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1 COMESA FINANCIAL STABILITY ASSESSMENT HANDBOOK Gift Chirozva Business Operations Director Deposit Protection Corporation email: gchirozva@dpcorp.co.zwgchirozva@dpcorp.co.zw giftezh@gmail.com
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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 2
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Indicators & Benchmarks Source Rosenthal: www.newyorker.com/online/blogs/johncassidy/ -233.jpg 3
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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 4
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The Weighted CAMELS Framework 5
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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. 6
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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. 7
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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. 8
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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) 9
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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. 10
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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 ??? 11
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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 12
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Qualitative Example: Expert Opinion Index 13 Global Macrofinacial Conditions
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The GLYOR Risk Scale 15 ExtremeMinor
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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
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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
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Institutional Quality Institutional governance Risk management Infrastructure conditions Systemic impact 18
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Earnings Conditions Bank profitability Income generation risk Viability of coporates Systemic impact 19
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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
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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
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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 22
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