market
Major crisis in 2008
Major crisis in 2008
Emerging market
Minimal crisis in 2008
Spain
Advanced
Crisis in 2008
New Zealand
Advanced
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
Brazil
South Africa
Emerging market
Emerging market
Minimal crisis in 2008
Minimal crisis in 2008
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Minimal crisis in 2008
Financial Stability Reports: What Are They Good For?
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Framework introduced in Čihák (2006)
“Three Cs”
Consistency
Coverage
A. Aims
B. Overall assessment
C. Issues
E.g.: . Is it clear what data were
used to arrive at the results
presented in the report?
(5 % weight)
D. Data, assumptions, and tools
Key elements
of the report
Clarity
E. Structure and other features
Based on methodology used by Fracasso, Genberg, and Wyplosz (2003) to assess central banks’ inflation
reports. They showed that for inflation reports, higher ‘quality’ measured this way was associated with lower
dispersion in inflation expectations and lower inflation, on average.
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Framework introduced in Čihák (2006)
“Three Cs”
Consistency
Coverage
A. Aims
B. Overall assessment
C. Issues
D. Data, assumptions, and tools
E.g.: . Is it clear what
assumptions were used to
arrive at the results presented
in the report? (5 % weight)
Key elements
of the report
Clarity
E. Structure and other features
Based on methodology used by Fracasso, Genberg, and Wyplosz (2003) to assess central banks’ inflation
reports. They showed that for inflation reports, higher ‘quality’ measured this way was associated with lower
dispersion in inflation expectations and lower inflation, on average.
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Financial Stability Reports: What Are They Good For?
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Framework introduced in Čihák (2006)
“Three Cs”
Consistency
Coverage
A. Aims
B. Overall assessment
C. Issues
D. Data, assumptions, and tools
E.g.: Is the overall assessment
of financial stability presented
consistently with previous
reports? (5 % weight)
Key elements
of the report
Clarity
E. Structure and other features
Based on methodology used by Fracasso, Genberg, and Wyplosz (2003) to assess central banks’ inflation
reports. They showed that for inflation reports, higher ‘quality’ measured this way was associated with lower
dispersion in inflation expectations and lower inflation, on average.
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
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Financial Stability Reports: What Are They Good For?
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Framework introduced in Čihák (2006)
“The three Cs”
Consistency
Coverage
A. Aims
B. Overall assessment
C. Issues
E.g.: Does the report use a wide range
of tools, both quantitative (stress tests
etc) and qualitative (supervisory,
market participant surveys, etc.)?
(5 % weight)
D. Data, assumptions, and tools
E. Structure and other features
The key elements
of the report
Clarity
Based on methodology used by Fracasso, Genberg, and Wyplosz (2003) to assess central banks’ inflation
reports. They showed that for inflation reports, higher ‘quality’ measured this way was associated with lower
dispersion in inflation expectations and lower inflation, on average.
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Financial Stability Reports: What Are They Good For?
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Report’s objective: clearly indicated
Definition of financial stability: mixed experience
Financial stability definition is typically featured at
the beginning of the report
• Aims or objectives of FSR are clearly indicated in most of the
FSRs reviewed
• Objectives are usually presented at the beginning of the report
Definition of financial
stability included?
Yes
• Significant variation in FSRs objective is observed across the
reports:
• Identifying and analyzing risks to the financial system
No
• Canada
• Brazil
• Iceland
• Latvia
• Korea
• New Zealand
• South Africa
• Spain
• Provide information for major participants in the
financial industry to evaluate and manage risks
• Stimulate dialogue and discussions on financial
stability issues
• Highlighting efforts and policies of regulatory
authorities in mitigating risks
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A fair degree of consistency in covering key
systemic risk factors
Coverage of systemic risks across countries 1
2011
2010
2009
2008
Brazil
Canada
Iceland
Korea
Latvia*
New Zealand
South Africa
Spain
• Issues and developments in the FSRs examined
are consistently followed-up
• Some countries provided detailed analysis on
specific risks
Greatest
Moderate
Least
1
Exclude specific risk coverage by a particular country
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Less attention to analysis on contagion risks and
interconnectedness in the FSRs reviewed
• Not reported regularly in the
sample FSRs
• Some countries do perform adhoc analysis depending on
current macroeconomic and
financial conditions:
• All eight countries’ FSRs feature
a regular assessment of
corporate sector and households
• No analysis or explanation of
linkages or exposures among
domestic banks
• Two exceptions:
International
banks
Domestic
banks
Household
and
corporate
sector
Sovereigns
• Korea: November 2010
FSR, box article
• South Africa: March 2011
FSR, working paper
appendix
• No analysis on sovereign
exposures of the banking system
reported in our sample FSRs
• Description of the health of
household and corporate sector
and impact on banks’
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Forward looking views, assessments or projections are
neither consistently nor comprehensively reported
• Bulk of analyses and discussions concentrate on
current level of ratios and indicators
• FSRs reviewed seldom include statements,
assessments or even survey results, e.g:
• “Going forward, substantial upward pressure
on real estate prices seem to still exist..”
• “…a modest increase in the aggregate rate of
impairment are likely to continue into 2011.”
• Nonetheless, most of the sample FSRs do provide
qualitative outlook on credit risk
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Financial Stability Reports: What Are They Good For?
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Four countries’ FSRs in our sample reported stress test
results on a regular basis
• FSRs for Canada, Korea, Latvia and Brazil usually report at least one type of stress test results in each publication
• In some cases, stress tests done by other regulators: Australia Prudential Regulatory Authority (APRA) in New Zealand’s FSR,
Financial Supervisory Authority (FME) in Iceland’s FSR and ECB in Spain’s FSR
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Reporting of stress test results across countries
(2008-2011)
Iceland
Canada
0.5
Graphically
Granular
Methodology
Text
Text
0.5
Text
0
Methodology
0.5
Methodology
1
1
Text
0.5
Graphically
Text
Granular
Methodology
0.5
Graphically
0
0
0
Granular
Brazil
Assumptions
Assumptions
Graphically
Granular
Granular
Spain
1
Graphically
0
Methodology
Granular
Assumptions
1
Graphically
0
South Africa
Assumptions
0.5
Graphically
Methodology
New Zealand
Text
0.5
Graphically
0
0
Methodology
1
0.5
Text
1
Assumptions
1
1
Latvia
Assumptions
Assumptions
Assumptions
Text
Korea
Granular
Methodology
Granular
Legend
For each of these questions, a response of ‘yes’ gets a value of 1, while a 0 is assigned to a ‘no’
•
Assumptions: Are the assumptions to the stress tests included whenever the results of a stress test are reported?
•
Graphically: Does the reporting of the stress test results include any graphical presentations, either as a diagram or in a table?
•
Granular: Do the FSRs report stress test results beyond aggregated level i.e. there is some degree of granularity e.g. no. of institutions, percentage of banks?
•
Methodology: Is the methodology of the stress test s explained in the FSR?
•
Text: Are the results to the stress tests reported as part of regular text of the report?
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In practice, FSR discussion on policies extends beyond
macroprudential policies
• Ideally, policy discussions (regardless of the type) should be tied back to its impact on financial stability
• Policies and measures to mitigate the impact of
the global financial crisis, especially post-Lehman
• E.g. new responsibilities
granted to central bank and
announcement of new
mandates
• E.g. measures on
improving access to
financing for SMEs, merger
between exchanges
Crisis-type
policies
Regulatory
updates and
changes
Broad
discussions
Financial sector
development
Monetary policy
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
• E.g. developments and progress on
financial stability made at the G-20,
analysis and reforms regarding the
Basel II framework
Microprudential
FSRs policy
discussions
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Macroprudential
Financial Stability Reports: What Are They Good For?
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Scope to improve standardization in FSR …
… and to be more open about data constraints
• FSRs with standardized period of coverage also have standardized timing of release
8
7
6
5
4
3
2
1
0
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Raise concern on data
gaps
Regular publication of
supporting materials
Standardized timing of
FSR release
Standardized period of
coverage
Semi-annual
publication
Yes
All FSRs feature an
English version
No. of countries
• Most FSRs rarely caution or raise concerns on data gaps issues
No
Financial Stability Reports: What Are They Good For?
June 20, 2012
Financial stability reports: what are they good for?
1. Trends in financial stability reporting
2. Case studies
3. Empirical evidence
4. Conclusions, further research
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
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Is there an empirical link between FSRs and
financial stability?
Financial Stability
Banking system fragilities
Macroeconomic and
institutional environment
?
FSR quality
?
FSR
publication
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Motivation: diverse country experiences during crisis
United States
Iceland
Latvia
Canada
Australia
No FSR (until 2011)
FSR since 2000 (2005)
FSR since 2003
FSR since 2002
FSR since 1999
Major crisis
Major crisis
Major crisis
Little crisis impact
Little crisis impact
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Literature overview
Transparency
Nier (2005)
Čihák (2006)
Oosterloo et al (2007)
Born et al (2011)
Čihák, Muñoz, Teh Sharifuddin, and Tintchev
Financial Stability
Bank-level transparency reduces the likelihood of banking
problems and thus enhances financial stability
Evidence generally supportive but limited data. Income level and
time since first publication affect FSR quality
Little evidence of a direct relationship between FSR
transparency and financial stability
FSR communication about financial stability moves financial
stock prices in the expected direction and reduces price volatility
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Baseline model (probit/panel with random effects)
FSi ,t   1   2 FSRi ,t   3 MACROi ,t 1   4 BANK i ,t 1   5 IQi ,t 1  i ,t
Dependent variable:
• Probability of a banking crisis
• Moody’s Banking Sector
Financial Strength Rating
Independent variables:
• Two alternative FSR specifications:
 FSR publication dummy
 FSR quality index (CCC framework as in Čihák, 2006)
• Stock market volatility
• MACRO: Macroeconomic controls
• ICRG sovereign financial risk
rating
• BANK: Banking controls
• 1-year median banking
system EDF
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• IQ: Institutional quality controls
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Heckman model
• To address issues of endogeneity/selection bias
• Two equation model:
FSRi ,t   1   2 Crisis i ,t 3   3GDPi ,t 1   4 Credit / GDPi ,t 1   5 FSRN i ,t 1   i ,t
FSi ,t   1   2 FSRi ,t   3 MACROi ,t 1   4 BANK i ,t 1   5 IQi ,t 1  t  i ,t
• FSRi,t-1= a dummy =1 if country i published an FSR at time t
• Crisisi,t-3 is a dummy =1 if country i had a banking crisis (3rd lag)
• GDPi,t-1 and Credit/GDPi,t-1 are GDP per capita and credit over GDP at t-1
• FSRNt-1 is the total number of countries publishing FSRs at time t-1
• λt is the inverse of the Mills ratio (defined as the normal probability density of
the prediction in the first equation, divided by the cumulative normal density).
• Meaning of the other variables same as in the baseline model
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Variables of
interest
Other
controls
Banking
controls
Macroeconomic
controls
Summary results
Financial stability reports: what are they good for?
1. Trends in financial stability reporting
2. Case studies
3. Empirical evidence
4. Conclusions, further research
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FSRs effectiveness depend on their quality

Higher-quality reports (those that are clear, consistent, and have good coverage)
tend to be associated with more stable financial environments; low-quality FSRs seem
associated with sub-par financial stability.

Publication of an FSR by itself does not have a robust empirical link to financial stability
!
Despite some improvements in recent years, FSRs still leave much to be desired in
terms of clarity/coverage/consistency over time
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Major areas for improvement
!
Lack of a forward-looking nature of the reports
!
Analysis of interconnectedness
!
Data issues (clarity on what are the “blind spots”)
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Areas for further research …
 How (by what channels) does FSR quality promote financial stability?
 Improved information in the market, stronger market discipline
 Signals the FSR provides for policymakers and regulators
 Other factors
 Which institutional frameworks for FSRs work better than others?
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Institutional models for macro-pru (and FSRs)
Source: IMF Staff Discussion Note “Institutional Models for Macroprudential Policy” (SDN/11/18)
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Institutional framework: key “desirables”…
General
1. Central bank to play an important role in macroprudential policymaking.
2. Complex and fragmented regulatory structures should be avoided.
3. Participation of the treasury in the policy process is useful, but a leading role poses risks.
4. Systemic risk prevention and crisis management should be supported by separate
organizational arrangements.
5. Macroprudential policy frameworks should not become a vehicle to compromise the autonomy of
other established policies.
6. Arrangements need to take account of country-specific circumstances.
Provide for effective identification, analysis, and monitoring of systemic risk
7. Mechanisms for effective sharing of information to assess risks should be in place.
8. At least one institution involved in assessing systemic risk should have access to all relevant
information. It should be the one that disposes of the best expertise to assess systemic risk.
9. Mechanisms are needed to challenge dominant views of one institution.
Provide for timely and effective use of macroprudential policy tools
10. Institutional mechanisms should support willingness to act against the buildup of systemic risk
and reduce the risk of delay in policy actions.
Source: IMF Staff Discussion Note “Institutional Models for Macroprudential Policy” (SDN/11/18)
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Institutional framework: key “desirables” (continued)
11. A lead authority should be identified and be provided with a clear mandate and powers, in a
manner that harnesses incentives of existing institutions to mitigate systemic risk.
12. The mandate needs to be matched by powers, including to initiate the use of prudential tools to
address systemic risk. Mechanisms should be established to expand powers when needed.
13. The mandate should give primacy to the mitigation of systemic risk, but include secondary
objectives to ensure that the policymaker takes into account costs and trade-offs.
14. To guard against overly restrictive or inadequate policy, accountability and transparency need
to be put in place, without unduly compromising the effectiveness of macroprudential policy.
Provide for effective coordination across policies to address systemic risk
15. Institutional integration of financial regulatory functions within the central bank can support
effective coordination of macroprudential policy with monetary as well as microprudential
policy, but also requires safeguards.
16. Where separation of policy decisions and control over policy tools cannot be avoided, legal
framework needs to assign powers to recommend or direct action of other policymakers.
17. Where there is distributed decision making among several agencies, establishing a
coordinating committee is useful, but may not necessarily be sufficient to overcome collective
action and accountability problems.
Source: IMF Staff Discussion Note “Institutional Models for Macroprudential Policy” (SDN/11/18)
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Institutional frameworks in practice
Source: Calculations based on 2011 update of World Bank’s Banking Regulation and Supervision Database. Data for 135 jurisdictions.
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Thank you!
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