## ppea2021043 ## Source details **Canonical URL:** [ppea2021043](https://www.imf.org/-/media/files/publications/pp/2021/english/ppea2021043.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2021/english/ppea2021043.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2021/english/ppea2021043.pdf.json) --- ### INTRODUCTION — scope and key proposals - Financial stability assessments under the FSAP use a three-pillar framework since 2009: risk analysis, oversight, and safety net. - The 2014 FSAP Review background: review developments in scope since 2014, focusing on robustness of the three-pillar approach, use of the qualitative Risk Assessment Matrix (RAM) to set scope, a risk-focused approach to standards assessments, and possibilities for thematic approaches. - The paper excludes analytical approaches, participation, or resources. Key proposals to strengthen scoping: - I-1 Use the flexibility in the three-pillar framework to capture emerging risks and prioritize scope according to systemic importance. - I-2 If a recent positive comprehensive standards assessment is available, structure financial stability assessments around one or two cross-cutting themes while preserving assessments across all three pillars. - I-3 Continue to use the risk-focused approach to international standards, as per IMF (2017a). - I-4 Endorse the Key Attributes of Effective Resolution Regimes as the assessment benchmark for insurance resolution frameworks in FSAPs and stand-alone assessments and the Key Attributes Methodology for the Insurance Sector. Survey evidence — pre-COVID-19: - "More than 90 percent" of authorities agreed/strongly agreed FSAPs were clearly structured around the three pillars. - "More than 90 percent" agreed/strongly agreed FSAP analysis focused on the most relevant financial sector issues. - "87 percent" agreed/strongly agreed analysis was appropriately framed within country circumstances. - "60 percent" highlighted standardized principle-by-principle assessments as among the most useful aspects. - For each pillar, "about 95 percent" thought pillar resources should be kept the same or increased; "only about 5 percent" suggested a reduction. ### Three-pillar framework — COVID-19 implications and adaptation Pandemic context and impacts: - Strong bank buffers and massive policy interventions limited financial-system impacts; asset managers entered the pandemic with elevated vulnerabilities (sizeable liquidity mismatches, increased roles in risky credit markets). - Asset managers drew on bank credit lines, increasing interconnectedness between NBFIs and banks. - Corporate vulnerabilities increased as firms took on more debt; public finances deteriorated, elevating sovereign-financial linkages. - Global regulatory reform agenda implementation slowed (FSB, 2020 annual report). Survey updates (2020): - Share of country authorities that consider more work in each pillar rose noticeably between 2019 and 2020; increase most marked among authorities, followed by Executive Directors; staff flagged increased needs particularly in Pillars 1 and 3. Common themes for FSAPs over next five years (recovery-phase dependent): - Continue to prioritize within the three pillars as countries remain at different recovery phases. - Monetary policy likely to remain accommodative; support measures may be expanded/extended; macroprudential buffers have been released where feasible. - Potential phases: continued policy support → unwind extraordinary measures while supporting recovery → corporate restructuring and possible bankruptcies → need to rebuild prudential buffers. - Regulatory agenda will refocus on pandemic-revealed stresses, including role of NBFIs and market liquidity/functioning. How the three pillars can adapt: - Pillar 1: deeper granular risks in household, corporate, public sectors; heterogeneous sectoral impacts; bank-sovereign linkages; systemic risks from interconnectedness and NBFI vulnerabilities. - Pillar 2: assess effectiveness/adequacy of regulatory responses; incorporate evolving NBFI guidance; account for Fintech implications (payments, financial structure, cybersecurity). - Pillar 3: test resolution, safety nets, crisis management where systemic distress emerges; discuss corporate debt restructuring and insolvency frameworks. ### Role of the RAM in scoping and mission modalities Role and characteristics of RAM: - RAM focuses on main systemic risks: macroeconomic environment, financial system characteristics, and real/financial cycles. - RAM design and scope discussion are conducted in close consultation with Article IV teams. - RAM expanded FSAP scope to include NBFIs and capital markets; strengthened analysis of interconnectedness, cross-border exposures, and spillovers. - FSAP RAMs link to the semi-annually updated Global-RAM (Fund-wide view of key global risks). - Distinctions: - Global-RAM and Article IV RAMs emphasize high and medium likelihood events. - FSAP RAM includes “low likelihood but plausible” events if they could result in systemic distress. - Article IV RAMs cover a wider range of macroeconomic risks; FSAP RAMs have deeper coverage of financial stability risks. Modalities — remote engagement and mission design: - MCM staff consider remote engagement less effective than physical missions due to challenges building relationships, time zone differences, and remote sharing of confidential data. - Survey impressions on mission effectiveness (as reported) include the labels: More effective than normal times FSAPs; About the same; Less effective than normal times FSAPs (chart entries reported as numbers and percents below). - Experience with Remote FSAP Missions: MCM Staff (In percent of total respondents) summary values reported: 23; 23; 46; 46; 69; 77. - Factors reducing effectiveness (survey-listed): Other challenges; Communication technology; Sharing of confidential data; Time zone differences; Sensitive conversations; Building rapport. - Survey comments: remote engagement could be used for scoping missions, but physical visits are more effective for main missions; lower effectiveness may offset travel cost savings. ### Risk-focused approach to international standards and assessment modalities Standards and modalities: - FSAP assessments of microprudential oversight, financial safety net, and financial integrity are based on standards set by SSBs: BCBS, IAIS, IOSCO, CPMI, FSB, IADI, and FATF for AML/CFT. - Two modalities: - Graded assessment: uses SSB assessment methodology, produces a “Detailed Assessment Report (DAR).” - Focused review: benchmarks specific prudential/supervisory gaps, produces an FSAP Technical Note (TN). - Guidance on choosing modality: - Decision by agreement between staff and authorities; factors: sector importance, degree of vulnerabilities, FSAP priorities, extent of changes in sector/oversight, and changes in standard/methodology since last graded assessment. - In FSAP survey, 86 percent of respondents thought IMF guidance was appropriate. - Respondents supported greater flexibility via focused reviews, though DARs valued for standardization/comparability. - Specific suggestion: discontinue a ROSC when a DAR is published. - Number and modality of assessments jointly chosen with authorities during scoping. Trends and recommendations: - Since 2014, jurisdictions with established compliance have seen fewer DARs and more TNs. - Recommendation for mandatory FSAP members: full assessments for banks and insurers should be recommended at least every ten years and also when: - The last assessment used an outdated version of the principles. - There has been a major change to regulatory architecture (e.g., move into or out of a single regulatory authority). - Ensuring sound regulatory frameworks requires adequate resourcing for sectoral supervision assessment. ### Thematic approach to FSAPs - Thematic focus on one or two issues works when a recent positive comprehensive standards assessment exists. - Example: 2013 Singapore FSAP found regulation and supervision “among the best globally”; the 2019 FSAP focused on cross-border links, fintech challenges, a focused review of bank regulation/supervision, FMIs, and crisis management/resolution. - Choice of 1–2 themes anchored by FSAP RAM and based on jurisdictional relevance. - Thematic approach useful for regional exercises in regions with strong financial linkages but without supra-national authorities. ### Pillar 1 — evolving scope, priorities, and stress testing Expanded sources of financial stability risk: - Growth of NBFIs in asset, funding, and credit markets. - Increasing cross-border and cross-sectoral interconnectedness. - New risks from digitalization. - Observed shifts: risks shifting from banks to NBFIs in major jurisdictions; greater emphasis on interconnectedness. Pandemic-driven changes in analytical focus (survey share of respondents, up to five options, 2020 vs 2019): - Households and NFCs: 73 (2020), 61 (2019) - Interconnectedness: 60 (2020), 44 (2019) - Bank ST: 41 (2020), 39 (2019) - MPM calibration: 33 (2020), 22 (2019) - Cyber risk: 22 (2020), 21 (2019) - NBFI risk: 13 (2020), 12 (2019) - Macro-financial feedback: 4 (2020), 0 (2019) - (Markets, Fintech, Housing market, Growth-at-risk, Climate, Other follow as listed in Figure 6.) Analytical tool development: - Detailed analysis of household and corporate vulnerabilities. - Quantitative calibration of MPMs. - NBFI risks and links to banking/markets. - Pilot analyses of climate, cyber, fintech. - Refinement/standardization of bank stress testing tools. - Development of a new credit risk approach to adapt to the Expected Credit Loss (ECL) framework under IFRS 9. - Bayesian model averaging techniques to improve model fit for stress testing. - Macro scenario stress testing tools for NFCs and households using firm-level and household survey data. - System-wide FX liquidity risk tool for small open economies. Role and value added of FSAP stress tests: - Bank stress testing is core to independent financial stability assessment in FSAPs. - FSAP stress tests provide a macroprudential perspective—incorporating amplification and feedback effects (solvency-liquidity, bank-sovereign, bank-NBFI, second-round real economy effects). - Where national authorities have sophisticated frameworks, FSAPs should review authorities’ frameworks rather than undertake independent exercises; nevertheless, stakeholders value FSAPs’ independence. - GST and UST under development: - GST: solvency stress tests using publicly available individual bank data for about 30 jurisdictions. - UST: expand sample to about 70 using IMF Financial Soundness Indicator database and simplified methodology. - FSAP stress tests ideally require teams to run their own models to operationalize macrofinancial linkage analysis. COVID-19-specific stress test challenges: - Need to link household and NFC vulnerability tools to bank stress tests. - Account for cross-industry differences and mitigating policies (guarantees, moratoria). - GST approach illustrated methods to incorporate government guarantees and capital adequacy policies. - FSAPs using pandemic-period balance sheets need to adjust for supportive policies to reveal underlying capital positions. Data issues and access: - Member sharing of confidential institution-level supervisory data improved since 2014; in all but one jurisdiction staff on recent assessments accessed confidential supervisory data. - Access challenges: authorities often require limited-access data rooms (adds mission travel costs and time); pandemic travel restrictions prevented access—remote data access critical while restrictions last. - Data gaps remain: NBFIs, sectoral accounts, cross-border exposures; confidentiality constraints limit access to G-SIFI and market-finance data. - Pursuing efficient confidential data sharing and remote access can lower FSAP costs and increase quality. ### Pillar 2 — prudential oversight, insurance, securities, payments, and AML/CFT Insurance sector: - ICPs enhanced in November 2019; now incorporate ComFrame for IAIGs. - IAIG criteria: - Internationally active: premiums written in three or more jurisdictions and gross written premiums outside home jurisdiction ≥ 10 percent of group total. - Size criteria: total assets ≥ US$50 billion or total gross written premiums ≥ US$10 billion (three-year rolling average). - ICPs/ComFrame include requirements to address systemic risk. - Implementation challenges: insufficient supervisor independence, lack of resources, absence of clear financial stability mandates, weak related-party transaction supervision. - ICPs update may trigger more insurance DARs in future FSAPs. Securities sector and asset managers: - FSB and IOSCO reforms (post-GFC) identified liquidity and leverage of investment funds as critical vulnerabilities. - COVID-19 caused large outflows from MMFs and open-ended funds in risky credit assets, prompting central bank market interventions as unprecedented market makers of last resort. - Reforms needed in asset management industry supervisory and regulatory frameworks. Payments and FMIs: - FMIs include payment systems, SSSs, CSDs, CCPs, trade repositories. - Shift to CCPs raised CCP systemic importance—supervision, crisis management, resolution planning critical. - Digital payments, fintech, and digital currencies introduced cyber risk, competition concerns, regulatory perimeter questions, and potential financial stability impacts. - Suggested enhancements: - Stock takes of digital payments to become integral to FSAPs. - Develop interim assessment tools to complement PFMI and other standards, with focus on operational risks (IT, cybersecurity), third parties, BigTech payment infrastructure, data governance, and legal basis for DLT services. Financial integrity (AML/CFT) coverage: - AML/CFT input mandatory and flexible in scope for every FSAP; modalities include TNs, annexes, or paragraphs in FSSA depending on prior assessments. - Where possible, FSAP AML/CFT input based on a comprehensive assessment or targeted reassessment finalized prior to FSAP; otherwise staff derive findings from previous reports and national risk assessments. - Typical AML/CFT topics in FSAPs: preventive measures; national risk assessments; risk-based supervision; beneficial ownership transparency; terrorist financing and targeted sanctions; suspicious transaction reporting; international cooperation. ### Pillar 3 — safety nets, resolution, systemic liquidity, NPLs Resolution frameworks and deposit insurance: - FSB Key Attributes (KA) adopted in 2011; Core Principles for Effective Deposit Insurance Systems revised in 2014. - KA use a modular approach applying to banks and non-bank financial institutions. - Progress since 2014: many jurisdictions strengthened resolution frameworks; less progress in low-income and developing countries. - Remaining priorities for G-SIB resolvability: resolution funding strategies; valuation frameworks in resolution; continuity of access to FMIs; finalize cross-border cooperation agreements. - Reforms should follow proportionality principles. Methodologies and resources: - FSB Assessment Methodology for Banking Sector (2016) endorsed for graded assessments. - 2020: FSB, IAIS, WB, IMF developed an Assessment Methodology for the Insurance Sector to guide compliance of insurance resolution frameworks against the KA; Fund staff supported development and piloted an assessment (2019 France FSAP). - Fund and Bank intend to use KA methodology as assessment benchmark for insurance resolution frameworks in FSAPs and stand-alone assessments. - Complexity of Pillar 3 work increases staff demand; careful prioritization and resource allocation essential. COVID-19 implications for safety nets and resolution: - Crisis does not fundamentally change desirable safety net design (IMF, 2020b). - Early intervention frameworks allow supervisors to require prompt corrective actions to restore capital/liquidity and curb risk-taking. - Given uncertainties, supervisors may need to give more time for rebuilding capital and temporarily suspend automatic triggers for prompt corrective actions (see IMF 2020c). - Initiating bank resolution may be impracticable during pandemic due to operational challenges and asset valuation uncertainty. - Authorities should strengthen resolution regimes, operational capabilities, and maintain up-to-date resolution plans for post-support intervention readiness. - Operational readiness of deposit insurance and ELA frameworks should be ascertained; ML/TF risks on reimbursing insured depositors require AML/CFT safeguards and coordination. Systemic liquidity assessments: - Assess risk of multiple institutions simultaneously facing liquidity difficulties; amplification by interconnectedness. - Systemic liquidity risk varies by system structure: well-developed markets vs deposit-funded bank systems; small open economies without reserve currencies face FX liquidity constraints. - MCM developed a tool to assess FX liquidity shocks' impact on economic sectors and spillovers to financial system and international reserves (see IMF, 2016 Guidance note on the assessment of reserve adequacy). - Systemic liquidity assessment spans all three pillars: vulnerabilities (Pillar 1), prudential measures and FMI oversight (Pillar 2), central bank liquidity support and cross-border backstops (Pillar 3). - Depth of assessments varies due to data gaps and methodological challenges; notable exceptions include 2017 Luxembourg FSAP and 2020 Philippines FSAP. Borrower vulnerabilities and NPL restructuring: - Pandemic scarring may increase NPLs as support measures are unwound. - FSAPs may need to enhance asset quality supervision, conduct asset quality reviews, and review frameworks for NPL restructuring. - Policy options for banks with large NPLs: - Supervision/regulation: appropriate classification/provisioning, collateral valuation attention, timely write-offs, dedicated workout units, bank-specific NPL resolution strategies. - Insolvency and creditor rights: regimes enabling rehabilitation of viable firms and liquidation of nonviable ones; efficient enforcement to incentivize out-of-court restructurings. - Asset disposal: develop distressed asset markets by removing impediments (credit information, legal obstacles, parity of regulation/consumer protection, tax treatment) and improving enforcement. - Technical notes on NPL resolution prepared for 2017 Bulgaria and 2020 Italy FSAPs. ### Emerging issues — climate, cyber, fintech Climate risk stress testing — purpose and practice: - Objective: help members understand potential pressure points from physical shocks and the transition to a low-carbon economy; inform policies to enhance risk management and resilience. - Distinction: not focused on quantifying possible capital needs relative to regulatory minima. - Evidence: textual analysis of 192 FSAP reports (up to 2019) found 33 (17 percent) contained meaningful references to droughts, floods, storms; many for small island states but also advanced economies. - Pilots: Norway (transition risk) and Philippines (physical risk) piloted climate in bank stress tests; others discussed risks without stress tests. - Oversight examples: 2020 US FSAP considered regulatory response to natural catastrophes; staff developing approach to embed climate considerations in supervision review (to be pilot tested). Adaptations for climate stress testing: - Horizon: consider both medium-term (3-5 year) and long-term (30-50 year) horizons. - Nature: consider physical and transition risks; scope based on country vulnerabilities. - Scenarios for physical risk: need micro-sectoral and geo-spatial data and external climate expertise. - Scenarios for transition risk: assume a range of carbon price paths (from large up-front increases to gradual increases), leveraging NGFS approaches and Fund/external models. - Modeling needs: macroeconomic models suited for industry analysis (CGM, GTAP) are not currently in Fund toolkit; collaboration with Bank and external experts advised. - Resource constraints: IMF staff will extend climate analysis as feasible within resources. Cyber risk — systemic channels and FSAP response: - Cyberattacks can be systemic by targeting multiple institutions, a SIFI, or market infrastructure; spillovers from ICT/provider attacks and physical infrastructure risks. - Pandemic heightened concerns about cyber and operational resilience; coverage in FSAPs increasing. - Quantitative pilots: Euro Area FSAP cyber-motivated liquidity stress test; Singapore FSAP cyber RAM and insurer estimates; Norway and South Africa pilots on systemic implications and policy responses. - Data constraints: cyber breach data often national security information; public data incomplete. - Regulatory/supervisory work and cross-sector exercises are crucial; strong authority collaboration needed due to sensitivity. Fintech — opportunities, risks, and FSAP coverage: - Fintech transforms financial landscape; offers inclusion and efficiency benefits but poses stability, integrity, and consumer risks. - Coverage to date: fintech covered in 13 assessments, with 5 ongoing FSAP missions focusing on fintech; mostly oversight-focused. - Pilot quantitative approaches: 2019 Singapore FSAP bottom-up bank stress tests and industrial organization models; 2020 Korea FSAP overlayed fintech competition effects in bank stress tests (results sensitive to competitive pressure and market structure). - Common challenges from pilots: (i) resource limitations and skills; (ii) lack of reliable data due to regulatory perimeter; (iii) need for international cooperation; (iv) development of international standards. - Future needs: new frameworks and data to assess efficiency-stability tradeoffs, incentives for innovation and risk-taking, market structure roles, and BigTech impacts; EMDEs may face rapid fintech/BigTech development and higher demand for analysis. Pilot assessments and staffing: - Pilot assessments provide pragmatic near-term approach; chosen based on potential systemic importance. - Staff should broaden expert rosters, hire specialists, and cooperate with World Bank and SSBs. - FSAP teams must leverage scoping (RAM) to prioritize emerging risks given resource constraints. *Source: ppea2021043 — 2021 FSAP REVIEW — Background paper on scope* ### INTRODUCTION _____________________________________________________________________ 4 ### INTRODUCTION ### Overall scope and framing - Financial stability assessments under the Financial Sector Assessment Program (FSAP) have been based on a three-pillar framework since 2009: risk analysis, oversight, and safety net. - The 2014 FSAP Review background: this paper reviews developments in scope since the 2014 FSAP Review, focusing on the robustness of the three-pillar approach, the use of the qualitative Risk Assessment Matrix (RAM) to set scope, a risk-focused approach to standards assessments, and possibilities for thematic approaches. - The paper does not examine analytical approaches, participation, or resources. ### Key proposals to strengthen scoping (Table 1) - I-1 Use the flexibility in the three-pillar framework to capture emerging risks and prioritize scope according to systemic importance. - I-2 If a recent positive comprehensive standards assessment is available, structure the financial stability assessments around one or two cross-cutting themes while preserving assessments across all the three pillars. - I-3 Continue to use the risk-focused approach to international standards, as per IMF (2017a). - I-4 Endorse the Key Attributes of Effective Resolution Regimes as the assessment benchmark for insurance resolution frameworks in FSAPs and stand-alone assessments and the Key Attributes Methodology for the Insurance Sector. ### The Three Pillar Framework for Financial Stability Assessments — pre-COVID-19 experience - Survey results (2019) showed broad support for the three-pillar structure: - "More than 90 percent" of authorities agreed or strongly agreed that the financial stability assessment was clearly structured around the three pillars. - "More than 90 percent" agreed or strongly agreed that the FSAP analysis focused on the most relevant financial sector issues. - "87 percent" of respondents agreed or strongly agreed that analysis was appropriately framed within the country's circumstances. - "60 percent" highlighted that standardized principle-by-principle assessments of compliance with international standards are among the most useful aspects of the FSAP. - For each pillar, "about 95 percent" of respondents thought that the pillars’ resources should be kept the same or increased, with "only about 5 percent" suggesting a reduction. - Authorities reported high satisfaction with customization of FSAPs, noting tailoring guided by the FSAP Risk Assessment Matrix (RAM), which focuses on the main systemic risks including the macroeconomic environment, financial system characteristics, and real and financial cycles. ### Implications of COVID-19 for FSAP scope and prioritization - Pandemic context and observed impacts: - Strong bank buffers and massive policy interventions have thus far limited financial-system impacts, reflecting regulatory reform over the prior decade. - Asset managers in advanced economies entered the pandemic with elevated vulnerabilities, including sizeable liquidity mismatches and increased roles in risky credit markets. - Asset managers drew on bank credit lines during stress, increasing interconnectedness between NBFIs and banks. - Corporate vulnerabilities have increased as firms took on more debt to cope with cash shortages amid extreme earnings shocks. - Public finances deteriorated as fiscal deficits widened, potentially elevating sovereign-financial linkages. - The global regulatory reform agenda implementation slowed during the pandemic (FSB, 2020 annual report). - Survey updates (2020) show increased demand for more work across all three pillars: - The share of country authorities that consider more work in each pillar rose noticeably between 2019 and 2020. - The increase is most marked among authorities, followed by Executive Directors; staff also flagged increased needs particularly in Pillars 1 and 3. - Common themes for FSAPs over the next five years (recovery-phase dependent): - Continued need to prioritize within the three pillars as countries remain at different recovery phases. - Monetary policy likely to remain accommodative; support measures may be expanded/extended; macroprudential buffers have been released where feasible. - Potential phases: continued policy support → unwind extraordinary measures while supporting recovery → corporate restructuring and possible bankruptcies → need to rebuild prudential buffers. - The regulatory agenda will refocus on stresses revealed by the pandemic, including the role of NBFIs and market liquidity/functioning. ### How the three-pillar framework can adapt to pandemic-related risks - Pillar 1 (Risk analysis): - Dive deeper into granular risks in the household, corporate, and public sectors. - Assess heterogeneous sectoral impacts and banks’ exposures to troubled industries. - Evaluate bank-sovereign linkages amid fiscal deterioration. - Assess systemic risks from interconnectedness and NBFI vulnerabilities. - Pillar 2 (Oversight framework assessment): - Assess effectiveness and adequacy of regulatory responses to the pandemic and recommend adaptations. - Use joint IMF-World Bank staff work and MCM COVID-19 notes to support consistency of assessments. - Incorporate new principles/guidance as the reform agenda for NBFIs progresses. - Account for elevated role of Fintech and implications for payments, financial structure, and cybersecurity. - Pillar 3 (Financial safety nets and crisis management): - Test frameworks for resolution, safety nets, and crisis management where systemic distress emerges. - Discuss implications of corporate debt restructuring for the financial system and adequacy of corporate insolvency frameworks. *2021 FSAP REVIEW—BACKGROUND PAPER ON SCOPE, INTRODUCTION* ### 13. By focusing on systemic risks, the RAM plays a critical role in FSAP scoping and ### 13. By focusing on systemic risks, the RAM plays a critical role in FSAP scoping and ### Role of the RAM in FSAP scoping and prioritization - The RAM focuses on the main systemic risks facing a financial system, including the macroeconomic environment, the characteristics of the financial system, and the position of real and financial cycles. - Both the design of the RAM and the discussion of scope are conducted in close consultation with Article IV teams. - The RAM has helped expand the scope of FSAPs to include new sources of systemic risks such as NBFIs and capital markets. - The use of RAMs has strengthened analysis of interconnectedness, cross-border exposures, and spillovers. - FSAP RAMs are linked to the semi-annually updated Global-RAM, representing the Fund-wide view of key global risks. - Distinction between RAM types: - Global-RAM and Article IV RAMs emphasize high and medium likelihood events. - FSAP RAM includes “low likelihood but plausible” events if they could result in systemic distress. - Article IV RAMs cover a wider range of macroeconomic risks; FSAP RAMs have deeper coverage of financial stability risks. ### Modalities: remote engagement and mission design - The 2021 FSAP Review survey shows MCM staff consider remote engagement is less effective than physical missions due to: - Challenges of building relationships with authorities and engaging in sensitive conversations. - Time zone differences. - Remote sharing of confidential data. - Survey impressions on mission effectiveness (as reported): - 5 - 33 - 62 - 0 - 10 - 20 - 30 - 40 - 50 - 60 - 70 - More effective than normal times FSAPs - About the same - Less effective than normal times FSAPs - Experience with Remote FSAP Missions: MCM Staff (In percent of total respondents) summary values reported: - 23 - 23 - 46 - 46 - 69 - 77 - Factors reducing the effectiveness of remote FSAP missions (In percent of total respondents) listed in the survey: - Other challenges - Communication technology - Sharing of confidential data - Time zone differences - Sensitive conversations - Building rapport - Survey comments suggest remote engagement could be considered for the scoping mission, but physical visits would be more effective for main missions. - MCM staff view that the lower effectiveness of remote engagement may offset travel cost savings for some mission types. ### Risk-focused approach to assessing international standards - FSAP assessments of microprudential oversight, financial safety net, and financial integrity are based on international standards set by SSBs: BCBS, IAIS, IOSCO, CPMI, FSB, IADI, and FATF for AML/CFT. - Two modalities for use of standards in FSAPs: - A graded assessment: - Uses the assessment methodology of the SSB. - Produces a “Detailed Assessment Report (DAR).” - Provides a comprehensive picture of the prudential framework. - A focused review: - Benchmarks specific prudential or supervisory gaps that could exacerbate or fail to contain systemic risk. - Produces an FSAP Technical Note (TN). - Allows FSAPs to focus on the most relevant activities, particularly for standards that include numerous subsectors. - Guidance on choosing graded assessment vs focused review: - Decision is by agreement between staff and authorities. - Factors: sector importance, degree of vulnerabilities, FSAP priorities, extent of changes in sector or oversight framework, and extent of changes in the standard or assessment methodology since last graded assessment. - In the FSAP survey, 86 percent of respondents thought the IMF guidance was appropriate. - Respondents supported greater flexibility enabled by focused reviews, though some valued DARs for standardization and comparability. - One specific suggestion: discontinue a ROSC when a DAR is published. - Number and modality of assessments are chosen jointly with national authorities during scoping, balancing resources and desired scope. - Staff leverage desk analysis of macrofinancial risks, structural and conjunctural factors, institutional and supervisory developments, and up-to-date self-assessments provided by authorities. ### Trends in use of DARs and TNs; implications for supervision coverage - Since the 2014 Review, jurisdictions with established compliance have seen fewer formal graded assessments and more focused reviews. - The number of DARs per FSAP has declined while the number of TNs has increased (Figure 4 referenced). - Since the 2012 update of the Basel Core Principles and the 2011 update of the Insurance Core Principles, most jurisdictions with mandatory FSAPs have undergone full assessments, allowing subsequent FSAPs to focus on progress addressing previously flagged weaknesses. - ICPs were updated in November 2019 with substantive changes including new provisions focused on systemic risk; this may trigger more insurance DARs in future FSAPs. - Securities sector: targeted reviews of IOSCO principles are generally more suitable than full assessments in many jurisdictions. - Recommendation for mandatory FSAP members: full assessments for banks and insurers should be recommended at least every ten years and also when: - The last assessment used an outdated version of the principles. - There has been a major change to regulatory architecture (e.g., move into or out of a single regulatory authority). - Ensuring a sound regulatory framework and effective supervision requires adequate resourcing for sectoral supervision assessment. ### Thematic approach to FSAPs - A thematic focus on one or two issues can work well when a recent positive comprehensive standards assessment exists. - Example: 2013 Singapore FSAP found regulation and supervision “among the best globally,” manageable risks, and strong crisis management and resolution arrangements; the 2019 FSAP focused on: - Financial system’s cross-border links. - Challenges posed by current and prospective financial innovation (fintech). - Focused review of bank regulation and supervision. - Special attention to financial market infrastructures and crisis management and resolution. - The choice of 1–2 themes is based on relevance to financial stability in the jurisdiction and anchored by the FSAP RAM. - Thematic approach can be useful for regional exercises in regions with strong financial linkages but without supra-national authorities; a formal regional FSAP is difficult without a clear counterpart, but a regional thematic exercise could complement national FSAPs. ### Pillar 1 — Scope of risk analysis: evolving scope and priorities - Potential sources of financial stability risks have expanded with: - Growth of NBFIs in asset, funding, and credit markets. - Increasing cross-border and cross-sectoral interconnectedness. - New risks from digitalization. - Shifts observed: - Risks shifting from banks to NBFIs in many major jurisdictions. - Growing emphasis on interconnectedness. - Notwithstanding broader topics, resource costs have been broadly flat, suggesting successful prioritization. - Pandemic implications: - Increased focus on risks from corporate and household vulnerabilities and bank-sovereign linkages. - 2020 stakeholder survey revealed increased interest in vulnerability assessments of household and corporate sectors and bank stress testing, followed by macrofinancial feedback effects and quantitative calibration of macroprudential measures (MPMs). - Demand for interconnectedness analysis remains strong. - Staff view risks from potential bank-sovereign loops and emerging risks related to climate change and cyber issues also merit further analysis. - FSAP analytical focus—survey results (share of respondents, up to five options) for 2020 vs 2019 (values reported in chart): - Households and NFCs: 73 (2020), 61 (2019) - Interconnectedness: 60 (2020), 44 (2019) - Bank ST: 41 (2020), 39 (2019) - MPM calibration: 33 (2020), 22 (2019) - Cyber risk: 22 (2020), 21 (2019) - NBFI risk: 13 (2020), 12 (2019) - Macro-financial feedback: 4 (2020), 0 (2019) - Markets, Fintech, Housing market, Growth-at-risk, Climate, Other follow as listed in Figure 6 (chart referenced). - Staff efforts to strengthen analytical tools: - More detailed analysis of household and corporate sector vulnerabilities. - Quantitative calibration of MPMs. - NBFI risks and their link to banking system or financial markets. - Pilot analyses of selected emerging risks (climate, cyber, fintech). - Continued refinement and standardization of bank stress testing tools. - Development of a new credit risk approach to adapt to the Expected Credit Loss (ECL) framework under IFRS 9. - Development of Bayesian model averaging techniques to improve model fit for stress testing. - Development of macro scenario stress testing tools for NFCs and households using firm-level and household survey data. - Interconnectedness analysis deepened through improved data: - Early FSAPs focused on interbank and cross-border banking interconnectedness using direct exposure data. - Recent FSAPs examine cross-financial-segments interlinkages (e.g., banks and asset managers or insurers) and contagion in financial markets (systemic liquidity). - Staff developed a tool to assess system-wide foreign exchange (FX) liquidity risks, investigating liquidity spillovers across economic sectors, particularly relevant for small open economies without reserve currencies. - Ongoing challenges in adapting FSAP risk analysis: - Extending risk assessment tools (e.g., stress testing) to cover NBFIs, nonfinancial sectors, and emerging risks while containing resource demands. - Alleviating data constraints, especially for broad interconnectedness, nonfinancial sector analyses, and emerging risks. - Developing new tools to assess emerging risks and expand stress tests to assess macrofinancial linkages and calibrate MPMs. - Specific methodologies are discussed in the background paper on Quantitative Analysis. ### The role and value added of FSAP stress tests - Bank stress testing is a core element of the independent financial stability assessment in FSAPs. - The 2019 IEO Review on Financial Surveillance suggested that where national authorities have sophisticated stress testing frameworks, FSAPs should review the authorities’ framework rather than undertake an independent exercise. - The FSAP Review survey suggests most authorities value the independence of FSAP assessments, including for jurisdictions other than their own. - The 2020 stakeholder survey reveals substantially increased interest from authorities in core bank stress testing. - Staff consider FSAP stress tests essential for an independent assessment of financial sector risks, analogous to independent assessment of macroeconomic risks in an Article IV consultation. - Adaptations of FSAP stress testing tools (e.g., Global Bank and Universal Bank Stress Tests — GST and UST currently under development) could be shared with area departments and used to enhance financial surveillance in Article IVs. *Source: ppea2021043 - 13. By focusing on systemic risks, the RAM plays a critical role in FSAP scoping and* ### 31. Independent stress tests are essential for assessing frameworks used in different ### Independent stress tests are essential for assessing frameworks used in different jurisdictions ### Role and value of FSAP stress tests - Stress tests conducted by FSAP teams allow for comparing risk analysis across different models, which is effective to discuss model and parameter uncertainty and assess the robustness of specific stress testing results. - Model comparison exercises that run the same scenarios with the same data across different models are an important and accepted validation technique to understand complex models more generally. - Supervisors in many jurisdictions validate banks’ internal models by comparing bank-produced results to the supervisors’ top-down models. - FSAP stress tests add value by providing a more macroprudential perspective than is typical in supervisors’ stress tests. Most national authority stress testing exercises are microprudential and typically: - Focus on individual banks’ results and use them to inform supervisory actions (such as limiting dividend distributions). - Usually do not incorporate contagion and feedback effects that add to systemic risk. - FSAP stress tests are designed to be more macroprudential and examine systemic risks by incorporating amplification and feedback effects (e.g., solvency-liquidity feedback, bank-sovereign linkage, bank-NBFI linkage, and second-round effects to the real economy). - Many FSAP exercises require granular bank stress testing models; to estimate second-round effects from bank distress to the real economy an integrated model that includes a bank stress test module and a macrofinancial module is needed. - Effectively operationalizing fuller macrofinancial linkage analysis in FSAPs places a premium on teams running their own stress testing models. ### Tools and scope - GST is a tool to conduct bank solvency stress tests using publicly available individual bank financial statement data for about 30 jurisdictions. - UST aims to expand the sample countries to about 70, using jurisdiction-aggregated data from the IMF’s Financial Soundness Indicator database and a simplified methodology. - The IMF defines systemic risk as “the risk of widespread disruption to the provision of financial services that is caused by an impairment of all or parts of the financial systemic, which can cause serious negative consequences for the real economy.” ### Challenges from COVID-19 - The pandemic shock raised new challenges for FSAP risk analysis, including a sharp increase in authorities’ demand for household and NFC analyses, bank stress tests, and MPM calibration. - New macro-scenario-based household and NFC vulnerability assessment tools under development should help near-term FSAPs; the challenge is linking these vulnerability assessments to bank stress tests. - Bank stress tests should, where possible: - Consider cross-industry differences as COVID-19 impacted certain industries more than others. - Incorporate effects of mitigating policies at the sectoral level (e.g., guarantees, moratoria). - The GST approach (October 2020 GFSR) illustrated methods to incorporate the effects of government guarantees and capital adequacy policies (i.e., effects of limiting dividend distribution). - The 2020 Philippines FSAP examined effects of moratoria on liquidity shock spillovers between banks and NFCs. - FSAPs that use balance sheet data from during the pandemic to anchor analysis will need to consider adjustments for the size and duration of supportive policies to reveal underlying capital positions of financial institutions. ### Data issues and access - Increases in breadth and depth of risk analysis have been possible partly due to improved data quality and access in individual country FSAPs. - Member countries’ sharing of confidential institution-by-institution supervisory data has improved since the 2014 FSAP Review; in all but one jurisdiction staff working on recent assessments were able to access confidential supervisory data. - Accessing confidential data brings challenges: - Authorities often require additional arrangements, such as limited access via a dedicated data room, which adds significantly to mission travel costs and requires highly skilled staff to spend time on data collection and entry-level tasks. - Travel restrictions associated with the pandemic have prevented access to data rooms; remote data access is critical while travel restrictions last and could be considered more broadly as a resource-saving mechanism. - The quality of interconnectedness analysis depends critically on data availability and access. - Global efforts such as the G-20 Data Gaps Initiative (due to be completed by end-2021) have helped close some data gaps but considerable gaps remain. - Authorities have started to collect more activity-based data, including all types of participating institutions and cross-financial segments; more countries have started to compile cross-sectoral data such as flow of funds by counterpart (who-to-whom balance sheet approach data). - Gaps remain, including data on NBFIs, sectoral accounts, and cross-border exposures; due to confidentiality constraints, FSAPs have generally not benefited from improved data collection from G-SIFIs and market-finance data. - Pursuing more efficient confidential data sharing arrangements with national authorities can lower FSAP costs and increase quality; modalities for remote data access would help ensure continuity of FSAP engagement and could save resources. *Source: 2021 FSAP REVIEW—BACKGROUND PAPER ON SCOPE* ### 49. In the insurance sector, the ICPs were enhanced significantly in 2019, which could ### ppea2021043 - 49. In the insurance sector, the ICPs were enhanced significantly in 2019, which could ### Insurance sector: standards, scope, and implementation challenges - The ICPs were enhanced significantly in 2019 and now incorporate the Common Framework for the Supervision (ComFrame) of Internationally Active Insurance Groups (IAIGs)—the first global insurance standards for internationally active insurers similar to advanced criteria in the BCPs for banks. - The standards and guidance are meant to be applied to 48 currently identified IAIGs with group-wide supervisors in 16 countries. - IAIG definition and internationally active criteria: - Internationally active criteria: premiums are written in three or more jurisdictions and gross written premiums outside of the home jurisdiction are at least 10 percent of the group’s total gross written premiums. - Size criteria: total assets are at least US$50 billion or total gross written premiums are at least US$10 billion (calculated on a three-year rolling average). - The ICPs and ComFrame include new requirements for supervisors to address systemic risk in the insurance sector. - Insurance supervisors are facing significant implementation challenges as the new standards raised the bar for the institutional framework which many jurisdictions have not met. - Common institutional weaknesses identified (figure summary): - Insufficient independence of supervisors is the most common weakness, followed by lack of resources and absence of a clear mandate for financial stability. - Supervisory challenges include establishing the regulatory framework for governance and adapting supervisory practices; related-party transaction supervision has been poor, with absence of or overly narrow definitions of related parties’ transactions. - Advances have been made in risk management and corporate governance, consolidating improvements in oversight of internal controls. ### Securities sector: investment funds and COVID-19 vulnerabilities - Since the GFC, the FSB and IOSCO strengthened the regulatory framework for investment funds; FSB’s 2017 Recommendations to Address Structural Vulnerabilities from Asset Management Activities identified liquidity and leverage of investment funds as critical sources of vulnerabilities. - FSAPs confirmed the relevance of these vulnerabilities and suggested reforms. - COVID-19 triggered large outflows from money market funds (MMFs) and open-ended funds invested in risky credit assets and led to market turmoil. - Central banks acted, directly and indirectly, as the “market maker” of last resort in multiple markets involving NBFIs—an intervention unprecedented because NBFIs are not usually counterparts of central bank operations and liquidity facilities. - The challenges faced by NBFIs suggest that more regulatory and supervisory action and reforms would be needed in the asset management industry. ### Payments and Financial Market Infrastructures (FMIs) - FMIs include payment systems, securities settlement systems (SSSs), central securities depositories (CSDs), central counterparty clearing houses (CCPs), and trade repositories. - Since the GFC, efforts shifted bilateral transactions to CCPs, making some CCPs highly interconnected and systemically important—elevating the importance of their supervision, crisis management framework, and resolution planning. - Emergence of digital payments, fintech, and digital currencies introduced new service providers and issues: cyber risk, competition, expanding regulatory perimeter to create equal footing, and potential impacts on financial stability. ### The next five years: evolving priorities and supervisory scope - The COVID-19 crisis reinforced lessons from the GFC: importance of adequate capital, sufficient liquidity, comprehensive risk coverage of the regulatory framework, good governance, effective risk management by financial institutions, proactive supervision, and early intervention by authorities. - Assessments of prudential oversight under pillar 2 will remain critical as international standards evolve; digitization and rising roles of NBFIs continue to produce new channels for propagation and transmission of systemic risk. - Notable standard developments: - The revised insurance standards came out only in 2019. - Regulatory reforms for investment funds are relatively new and may need further enhancement in light of pandemic market turbulence. - International standards for payments have not yet fully caught up with digitalization. - FSAP pillar 2 work will need to integrate country-specific characteristics into assessments of evolving global regulatory reform measures. ### Regulatory response to COVID-19 and implications for oversight - National crisis-response measures taken during the pandemic included loan moratoria, expanding government guarantees, releasing additional capital and liquidity buffers, limiting capital distributions, intervention in markets as market maker of last resort, and, in some cases, measures not compatible with international standards. - The SSBs, IMF, and World Bank issued guidance clarifying international best practices, including on supervisory reporting to assess these measures. - Near-term FSAPs will need to discuss adequate withdrawal of these measures as the pandemic calms down. ### Payments/FMI coverage and interim assessment tools - Payments and FMIs have been optional elements in FSAPs; given rapid sector transformation and operational risk vulnerabilities from IT disruptions and cyberattacks, this treatment may need reconsideration. - Retail payment innovations requiring greater coverage include fast payments, application programming interface (API), E-wallets, mobile platforms, open banking, distributed-ledger technology (DLT), and new intermediaries—some platforms are becoming critical infrastructure. - Suggested enhancements: - Stock takes of digital payments should become an integral part of FSAP assessments. - Additional interim assessment tools should be developed to complement PFMI and other standards for payments, clearing, and settlement risks. - Interim frameworks should be based on close dialogue with the SSBs and pay greater attention to operational risks such as IT and cybersecurity. - The perimeter of assessment may need to include third parties, BigTech payment service infrastructure, data governance, and the legal basis for DLT-based services. ### Coverage of financial integrity (AML/CFT) within FSAPs - Updates on AML/CFT issues are an essential part of the FSAP; current Fund policy requires timely and accurate input of AML/CFT information into every FSAP. - Since 2014, discussion of AML/CFT issues in FSAPs has been mandatory but flexible in scope; the scope, depth, and modalities of analysis have varied. - AML/CFT discussions may take the form of technical notes, annexes, background notes to the Aide Memoire, or several paragraphs in the FSSA, depending on availability of a recent assessment and other information. - The flexibility allows focused discussions and avoids unnecessary duplication with formal AML/CFT assessment processes by FATF and FATF-style regional bodies. - In line with Executive Board guidance, AML/CFT input is, where possible, based on a comprehensive AML/CFT assessment or a targeted reassessment against the prevailing standard finalized prior to the FSAP; if unavailable, staff may derive findings from other sources (previous AML/CFT assessment reports, Fund reports, national risk assessment reports, authorities’ responses to FSAP questionnaires, and other reliable information). - Inclusion of AML/CFT issues has deepened global understanding that robust AML/CFT implementation contributes to financial stability and development. - Typical AML/CFT issues discussed in FSAPs have included: - Preventive measures (customer due diligence measures) - Country’s assessment of money laundering and terrorist financing risks - Risk-based AML/CFT supervision - Transparency of beneficial ownership of legal persons and arrangements - Terrorist financing and targeted financial sanctions - Suspicious transactions reporting and effectiveness in use of financial intelligence - International cooperation ### Pillar 3: scope of financial safety nets — overview - Effective frameworks for crisis management, safety nets, and resolution of financial institutions are critical components of the financial stability framework. - FSAPs assess robustness of countries’ financial safety nets: supervisory intervention arrangements; resolution of financial institutions; deposit insurance; and emergency liquidity assistance (ELA). - The COVID-19 pandemic increases the premium on authorities’ capacity to respond effectively to distress as exceptional measures are phased out and long-term economic fallout becomes clear. - The GFC highlighted that existing frameworks were primarily designed for idiosyncratic institution distress and were not sufficient for systemic financial crises or for cross-border resolution challenges involving SIFIs; clearer roles for home and host supervisors are needed. *International Monetary Fund — 2021 FSAP REVIEW — Background paper on scope* ### 63. Recent FSAP assessments have followed the substantially revised international ### 63. Recent FSAP assessments have followed the substantially revised international ### Resolution frameworks and deposit insurance - The FSB adopted the Key Attributes of Effective Resolution Regimes for Financial Institutions (KA) in 2011 and issued additional guidance in 2014. - The KA set out core elements enabling authorities to resolve financial institutions without exposing taxpayers to losses while maintaining continuity of vital economic functions. - The Core Principles (CP) for Effective Deposit Insurance Systems, revised in 2014, provide benchmarks covering governance, membership, coverage limits, funding modalities, and arrangements for quickly reimbursing insured depositors. - The KA were designed to apply to both banks and non-bank financial institutions using a modular approach to assessment. - The IMF Board endorsed the inclusion of the Deposit Insurance Core Principles and KA in the Standards and Codes Initiative in 2011 and 2017, respectively. - Progress since the 2014 FSAP Review: - Many jurisdictions have strengthened resolution frameworks. - Less progress in low-income and developing countries. - Advanced economies continued aligning bank resolution regimes with international standards and enhanced resolution planning for systemically important non-banks. - Remaining priorities to ensure all G-SIBs can be effectively resolved include: - Development of resolution funding strategies. - Frameworks for conducting valuations in resolution. - Continuity of access to FMIs. - Finalization of cross-border cooperation agreements. - Experience with bank failures in low-income and developing countries since the 2014 Review highlights continuing weaknesses in financial safety nets. - Reforms should be guided by the principles of proportionality to avoid undue burdens or market distortions (Nolte and Hoelscher, 2020). ### The Next Five Years: methodologies, benchmarks, and resources - In 2016, the FSB issued the Assessment Methodology for the Banking Sector; the Board endorsed it for graded assessments (IMF 2017a and b). - In 2020, the FSB, in consultation with IAIS, WB, and IMF, developed an Assessment Methodology for the Insurance Sector to guide compliance assessments of insurance resolution frameworks against the KA. - Fund staff supported development and undertook a pilot assessment as part of the 2019 France FSAP. - For deposit insurance, the International Association of Deposit Insurers released a comprehensive handbook in 2016 for assessing compliance with the Core Principles. - The Fund and the Bank intend to use the KA methodology as the assessment benchmark for insurance resolution frameworks in FSAPs and stand-alone standards assessments. - The Board is asked to endorse the KA as they apply to insurance resolution regime assessments and the related assessment methodology. - Resource implications: - The complexity of the standard and other Pillar 3 work will place heavy demand on staff. - Careful prioritization and allocation of resources will be critical to ensure full (graded) assessments are appropriately resourced. ### COVID-19 implications for safety nets and resolution - The COVID-19 crisis does not fundamentally change the desirable design of financial safety nets (IMF, 2020b). - Early intervention frameworks allow supervisors to require prompt corrective actions and monitor emerging weaknesses. - Corrective actions should aim to restore capital and liquidity buffers, ensure long-term viability, and curb excessive risk-taking. - Given substantial uncertainties over economic impact and recovery speed, supervisors may: - Need to give more time for rebuilding capital. - Temporarily suspend automatic triggers for prompt corrective actions where relevant (see IMF 2020c). - Initiating bank resolution may not always be practicable during the pandemic because of operational challenges and high uncertainty over asset valuations. - Authorities should continue efforts to: - Strengthen resolution regimes. - Improve operational capabilities. - Maintain up-to-date resolution plans to be ready to intervene after removal of exceptional policy support. - Operational readiness and capacity of deposit insurance schemes and ELA frameworks should be ascertained to underpin confidence and reduce contagion risks. - Footnote: Given potential ML/TF risks when reimbursing insured depositors, adequate AML/CFT safeguards should be in place, including effective coordination with relevant AML/CFT authorities and active channels for cooperation and information sharing. ### Coverage of cross-cutting issues — Systemic liquidity - Systemic liquidity assessments have become an increasing topic of interest in FSAP since the GFC. - These analyses examine the risk of multiple institutions simultaneously facing liquidity difficulties and the amplification effects of interconnectedness. - Systemic liquidity risk varies by financial system structure: - In systems with well-developed money and capital markets, shocks can spill over across institutions and markets, amplified by behaviors like liquidity hoarding and asset fire sales. - In systems dominated by deposit-funded banks, a system-wide liquidity shortfall can occur from net aggregate outflows (e.g., external drains from balance of payment shocks or domestic financial disintermediation). - For some jurisdictions, systemic liquidity could be the central macrofinancial topic, closely related to Article IV external sector assessment. - Major central banks have mitigated impacts by providing ample liquidity in recent crises. - Central banks in small open economies without reserve currencies may not fully mitigate aggregate FX liquidity shocks due to limited firepower (often limited to international reserves). - These economies are subject to the assessment of reserve adequacy (ARA) in Article IV consultations where financial stability risk contributes to external balance distress. - MCM has developed a tool to assess impact of FX liquidity shocks from balance of payment stress to economic sectors and spillovers to the financial system and international reserves held by the central bank. (See IMF, 2016 Guidance note on the assessment of reserve adequacy.) - A systemic liquidity assessment spans the three pillars of a financial stability assessment: - Pillar 1: Vulnerabilities by institution type or activity (e.g., banks, asset managers, CCPs, repo markets). - Pillar 2: Prudential measures to prevent liquidity stress at the institution and system levels, and robustness of FMI oversight. - Pillar 3: Liquidity support by central banks and design (eligible collateral, lending terms), including cross-border backstops such as central bank swap arrangements for systemic FX liquidity shocks. - Ideally, assessments include qualitative and quantitative descriptions of financial linkages integrated with liquidity stress tests of systemically important segments or activity-based analysis of relevant liquidity markets. - Depth of systemic liquidity assessments in FSAPs has varied due to data gaps and methodological challenges: - Some assessments focused on qualitative descriptions of core liquidity markets and FMIs with related prudential and safety net recommendations. - Quantitative liquidity stress tests have focused on banks (and occasionally investment funds). - Nonavailability of extremely granular data and methodological challenges in modeling complex interconnectedness and participant behavior in extreme stress scenarios has limited depth. - Exceptions noted include 2017 Luxembourg FSAP (detailed analysis of mutual funds) and 2020 Philippines FSAP (linkage between banks and nonfinancial corporations triggered by COVID-19 earnings shocks). ### Borrower vulnerabilities and distressed asset restructuring - The pandemic's potential scarring effects renew attention to nonperforming loan (NPL) management relevant for FSAPs. - Borrower distress may become more visible as extraordinary support measures are unwound, requiring balance sheet workouts in real and financial sectors. - FSAPs may need to consider: - Enhancing supervision of asset quality, including asset quality reviews as needed. - Reviewing frameworks for NPL restructuring given the possibility of a spike in distressed assets. - These cross-cutting topics span regulation and supervision, corporate insolvency, and enforcement of creditor rights. - Country authorities have roles in pillar 2 and 3 areas: - (i) Strengthening regulation and supervisory oversight. - (ii) Enhancing insolvency and creditor rights frameworks. - (iii) Facilitating asset disposal (see IMF 2020b). - Building on recent FSAP experience, deep dives in these areas are likely to become more important post-COVID. - Options for banks dealing with large stocks of NPLs (effectiveness hinges on legislative frameworks and institutional capacity): - Supervision and regulation: - Ensure loans are appropriately classified and provisioned. - Pay attention to collateral valuation and treatment of restructured loans. - Encourage timely write-offs of uncollectible loans before exhausting legal remedies. - Enhanced oversight for banks with high NPLs, requiring bank-specific NPL resolution strategies and improved internal capabilities (e.g., dedicated workout units). - Reviews of supervisory and regulatory policies should be informed by and coordinated with financial sector oversight evaluations, such as the BCP. - Insolvency and creditor rights: - Require regimes that enable rehabilitation of viable firms and liquidation of nonviable ones with robust enforcement and foreclosure processes to maximize recoveries (see IMF 2020d). - Efficient insolvency and enforcement mechanisms can incentivize meaningful out-of-court restructurings. - Reviews can follow World Bank Principles for Effective Insolvency and Creditor/Debtor Regimes and UN Commission on International Trade Law guidance on insolvency law. - Asset disposal: - Timely disposal of distressed assets facilitates balance sheet clean-up and market efficiency by involving specialized investors. - Development of distressed asset markets hinges on reforms removing structural impediments (incomplete credit information, legal obstacles to asset transfers, regulatory/consumer protection parity, unfavorable tax treatment) and improving enforcement of creditor rights. - Technical notes on NPL resolution were prepared for the 2017 Bulgaria and 2020 Italy FSAPs. ### Coverage of emerging issues: overall considerations and FSAP response - Emerging risks—climate change, cyber, and fintech—are increasingly important for financial stability. - Central banks and financial regulators are paying increased attention to climate change implications and green investment opportunities. - International fora such as the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) have intensified work programs. - Rapid advances in financial technologies increase potential cyber risk to financial stability through digitalization and interconnectedness of services and infrastructures. - Fintech supports growth and poverty reduction but may pose risks to consumers, investors, financial stability, development, and integrity. - Tackling emerging issues in FSAPs requires a combination across the three pillars: - Pillar 1: Stress testing could include scenarios for climate change and fintech impacts over extended horizons. - Pillar 2: Develop comprehensive approaches to climate change, cyber risks, and fintech based on new standards and guidance from SSBs as they become available. - Given fintech’s role in payments and cyber risks, FSAPs may need closer examination of operational resilience of market intermediaries and FMIs. - Addressing emerging issues calls for collaboration and human capital investment at the Fund: - Climate analysis requires collaboration with climate scientists and hazard risk specialists (e.g., catastrophe insurance experts). - Cyber and fintech require work with technology specialists and ideally security/law enforcement agencies, though collaboration has been limited so far. - Staff should continue working with external experts, broaden expert rosters, hire specialists, and cooperate closely with the World Bank Group and other stakeholders. - Cross-fertilization with Fund-wide workstreams on climate change, fintech (including digital money), and cyber risks can benefit FSAP analysis. - Future FSAPs must balance traditional topics and emerging issues based on country circumstances: - Pace of digitization and policy efforts on climate change will increase over the next five years. - SSBs are incorporating new risks into standards and guidance; FSAPs will need to adapt approaches to evaluate practice. - Analytical frameworks for these risks are at an early stage but developing rapidly. - Given resource constraints, FSAP teams must leverage scoping to prioritize emerging risks and use the Risk Assessment Matrix to inform staff judgment. - A forward-looking approach is important given the rapidly evolving landscape. - Pilot assessments: - Offer a pragmatic near-term approach; recent FSAPs have covered some emerging risks on a pilot basis with external experts. - Pilots are chosen based on potential systemic importance of an emerging risk in the country. - Use of pilots has helped develop assessment techniques for future FSAPs and allowed deeper examination where relevant. - Further pilot experience, combined with MCM and IMF/World Bank projects, technical assistance, flagships, and collaboration with SSBs and other central banks/regulators, should increase coverage on these topics. *Source: 2021 FSAP REVIEW——BACKGROUND PAPER ON SCOPE (excerpts provided).* ### 79. Climate risk stress testing in FSAPs can help our members better understand ### 79. Climate risk stress testing in FSAPs can help our members better understand ### Climate risk stress testing: purpose and distinction - Climate risk stress testing in FSAPs aims to help members better understand potential pressure points for the financial system due to physical climate shocks and in the transition to a low-carbon economy. - It will help inform policies needed to enhance risk management and the resilience of the financial system. - Unlike conventional stress testing, climate risk stress testing is not focused on quantifying possible capital needs of financial institutions relative to regulatory minima. ### Evidence from past FSAPs and current practice - Risk analysis: - A textual analysis of 192 FSAP reports (up to 2019) found that 33 (17 percent) contained meaningful references to risk factors such as droughts, floods, and storms. - Many of these are for small island states (such as the Bahamas, Jamaica, and Samoa), but some assessments for advanced economies (such as the United States, France, Belgium, Denmark, and Sweden) have also covered natural catastrophe risks as part of insurance stress testing. - Some FSAPs have piloted new approaches to incorporate climate change in bank stress tests (Norway on transition risk and the Philippines on physical risk), while others discussed the risks without necessarily conducting stress tests. - Oversight: - The oversight section of FSAP also started to cover climate issues. In the 2020 US FSAP, the regulatory response to the increasing incidence and severity of natural catastrophes was considered as part of the assessment of supervision and regulation of the insurance sector. - Assessing progress with disclosure rules on climate change risk (for all types of firms) is another area. - IMF staff are developing an approach to embed climate risk considerations in the review of supervision and regulation; this approach to climate risks will be pilot tested in upcoming FSAPs. ### Adaptations required to conventional stress testing - Horizon: - Climate risk stress testing will consider financial stability risks at both the conventional medium-term (3-5 year) horizon and the long-term (30-50 year) horizon. - The examination of both medium- and long-term climate risks is important, as many others in the field focus only on long-term risks. - Nature of risks: - FSAPs will need to consider both physical and transition risks. - In any given country, the scope of the analysis would be based on an assessment of each country’s specific vulnerabilities. - Scenarios for physical risk: - The highly micro-sectoral and geo-spatial sources of climate-related financial stability risks present important data and modeling challenges. - FSAPs will need to draw on external expertise on physical risk and obtain granular data. - Scenarios for transition risk: - The large uncertainties surrounding the carbon price path and associated spending of carbon tax proceeds present important modeling challenges. - FSAP stress testing will need to assume a range of carbon price paths, from large up-front price increases to more gradual increases, drawing on approaches being used by leading central banks and leveraging models developed within the Fund and external experts, linking close to the approach of the NGFS. ### Modeling and data needs; collaboration - Macroeconomic modeling: - More effort will be needed on macroeconomic modeling of climate change to build climate stress test scenarios and integration of discussions with the revised Climate Change Policy Assessment (CCPA). - Climate change would have different impacts across economic industries (e.g., “brown” industries vs. “green” industries) and geography; therefore, one would need to use economic models suited for analysis by industry, such as computational general equilibrium (CGM) models and global trade analysis project (GTAP) models. - Currently, such models are not part of the Fund’s macroeconomic modeling toolkit. - External collaboration: - FSAPs will need to leverage other climate work in the Fund, the Bank, and international fora. - Staff are engaging with the NGFS for stress tests and supervision, and the Task Force on Climate related Financial Disclosures on the taxonomy of green assets as well as disclosure standards. - Collaboration with the Bank could be particularly relevant for jurisdictions with joint Bank-Fund responsibilities, especially for building physical risk stress test scenarios where expert knowledge on climate science and disaster models (e.g., catastrophe (CAT) risk models for cyclones and flood) and sectoral expertise (e.g., agriculture, energy) would be salient. - Resource constraints: - IMF staff will seek to extend climate risk analysis—including on materiality and, as relevant, physical and transition risk modeling—to more FSAPs, as feasible within the prospective resource envelope. ### Cyber risk - Systemic vulnerability and channels: - Financial systems are particularly vulnerable to cyberattacks given the increasing reliance on information and communication technology (ICT). - Entry points of attacks are diverse; an attack on a handful of firms could spread quickly through ICT interconnection and the inherent interconnectedness of the financial system. - Cyberattacks can be systemic if they target several financial institutions simultaneously, a systemically important financial institution, or market infrastructure; spillovers may also come indirectly from attacks on ICT providers and physical infrastructures. - Cyberattacks could exacerbate an emerging financial crisis by propagating disinformation, undermining confidence, or disrupting safety nets, potentially stalling payments and settlement transactions, causing liquidity crunches to banks, and prompting mass insurance claims. - FSAP coverage and pilot exercises: - Coverage of cyber risks in FSAPs has been increasing: examples include descriptive information gathered through interviews (Namibia) and potential losses from cyberattacks via questionnaires (Poland). - MCM has provided workshops and technical assistance connecting supervisors from emerging and developing economies to external experts and supervisors from more developed economies, and organized crisis management simulation exercises in collaboration with a major global bank and cybersecurity experts. - The pandemic has heightened concerns regarding cyber and operational resilience and led to inclusion of these topics in forthcoming FSAPs. - Quantitative approaches and data constraints: - Some FSAPs developed new approaches for quantitative risk assessment of cyber risks despite data challenges: the Euro Area FSAP conducted a cyber risk-motivated liquidity stress test simulating banks unable to access collateral at CCPs; the Singapore FSAP used detailed authority data and bank-provided scenarios, developed an inventory of scenarios and a cyber RAM, and insurers estimated policy payouts if significant policyholders experienced cyberattacks. - Data gaps are a critical constraint; cyber security breach data could be considered national security information, raising access barriers beyond standard stress testing data. Publicly available data depends on voluntary reporting and often misses loss information. - Regulatory and supervisory work: - Developing regulation and supervisory processes are essential; pilot FSAP exercises in Norway and South Africa examined potential systemic implications of cyber risk and policy actions to improve cyber resilience, focusing on regulatory and supervisory frameworks using international best practices. - Exercises developed a cross-sectoral approach covering systemically important FMIs and banks; narrow scope focusing on systemically important FMIs and banks was crucial. - Strong collaboration with authorities is required due to sensitive subject matter and confidentiality needs. - Disclosure expectations: - To clarify expectations of cyber risk coverage in FSAPs, staff proposes to amend the FSSA disclaimer to highlight the distinction between systemic risk (which financial stability assessments focus on) and idiosyncratic risk (which they do not necessarily cover). ### Fintech - Opportunities and risks: - Rapid advances in fintech are transforming the financial landscape, offering opportunities but posing risks that may affect financial stability, business models of established institutions, and require regulatory adaptation. - Coverage to date: - Fintech issues have been covered in 13 assessments, with 5 ongoing FSAP missions focusing on fintech; assessments have primarily focused on oversight issues so far. - The World Bank has discussed fintech from the perspective of improving access to finance, financial inclusion, financial development, and reducing the cost of retail payments, including cross-border payments. - Quantitative analysis of financial stability risks from fintech is still at an early stage. - Policy and supervisory responses observed: - FSAPs have integrated fintech elements into the oversight pillar; regulators and supervisors monitor fintech developments to evaluate whether frameworks and supervisory processes need adaptation (e.g., sandboxes, innovation hubs, enhanced monitoring, clarifying/adjusting regulations, and strengthening resources). - Some authorities have amended legal and regulatory frameworks for new entities and services to balance financial innovation with financial stability, integrity, and consumer protection. - Pilot exercises have been conducted in jurisdictions with rapid fintech development (e.g., Malta, Singapore, Switzerland, and United States). - With a focus on financial inclusion, the World Bank has included fintech in development modules of FSAPs (such as India, Indonesia, South Africa, and Thailand). - Common challenges from pilot experience: - (i) Resource limitations given specific skills needed; (ii) lack of reliable data due to the regulatory perimeter; (iii) importance of international cooperation due to cross-border nature of fintech activities; (iv) need to further develop international standards in some areas. - Emerging market and developing economies (EMDEs) may face more rapid development of fintech and Big Tech, increasing demand for fintech and Big Tech analysis in future FSAPs. - Quantitative pilot approaches: - The 2019 Singapore FSAP: national authority conducted bottom-up stress tests on capital and liquidity based on bank-relevant scenarios; staff estimated potential gains from fintech by gauging unit cost of financial intermediaries and reduction of incumbent banks’ noninterest income; staff discussed sandbox desirability using an industrial organization model. - The 2020 Korea FSAP: overlayed effects of competition from fintech firms on banks’ interest income and funding costs in standard bank stress tests; results depend critically on likely competitive pressures and market structure evolution (e.g., whether digital retail payment firms can access banks’ payment networks). - Future needs: - Future analysis will need new frameworks and data sources to potentially assess efficiency-stability tradeoffs, model incentives for financial innovation and risk-taking for incumbents and entrants, roles of market structure and government policies, and mapping to efficiency/inclusion versus stability/integrity risks. - Large data gaps persist, reflecting challenges monitoring activities of new fintech entrants and the role of BigTechs. *Source: ppea2021043 - 79. Climate risk stress testing in FSAPs can help our members better understand* --- _Source: https://www.imf.org/-/media/files/publications/pp/2021/english/ppea2021043.pdf_