## Mandatory FSAP Stability Assessments: Update (Content unit _111513)

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### Executive summary — landmark decision, implementation, and rationale
- In September 2010, the Executive Board made stability assessments under the Financial Sector Assessment program (FSAP) a regular and mandatory part of bilateral surveillance under Article IV for jurisdictions with systemically important financial sectors.
- Purpose: adopt a more risk-based approach to financial sector surveillance and better integrate FSAPs into Article IV consultations.
- Mandatory periodicity proposed: financial stability assessments under the FSAP to be mandatory every five years for jurisdictions deemed systemically important.
- Implementation and uptake:
  - By November 2013, 24 out of the 25 jurisdictions have requested—and most have already undergone—mandatory financial stability assessments under the FSAP.
  - The remaining jurisdiction, Ireland, a UFR case, is considering an assessment in late 2014 or early 2015.
- Scheduling and resources:
  - Most jurisdictions requested assessments close to the five-year mark since their last FSAP, avoiding excessive bunching; the time profile is relatively spread out with a peak in one year.
  - Conducting mandatory assessments every five years while maintaining voluntary FSAPs for non-systemic jurisdictions would require increased overall FSAP resources.
  - Total number of FSAPs per year was progressively reduced from an annual average of 17–20 prior to 2010 to 14 in the current fiscal year, reflecting resource constraints and increased cost per FSAP.

### Case for revisiting the 2010 Decision and methodological lessons
- Three arguments for an update:
  - The first round of mandatory assessments is almost completed (24 of 25 assessed by end of fiscal year).
  - The 2012 Integrated Surveillance Decision (ISD) requires alignment of the 2010 Decision with ISD provisions on spillovers and multilateral surveillance.
  - Lessons from the global financial crisis, the sovereign debt crisis in Europe, and recent emerging market turbulence emphasize interconnectedness, nonbank linkages (notably sovereign debt holdings), and contagion via market sentiment.
- Need for methodological improvements:
  - Place greater emphasis on interconnectedness.
  - Expand range of covered exposures beyond bilateral interbank exposures.
  - Incorporate potential for price contagion across financial sectors and use the most recent available data.
  - Any new methodology must adhere to principles of relevance, transparency, and even-handedness from the 2010 decision.

### New methodology — conceptual changes and implementation
- Conceptual shifts:
  - Still anchored in size and interconnectedness but shifts emphasis toward interconnectedness; expands exposures; introduces complexity and potential for price contagion.
- Network construction:
  - Constructs four global financial networks based on different bilateral cross-border linkages: bank claims, debt claims, equity claims, and potential for “pure” price contagion (approximated by cross-correlations of domestic stock market returns).
- Link weighting:
  - Bilateral exposure and correlation matrix data are weighted by (i) PPP GDP and (ii) gross derivatives exposures vis-à-vis BIS reporting banks.
  - Uses most recent available data (in most cases, 2012) to construct the four networks and weights.
- Core identification: Clique Percolation Method (CPM)
  - CPM identifies cores as fully-interconnected “cliques”; the union of these cliques defines the systemic core.
  - Advantages over 2010 approach:
    - Captures network-global properties (neighbors’ linkages).
    - Avoids ordinal ranking; allows overlapping cliques and “gatekeepers”.
  - CPM calibration:
    - Minimum k-clique chosen as k = 5 for all four networks (optimal ranges: 5–8 for exposure networks; 4–8 for correlation network).
    - Thresholds calibrated to produce coverage similar to 2010 exercise:
      - Calibrated thresholds: 1½ percent for all direct exposures networks; 0.015 for the correlation network.
    - Data vintages used:
      - Banking network: 2012 Q3 data.
      - Debt and equity networks: end-2011 data.
      - Correlation network: weekly equity returns for September 2008–September 2013.
      - Weights (PPP GDP and gross derivatives exposures): 2012 data.

### Results — updated list of jurisdictions and coverage
- On the basis of the new methodology, "29" jurisdictions are deemed to have systemically important financial sectors:
  - Australia, Austria, Belgium, Brazil, Canada, China, Denmark, Finland, France, Germany, Hong Kong SAR, India, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Norway, Poland, Russia, Singapore, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.
- Comparison with 2010 methodology:
  - New systemic core includes all "25" jurisdictions identified in 2010 plus "Denmark", "Finland", "Norway", and "Poland".
  - Applying the new methodology retrospectively to the 2008 data used in 2010 would also yield a systemic core of "29" jurisdictions and includes "28" of the "29" jurisdictions in Table 4 (new methodology).
  - Example dynamics: Portugal was in the 2008-core under the new methodology but later fell below the k = 5 threshold as exposures were reduced; Finland moved into the core with stronger links to France, Belgium, Norway, and Sweden.
- Coverage and European representation:
  - A large number of European countries appear in the systemic core owing to sizeable and highly interconnected financial sectors.
  - The model emphasizes interconnectedness while still taking size into account.

### Operational and resource implications
- Immediate operational impact of expanding list from "25" to "29" jurisdictions:
  - Small immediate operational impact and modest incremental resource impact.
  - Of the four additional jurisdictions:
    - Finland and Poland have had FSAPs in the last "three" years;
    - Preparations for an FSAP in Denmark in early "2014" are underway;
    - An FSAP in Norway is tentatively planned in "2015".
  - Adding these countries to the mandatory list would have virtually no impact on FSAP workload in the immediate future.
- Medium-term and steady-state implications:
  - Subsequent FSAPs in these four jurisdictions would not materially affect the distribution of mandatory assessments over time.
  - Incremental impact at steady state would be modest, amounting to less than one additional FSAP per year on average.
- Tension with voluntary FSAPs:
  - Unless total program resources are increased, tensions between mandatory stability assessments in systemic jurisdictions and voluntary FSAPs in other members will persist.
  - Mandatory assessments take priority over all other FSAP requests; maintaining the same level of delivery for the rest of membership would require a modest increase in program resources.
  - The fundamental tension will be addressed in the forthcoming Board review of the FSAP in late "2014".
- Modalities and coordination:
  - Individual FSAPs will be adapted to jurisdictions’ forms of interconnectedness.
  - For Nordic jurisdictions, FSAPs will account for the regional dimension and leverage information across FSAPs, suggesting potential benefits in coordinating assessment timing.

### Legal framework, surveillance integration, and proposed Decision revisions
- Legal grounding:
  - Mandatory financial stability assessments are grounded in the Fund’s Articles, in particular Article IV, Section 1 (systemic stability).
  - The mandatory assessment facilitates the Fund’s assessment of members’ domestic financial policies for bilateral surveillance.
- Proposed revisions to the 2010 Decision:
  - Replace the 2010 methodology with the new methodology described in this paper.
  - Enable mandatory assessments to more comprehensively address spillovers, reflecting the 2012 ISD and Article IV, Section 3(a) obligations to oversee the international monetary system and focus on spillovers that may undermine global economic and financial stability.
  - Clarify that outward spillovers should be discussed irrespective of transmission channels (balance of payments or non-balance of payments).
- Proposed application for bilateral and multilateral surveillance:
  - Mandatory assessments to cover spillovers in bilateral surveillance where domestic policies undermine domestic or balance of payments stability.
  - For multilateral surveillance, mandatory assessments to cover spillovers whenever they may significantly influence the effective operation of the international monetary system and undermine global economic and financial stability.
- Interaction with Article IV consultations and Guidance Note:
  - Staff will be guided by the ISD and the Guidance Note on Article IV consultations when considering whether outward spillovers should be discussed.
  - Outward spillovers are deemed significant if, by themselves or in combination with other members’ policies, or through regional impact, they would enter macrofinancial policy considerations of members representing a significant portion of the global economy.
  - When the threshold is met (expected in practice for a relatively small number of countries), such spillovers must be discussed and analyzed in the mandatory financial stability assessment and included in the FSSA and potentially in the main Article IV report.

### Scope, frequency, and review provisions (Decision text highlights)
- Scope of assessments (elements a–d):
  - a. Evaluation of the source, probability, and potential impact of main near-term macro-financial stability risks using quantitative (balance sheet indicators, stress tests) and qualitative analysis.
  - b. Assessment of authorities’ financial stability policy framework, including supervision effectiveness, quality of analysis and reports, institutional coordination, and monetary policy effectiveness.
  - c. Assessment of authorities’ capacity to manage and resolve a financial crisis (liquidity management, financial safety nets, crisis preparedness/resolution, possible spillovers onto sovereign balance sheet).
  - d. Where relevant, cover spillovers from a member’s financial sector policies that may significantly influence global economic and financial stability.
- Modalities and reporting:
  - Key findings and recommendations summarized in a Financial System Stability Assessment Report (FSSA).
  - The FSSA will normally be discussed by the Executive Board at the same time as the relevant Article IV consultation report.
- Frequency (paragraph 8):
  - For a member determined to have a systemically important financial sector:
    - A financial stability assessment will be conducted and the resulting FSSA discussed by the Executive Board by no later than the first deadline for completion of an Article IV consultation that follows the fifth anniversary of such determination.
    - Subsequent FSSAs follow the same five-year anniversary rule relative to the previous Executive Board discussion of the FSSA.
    - Analogous timing applies to the financial sector of a territory of a member.
- Review (paragraph 9):
  - The Fund will review this Decision no later than five years following adoption and subsequently at intervals of no longer than five years.
  - In each review the Fund will examine and revise, as necessary, the criteria and methodology for determining members with systemically important financial sectors.
  - The Fund may review this Decision at any time to take into account major advances in data availability and methodological development.

*Source: Mandatory FSAP Stability Assessments: Update (excerpts). (EXECUTIVE SUMMARY, November 15, 2013; SM/13/304, 11/18/13; Decision No. 14736-(10/92), adopted September 21, 2010).*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Landmark decision and rationale
- In September 2010, the Executive Board made stability assessments under the Financial Sector Assessment program (FSAP) a regular and mandatory part of bilateral surveillance under Article IV for jurisdictions with systemically important financial sectors.
- Purpose: adopt a more risk-based approach to financial sector surveillance and better integrate FSAPs into Article IV consultations for those jurisdictions.
- Mandatory periodicity proposed: financial stability assessments under the FSAP to be mandatory every five years for jurisdictions deemed systemically important.

### Implementation of the 2010 Decision: first round of mandatory assessments
- Adoption and uptake:
  - The 2010 Decision was embraced by the membership and implementation was successful.
  - By November 2013, 24 out of the 25 jurisdictions have requested—and most have already undergone—mandatory financial stability assessments under the FSAP.
  - The remaining jurisdiction, Ireland, a UFR case, is considering an assessment in late 2014 or early 2015.
- Scheduling and workflow:
  - Most jurisdictions requested assessments close to the five-year mark since their last FSAP.
  - This avoided excessive bunching; the time profile of assessments is relatively spread out with a peak in one year.
- Coordination with the World Bank:
  - In six emerging market countries among the 25 (Brazil, China, India, Mexico, Russia, and Turkey), FSAP missions are in principle conducted jointly with the World Bank.
  - In five out of these six countries, mandatory stability assessments since 2010 took place in the context of joint Fund-Bank FSAP missions; in Russia the mandatory assessment was a stand-alone FSAP stability module.
- Resource implications:
  - Conducting mandatory stability assessments every five years while maintaining the same level of voluntary FSAPs for non-systemic jurisdictions would require increased overall FSAP resources.
  - In practice, the total number of FSAPs per year was progressively reduced from an annual average of 17–20 prior to 2010 to 14 in the current fiscal year, reflecting resource constraints and increased cost per FSAP.

### The case for an update and lessons from the crisis
- Three arguments for revisiting the framework:
  - The first round of mandatory assessments is almost completed (24 of 25 assessed by end of fiscal year).
  - The legal framework for surveillance evolved with the 2012 Integrated Surveillance Decision (ISD), requiring alignment of the 2010 Decision with ISD provisions on spillovers and multilateral surveillance.
  - The original methodology was heavily skewed toward size and limited interconnectedness measures; lessons from the global financial crisis, the sovereign debt crisis in Europe, and recent emerging market turbulence underscore the importance of interconnectedness, nonbank linkages (notably sovereign debt holdings), and contagion via market sentiment.
- Need for methodological improvements:
  - Recent advances in modeling interconnectedness enable a methodology that places greater emphasis on interconnectedness, expands the range of covered exposures, incorporates potential for price contagion across financial sectors, and uses the most recent available data.
  - Any new methodology must adhere to principles of relevance, transparency, and even-handedness established by the 2010 Executive Board decision.

### New methodology and updated list of jurisdictions
- Methodological changes (summary):
  - Greater emphasis on interconnectedness.
  - Expanded range of covered exposures beyond bilateral interbank exposures.
  - Consideration of potential for price contagion across financial sectors.
  - Use of the most recent available data and improved interconnectedness modeling (including a formula capturing these factors).
- On the basis of the new methodology, 29 jurisdictions are deemed to have systemically important financial sectors:
  - Australia, Austria, Belgium, Brazil, Canada, China, Denmark, Finland, France, Germany, Hong Kong SAR, India, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, Norway, Poland, Russia, Singapore, Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United States.
- Proposed application:
  - Financial stability assessments under the FSAP would be a mandatory part of Article IV surveillance in these jurisdictions every five years.
- Operational implications:
  - The Managing Director would, in consultation with the Executive Board, update the list of countries subject to mandatory financial stability assessments using the new methodology.
  - Mandatory assessments should cover more comprehensively spillovers arising from a member’s domestic financial sector policies, consistent with the ISD emphasis on outward spillovers irrespective of transmission channels (balance of payments or non-balance of payments such as contagion and market pricing).

### Legal framework and proposed revisions
- Legal grounding:
  - Mandatory financial stability assessments are grounded in the Fund’s Articles, in particular Article IV, Section 1 (obligations to collaborate to assure orderly exchange arrangements and promote a stable system of exchange rates — “systemic stability”).
  - The mandatory assessment was designed to facilitate the Fund’s assessment of members’ domestic financial policies for bilateral surveillance.
- Proposed revisions to the 2010 Decision:
  - Replace the methodology in the 2010 Decision with the new methodology described in this paper.
  - Enable mandatory financial stability assessments to more comprehensively address spillovers, reflecting the 2012 Integrated Surveillance Decision (ISD) and Article IV, Section 3(a) obligations to oversee the international monetary system and focus on spillovers that may undermine global economic and financial stability.
  - Clarify that outward spillovers should be discussed irrespective of the channels through which they transmit (balance of payments or non-balance of payments).

*Source: EXECUTIVE SUMMARY, November 15, 2013.*

### 12.      Consistent with this approach, the proposed revision to the 2010 Decision would make

### _111513 - 12.      Consistent with this approach, the proposed revision to the 2010 Decision would make

### Proposed revision: mandatory financial stability assessments and spillovers
- The proposed revision to the 2010 Decision would make mandatory financial stability assessments a vehicle for both bilateral and multilateral surveillance, allowing coverage of spillovers in two separate contexts.
- In bilateral surveillance:
  - Mandatory financial stability assessments would continue to cover spillovers arising from a member’s domestic financial policies when those policies undermine the member’s own domestic or balance of payments stability.
- In multilateral surveillance:
  - Mandatory financial stability assessments would cover spillovers arising from a member’s domestic financial policies whenever they may significantly influence the effective operation of the international monetary system and, in particular, when they may undermine global economic and financial stability.

### Legal basis and consultation obligations
- It is legally possible to make a mandatory stability assessment an instrument for multilateral surveillance and to cover spillovers relevant for multilateral surveillance without modifying members’ obligations under the Fund’s Articles.
- Under Article IV, Section 3 (a), members are obligated to consult with the Fund on any issue relevant for the Fund’s multilateral surveillance and mandate to oversee the international monetary system.
- The ISD already includes provisions requiring the Fund in its multilateral surveillance to focus on spillovers from members’ financial policies that may significantly influence the effective operation of the international monetary system.

### Interaction with Article IV consultations and Guidance Note
- Expanded coverage of spillovers in mandatory financial stability assessments would facilitate coverage of spillovers in Article IV consultations.
- Staff guidance:
  - Staff will be guided by the ISD and the Guidance Note on Article IV consultations when considering whether outward spillovers from financial sector policies should be discussed in mandatory financial stability assessments.
  - Outward spillovers are deemed significant if, by themselves, or in combination with other members’ policies, or through regional impact, they would enter the macrofinancial policy considerations of members representing a significant portion of the global economy.
- Operational implication:
  - Where such actual or potential spillovers meet this threshold (expected in practice for a relatively small number of countries), they would have to be discussed and analyzed as part of the mandatory financial stability assessment.
  - The relevant analysis would be included in the resulting Financial System Stability Assessment report, and could also be reflected in the main Article IV consultation report.

### Updated list of jurisdictions with systemically important financial sectors — general framework
- Systemic importance:
  - There is no universally accepted definition; systemic importance is a continuum and contingent on the state of global markets.
- Principles for methodology:
  - Criteria must be transparent and relevant to Article IV provisions.
  - Criteria must have general applicability (data and methodologies available for and applicable to all, or at least the majority, of members) and be applied uniformly.
  - Determination of the list must be objective and data-driven, limiting a priori judgments about size and membership of the list.
- Scope and limitations:
  - The concept applies specifically to the financial sector, not to a jurisdiction’s systemic importance writ large (does not capture domestic market size, trade linkages, or broader political influence).
  - The exercise focuses on maximizing benefits of regular financial stability assessments, not on identifying the most vulnerable jurisdictions.
  - Analysis is limited by data quality, may not reflect nonbank and/or unregulated segments, and cannot fully account for differences in data collection and reporting across countries.

### The 2010 methodology revisited: design and results
- 2010 methodology summary:
  - Identified 25 jurisdictions using a composite index of size and interconnectedness based on 2008 data.
  - Size and interconnectedness were composite indices; aggregate ranking was a weighted average with weights of 0.7 for size and 0.3 for interconnectedness.
  - Cluster analysis was then used to identify groups; the top two clusters, together accounting for 89 percent of the global financial system, were deemed systemically important.
  - Box 1 summarized the three-stage process: ordinal rankings for size and interconnectedness; composite index with 0.7/0.3 weights; cluster analysis minimizing within-cluster sum of squared standard deviations across many weight permutations.
- Applying the 2010 methodology to 2012 data:
  - Yields very similar results, with several marginal rank changes (shifts by two to three places), except Ireland shifting from fifteenth to the twenty-fourth position.
  - Cluster analysis indicates 24 jurisdictions with systemically important financial sectors: the original 25 minus Mexico.
  - These 24 jurisdictions cover 88 percent of the global financial system.
  - Note: six jurisdictions (Mexico, Denmark, Malaysia, Saudi Arabia, South Africa, Indonesia, and Poland) consistently appear in about half of all possible permutations.
- Limitations highlighted since 2010:
  - Heavy skew toward size (weight 0.7) may understate the role of interconnectedness—events in relatively small but highly interconnected countries can have outsized spillovers.
  - Limiting interconnectedness measurement to bilateral bank exposures misses key cross-border linkages (sovereign debt exposures, sovereign-bank link, large capital movements across asset classes).
  - Defining the global network based on bilateral exposures omits channels of shock propagation dependent on “pure” price correlation, potentially missing jurisdictions central to flows driven by asset return correlation or flight-to-quality phenomena.

### The new methodology: conceptual changes and implementation
- Conceptual shifts:
  - Still anchored in size and interconnectedness, but:
    - shifts emphasis toward interconnectedness;
    - expands the range of covered exposures; and
    - introduces consideration of complexity and potential for price contagion across financial sectors.
- Network construction and weighting:
  - Constructs four different global financial networks based on different types of bilateral cross-border linkages:
    - bank claims,
    - debt claims,
    - equity claims,
    - potential for “pure” price contagion (approximated by a matrix of cross-correlations of domestic stock market returns).
  - Bilateral exposure and correlation matrix data are weighted by:
    - (i) PPP GDP, to capture size, and
    - (ii) gross derivatives exposures vis-à-vis BIS reporting banks, to capture complexity of financial sectors.
  - Rationale: the systemic importance of a bilateral link depends on the size and complexity of the respective economies; a large exposure between two small financial sectors is less systemic than the same exposure between two large or more complex financial sectors.
  - Uses the most recent available data (in most cases, 2012) to construct the four networks and the weights.
- Core identification: Clique Percolation Method (CPM)
  - CPM is used to identify the core of each network as fully-interconnected “cliques”; the union of these cliques defines the systemic core of the global network.
  - Advantages of CPM relative to 2010 approach:
    - Captures that systemic importance is a global property of the network, reflecting neighbors’ linkages as well as a jurisdiction’s direct linkages.
    - Avoids ordinal ranking of jurisdictions; focuses on network properties.
    - Allows overlapping cliques so jurisdictions may belong to more than one group and act as “gatekeepers” between groups.
  - CPM origins and use: originally developed in physics and subsequently used in economic analysis.

*Source: Mandatory FSAP Stability Assessments: Update (excerpts).*

### 26.      The group of jurisdictions with systemically important financial sectors is defined as

### 26.      The group of jurisdictions with systemically important financial sectors is defined as

### Definition and core principle
- The group is defined as the union of the systemic cores of the four networks.
- Rationale: each of the four networks identified is important for global financial system stability; therefore, if a jurisdiction is part of the core of any one of the four networks, it is included in the final list of jurisdictions with systemically important financial sectors.

### Implementation — Clique Percolation Method (CPM) calibration
- CPM is based on two key parameters:
  - (i) the minimum size of the k-clique, a set of fully connected jurisdictions;
  - (ii) the threshold above which bilateral exposures are considered in the network.
- Minimum size of the k-clique:
  - Optimal range for k is "5–8" for the three exposure networks and "4–8" for the correlation network.
  - To maximize the size of the systemic core while remaining within the theoretically-determined optimal range, the size of the k-clique is set at k = 5 for all four networks.
  - Interpretation: to belong to the systemic core, a jurisdiction must belong to at least one clique with at least four other fully interconnected members in at least one of the four networks.
- Threshold:
  - Determines which bilateral links (exposures or correlations) are taken into account.
  - The theoretically-optimal threshold values (Appendix I) are starting points; final thresholds calibrated so coverage of resulting systemic core is similar to that in the 2010 exercise.

### Results — systemic core membership and coverage
- The new methodology identifies "29" jurisdictions as the systemic core of the global financial system.
- The systemic core estimated with the new methodology includes all "25" jurisdictions identified in 2010 plus "Denmark", "Finland", "Norway", and "Poland".
- European representation:
  - A large number of European countries appear in the systemic core owing to relatively sizeable financial sectors that are highly interconnected.
  - The model-based approach emphasizes interconnectedness while still taking size into account.
- Overlap with 2010 methodology:
  - Applying the new methodology retrospectively to the 2008 data used in 2010 would also yield a systemic core of "29" jurisdictions, which includes "28" of the "29" jurisdictions in Table 4 (new methodology).
- Examples and dynamics:
  - Portugal was included in the 2008-core under the new methodology but, by the latest data, has fallen below the threshold of k = 5 cliques as exposures were reduced.
  - Finland moved above thresholds with stronger links to France, Belgium, Norway, and Sweden, bringing it into the core.
  - Finland’s banking linkages reflect that it hosts branches from banks headquartered in other Nordic countries; these linkages could be potential channels for the transmission of shocks.

### Operational implications for the FSAP
- Incremental impact of expanding list from "25" to "29" jurisdictions:
  - Small immediate operational impact and modest incremental resource impact.
  - Of the four additional jurisdictions:
    - Finland and Poland have had FSAPs in the last "three" years;
    - Preparations for an FSAP in Denmark in early "2014" are underway;
    - An FSAP in Norway is tentatively planned in "2015".
  - Adding these countries to the mandatory list would have virtually no impact on FSAP workload in the immediate future.
- Medium-term and steady-state resource implications:
  - Subsequent FSAPs in these four jurisdictions would not materially affect the distribution of mandatory financial stability assessments over time.
  - The incremental impact on the overall FSAP resource envelope at the steady state would be modest, amounting to less than one additional FSAP per year on average.
- Tension with voluntary FSAPs:
  - Unless total program resources are increased, tensions between mandatory stability assessments in systemic jurisdictions and voluntary FSAPs in other members will persist.
  - Mandatory assessments take priority over all other FSAP requests; maintaining the same level of delivery for the rest of membership would therefore require a modest increase in program resources.
  - The fundamental tension between FSAPs in systemic and non-systemic jurisdictions will not be resolved under an unchanged resource envelope; the issue will be addressed in the forthcoming Board review of the FSAP in late "2014".
- Modalities and coordination:
  - Individual FSAPs will be adapted to the form of interconnectedness of jurisdictions’ financial systems.
  - For Nordic jurisdictions (Denmark, Finland, Norway, and Sweden), FSAPs will take careful account of the regional dimension and leverage information collected in each individual FSAP to enhance assessment quality.
  - This suggests potential benefits in coordinating the timing of these mandatory financial stability assessments, similar to clustered Article IV consultations.

### Institutional and decision context
- Determination of systemic importance:
  - The Managing Director, in consultation with the Executive Board, will identify members that have systemically important financial sectors.
  - This determination will be made in the context of each review under the Decision and will be based on an assessment taking into account the size and interconnectedness of members’ financial sectors as contemplated in paragraphs "23" to "26" in SM/10/23513/304.
- Financial stability assessments:
  - Where a member’s financial sector is determined to be systemically important pursuant to the Decision, the member shall engage in a financial stability assessment in the context of bilateral and multilateral surveillance under Article IV of the Fund’s Articles in accordance with the terms of the Decision.

*MANDATORY FSAP STABILITY ASSESSMENTS: UPDATE*

### 6.  Scope of financial stability assessments. The financial stability assessments undertaken

### 6.  Scope of financial stability assessments. The financial stability assessments undertaken

### Scope of assessments (elements a–d)
- a. Evaluation of the source, probability, and potential impact of the main risks to macro-financial stability in the near-term for the relevant financial sector. Such an evaluation will involve:
  - analysis of the structure and soundness of the financial system;
  - trends in both the financial and nonfinancial sectors;
  - risk transmission channels; and
  - features of the overall policy framework that may attenuate or amplify financial stability risks (such as the exchange rate regime).
  - Both quantitative analysis (such as balance sheet indicators and stress tests) and qualitative assessments will be used to evaluate the risks to macro-financial stability.
- b. Assessment of the authorities’ financial stability policy framework. Such an assessment will involve:
  - evaluation of the effectiveness of financial sector supervision;
  - the quality of financial stability analysis and reports;
  - the role of and coordination between the various institutions involved in financial stability policy; and
  - the effectiveness of monetary policy.
- c. Assessment of the authorities’ capacity to manage and resolve a financial crisis should the risks materialize. Such an assessment will involve:
  - overview of the country’s liquidity management framework;
  - financial safety nets (such as deposit insurance and lender-of-last-resort arrangements);
  - crisis preparedness and crisis resolution frameworks; and
  - possible spillovers from the financial sector onto the sovereign balance sheet.
- d. Where relevant, assessments will also cover the spillovers arising from a member’s financial sector policies that may significantly influence global economic and financial stability.

### Modalities of assessments (paragraph 7)
- Key findings and recommendations of a financial stability assessment under this Decision will be summarized in a Financial System Stability Assessment Report (FSSA).
- The FSSA will normally be discussed by the Executive Board at the same time as the relevant Article IV consultation report.

### Frequency (paragraph 8)
- For a member whose financial sector is determined to be systemically important pursuant to this Decision:
  - A financial stability assessment will be conducted and the resulting FSSA will be discussed by the Executive Board by no later than the first deadline for completion of an Article IV consultation with the member that follows the fifth anniversary of such determination.
  - For the financial sector of a territory of a member, the analogous deadline applies: the first deadline for completion of an Article IV consultation discussion with respect to that territory by the Executive Board that follows the fifth anniversary of such determination.
  - Subsequent FSSAs for a member with a systemically important financial sector will be discussed by the Executive Board by no later than the first deadline for completion of an Article IV consultation with that member that follows the fifth anniversary of the date of completion of the previous Executive Board discussion of the FSSA respecting that member.
  - For a territory of a member, subsequent timing follows the same five-year anniversary rule relative to the previous Executive Board discussion of the FSSA respecting the financial sector of that territory.

### Review (paragraph 9)
- The Fund will review this Decision no later than five years following the date of its adoption and subsequently at intervals of no longer than five years.
- In each review the Fund will examine and revise, as necessary, the criteria and methodology for determining members with systemically important financial sectors, since "systemic importance" is a dynamic concept.
- The Fund may review this Decision at any time to take into account major advances in the availability of data and in the development of methodologies for assessing the systemic importance of financial sectors.
- Document references: (SM/10/235, Sup. 3, 9/20/10) (SM/10/235, Sup. 3, 09/20/10) (SM/13/304, 11/18/13). Decision No. 14736-(10/92), adopted September 21, 2010.

### Appendix I — Clique Percolation Method (CPM): data, implementation, and parameter choices
- CPM purpose:
  - Practical approach for identifying the core of systemic jurisdictions by identifying all k-cliques (sets of at least k jurisdictions all fully connected to each other).
- Networks used (four global financial networks):
  - Direct exposures: banking, debt, and equity portfolio exposures.
    - Banking network: constructed using bilateral exposures based on bilateral claims reported in the Locational Banking Statistics compiled by the BIS; two jurisdictions considered connected if there are bilateral claims between them; strength measured as the higher of the two jurisdictions’ mutual exposures.
    - Debt and equity exposures: constructed using portfolio holdings data from the Coordinated Portfolio Investment Survey (CPIS).
  - Price correlation network: matrix of cross-country equity return correlations, with equity returns calculated from the MSCI equity index.
    - Note: MSCI indices available for 53 jurisdictions; jurisdictions without MSCI indices are excluded from the correlation network.
- Link weighting:
  - Bilateral linkages weighted by the geometric average of both countries’ 2012 GDP on a PPP basis and their derivatives exposures vis-à-vis BIS reporting banks.
  - Relative importance captured by scaling bilateral exposures by the geometric average of the two countries’ total exposures.
  - Resulting link values range from 0 to 1.
- Data vintage used:
  - Banking network: 2012 Q3 data.
  - Debt and equity networks: end-2011 data.
  - Correlation network: weekly equity returns for September 2008–September 2013.
  - Weights (PPP GDP and gross derivatives exposures): 2012 data.
- Interpretation of cliques:
  - Jurisdictions may be members of several k-cliques, forming chains of interlocking rings; some countries can act as "gatekeepers" straddling more than one cluster.
- Choice of minimum k:
  - Minimum k influences systemic core size; k too large → empty core; k too low → overly large core (k=2 yields entire network).
  - Graph theory heuristic algorithms used to determine optimal k by maximizing the average number of nearest neighbors of a jurisdiction.
  - Optimal ranges found:
    - Exposure networks (bank, debt, equity): optimal k range 5–8.
    - Correlation network: optimal k range 4–8.
  - Selected value: k = 5 for all four networks; minimum clique size set to 5 to maximize number of jurisdictions in the systemic core.
- Threshold for bilateral links:
  - Threshold determines which bilateral links are included; low/zero threshold yields dense network and larger systemic core.
  - Heuristic algorithm suggests threshold ranges for k = 5:
    - Bank exposure network: between 1¼–2½ percent of total weighted assets.
    - Equity and debt exposures networks: between 3½–7 percent.
    - Weighted equity return correlations network: between 0.01 to 0.08.
  - Calibrated thresholds for this exercise:
    - 1½ percent for all direct exposures networks.
    - 0.015 for the correlation network.
- Sensitivity analysis findings:
  - Varying minimum k:
    - Increasing k to 6 or 7 (still within theoretical range) can lead to no fully connected clique for the equity exposures network.
    - Keeping k = 5 for the correlation network but increasing to 6 or 7 for exposure networks drops important countries and substantially reduces systemic core size and coverage of global system assets.
    - Reducing k to 4 moves k outside the optimal range for three networks and increases the number of jurisdictions in the systemic core to 34.
  - Varying threshold around central value has asymmetric effects:
    - Lowering threshold to 1.3 percent: no impact on systemic core.
    - Raising threshold to 1.8 percent: results in dropping a number of important jurisdictions and significantly reducing coverage of systemic core in terms of global financial system assets.

### Appendix II — Integration into Article IV surveillance (introductory paragraphs)
- Purpose:
  - Decision sets scope and modalities of bilateral surveillance over financial sector policies of members with systemically important financial sectors and multilateral surveillance over spillovers arising from such policies in accordance with Article IV and the ISD (Decision No. 15203-(12/72), adopted July 18, 2012).
- Article IV context:
  - Bilateral surveillance: Article IV, Section 1 requires each member to “collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates” (“systemic stability”).
    - Article IV, Sections 1(i) and (ii) establish obligations respecting conduct of domestic economic and financial policies, including financial sector policies.
    - ISD provides that systemic stability is achieved by members adopting policies that promote balance of payments stability and domestic stability; financial sector policies (both macroeconomic aspects and macroeconomically relevant structural aspects) will always be the subject of the Fund’s bilateral surveillance for each member.
  - Multilateral surveillance: Article IV, Section 3 (a) requires the Fund to oversee the international monetary system and consult with members on issues necessary for effective operation.
    - ISD provides the Fund’s multilateral surveillance will focus on issues that may affect global economic and financial stability, including spillovers arising from policies of individual members that may significantly influence the international monetary system; members’ financial sector policies are among those policies.

*MANDATORY FSAP STABILITY ASSESSMENTS: UPDATE  INTERNATIONAL MONETARY FUND*

### 3.  This Decision does not impose new obligations on members or, in particular, modify the

### 3.  This Decision does not impose new obligations on members or, in particular, modify the 

### General scope
- This Decision does not impose new obligations on members or, in particular, modify the scope of their obligations under Article IV.
- The Fund will, in bilateral surveillance, continue to assess whether a member’s domestic economic and financial policies are directed toward the promotion of domestic stability.
- In multilateral surveillance, the Fund may discuss the impact of members’ policies on the effective operation of the international monetary system and may suggest alternative policies that, while promoting the member’s own stability, better promote the effective operation of the international monetary system.

### Determination of systemic importance (paragraph 4)
- The Managing Director, in consultation with the Executive Board, will identify those members that have systemically important financial sectors.
- This determination will be made in the context of each review that is conducted under paragraph 9 below.
- The determination will be based on an assessment taking into account the size and interconnectedness of members’ financial sectors as contemplated in paragraphs 23 to 27 in SM/13/304.

### Requirement to engage in financial stability assessments (paragraph 5)
- Where the financial sector of a member is determined to be systemically important pursuant to paragraph 4 of this Decision, the member shall engage in a financial stability assessment in the context of bilateral and multilateral surveillance under Article IV of the Fund’s Articles in accordance with the terms of this Decision.
- For this purpose, the member shall consult with the Fund and the authorities of the member shall make themselves available for discussions with Fund staff of the issues that fall within paragraph 6 of this Decision.

### Scope of financial stability assessments (paragraph 6)
- The financial stability assessments undertaken under this Decision will consist of the following elements:
  - a. An evaluation of the source, probability, and potential impact of the main risks to macro-financial stability in the near-term for the relevant financial sector. Such an evaluation will involve:
    - an analysis of the structure and soundness of the financial system;
    - trends in both the financial and nonfinancial sectors;
    - risk transmission channels; and
    - features of the overall policy framework that may attenuate or amplify financial stability risks (such as the exchange rate regime).
    - Both quantitative analysis (such as balance sheet indicators and stress tests) and qualitative assessments will be used to evaluate the risks to macro-financial stability.
  - b. An assessment of the authorities’ financial stability policy framework. Such an assessment will involve:
    - an evaluation of the effectiveness of financial sector supervision;
    - the quality of financial stability analysis and reports;
    - the role of and coordination between the various institutions involved in financial stability policy; and
    - the effectiveness of monetary policy.
  - c. An assessment of the authorities’ capacity to manage and resolve a financial crisis should the risks materialize. Such an assessment will involve:
    - an overview of the country’s liquidity management framework;
    - financial safety nets (such as deposit insurance and lender-of-last-resort arrangements);
    - crisis preparedness and crisis resolution frameworks; and
    - the possible spillovers from the financial sector onto the sovereign balance sheet.
  - d. Where relevant, the assessments will also cover the spillovers arising from a member’s financial sector policies that may significantly influence global economic and financial stability.

### Modalities of assessments and reporting (paragraph 7)
- The key findings and recommendations of a financial stability assessment under this Decision will be summarized in a Financial System Stability Assessment Report (FSSA).
- The FSSA will normally be discussed by the Executive Board at the same time as the relevant Article IV consultation report.

### Frequency and timing (paragraph 8)
- Where the financial sector of a member is determined to be systemically important pursuant to this Decision:
  - it will be expected that a financial stability assessment will be conducted and the FSSA resulting from such an assessment will be discussed by the Executive Board by no later than the first deadline for completion of an Article IV consultation with the member that follows the fifth anniversary of such determination;
  - in the case of the financial sector of a territory of a member, the same timing applies with respect to the first deadline for completion of an Article IV consultation discussion with respect to that territory by the Executive Board that follows the fifth anniversary of such determination.
- Subsequent FSSAs:
  - It is expected that subsequent FSSAs for a member with a systemically important financial sector will be discussed by the Executive Board by no later than the first deadline for completion of an Article IV consultation with that member that follows the fifth anniversary of the date of completion of the previous Executive Board discussion of the FSSA respecting that member.
  - In the case of the financial sector of a territory of a member, the same timing applies with respect to the first deadline for completion of an Article IV consultation discussion with respect to that territory by the Executive Board that follows the fifth anniversary of the date of completion of the previous Executive Board discussion of the FSSA respecting the financial sector of that territory.

### Review (paragraph 9)
- It is expected that the Fund will review this Decision no later than five years following the date of its adoption and subsequently at intervals of no longer than five years.
- As "systemic importance" is a dynamic concept, the Fund will, in the context of each such review, examine and revise, as necessary, the criteria and methodology for determining members with systemically important financial sectors.
- The Fund may review this Decision at any time to take into account major advances in the availability of data and in the development of methodologies for assessing the systemic importance of financial sectors.
- Reference: (SM/13/304, 11/18/13).

*Source: _111513 - 3.  This Decision does not impose new obligations on members or, in particular, modify the*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2013/_111513.pdf_