V. Sundararajan, Charles Enoch, Armida San José, Paul Hilbers, Russell Krueger, Marina Moretti, and Graham Slack
List of Abbreviations
Part I. Selected Analytical Aspects
The Macroprudential Framework
FSIs in the Context of the FSAP
Bank Behavior and Vulnerabilities
Nonbank Financial Intermediaries
Real Estate Markets
Defining System-Wide Stress Tests
Part II. Country Practices
Response to the Survey
FSIs by Usefulness Group
Additional FSIs Identified by Respondents
Compilation and Dissemination of FSIs and Their Components
Accounting, Regulatory, and Statistical Issues
Coverage of Financial Institutions
Norms, Benchmarks, and Thresholds
Identification of Core and Encouraged Sets of FSIs
Directions for Further Work
3.1. Basel Capital Adequacy Ratio
3.2. Valuation of Capital
4.1. Sectoral Balance Sheet Analysis
6.1. Structure of the Survey on FSIs
8.1. Compilation and Dissemination Practices
8.2. Country Practices on Nonperforming Loans
2.1. FSIs Used in Financial System Stability Assessments
3.1. Income Summary
4.1. Determinants of Corporate Vulnerabilities
4.2. Indicators for the Corporate Sector
4.3. Cash Flow Summary
4.4. Household Indicators Used in Norway, Sweden, and the
4.5. Real Estate Indicators
5.1. Data Requirements for an Integrated VaR Analysis
6.1. Summary of the Responses by Type of Economy
6.2. Summary of the Responses by Indicator
7.1. Group I FSIs by Type of Economy
7.2. Group II FSIs by Type of Economy
7.3. Groups III–IV FSIs by Type of Economy
8.1. FSIs: Compilation and Dissemination Practices
8.2. Periodicity of FSIs
8.3. Valuation Practices Affecting FSIs by Data Source
10.1. Core Set of FSIs
10.2. Encouraged Set of FSIs
5.1. Decision Sequence for Stress Testing
7.1. Summary of the Usefulness of FSIs
9.1. Institutional Coverage of Analysis
9.2. Factors Used to Identify Key Subsectors
9.3. Presentation of FSIs
A4.1. FSIs for Which Components Are Extensively Compiled
A4.2. SDDS Subscribers: Compilation and Dissemination of FSIs
A4.3. Usefulness of FSIs by Type of User and Type of Economy
A4.4. Compilation and Dissemination of FSIs by Type of Economy
A5.1. MPI Survey—Part I (a): User Questionnaire
A5.2. MPI Survey—Part I (b): Supplementary Issues
A5.3. MPI Survey—Part II (a): Compilation and Dissemination
A5.4. MPI Survey—Part II (b): Supplementary Issues
A5.5. MPI Survey—Part II (c): Valuation Issue
Structural, institutional, and macroeconomic aspects of financial system stability are receiving growing attention both nationally and in international fora. The magnitude and mobility of international capital flows have made it increasingly important to strengthen the foundations of domestic financial systems as a way to build up resilience to capital flow volatility. The soundness of financial institutions is also a key part of the infrastructure for strong macroeconomic performance and effective monetary policy at the national level. Hence, central banks and governments are paying increasing attention to monitoring the health and efficiency of financial institutions and markets, and to macroeconomic and institutional developments that pose potential risks to financial stability.
Such activities are typically embedded in central banks' mandates to promote financial stability and sound payment systems. They differ from financial supervisory activities insofar as they are primarily directed at a range of factors that may pose risks to the financial system as a whole—systemic risks—with significant macroeconomic repercussions. Financial supervisory tasks, on the other hand, are often focused more directly on the health of individual institutions. Given the linkages between microeconomic conditions and macroeconomic and overall financial stability, the monitoring of developments and policy responses to ensure financial stability poses special challenges, particularly when financial supervision functions are separated from the central bank.
The development of measures of financial sector soundness, and of methods to analyze them, are the subjects of this occasional paper. We refer to them as financial soundness indicators (FSIs) and macroprudential analysis, respectively (see Box 1.1). The IMF has been accumulating experience in these areas as part of its surveillance, technical assistance, and policy development work, and, more recently, in the context of the Financial Sector Assessment Program (FSAP).1 An initial, relatively broad set of indicators—the so-called macroprudential indicators—was identified in this earlier work, comprising aggregated prudential indicators, macroeconomic variables associated with financial system vulnerability, and market-based indicators. A consultative meeting on macroprudential indicators was held at IMF headquarters in September 1999. High-level experts from central banks, supervisory agencies, international institutions, academia, and the private sector discussed their experiences in using, measuring, and disseminating indicators of financial system soundness. An IMF Executive Board meeting in January 2000 discussed the state of knowledge in these areas and proposals for further work.2 Recent Board papers on the Special Data Dissemination Standard (SDDS) and on the FSAP also discussed related issues.3
Discussions at the January 2000 review highlighted the need for more research and analysis to improve understanding of what determines financial system soundness and to deal with the considerable conceptual and statistical difficulties that arise in defining and compiling indicators of financial soundness. The Board recommended that the IMF conduct a survey of member countries on their needs and practices related to indicators of financial soundness. The Board also concurred on the need for better indicators on developments in specific sectors and markets that have proven to be relevant in assessing financial sector vulnerabilities, but that have been difficult to gauge in practice. These include nonbank financial institutions, the corporate sector, households, and real estate markets. Moreover, the Board pointed to the need to select a smaller and more operationally useful "core set" of indicators, intended to serve as a basis for structuring data work in support of financial system monitoring, including through the FSAP, and as a focal point for efforts by the IMF to encourage compilation and dissemination of macroprudential information by national authorities.
Since then, the IMF has substantially advanced the work on the measurement and analysis of financial soundness, including through activities in the context of the FSAP and the Survey on the Use, Compilation, and Dissemination of Macroprudential Indicators, conducted in the summer of 2000.4 Efforts have been directed, in particular, to gauge the usefulness of specific indicators; identify analytically relevant definitions of these indicators; appraise compilation and dissemination practices among member countries; explore methods of macroprudential analysis, notably stress testing; and explore the role of nonbank financial intermediaries, the corporate sector, and real estate markets in assessing financial system vulnerabilities.
Other international organizations have also focused on these issues. For instance, the topic of the October 2000 Bank for International Settlements (BIS) annual meeting of central bank economists was Marrying the Macro- and Micro-Prudential Dimensions of Financial Stability.5 At the European Central Bank (ECB), the Working Group on Macroprudential Analysis of the Banking Supervision Committee received a mandate in 2000 to prepare semi-annual reports on macroprudential developments in Europe. These analyses, which are not made public, serve as input to discussions on financial stability issues in the ECB Governing Council. The Asian Development Bank has a program to collect and disseminate FSIs and related macroeconomic series for a group of Asian-Pacific countries. Similar efforts are ongoing at the national level in an increasing number of countries.6
This paper proposes two sets of indicators that are considered useful for the purpose of periodic monitoring, and for compilation and dissemination efforts by national authorities (Table 1.1). The core set includes indicators for the banking sector that should have priority in future compilation and monitoring of FSIs. The encouraged set includes additional banking indicators, as well as data on other institutions and markets that are relevant in assessing financial stability—the corporate sector, real estate markets, and nonbank financial institutions and markets. In particular, indicators of corporate health and of developments in real estate markets are considered a priority in light of their analytical significance for assessing financial vulnerabilities in a wide variety of circumstances. Their compilation, which is at present limited, should therefore be encouraged so that they could be included in the core set, in due course.
Working with two sets of FSIs—a core set and an encouraged set—avoids a one-size-fits-all approach, and provides a degree of flexibility in the selection of indicators that are most relevant to assessing vulnerabilities in country-specific circumstances. Indicators of the core set can be combined with selected, additional indicators of the encouraged set that might be of particular relevance in the country concerned, depending on its level of financial development, institutional structure, and regional circumstances.
Six criteria were applied in order to identify the core set, and some of those were applied to suggest the encouraged set: focus on core markets and institutions; analytical significance; revealed usefulness; relevance in most circumstances (i.e., not country-specific); availability; and parsimony—that is, achieving the maximum information content with a limited number of FSIs. The revealed usefulness and availability were judged based on the results of the survey noted earlier (see Part II), the analytical significance and parsimony were judged based on a survey of the literature as well as new empirical analysis undertaken in the IMF on the definition, interpretation, and analysis of FSIs (see Part I). Both the survey and the analytical aspects were brought to bear in judging focus and country relevance.
Ideally, indicators included in the core and encouraged sets should also be comparable across countries—which would be possible if there existed in all areas internationally agreed prudential, accounting, and statistical standards to which all countries adhered—to facilitate monitoring of the financial system, not only at the national but also at the global level. The latter is important in view of the magnitude and mobility of international capital flows, and the risk of contagion of financial crises from one country to another. Advancing international comparability of FSIs and convergence toward best practice are important goals for further work in this area.
The review contained in this occasional paper highlights that work on measuring and analyzing FSIs has advanced substantially in recent years, and proposes specific areas where more work is needed.
Monitoring and analysis of FSIs are just one element in an overall assessment of financial stability. Other elements include analyses of macroeconomic developments, market-based data such as stock prices and credit ratings, structural information on the financial sector, and—last but not least—qualitative assessments, in particular assessments of observance of relevant international standards and codes. These elements, which feed into macroprudential analysis, will help to identify various dimensions of risks as well as the capacity of the system to cope with and manage these risks, thereby helping to form a judgment on overall financial stability. While these tools still remain imperfect and continue to evolve, over time, macroprudential analysis can reduce the incidence of crises by providing national authorities with a set of tools to comprehensively assess their financial sectors and identify weaknesses at an early stage.
The paper is organized in two parts—Part I focuses on selected analytical aspects of defining and analyzing FSIs, and Part II discusses country practices in the use, compilation, and dissemination of FSIs.
Within Part I, Chapter II introduces the framework of macroprudential analysis, including its quantitative as well as qualitative aspects, and reviews the experience with macroprudential analysis and indicators gained through the FSAP. Chapter III focuses on the definition and interpretation of indicators of the current health of the banking system, primarily derived by aggregating indicators of the health of individual banks. Indicators of specific sectors and markets that can have an impact on financial system stability—specifically, nonbank financial intermediaries (NBFIs), the corporate sector, households, and real estate markets—are discussed in Chapter IV. Chapter V looks at stress testing as a key component of macroprudential analysis.
Within the second part of this paper, Chapter VI introduces the Survey on the Use, Compilation, and Dissemination of Macroprudential Indicators. Chapter VII discusses survey results in terms of perceived usefulness of specific FSIs. Survey results on the compilation and dissemination of FSIs or their components are reported in Chapter VIII, and responses related to the analytical frameworks used by countries to analyze these indicators are reported in Chapter IX.
Chapter X concludes with proposals for a core set and an encouraged set of indicators to be used for the purpose of periodic monitoring, and for compilation and dissemination by national authorities. The chapter also discusses directions for further work on FSIs.
1The FSAP was launched jointly by the IMF and the World Bank in May 1999. The program is designed to identify financial system strengths and vulnerabilities and to help to develop appropriate policy responses. Financial System Stability Assessments (FSSAs) are prepared by IMF staff in the context of Article IV consultations, by drawing on the FSAP findings, for discussion in the IMF Executive Board. In the World Bank, the FSAP reports provide the basis for producing Financial Sector Assessments and formulating financial sector development strategies. See IMF (2001a, b) and Hilbers (2001).
2See Evans, Leone, Gill, and Hilbers (2000).
3See IMF (2000c, 2001b).
4The survey explicitly listed around 60 indicators, identified in earlier work.
6In some countries—for instance, Finland, Hungary, Iceland, Norway, Sweden, and the United Kingdom—central banks publish special reports dealing with financial stability issues.