## _082809a

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---

### Executive summary — Key takeaways
- The Fund has continued to make great efforts to enhance financial sector focus and analytics in bilateral surveillance.
- Main initiatives include enhancing collaboration with other multilateral institutions, improving analytical tools and methodologies, and a major strengthening of the financial sector capabilities in area departments.
- The fruits of these efforts are already visible in the better treatment of financial sector issues in Article IV reports.
- Amendments to the Financial Sector Assessment Program (FSAP), including the introduction of financial stability modules, represent an important step but complementary efforts are required to strengthen Article IV consultations.

### Priority initiatives discussed
- Ensure Better Integration of FSAP Findings into Article IV Reports:
  - Produce a standardized risk-assessment matrix (RAM) in FSAPs to identify the most important threats to financial sector stability, evaluate their likelihood, and discuss their expected impact on macro-financial stability to help frame Article IV consultations.
- Build Bridges Across Complementary Initiatives:
  - Integrate findings from the Fund’s multilateral exercises into bilateral surveillance through: (i) the review process; (ii) an enhanced interdepartmental Financial Sector Group; and (iii) cross-country, thematic staff papers.
- Strengthen Analytical Content of Bilateral Surveillance:
  - Improve coverage of cross-border issues by: (i) better integrating existing data resources and making data more accessible to country teams; (ii) improving measurement of cross-border risks and integrating offshore exposures into Article IV consultations; and (iii) making greater use of cross-border analytical tools (as developed in EWE and the GFSR).
  - Integrate balance sheet analysis more systematically into macroeconomic scenarios, and use stress tests and scenario analysis to assess impacts on financial solvency.
  - Strengthen financial sector coverage in low-income countries (LICs) by focusing on how underdeveloped financial markets affect macroeconomic policy effectiveness and shock absorption.
  - Create a new IMF-World Bank LIC Financial Group, under the Financial Sector Liaison Committee (FSLC), to: (i) help upcoming Article IV missions identify macro-financial stability issues and market development needs; (ii) align Bank activity under FSAPs with LIC stability needs; and (iii) facilitate collaboration in the field or off site.

### Resource and process considerations
- These initiatives will require difficult tradeoffs in a constrained budget environment.
- Current budget realities may require a phased approach guided by collaborative reviews by area departments, MCM, and SPR.

### The evolving context and recent steps
- The global financial crisis prompted renewed expectations for the Fund to enhance analysis of macro-financial linkages, cross-border spillovers, and systemic risk sources.
- Relevant decisions and outputs:
  - The 2007 Decision on Bilateral Surveillance affirmed that financial sector policies are always a subject of Fund surveillance.
  - In October 2008, the Board adopted a Statement of Surveillance Policies (SSP) for 2008–11 prioritizing financial sector surveillance and real-financial linkages.
  - Initiatives launched include the IMF-FSB Early Warning Exercise (EWE), issuance of a Financial Sector Surveillance Guidance Note (FSSGN), and continued analytical research.
- Knowledge management and data advances:
  - The FSSGN was issued in April 2009.
  - An intra-Fund collaborative website on cross-country work, spillovers, and linkages was established.
  - A dry-run of the EWE was conducted in early 2009 with a full rollout during the 2009 Annual Meetings.
  - New data access: STA’s Data Link (internal) and the external Principal Global Indicators site; a group of more than 25 countries began disseminating FSIs via the IMF’s Financial Soundness Indicators website starting July 2009.
  - Work is under way to explore inclusion of financial indicators in the SDDS on an encouraged basis.
  - An Inter-agency Group on Economic and Financial Statistics, chaired by the Fund and comprising BIS, ECB, Eurostat, OECD, World Bank, and UN is addressing data gaps revealed by the crisis.
  - An FSB/IMF “Users Conference on the Financial Crisis and Information Gaps” (July 2009) highlighted priorities to develop system-wide risk frameworks, monitor systemically important institutions and nonbank sectors, reprioritize and broaden FSIs, and enhance cross-border flow analysis.
  - A Working Group (BIS, ECB, IMF and World Bank) on Securities Databases is preparing a Handbook on Securities Statistics.

### Financial Sector Surveillance Guidance Note (FSSGN) — key features
- Provides a nonprescriptive organizing framework and web-based access to quantitative tools and analytical material on macro-financial risk assessment and international views on financial sector policy.
- Guidance on assessing sources of risks:
  - Exposures of financial institutions to credit, market, liquidity, and operational risks;
  - Risks from linkages across domestic sectors and across borders;
  - Legal, institutional, and structural issues (contractual environment, state banks, foreign bank entry).
- Quantitative diagnostic tools described:
  - Financial Soundness Indicators (FSIs);
  - Market-based indicators (equity prices, credit spreads, credit ratings, etc.);
  - Modeling techniques such as stress testing and the balance sheet approach.
- Qualitative tools described:
  - Assessments of compliance with standards;
  - Codes and guidelines as benchmarks to identify deficiencies.
- Possible policy recommendations depending on country circumstances:
  - Crisis prevention policies addressing asset price bubbles, credit booms, potential capital flow reversals, and inadequacies in capital, supervisory, and liquidity frameworks;
  - Crisis management policies to improve frameworks for containment, restructuring, resolution, and asset management.

### Improvements in financial sector analysis and capacity
- Article IVs, Regional Economic Outlooks (REOs), and Selected Issues Papers (SIPs) have strengthened financial sector coverage.
- Staff output includes Staff Position Notes and Working Papers; ongoing studies cited include: "Financial globalization and economic policies", "the implications of global liquidity for monetary policy", "the contribution of financial globalization to systemic risk", and "the evolution of financial balance sheets and links to macroeconomic fundamentals".
- Area departments have invested in capacity with:
  - Enhanced Article IV and SIP coverage of impacts of global turmoil on domestic banking, real-financial linkages, and stress testing;
  - Regional studies divisions producing focused research and increased REO coverage (examples cited from May 2009 APD REO and April 2009 AFR REO).
- Infrastructure and training:
  - Internal guidance notes (APD, MCD); special financial sector working groups (AFR, WHD, MCD); internal websites and monitors; increased INS/MCM training.
- Mission-related outreach:
  - Multiple-country missions (example: MCM-supported 2009 cross-country mission to systemically important African emerging markets); seminars and EUR participation on EU financial integration.
- Increased collaboration and integration:
  - Closer follow-up of FSAP recommendations and stress testing; EUR and MCM collaboration on stress testing and bank recapitalization for EUR-area program cases; participation of MCM and RES economists in Article IV missions.

### Framework for surveillance after FSAP reforms
- FSAP review proposes modular FSAP assessments and risk-focused ROSC updates to allow targeted, deeper, country-aligned assessments and potentially higher frequency.
- Surveillance continuum:
  - Full FSAP: low-frequency, comprehensive.
  - Article IV missions: mandatory, higher-frequency; depth varies with expert resources (e.g., MCM backstopping).
  - Multilateral surveillance: WEO/GFSR/EWE and REOs, with potential for quarterly updates and daily monitoring by MCM and area departments.
- Considerations on merging FSAP and Article IV:
  - Advantages of merger: make FSAP mandatory; reallocate resources by systemic risk priorities.
  - Arguments for separation: Article IV focuses on external stability issues while FSAP supports a wider range and technical assistance; FSAP joint program with World Bank complicates mandatory status; FSAPs require data access and cooperation not enforceable under Article IV (e.g., Article VIII, Section 5(b) members are under no obligation to provide data on individual institutions).

### Remaining challenges and implementation steps
- Key gaps identified in the 2008 Triennial Surveillance Review (TSR):
  - Improve assessment of key financial stability risks and integrate financial and macro analysis; integrate FSAP assessments into Article IV reports.
  - Close gaps between multilateral and bilateral surveillance by including cross-country perspectives and cross-border spillover analysis in Article IVs.
  - Strengthen macro-financial analytical toolkit.
- Implementation priorities:
  - Standardized Risk Assessment Matrices (RAMs) to identify major sources of risk, triggers, transmission mechanisms, and to specify probability (low, medium, high) and potential impact over a three-year period.
  - RAMs have been used in recent FSAP assessments for Terms of Reference and Aide-Mémoires but not published in FSSAs; mainstreaming was expected in the Fall after piloting.
  - RAMs are tools to frame Article IV discussions and are not formal Article IV report requirements.
  - Area departments and MCM will design updating procedures for RAMs across Article IV cycles with breadth and depth varying by resources.
- Build bridges:
  - A cross-departmental Financial Surveillance Group to share information and identify cross-cutting issues.
  - Require vulnerabilities flagged in multilateral processes to be explicitly considered in Policy Consultation Meetings and Notes.
  - VEE, VEA, and EWE should inform allocation of financial expertise, including FSAP stability modules.
  - Thematic multi-country staff reports and regional REOs to translate multilateral issues into bilateral surveillance context and policy implications.
- Example initiative:
  - A thematic report on Article IV consultations of five systemic economies (China, the Euro area, Japan, the United Kingdom and the United States) was discussed by the Board in an informal seminar on August 26, 2009.

### Strengthening analysis and coverage of cross-border issues
- Steps to improve assessment of cross-border exposure risks:
  - Integrate existing resources and make them easily available to country teams via an automated facility (ongoing project; see Appendix 1).
  - Improve measurement of cross-border exposures; undertaking the Coordinated Direct Investment Survey (CDIS) is essential.
  - Pay greater attention to offshore transactions in Article IV consultations despite data and definitional challenges.
  - Make greater use of cross-border analytical tools developed in EWE and GFSR, including tools measuring systemic bank risk and contagion.
- Operational suggestions when considering Offshore Financial Centers (OFCs):
  - Account for risk exposures to onshore sector vis-à-vis ownership structures, services offered, and product innovation;
  - Assess exposure to regional contagion (reputation risk);
  - Evaluate onshore capacity for consolidated supervision;
  - Examine adequacy of cross-border supervision of foreign branches and subsidiaries;
  - Assess cooperation between local supervisors and offshore counterparts.

### Improving reporting and data on derivative markets
- Ongoing work to improve reporting of derivative market statistics, including additional geographical breakdowns for OTC derivatives.
- BIS’s CGFS established a Working Group on Credit Risk Transfers chaired by the ECB, with Fund (MCM, SPR and STA) contributing comments via BIS; the final report with recommendations to be published later this year.
- Working group focus (Box 5 highlights):
  - Explore revisions to CDS reporting to expand data on reference entity and counterparty type.
  - Consider widening CDS coverage to include multi-name indices and enrich statistics with geographical, credit rating, and counterparty breakdowns.
  - Examine compatibility of CDS statistics with other CRT instruments and related statistical needs (e.g., securitization).
  - Survey users (G-10 central banks and the Fund) and data reporters to assess implementation costs.
  - BIS collaboration with DTCC and ISDA to seek a more consistent measure of global CDS market size.
  - Anticipated benefits: address deficiencies on cross-border CDS exposures, OTC CDS concentration, and CDS exposure on ABS; help monitor growing instruments such as index CDS.

### Improving analytical approaches in macro-financial surveillance
- Progress and limitations:
  - Significant push to integrate financial sector considerations into macro analysis; progress is constrained by imperfect theoretical and empirical understanding and heterogeneity across countries.
- Partial methodologies and tools in use:
  - Econometric models linking macro variables with financial condition indices;
  - Balance sheet analysis (BSA) and options pricing frameworks (CCA);
  - Automated excel-based tools for quarterly BSA and CCA where data permit;
  - Indices of corporate and/or bank default risk; measures of systemic risk; the corporate vulnerability utility (CVU) from Research Department.
  - Routine use of market-based indicators (yields, CDS spreads).
- New tool development and integration needs:
  - Tools focusing on leverage, liquidity, and interconnections within financial systems.
  - More systematic inclusion of balance-sheet effects in macro scenarios and within the Fund’s four-sector framework (real, fiscal, monetary, and external).
  - Greater integration of stress tests into macroeconomic and financial programming frameworks to assess impacts of macro scenarios (including sudden stops) on solvency.

### Deepening financial sector coverage in low-income countries (LICs)
- Observations:
  - Shallow financial markets create vulnerabilities for LICs; the global financial crisis had limited direct financial impact on many LICs but negative spillovers via trade, commodity prices, FDI, and remittances.
  - Shallow markets limit institutions’ portfolio management, increase concentration risk, and constrain countercyclical policy scope.
  - Coverage in LICs tends to be uneven and often narrowly focuses on banking soundness; data and supervisory capacity gaps hinder analysis and policy advice.
  - Tension exists between stability-focused Fund surveillance and development-focused World Bank mandates.
- Fund-Bank LIC Financial Group objectives and modalities:
  - Key off upcoming Article IV missions to identify macro-financial stability issues and market development needs.
  - Serve as a forum to align Bank development projects under FSAPs with LIC stability needs.
  - Establish joint modalities for field or off-site collaboration; create a LIC portal accessible to Bank and Fund staff with common templates and shared databases.
  - Article IV teams will produce regular FSIs with agreed coverage and definitions; the Bank will produce structural benchmarks for LIC market development.

### Key challenges, resource constraints, and implementation tradeoffs
- The Fund faces heightened expectations for bilateral and multilateral financial surveillance after the crisis and significant downsizing of staff resources.
- The quality of financial sector coverage in Article IVs depends on availability of expert resources on missions; MCM’s role in staff report reviews has been scaled back to save resources.
- Progress has reflected efficiency gains: improved collaboration, knowledge transfer, and greater area department focus.
- Capacity-building initiatives include improved information sharing, hiring specialists, guidance dissemination, training, revamping FSLC, and creating the LIC Financial group.
- Suggested investments: more training; short-term assignments of area staff to MCM; greater access to external private-sector assignments and assignments at institutions such as the BIS.
- FSAP reprioritization and targeted assessments could facilitate better allocation of expertise and more frequent interim missions.
- Implementation will require phased approaches and difficult tradeoffs; examples of resource implications:
  - Integrating balance sheet analysis and stress testing into macro scenarios increases demands on country teams.
  - Making tools and data more accessible and allowing more frequent MCM stability assessments requires initial investment but could yield efficiency gains.
- The proposed Financial Sector Group would provide a forum for area departments, MCM, and SPR to review experience and tailor implementation.

### Appendix I — Quantifying and identifying cross-border exposures (summary)
- Crisis experience underscores importance of quantifying cross-border financial exposures (examples: exposures to U.S. subprime mortgage market; exposures to U.S. institutions such as Lehman Brothers; derivative market exposures).
- Cross-border spillovers can transmit from global/regional financial centers to dependent countries (example: Western Europe’s effect on Central and Eastern Europe).
- Data limitations:
  - Cross-border exposure data are limited; key databases include BIS’ International Financial Statistics and the IMF’s CPIS.
  - Country-specific cross-border data are sometimes compiled but are hard to compare and costly to assemble.
  - Note: "Results of the IMF’s 2009 CDIS will provide data at end-2010 or early 2011 on a country’s bilateral foreign direct investment positions." (footnote 20)
- Organizing exposures:
  - Two exposure types: Dimension A (exposures to financing risk) and Dimension B (exposures to default risk).
  - The balance sheet approach (BSA) and the International Investment Position (IIP) help organize exposures and assess data usefulness.
  - Dataset utilities:
    - BIS data: identify cross-border default risk for banking systems.
    - CPIS data: identify cross-border financing and default risk.
    - IIP and external debt data: identify financing and default risks at an aggregate level.
- Template and data retrieval facility:
  - SPR, STA, and TGS are developing a facility to retrieve key data per a predetermined template.
  - Template pulls from IIP, Standardized Report Forms (SRFs) for Monetary and Financial Statistics, external debt data (QEDS), BIS statistics (Table 9.D of the Consolidated Banking Statistics), and CPIS.
  - Template fields include time breakdowns and sample periods: 2006, 2007, 2008, 2008Q1, 2008Q2, 2008Q3, 2008Q4, 2009Q1.
  - Template components (short form examples):
    - External Assets: Aggregate IIP items; SRFs by sector; CPIS and BIS geographical breakdowns.
    - External Liabilities: Aggregate IIP items; SRFs; QEDS by sector; CPIS and BIS geographical breakdowns.
    - Memoranda: Nominal GDP; Exchange rate vis-à-vis the US dollar; Data frequency: Annual / Quarterly.
  - Purpose: facilitate use of existing data to assess external vulnerabilities and cross-border risks and support bilateral surveillance.
  - Figure A1-1 conceptualizes Net Intersectoral Asset and Liability Positions across sectors and distinguishes currency denomination and maturity.

*Source: chapter III of the May 2009 REO for Europe (content unit _082809a).*

### Executive Summary ......................................................................................................

### Executive Summary

### Key takeaways
- The Fund has continued to make great efforts to enhance financial sector focus and analytics in bilateral surveillance.
- Main initiatives include enhancing collaboration with other multilateral institutions, improving analytical tools and methodologies, and a major strengthening of the financial sector capabilities in area departments.
- The fruits of these efforts are already visible in the better treatment of financial sector issues in Article IV reports.
- Amendments to the Financial Sector Assessment Program (FSAP), including the introduction of financial stability modules, represent an important step but complementary efforts are required to strengthen Article IV consultations.

### Priority initiatives discussed
- Ensuring Better Integration of FSAP Findings into the Article IV Reports:
  - Standardized risk-assessment matrix (RAM), to be produced in FSAPs, would identify the most important threats to financial sector stability, evaluate their likelihood, and discuss their expected impact on macro-financial stability, thereby helping to frame the discussion of these issues in Article IV consultations.
- Building Bridges Across Complementary Initiatives:
  - Integrate findings from the Fund’s multilateral exercises into bilateral surveillance more consistently through: (i) the review process; (ii) an enhanced interdepartmental Financial Sector Group; and (iii) cross-country, thematic staff papers.
- Strengthening the Analytical Content of Bilateral Surveillance:
  - Improve coverage of cross-border issues by: (i) better integrating existing data resources and making such data more accessible to country teams; (ii) improving measurement of cross-border risks and better integrating assessments of off-shore exposures in Article IV consultations; and (iii) making greater use of cross-border analytical tools (as developed in EWE and the GFSR).
  - Integrate balance sheet analysis more systematically into staff’s macroeconomic scenarios, and use stress tests and scenario analysis to assess the impact of macroeconomic scenarios on financial solvency.
  - Strengthen financial sector coverage in low-income countries (LICs) through greater attention to the impact of underdeveloped financial markets on the effectiveness of macroeconomic policies and the economy’s ability to absorb shocks.
  - Create a new IMF-World Bank LIC Financial Group, under the auspices of the Financial Sector Liaison Committee (FSLC), to: help upcoming Article IV missions identify macro-financial stability issues and associated market development needs; serve as a forum to align Bank activity under FSAPs with stability needs of LICs; and facilitate collaboration in the field or off site.

### Resource and process considerations
- These initiatives will require difficult tradeoffs in a constrained budget environment.
- Current budget realities may require a phased approach, one that will be guided at least in part by collaborative efforts by area departments, MCM, and SPR to review the experience and tailor priorities where they are likely to be most effective.

### The evolving context (summary)
- The global financial crisis has spurred renewed calls for the Fund to play a lead role in financial sector surveillance, including enhancing analysis of macro-financial linkages, cross-border spillovers, and sources of systemic risks to help prevent future crises.
- The 2007 Decision on Bilateral Surveillance stated that financial sector policies will always be a subject of the Fund’s surveillance.
- In October 2008, the Board adopted a Statement of Surveillance Policies (SSP) for 2008–11 that gave prominence to financial sector issues. The operational priorities included financial sector surveillance and real-financial linkages, as well as risk assessments and multilateral perspectives.
- The Fund has embarked on initiatives to enhance the quality of financial sector surveillance, including the joint IMF-Financial Stability Board’s (FSB) Early Warning Exercise (EWE), issuance of a Financial Sector Surveillance Guidance Note (FSSGN), and continued research to strengthen analytical tools and methodologies.

### Recent steps taken (highlights)
- Knowledge management improvements:
  - The FSSGN was issued in April 2009, providing an organizing framework to help country teams conduct financial sector surveillance and access a wealth of resources.
  - An intra-Fund collaborative website on cross-country work, spillovers, and linkages was established.
- Early Warning Exercise (EWE):
  - A dry-run was conducted in early 2009 and a full-scale rollout will be conducted during the 2009 Annual Meetings.
- Data collection, dissemination, and quality:
  - New websites including STA’s Data Link (for internal Fund use only) and the external Principal Global Indicators site provide access to cross-country comparable indicators for the G-20, links to key country-specific public agencies, and economic and financial indicators from selected international agencies.
  - A group of more than 25 countries started in July 2009 to disseminate FSIs via the IMF’s Financial Soundness Indicators website, with the participation expected to increase as the database is expanded.
  - Work is under way to explore the inclusion of financial indicators in the Special Data Dissemination Standard (SDDS) on an encouraged basis.
- Filling data gaps:
  - An Inter-agency Group on Economic and Financial Statistics chaired by the Fund and comprising BIS, ECB, Eurostat, OECD, World Bank, and UN is working to fill data gaps revealed by the crisis.
  - An FSB/IMF “Users Conference on the Financial Crisis and Information Gaps” (July 2009) stressed: develop better analytical frameworks for system-wide risk assessments; strengthen monitoring of risk exposures of systemically important institutions and the nonbank financial sector and their inter-linkages both domestic and cross-border; reprioritize and review FSIs and broaden their coverage to nonbank intermediaries; and enhance analysis and data on cross-border financial flows.
  - A Working Group (BIS, ECB, IMF and World Bank) on Securities Databases is preparing a Handbook on Securities Statistics to promote coherent and internationally comparable securities statistics.
  - Work is under way to better assess the systemic importance of financial institutions.
- Area department capacity building:
  - Area departments have continued to build financial sector analysis capacity through many initiatives to strengthen in-house quality of financial sector surveillance.
- Multilateral analysis strengthening:
  - MCM’s high-frequency market monitoring has been strengthened and provides important input for country teams.
  - Weekly interdepartmental meetings chaired by management have provided a platform for disseminating information and flagging emerging vulnerabilities.
  - Efforts to integrate core policy messages of the WEO and GFSR have yielded improvements.
  - Greater effort is being made to integrate the results of the Fund’s various vulnerability exercises into bilateral surveillance.

### Financial Sector Surveillance Guidance Note (FSSGN) — key features (from Box 1)
- The FSSGN provides an organizing framework and access to a wealth of resources for the conduct of financial sector surveillance; it is nonprescriptive and provides access to quantitative tools and analytical material on macro-financial risk assessment and evolving international views on financial sector policy issues through an interactive web-based platform.
- Guidance on assessing possible sources of risks, including:
  - Exposures of financial institutions to credit, market, liquidity, and operational risks;
  - Risks from linkages across sectors in the domestic economy and across borders; and
  - Legal, institutional, and other structural issues, including the contractual environment, the role of state banks, and foreign bank entry.
- Describes quantitative diagnostic tools to assess various types of risks, including:
  - Financial Soundness Indicators (FSIs);
  - Market-based indicators (i.e., equity prices, credit spreads, and credit ratings, etc.); and
  - Modeling techniques such as stress testing and the balance sheet approach.
- Describes qualitative tools, including:
  - Assessments of a country’s compliance with various standards; and
  - Codes and other guidelines that provide broad principles and benchmarks to identify deficiencies in key areas.
- Points out possible policy recommendations depending on country circumstances, including macro and micro aspects of:
  - Crisis prevention policies to address emerging asset price bubbles, credit booms, potential capital flow reversals, and inadequacies of capital requirement frameworks, supervisory practices, and liquidity management frameworks; and
  - Crisis management policies to improve existing frameworks to deal with crisis containment, restructuring and resolution, and asset management.

*Executive Summary.*

### 7.      These efforts have helped improve the quality and depth of financial sector

### 7.      These efforts have helped improve the quality and depth of financial sector

### Improvements in financial sector analysis and capacity
- Regional Economic Outlooks (REO) have covered financial sector issues in depth; Article IV staff reports and selected issues papers (SIPs) have strengthened coverage despite added complexities of the current environment.  
- Staff output on financial sector topics includes Staff Position Notes and Working Papers; studies under way include: "Financial globalization and economic policies", "the implications of global liquidity for monetary policy", "the contribution of financial globalization to systemic risk", and "the evolution of financial balance sheets and links to macroeconomic fundamentals".
- Area departments have invested in building capacity, evidenced by:
  - Enhanced coverage in Article IV reports and SIPs of: the impact of the global financial turmoil on domestic banking systems; real-financial sector linkages; financial sector developments and risks; stress testing.
  - More focused research by regional studies divisions and increased REO coverage (examples from May 2009 APD REO and April 2009 AFR REO as cited).
  - Books, working papers, and informal/internal technical notes (examples: EUR’s book on Integrating Europe’s Financial Markets; MCD analytical papers on GCC regional developments).
- Infrastructure and training investments:
  - Internal guidance notes on treatment and integration of financial sector issues in Article IV reports (APD, MCD).
  - Special financial sector working groups on topics including capital outflow risks, credit risk, corporate sector financing, bank resolution frameworks, bank regulations and supervision, and central banking (AFR, WHD, MCD).
  - Internal websites, monthly and weekly monitors (AFR, APD), and increased INS/MCM training to staff on financial sector analysis.
- Mission-related activities and outreach:
  - Multiple-country missions to assess crisis impact (example: MCM-supported 2009 cross-country mission to systemically important African emerging markets; similar missions by APD and WHD).
  - Seminars and active EUR participation on EU financial integration and cross-border stability arrangements.
- Increased collaboration and integration:
  - Closer follow-up of FSAP recommendations and stress testing by area departments.
  - EUR and MCM collaboration on stress testing and bank recapitalization for EUR-area program cases.
  - Participation of MCM and RES economists in Article IV missions and area department economists in technical assistance missions.

### Framework for financial sector surveillance after FSAP reforms
- FSAP review proposes a more focused and nimble instrument:
  - Option of modular FSAP assessments and risk-focused ROSC updates to allow targeted, deeper, and country-aligned assessments; better prioritization could allow more frequent assessments.
- Continuum of surveillance and complementarities:
  - At one end: standard full-fledged FSAP (low-frequency, comprehensive review).  
  - At the other end: surveillance in Article IV missions (depth varies depending on expert resources, e.g., MCM backstopping or financial sector expert on mission).
  - Modular FSAPs aim to fill gaps by allowing targeted and possibly higher-frequency assessments of stability issues.
  - Higher-frequency multilateral surveillance: World Economic Outlook (WEO)/Global Financial Stability Report (GFSR)/EWE and REOs; even higher frequency via quarterly updates of the WEO and GFSR, and MCM and area department daily monitoring.
- Roles and mandates:
  - FSAP remains voluntary; Article IV consultations are mandatory and provide higher-frequency surveillance.
  - Reforms aim to integrate FSAP findings into Article IV consultations and strengthen treatment of financial sector issues in Article IVs.
- Considerations on merging FSAP and Article IV:
  - Potential advantages of merger: make FSAP mandatory; increase flexibility to allocate resources by systemic risk priorities.
  - Arguments for keeping instruments separate:
    - Article IV focuses on financial issues relevant for external stability; FSAP covers a wider range and supports technical assistance.
    - FSAP joint program with World Bank would complicate making FSAP a mandatory IMF instrument.
    - Effective FSAPs require data access and cooperation not easily required under Article IV (e.g., Article VIII, Section 5(b) states members are under no obligation to provide data to the Fund on individual institutions).

### Remaining challenges identified
- Findings from the 2008 Triennial Surveillance Review (TSR) highlighted needs to:
  - Improve assessment of key financial stability risks and better integrate financial sector and macroeconomic analysis; integrate FSAP assessments into Article IV reports.
  - Close gaps between multilateral and bilateral surveillance by introducing greater cross-country perspectives in Article IV consultations and improving analysis of cross-border spillovers.
  - Strengthen analytical framework and toolkit for macro-financial linkages.
- Despite the shift in recent Article IVs toward financial sector issues, further steps needed:
  - Integrate the Fund’s surveillance vehicles and inputs more closely (FSAP and Article IV).
  - Account for cross-border linkages and spillover risks in bilateral surveillance.
  - Use partial methodologies now to capture risks around alternative scenarios and assess financial sector viability and policy trade-offs while developing a fully integrated macro-financial framework.
  - Fill data gaps.
  - For LICs, better account for challenges from shallow markets in achieving macroeconomic and financial stability.
- Resource constraints:
  - Resources have been redirected to respond to the global crisis and G-20 demands; further reforms require careful prioritization and leveraging of MCM and area department resources.

### Further steps to integrate financial sector surveillance into bilateral surveillance
- Goal: deepen integration to improve staff analysis and support formal Executive Board surveillance.
- Linking the reformed FSAP and Article IVs:
  - Standardized Risk Assessment Matrices (RAMs) proposed to better target financial sector surveillance in individual consultations.
  - RAM functions and expectations:
    - Combine identified major sources of risks, possible triggers and transmission mechanisms, assessment of regulatory/supervisory/crisis frameworks, and stress test results to arrive at qualitative assessments.
    - Specify (i) probability of risk triggers being activated (low, medium, high); and (ii) potential impact on financial stability and the broader economy if events materialize.
    - Identify most important threats to financial sector stability, evaluate likelihood over a three-year period, and discuss expected macro-financial impact if risks materialize.
    - RAMs have been used in a number of recent FSAP assessments (for Terms of reference and Aide-Mémoires) but not published in Financial System Stability Assessments (FSSAs).
    - RAMs expected to be mainstreamed in the Fall after finalizing guidelines based on pilot experience; they could play an important role along with prioritized recommendations in discussions with authorities.
  - RAMs intended to frame Article IV discussions on policies to address identified risks; not a formal requirement in Article IV reports but a tool for framing risk discussions and policy responses.
  - Area departments and MCM will design ways to update RAMs in subsequent Article IV consultations, with breadth and depth varying by available resources.
- Building bridges across complementary initiatives:
  - A cross-departmental Financial Surveillance Group will provide a collaborative forum to share information, experiences, and identify cross-cutting issues.
  - Findings from multilateral work (GFSR, VEE, VEA, EWE) should be internalized and leveraged by area teams; vulnerabilities flagged in multilateral processes are required to be explicitly considered in Policy Consultation Meetings and Notes.
  - Proposal: VEE, VEA, and EWE should more systematically inform prioritization and allocation of financial sector expertise, including deployment of FSAP stability modules.
  - Thematic multi-country staff reports can translate multilateral issues into bilateral surveillance by providing context, cross-country experience, and flagging where coordinated action is warranted; themes could derive from the Fall multilateral round to provide policy traction.
  - Regional approaches (e.g., REOs) can bridge multilateral and bilateral surveillance by presenting stylized facts, assessing common trends, and discussing policy implications while accounting for country-specific features.
- Examples of recent initiatives:
  - A first thematic report distilling common themes in Article IV consultations of five systemic economies (China, the Euro area, Japan, the United Kingdom and the United States) was discussed by the Board in an informal seminar on August 26, 2009; it focused on policy responses to the crisis, exit strategies, and structural policies for balanced growth, noting the prominence of financial sector issues and the importance of coordination for unwinding banking system support and for the financial reform agenda.

*Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_082809a.pdf*

### chapter III of the

### C.   Strengthening Financial Sector Analysis in Bilateral Surveillance

### Strengthening the analysis and coverage of cross-border issues
- Steps to improve analysis of risks from cross-border exposures:
  - Integrate existing resources and make them more easily available to country teams to facilitate assessments of inward and outward spillovers. An ongoing project on cross-border exposures provides a first attempt in this area, with the aim to provide easy access through an automated facility to existing measures of cross-country exposures (Appendix 1).
  - Improve measurement of cross-border exposures. In this context, undertaking the planned Coordinated Direct Investment Survey (CDIS) is essential, as it will shed light on a source of cross-border exposures that is otherwise very difficult to measure.
  - Pay greater attention to offshore transactions in Article IV consultations. Mission teams should seek to take these into account when assessing the stability of members and spillovers between countries, despite challenges including complex linkages between on- and offshore transactions, the blurred distinction between offshore centers (OFCs) and other financial centers, and persistent data gaps, particularly for smaller low-income jurisdictions.
  - Make greater use of cross-border analytical tools (as developed in EWE and GFSR) in bilateral surveillance. These include tools for measuring systemic bank risk and contagion vulnerabilities, which some desks are already applying in their work.
- Operational suggestions for Article IV teams when considering OFCs:
  - take account of risk exposures to onshore sector vis-à-vis ownership structures, services offered, and innovation in financial products;
  - assess exposure to regional contagion (reputation risk);
  - evaluate the ability of the onshore sector to carry out effective consolidated supervision;
  - examine the adequacy of cross-border supervision of foreign branches and subsidiaries;
  - assess the degree of cooperation of local supervisors and authorities with their offshore counterparts.

### Improving reporting and data on derivative markets
- Work is under way to improve reporting of statistics on derivative markets, including with additional geographical breakdowns, to improve transparency and coverage of information on over-the-counter (OTC) derivatives markets.
- The BIS’s Committee on Global Financial Systems (CGFS) established a Working Group on Credit Risk Transfers chaired by the ECB, to which the Fund (MCM, SPR and STA) is contributing comments through the BIS. The final report of the working group, which will include recommendations, will be published later this year.
- Box 5 — Improving Credit Risk Transfer Data (summary of working group focus):
  - Explore possible revisions of the current reporting on credit default swaps (CDS) to expand data on reference entity and counterparty type.
  - Consider widening coverage of CDS instruments to include more detailed information on multi-name indices, and enrich current statistics with additional geographical, credit rating, and counterparty breakdowns.
  - Examine compatibility of CDS statistics with statistical information on other credit risk transfer (CRT) instruments, in particular on structured securities, and associated needs in other statistical areas (e.g., securitization).
  - The working group surveyed users of statistics (from G-10 central banks and the Fund) and surveyed data reporters to assess the cost of implementation of possible new data requirements.
  - The BIS has been working with the US Depository Trust and Clearing Corporation (DTCC) and the International Swaps and Derivatives Association (ISDA) to examine how best to provide a more consistent measure of global CDS market size.
  - Anticipated benefits: address deficiencies such as the lack of information on cross-border exposures through CDS markets, concentration of risk in OTC CDS, and amounts of exposure embedded in CDS on ABS (Asset-Backed Securities); help monitor rapidly growing financial instruments, such as index CDS.

### Improving analytical approaches in macro-financial surveillance
- Progress and limitations:
  - There has been considerable push to enhance integration of financial sector considerations into macroeconomic analysis; progress has been made but hampered by imperfect theoretical and empirical understanding of macro-financial channels and by diversity of country circumstances and evolving economic landscapes.
- Partial methodologies and tools in use:
  - Econometric models linking conventional macroeconomic variables with indices of financial conditions.
  - Balance sheet analysis (BSA) and options pricing frameworks (like the CCA) to assess risks to different sectors.
  - Automated, excel-based tools for producing quarterly BSA and CCA tables for countries with adequate data are available to Fund staff.
  - Indices of corporate and/or bank default risk used frequently; more recent staff analysis has enabled construction of measures of systemic risk.
  - The corporate vulnerability utility (CVU) developed by the Research Department is an automated tool to assess corporate balance sheet vulnerabilities.
  - Most staff reports routinely include market-based indicators—including yield and credit default swap (CDS) spreads—to assess asset price vulnerability and policy credibility.
- Development of new tools:
  - New analytical tools for macro-financial linkages are being developed, focusing on the role of leverage and liquidity in propagation of business and financial cycles, and on interconnections within financial systems.
  - Surveillance can draw on a set of stylized facts regarding macro-financial linkages (see Box 6).
- Integration needs:
  - There is scope for more systematic integration of balance-sheet effects in staff’s macro-scenarios. More consistent inclusion of financial sector viability within the Fund’s traditional four-sector framework (real, fiscal, monetary, and external) will enable better quantification and analysis of balance-sheet effects in baselines and facilitate discussion of costs and trade-offs in alternative scenarios—e.g., implications of contingent liabilities on the public sector accounts.
- Box 6 — Macro-Financial Linkages: Stylized Facts (highlights):
  - Large changes in credit and asset prices are associated with significant movements in macroeconomic variables over the business cycle.
  - Episodes of rapid credit growth generally coincide with large cyclical fluctuations; real output, consumption, and investment rise above trend during credit boom build-up and fall below trend during unwinding.
  - Credit booms are often followed by banking and currency crises in emerging market economies.
  - Recessions associated with house price busts and credit crunches are deeper and longer-lasting; residential investment falls more sharply and unemployment increases notably more in such recessions.
  - Specific methodologies useful for surveillance and early warning include:
    - Credit booms and bust analyses: statistical analyses of risks of credit booms ending in busts as a function of length of boom and other factors such as current account deficits, and initial conditions; also analysis of chances of creditless recoveries;
    - Business and financial cycles: facts of occurrence, duration, and amplitude for combinations of recessions, recoveries, credit booms/crunches and asset price booms/busts, and implications for speed and strength of recovery;
    - Spillovers through cross-border banking: analysis of BIS bilateral exposures and potential for banking system shocks to affect home countries and third countries through common lender effects;
    - Corporate Vulnerability Utility: exposures in and performance of the corporate sector relevant for surveillance.
- Stress testing integration:
  - There is scope for greater integration of stress tests in the macroeconomic and financial programming framework. Stress tests and scenario analyses assess risks by analyzing the impact of various macroeconomic scenarios (including sudden stops) on financial solvency.
  - Integrating such stress tests into bilateral surveillance (where data are available) would strengthen risk assessments in Article IV reports and improve integration with FSAP assessments.

### Deepening financial sector coverage in low-income countries (LICs)
- Observations on vulnerabilities:
  - Shallow financial markets create vulnerabilities for LICs. The global financial crisis had limited direct impact on LIC financial systems, but negative effects occurred through trade, commodity price, FDI, and remittance channels.
  - For many LICs, scope for maintaining macroeconomic stability and undertaking countercyclical policies is constrained in part by shallow financial markets (Box 7).
  - Thinness of markets limits financial institutions’ ability to manage portfolios, leaving them more vulnerable to shocks. Excess liquidity can lead to build up of excessive exposure to a limited number of counterparties, sectors, or institutions.
  - Shallow domestic debt markets limit scope of banks to manage exposures to the government sector.
- Surveillance and coordination issues:
  - Coverage of these issues in LICs tends to be uneven; many Article IV reports focus narrowly on banking soundness.
  - Lack of reliable and comprehensive data and capacity constraints in financial supervision hinder analysis and design of policy advice.
  - An observed tension exists between stability concerns (Fund surveillance) and developmental issues (World Bank mandate); uncoordinated “boundaries” limit focus on an important source of macroeconomic and financial vulnerability.
- Fund-Bank LIC Financial Group objectives and modalities:
  - A Fund-Bank LIC Financial Group under the auspices of the FSLC is being established with explicit objectives to:
    - Key off upcoming Article IV missions to establish macro-financial stability issues and associated market development needed.
    - Serve as a forum to align Bank “development” projects under FSAPs with stability needs of LICs.
    - Establish modalities for collaboration in the field or in off-site work jointly with the World Bank. A LIC portal will be established and will be jointly accessible to Bank and Fund staff with common templates and shared databases; Article IV teams will produce regular FSIs with agreed coverage and definition, and the Bank will produce structural information to benchmark LIC financial systems and their market development.

*Source: chapter III of the May 2009 REO for Europe (content unit _082809a).*

### 31.      Improving bilateral financial sector surveillance has been a challenge given the

### 31.      Improving bilateral financial sector surveillance has been a challenge given the existing resource envelope

### Key challenges and resource constraints
- The Fund faces new demands and heightened expectations to deliver on bilateral and multilateral financial surveillance following a financial crisis and a significant downsizing of staff resources.  
- There are tensions with the TSR observation that the quality of financial sector coverage in Article IVs depends importantly on the availability of expert resources on Article IV missions.  
- Internal review practices have been adjusted to save resources; for example, MCM’s role in staff report reviews has been scaled back.  
- Footnote: "19 SPR, together with MCM, is working to address this issue."

### Progress and efficiency gains
- Marked progress has largely reflected efficiency gains from:
  - improved mechanisms for collaboration and knowledge transfer;
  - an enhanced focus on financial surveillance work in area departments.
- Section II.A notes that recent Article IVs reflect knowledge gains in area departments and growing expertise in financial surveillance.

### Capacity-building and expertise initiatives
- Ongoing and planned initiatives include:
  - further improvement in mechanisms for information and knowledge sharing;
  - hiring of financial sector specialists according to internal needs;
  - dissemination of guidance and provision of training to existing staff;
  - revamping of the FSLC and creation of the LIC Financial group.
- Additional investments suggested:
  - more training;
  - short-term assignments of area department staff to MCM;
  - greater access to external assignments with the private financial sector and other international financial institutions such as the BIS.
- Objective: ensure area departments are well placed to fulfill their responsibility for bilateral financial surveillance.

### FSAP prioritization, targeted assessments, and interim missions
- Making the FSAP a more nimble instrument could:
  - facilitate better prioritization in the allocation of the Fund’s financial expertise;
  - allow resources to be deployed more consistently in line with the Fund’s mandate;
  - ensure allocation decisions are informed by the various vulnerability exercises in the Fund.
- Better prioritization and more targeted assessments should permit more frequent interim missions.

### Tradeoffs in a constrained budget environment
- Implementation will require difficult tradeoffs under current budget constraints.
- Examples of measures and their resource implications:
  - Integrating balance sheet analysis and stress testing into macroeconomic scenarios would add to the demands on country teams.
  - Making information, tools, and data more accessible and allowing more frequent stability assessments from MCM could yield efficiency and quality gains but would require initial investment.
- Progress will need to be phased gradually (e.g., use of risk assessment matrices).
- The proposed Financial Sector Group would provide a forum for area departments, MCM, and SPR to review experience and tailor implementation.

### Issues for discussion (paragraph 36): initiatives for Executive Directors to consider
- Ensure better integration of FSAP findings into the Article IV reports, and in particular the use of standardized risk-assessment matrices.
- Build bridges across complementary initiatives, including:
  - more consistent integration of the findings from the Fund’s multilateral exercises into bilateral surveillance;
  - using vulnerability exercises to inform the allocation of financial expertise, including FSAP stability modules.
- Strengthen the analytical content of bilateral surveillance, including:
  - improving the coverage of cross-border issues;
  - integrating more systematically balance sheet analysis and stress tests into staff’s macroeconomic scenarios;
  - strengthening financial sector coverage in LICs through greater attention to the impact of underdeveloped financial markets on the effectiveness of macroeconomic policies and the economy’s ability to absorb shocks.

### Appendix I — Quantifying and identifying cross-border exposures
- Crisis experience highlights the importance of quantifying cross-border financial exposures (e.g., exposures to the market of U.S. subprime mortgages; exposures to U.S. financial institutions such as Lehman Brothers; exposures in derivative markets).
- Cross-border spillovers: effects on global or regional financial centers can transmit to countries dependent on these centers for financing (example: Western Europe on Central and Eastern Europe).
- Data limitations and key databases:
  - Data on cross-border exposures is limited.
  - Key databases: BIS’ International Financial Statistics and the IMF’s CPIS.
  - Country-specific cross-border data are sometimes compiled but are difficult to compare and costly to assemble.
- Note on IMF CDIS: "Results of the IMF’s 2009 CDIS will provide data at end-2010 or early 2011 on a country’s bilateral foreign direct investment positions." (footnote 20)

### Organizing exposures and useful datasets
- Two types of cross-border financial exposures:
  - Dimension A: exposures to financing risk (vulnerability to difficulties in rolling over liabilities).
  - Dimension B: exposures to default risk (vulnerability to defaults in cross-border assets).
- The balance sheet approach (BSA) and the International Investment Position (IIP) help organize exposures and assess usefulness of existing data.
- Specific datasets and their utility:
  - BIS data: helpful to identify cross-border default risk for the banking system.
  - CPIS data: useful to identify cross-border financing and default risk.
  - IIP and external debt data: help identify financing and default risks at a more aggregate level.
- Reference: "See J. Mathisen and A. Pellechio, Using the Balance Sheet Approach in Surveillance: Framework and Data Sources and Availability, International Monetary Fund, 2007." (footnote 21)

### Template and data retrieval facility for external and cross-border exposures
- SPR, STA, and TGS are developing a facility to retrieve key data for each country under a predetermined template.
- The template pulls from multiple databases:
  - IIP, Standardized Report Forms (SRFs) for Monetary and Financial Statistics, and external debt data for aggregate financing and default risk (i).
  - BIS statistics (particularly Table 9.D of the Consolidated Banking Statistics) and the CPIS to identify cross-border financing and default risk (ii).
- Figure A1-1 conceptualizes Net Intersectoral Asset and Liability Positions across sectors (Sovereign, Banks, Nonbank financial corporations, Nonfinancial corporations, Other resident sectors, Nonresidents) and distinguishes currency denomination and maturity (In domestic currency / In foreign currency; Short-term / Long-term).
- Template fields and sample time breakdowns include years and quarters: 2006, 2007, 2008, 2008Q1, 2008Q2, 2008Q3, 2008Q4, 2009Q1.
- Template components (examples from short form):
  - External Assets: I. Aggregate data (1.A IIP: Total Assets; Direct Investment; Portfolio Investment; Financial Derivatives; Other Investment; Reserve Assets); 1.B Standardized Report Forms (Central Banks; Other Depository Corporations; Other Financial Corporations); II. Geographical Breakdowns (II.A CPIS: Portfolio Investment Assets vis-à-vis top 10 partners; II.B BIS Banking Statistics).
  - External Liabilities: I. Aggregate data (1.A IIP: Total Liabilities; Direct investment; Portfolio investment; Financial derivatives; Other investment); 1.B Standardized Report Forms; 1.C External Debt Statistics (QEDS) by sector; II. Geographical Breakdowns (II.A CPIS: Reported and Derived Portfolio Investment Liabilities vis-à-vis top 10 partners; II.B BIS Banking Statistics).
  - Memorandum items: Nominal GDP; Exchange rate vis-à-vis the US dollar; Data frequency: Annual / Quarterly.
- Purpose: facilitate use of existing data to assess external vulnerabilities and cross-border risks and support bilateral surveillance.

*Source: Excerpt from IMF document _082809a - 31. Improving bilateral financial sector surveillance has been a challenge given the*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2009/_082809a.pdf_