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COMESA F I NANCIAL STABILITY ASSESSMENT HANDBOOK

This handbook covers rating methodology, indicators, benchmarks, crisis identification, policy interventions, and crisis definitions in financial stability assessment.

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COMESA F I NANCIAL STABILITY ASSESSMENT HANDBOOK

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  1. COMESA FINANCIAL STABILITY ASSESSMENT HANDBOOK Gift Chirozva Business Operations Director Deposit Protection Corporation email: gchirozva@dpcorp.co.zw giftezh@gmail.com

  2. Rating Methodology … • There are two dimensions on indicators: • Choice of indicator. Policymakers should have a wide range of indicators at their disposal, rather than relying on one single indicator, bearing in mind that each indicator has its own purpose • Indicator Thresholds. Policy tools could be based, at least in part, on certain values of indicators associated with those levels that signalled systemic stress in the past. • Threshold levels could be set at those values of the near-coincident indicators observed at the turning points identified in the past

  3. Indicators & Benchmarks Source Rosenthal: www.newyorker.com/online/blogs/johncassidy/ -233.jpg

  4. Identifying SHIELDS benchmarks • Determination of benchmarks is very important so that one knows how to interpret the results. • Benchmarks should be established up front. • The SHIELDS framework employs the following benchmarks: • Absolute benchmarks, e.g. CAR; EU Surveillance Framework; • Z-scores: Deviations from the mean normalised by the standard deviation • Percentiles • Signal Extraction Method

  5. The Weighted CAMELS Framework

  6. Quintile Scale • Relevant Range • A “relevant range” for each indicator is established based on low-to-high distribution of the data set for all countries. Outliers that lie outside 2SDev from the mean are excluded to avoid distortion. • Quintile Scale • As the scale is based on quintiles, the scoring between the best ("1") and worst ("5") are based on a sliding scale. • Consider the following example: Given (a) Lowest Return on Assets: -1.5 per cent; (b) Highest Return on Assets: 3.5 per cent; it follows therefore, (c) Relevant Range = 5.0.

  7. Percentiles • Another possibility is to transform the variables in percentiles, using their sample cumulative distribution function – CDFs • In this case, the last percentile corresponds to a high instability period, while the value of the first percentile characterises a low stress level. • The other values around the median reflect an average risk level.

  8. Identification of Historical Crisis Episodes • Lindgren, Garcia & Saal (1996) classify systematic banking crises on the basis of whether bank runs, portfolio shifts, bank collapses or large-scale government intervention. • Any other episodes of financial stability are classified as non-systematic crises. • Demirguc-Kunt and Detragiache (1998a) use a achievement of at least one out of four criteria: • proportion of non-performing loans to total banking system assets exceeds 10%, or • the public bailout cost exceeds 2% of GDP, or • large scale bank nationalization, or • extensive bank runs are visible and if not, emergency government intervention is visible.

  9. Laeven & Valencia Data Set 2012 • A banking crisis is defined as systemic if two conditions are met: • Significant signs of financial distress in the banking system (as indicated by significant BK runs, losses in BK system (NPLs of 20%) & /or BK liquidations/ closures at least 20%. • Significant banking policy intervention measures in response to significant losses in the BK system. •  Consider the first year that both criteria are met to be the year when the crisis became systemic. • Policy interventions are significant if at least three out of the following six measures have been used: • 1) extensive liquidity support (5 percent of deposits and liabilities to nonresidents)

  10. Laeven & Valencia Data Set 2012 •  2) Gross bank restructuring gross costs (at least 3 percent of GDP). • 3) significant bank nationalizations • 4) significant guarantees put in place • 5) significant asset purchases (at least 5% of GDP) • 6) deposit freezes and/or bank holidays. •  Liquidity support is extensive when the ratio of central bank claims on financial sector to deposits and foreign liabilities exceeds 5 % & more than doubles relative to its pre-crisis level. • Liquidity support extended directly by Treasury is also included.

  11. Reinhart & Rogoff Crisis Definitions • Inflation crisis – 20% or higher, extreme 40% • Currency crush – Annual depreciation of 15% or more or currency debasement of 5% or removal of several “zeroes.” • Banking crisis – bank run leading to closure or merger or no runs but large scale closure/takeover • Debt Crisis- failure by government to honour • Domestic debt crisis – freezing deposits or forced conversions. • Global Financial Crisis ???

  12. Has global effect on • the level and volatility of economic activity as measured by world aggregates of prices, real GDP, and trade; and • Is relatively synchronised across countries • Has four main elements: • One or more global financial centres are mired in a systemic crisis & also directlty or indirectly financial flows to numerous countries • The crisis involves two or more regions • The number of countries in each region is 3 or more • Composite GDP weighted by index average of global financial is one std deviation above normal

  13. Qualitative Example: Expert Opinion Index Global Macrofinacial Conditions

  14. The GLYOR Risk Scale Minor Extreme

  15. Solvency Conditions - Current and future • Capital adequacy • Over-reliance on leverage • Weighted CAMELS framework (Banking v Market data based models; SIFS; DIFIS etc • Distance-to-Default (DtD), CoVaR • Expected Default Frequency (EDF) • Macro Stress Tests • Corporates Solvency • Solvency of Households • Solvency of the State / Nation

  16. Home Economic Conditions • FSIs on key sectors • Home economic conditions (household, corporate, public and external) • Credit to GDP based prediction models – credit booms or crunches (GDP growth or GDP gap) • Equity prices growth • House price growth • Real effective exchange rate (REER) • Asset quality • Hard-wired Vulnerabilities • Current account developments • Debt Sustainability Analysis (DSA) • Market data based models subject to availability

  17. Institutional Quality • Institutional governance • Risk management • Infrastructure conditions • Systemic impact

  18. Earnings Conditions • Bank profitability • Income generation risk • Viability of coporates • Systemic impact

  19. Liquidity Conditions • Current & future developments in • market, • monetary, • funding, • balance sheet, and bank liquidity • Short tem loans • Dollarisation • Systemic Liquidity Risk Indicator (SLRI) • Joint Distress models; CCA • Network Models

  20. Default Conditions • Default Conditions • Impact of price changes • Systemic Default • Debt Sustainability Analysis (Government Debt) • Corporate debt • Household debt • Fiscal Stress Analysis • Credit to GDP Gap • Asset Price Models • House Price Acceleration

  21. Systemic Loss • Systemic Loss [losses (to) depositors and creditors; deposit protection agencies; owners; the public sector fiscal accounts; on assets; and macroeconomic losses • NPLs • Structural VARS • DSGE Models • GDP at Risk Models • Systemic CCA

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