The IMF’s Systemic Financial Sector Surveillance
Seminar for Senior Bank Supervisors from Emerging EconomiesOctober 21, 2010
Elie CanettiAdvisor
Monetary and Capital Markets DepartmentInternational Monetary Fund
What Is Systemic Financial Sector Surveillance?
The Fund’s 3 Levels of Surveillance• Bilateral – Country‐Specific
– Article IV Consultations– Financial Sector Assessment Programs (FSAP)
• Regional– Regional Economic Outlook (REOs)
• Multilateral– Economic (WEO)– Financial (GFSR, EWE)
I. Why Is It Important to Do Systemic Financial Sector Surveillance at the Global Level?
Global Financial Flows are Increasing
0510152025303540
1997 2001 2002 2003 2004 2005 2006 2007 2008
Global Cross‐Border Portfolio Investment($ trillions)
Source: IMF's Coordinated Portfolio Investment Survey, Table 12
Finance Has Become More Complex and Opaque
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100
200
300
400
500
600
700Jun.19
98
Jun.19
99
Jun.20
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Jun.20
01
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Jun.20
04
Jun.20
05
Jun.20
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Jun.20
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Jun.20
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OTC Derivatives($ trillions)
Source: BIS
Crises Have Become GlobalGlobal Impact of US Subprime Crisis
• August 2007 ‐ BNP Paribas Halts Redemptions on 3 Investment Funds
• September 2007 ‐ UK’s Northern Rock Requires Rescue• September 2008 ‐ Fed expands swap facilities with advanced
country central banks • October 2008 – Fed establishes swap facilities with emerging
market central banks• September‐November 2008 – Crisis Erupts in Iceland• Late 2008‐Early 2009, Synchronised G3 recession confirmed
Sources: BIS, St. Louis Federal Reserve Bank
II. What Does Systemic Financial Sector Surveillance Achieve?
• Highlight Systemic Vulnerabilities• Examine Possible Spillovers
– Across Markets: (e.g. US Subprime Mortgages to Global Interbank Markets)
– Countries: (Emerging Market Financing, European Sovereign Crisis Spillovers)
• Provide Policy Advice– Financial Reform– Assure Level Playing Fields
III. IMF’s Major PublicationsMultilateral Financial Sector Surveillance
• GFSR• GFSR Updates• Staff Position Notes
– Addressing Information Gaps (March 2009)– The Perimeter of Financial Regulation (March 2009)– Policies to Address Financial Sector Weakness (October 2009)– Capital Inflows: The Role of Controls (February 2010)– The Making of Good Supervision (May 2010)– The Contours of the Financial System (August 2010)– Shaping the New Financial System (October 2010)
What is the Global Financial Stability Report
• Twice a year (timed to coincide with the Annual and Spring IMF/WB meetings)
• The IMF’s flagship Financial Sector Publication• Focus on Macrofinancial Linkages (e.g. impact on credit)
Chapter 1 – The IMF’s View on Financial Stability Risks
Source: GFSR, October 2010
Asset Class Heat Map
Source: GFSR, October 2010
Recent Major Chapter 1 Topics
• Sovereign Risks (focus on Europe) and Financial Fragilities
• Sovereign and Banking System Spillovers• Global Bank Loss/Writedown Estimates• Managing Upside Risks to Emerging Markets (Capital Flows and Asset Bubble Risks)
GFSR Special Features
Analytical chapters or essays on structural or systemic issues relevant to international financial stability
Selected Recent Examples:• Systemic Liquidity Risk: Improving the Resilience of Institutions and Markets
(October 2010)• The Uses and Abuses of Sovereign Credit Ratings (October 2010)• Systemic Risk and the Redesign of Financial Regulation (April 2010)• Making Over‐the‐Counter Derivatives Safer: The Role of Central Counterparties
(April 2010)• Restarting Securitization Markets: Policy Proposals and Pitfalls (October 2009)
Geographical Focus• Global Financial Stability ‐ Systemic Focus• Geographic Coverage is Primarily:
– Global Financial Centers– Major Source Countries of Global Capital– Major Recipients of Global Capital Flows– Contagion Threats for Capital Markets
• Coverage Limited for Countries That Are:– Non‐systemic; and– Not Major Sources/Recipients of Private Capital; and– Unlikely to Pose Contagion Threat
GFSR Market Update
• Off‐Cycle updates (July/January)• Short (6‐8 pages)
IV. iMF Direct ‐ The IMF’s New Blog – http://blog‐imfdirect.imf.org/– IMF’s financial bloggers (so far) include
• John Lipsky (First Deputy Managing Director• Jose Vinals (Director of MCM)• Laura Kodres (Division Chief – Global Financial Stability)• John Kiff (Senior Economist – Global Financial Stability)
V. The Early Warning Exercise (EWE)“the FSB should collaborate with the IMF to provide early warning of
macroeconomic and financial risks and the actions needed to address them”
‐G20 London Communiqué, April 2, 2009
– Focus on potential systemic crises, whether in advanced or emerging markets
– Combine IMF’s macrofinancial strengths with FSB’s expertise in regulation and supervision
– Provide actionable policy advice
What is the EWE?
• The EWE is a semi‐annual exercise launchedduring Annual Meetings in September 2009– Focuses on potential systemic crises, whether in advanced or emerging markets
– Identifies and prioritizes, macro‐financial vulnerabilities, key focus on potential spillovers
– Sets out tail risk scenarios– Provides broad policy advice
Main output: EWE Presentation
IMF Management and FSB Chair present EWE findings to IMFC*
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*The IMFC is the IMF’s steering committee, responsible for advising, and reporting to, the Board of Governors. Its 24 members are central bank governors, ministers, or others of comparable rank drawn from the Fund’s 187 member countries.
Outputs are confidential – why?
• Provide unvarnished views to decision makers
• EWE should be able to be specific and name names
• EWE is about tail risk scenarios with focus on contagion and spillovers
• Warn of consequences of Policy Mistakes
EWE Methodology
• Although the output is confidential, the methodology is not• Methodology paper just released• See John Lipsky blog on iMF Direct: “Forewarned is Forearmed: How the Early Warning Exercise Expands the IMF’s Surveillance Toolkit”
http://www.imf.org/external/pp/longres.aspx?id=4479
So How is the EWE Done?
• Integrates multilateral economic and financial surveillance
• Combine IMF’s macrofinancial strengths (fiscal/economic/financial) with FSB’s expertise in regulation and supervision
• Draws on IMF’s model‐driven vulnerability exercises for emerging and for advanced countries
• Draws on wide‐ranging discussions with markets, academics and officials
• Ultimate Outputs are Based on Staff Judgments, but Underpinned by Extensive Internal Analyses
Vulnerabilities versus Triggers
• Crises require vulnerabilities and a trigger• Vulnerabilities
– Excessive Leverage– Balance Sheet Mismatches– Liquidity Risks– Complexity, Interconnectedness, Opacity
• Triggers, and hence crisis timing, unpredictable
The IMF’s Vulnerability Exercises... for Advanced Economies (VEA) and Emerging Economies (VEE)
Fundamentals Systemic risk and contagion
Spillover analysis Model simulations
Global macro environment
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The VEA – A Sampling of Sectoral Models• External
– Overvalued Exchange Rates– Empirical External Crisis Model
• Macro– Growth Risks (GDP at Risk)– Inflation/Deflation Risks
• Fiscal– Rollover Risk– Market‐Based Default Probabilities– Fiscal Adjustment Need– Fiscal Vulnerability to Adverse Growth Shocks
• Asset Prices– Real Estate– Equities
• Financial Sector– Financial Crisis Model– Asset Quality (NPLs)
• Contagion Models– Trade Contagion– Cross‐Border Financial Sector Exposure
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VEA RatingsCountry Flags Raised by the VEA1
Countr
y 1Cou
ntry 2
Countr
y 3Cou
ntry 4
Countr
y 5Cou
ntry 6
Countr
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ntry 8
Countr
y 9Cou
ntry 1
0Cou
ntry 1
1Cou
ntry 1
2Cou
ntry 1
3Cou
ntry 1
4Cou
ntry 1
5Cou
ntry 1
6Cou
ntry 1
7Cou
ntry 1
8Cou
ntry 1
9Cou
ntry 2
0Cou
ntry 2
1Cou
ntry 2
2Cou
ntry 2
3Cou
ntry 2
4Cou
ntry 2
5Cou
ntry 2
6Cou
ntry 2
7Cou
ntry 2
8Cou
ntry 2
9Cou
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0Cou
ntry 3
1Cou
ntry 3
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Overall VEA rating 5 4 2 2 3 6 6 2 6 11 7 4 8 8 4 3 4 3 6 7 6 7 9 8 8 6 4 5 6 5 5 3
External 0 1 0 0 1 1 1 0 1 2 2 0 1 0 0 0 0 0 0 1 1 1 2 1 2 1 0 0 0 0 0 0
External imbalances (empirical crisis model, thresholds for 3 external sector indicators) 0 2 0 0 0 2 2 0 2 2 2 1 2 0 0 0 0 0 0 2 2 2 2 2 2 n.a. n.a. 0 0 0 0 0
Overvalued exchange rate (CGER) 0 0 0 0 2 1 1 0 0 0 0 0 0 0 0 0 0 0 0 1 0 0 0 0 2 1 0 0 0 0 0 0
International Balance sheet analysis 0 0 n.a. n.a. 0 0 0 0 0 2 2 0 n.a. 0 n.a. 0 0 1 n.a. n.a. n.a. 0 2 1 0 n.a. n.a. n.a. 1 1 0 1
Macro 2 1 1 1 1 2 1 1 1 2 1 1 1 2 2 1 1 1 1 2 1 1 1 2 1 2 2 2 2 2 2 1
Growth risks 2 1 1 1 1 2 0 1 1 2 1 1 1 2 2 1 1 1 1 2 1 1 1 1 1 2 2 2 2 2 2 1
Growth risks (empirical crisis model) 1 1 1 1 1 1 0 1 1 2 1 1 1 2 2 1 1 1 1 2 1 1 1 1 1 2 2 2 2 0 1 1
GDP at risk 2 0 n.a. n.a. 0 2 0 0 1 1 n.a. 0 0 0 n.a. 1 0 0 n.a. n.a. n.a. 1 0 1 1 n.a. n.a. n.a. 2 2 2 0
Growth above potential (general equilibrium macro model) 0 n.a. n.a. n.a. 0 n.a. 0 0 0 n.a. n.a. 0 n.a. n.a. n.a. 0 n.a. n.a. n.a. n.a. n.a. 0 0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Inflation risks 0 0 0 0 0 0 0 0 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 0 0 0 1
Loose monetary policy (Taylor rule) 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 0 0 0 1
Loose monetary conditions (general equilibrium macro model) 0 n.a. n.a. n.a. 0 n.a. 0 0 2 n.a. n.a. 0 n.a. n.a. n.a. 0 n.a. n.a. n.a. n.a. n.a. 0 0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Denflation risks 2 0 0 0 1 0 1 0 0 2 0 0 1 0 0 0 0 0 0 0 0 1 1 2 0 1 0 0 0 1 0 0
Tight monetary policy (Taylor rule) 2 0 0 0 1 0 1 0 0 2 0 0 1 0 0 0 0 0 0 0 0 0 1 2 0 1 0 0 0 1 0 0
Tight monetary conditions (general equilibrium macro model) 2 n.a. n.a. n.a. 0 n.a. 0 0 0 n.a. n.a. 0 n.a. n.a. n.a. 0 n.a. n.a. n.a. n.a. n.a. 1 0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.
Fiscal 2 0 0 0 0 0 1 0 1 2 2 1 1 1 1 0 0 0 1 0 1 2 2 2 2 1 0 2 0 0 0 0
Fiscal risks, overall indicator 2 0 n.a. n.a. 0 0 1 0 1 2 n.a. 1 1 1 n.a. 0 0 0 1 0 1 2 2 2 2 n.a. n.a. n.a. 0 0 0 0
Gross funding risk (sovereign financing risks analysis) 2 2 n.a. n.a. 0 0 2 1 0 0 2 1 2 0 n.a. 0 0 0 0 n.a. 0 2 0 1 1 n.a. n.a. n.a. 0 0 0 0
Market perception of sovereign default risk (CDS and RAS spreads, models for government bond yields and term risk premium)
1 2 n.a. n.a. 0 0 0 0 0 2 n.a. 0 1 1 n.a. 0 1 0 1 n.a. n.a. 2 1 2 2 n.a. n.a. n.a. 0 0 0 0
Medium-term fiscal adjustment need 2 0 n.a. n.a. 1 0 2 0 2 2 n.a. 1 0 1 n.a. 0 0 n.a. 0 n.a. 1 0 1 1 2 n.a. n.a. n.a. 0 0 0 0
Long-term fiscal adjustment need 1 2 n.a. n.a. 0 1 2 0 0 1 n.a. 0 1 1 n.a. 0 0 n.a. 2 0 2 0 2 0 2 2 n.a. n.a. 0 0 1 0
Fiscal vulnerability to an adverse growth shock 2 0 n.a. n.a. 0 0 1 0 0 1 n.a. 1 2 1 0 1 0 n.a. 0 0 0 2 1 2 2 0 0 n.a. 0 0 0 0
Contagion risk (distress dependence from other sovereigns) 0 n.a. n.a. n.a. n.a. n.a. 0 n.a. 1 1 n.a. 1 0 0 n.a. 0 0 n.a. n.a. n.a. n.a. 1 2 2 2 n.a. n.a. n.a. n.a. n.a. n.a. 0
Fiscal crisis risks (empirical crisis model) 1 0 0 0 0 1 1 1 1 2 2 2 2 1 1 1 1 0 1 1 2 2 1 1 2 2 0 2 1 1 0 0
Asset prices 0 1 n.a. n.a. 1 2 2 1 1 2 n.a. 0 2 2 n.a. 1 1 1 n.a. n.a. n.a. 1 2 n.a. n.a. n.a. n.a. n.a. 2 1 1 0
Real estate overall vulnerability 0 1 n.a. n.a. 1 2 2 0 1 2 n.a. 0 n.a. 2 n.a. 0 n.a. 1 n.a. n.a. n.a. 0 2 n.a. n.a. n.a. n.a. n.a. 1 1 1 0
Residential real estate 0 0 n.a. n.a. 1 2 0 0 1 2 n.a. 0 n.a. 2 n.a. 0 n.a. 0 n.a. n.a. n.a. 0 2 n.a. n.a. n.a. n.a. n.a. 1 1 0 0
House price misalignment 0 0 n.a. n.a. 2 2 0 1 2 0 n.a. 2 2 1 n.a. 0 0 0 n.a. n.a. n.a. 0 2 0 0 n.a. n.a. n.a. 1 0 2 2
Household debt burden 0 0 n.a. n.a. 1 1 1 1 1 1 n.a. 0 n.a. 2 n.a. 0 n.a. 1 n.a. n.a. n.a. 0 0 n.a. n.a. n.a. n.a. n.a. 2 0 0 0
Potential impact on GDP 0 0 n.a. n.a. 1 2 0 0 1 2 n.a. 0 n.a. 0 n.a. 0 n.a. 0 n.a. n.a. n.a. 0 0 n.a. n.a. n.a. n.a. n.a. 1 1 0 0
Mortgage market characteristics 0 0 n.a. n.a. 1 0 1 0 1 2 n.a. 0 n.a. 1 n.a. 0 n.a. 0 n.a. n.a. n.a. 2 2 n.a. n.a. n.a. n.a. n.a. 0 2 1 0
Commercial real estate 0 1 n.a. n.a. 1 0 2 0 1 1 n.a. 0 n.a. 0 n.a. 0 n.a. 1 n.a. n.a. n.a. 0 2 n.a. n.a. n.a. n.a. n.a. 1 1 1 0
Equity prices 0 n.a. n.a. n.a. 1 n.a. 0 1 0 1 n.a. 0 2 0 n.a. 1 1 0 n.a. n.a. n.a. 0 1 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 0
Model based misalignments 0 n.a. n.a. n.a. 1 n.a. 0 2 0 0 n.a. 0 1 0 n.a. 0 2 0 n.a. n.a. n.a. 0 2 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 0
Valuation multiples misalignments 0 n.a. n.a. n.a. 1 n.a. 0 0 0 1 n.a. 0 2 0 n.a. 1 0 0 n.a. n.a. n.a. 0 0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 0
Corporate sector vulnerability 0 0 0 1 0 2 n.a. 0 0 0 0 1 1 0 n.a. n.a. n.a. 1 0 1 0 n.a. n.a. n.a. 2 1 1 0
Financial sector and systemic models 1 1 0 0 0 0 1 0 1 1 0 1 1 1 0 0 1 0 1 1 1 1 1 1 1 0 0 0 1 1 1 1
Financial crisis (empirical crisis model) 0 0 0 0 0 0 0 0 0 1 0 0 1 1 0 0 0 0 0 0 0 1 0 1 1 0 0 0 0 0 0 0
Financial stability at risk 1 2 n.a. n.a. 0 0 0 0 2 0 n.a. 1 0 2 n.a. 0 1 0 n.a. n.a. n.a. 1 0 0 0 n.a. n.a. n.a. 2 2 2 1
Expected deterioration of asset quality (NPL model) 2 0 n.a. 0 0 0 2 0 1 n.a. n.a. 1 0 0 n.a. 2 2 0 2 n.a. n.a. 2 2 0 2 n.a. n.a. 0 0 0 0 0
Interbank spreads 0 1 0 0 1 0 0 0 0 1 n.a. 1 1 1 1 1 1 0 n.a. 1 1 1 1 1 1 1 1 n.a. 0 1 1 1
Distress from Large Complex Financial Institutions 0 1 0 0 0 n.a. 2 1 2 2 n.a. 1 1 n.a. n.a. 0 2 1 n.a. n.a. n.a. 1 1 2 2 n.a. n.a. n.a. 1 n.a. 0 2
Duration of crisis (duration model) 2 2 0 0 1 2 2 1 0 0 0 0 0 0 0 0 0 0 n.a. 2 2 1 1 0 1 0 0 n.a. 0 1 0 0
Contagion 0 0 0 0 0 1 0 0 1 2 1 1 2 2 0 1 1 1 2 2 1 1 1 1 1 1 1 0 1 1 1 1
Cross-border financial sector exposure (contagion through bank channels) 0 0 1 0 0 2 0 0 0 2 0 1 2 1 0 0 0 2 0 2 0 0 0 0 0 0 0 0 0 0 0 0
Financial sector exposure to vulnerable advanced economies 0 0 0 0 1 0 1 0 2 2 2 2 2 2 1 2 2 2 2 1 2 2 2 2 2 2 2 0 2 1 1 1
Financial sector exposure to vulnerable emerging economies 0 0 0 0 0 0 0 0 1 1 0 0 1 1 0 0 2 1 2 2 2 0 0 1 2 0 0 n.a. 1 0 0 2
Contagion through trade channels 0 1 0 0 0 1 0 1 0 1 1 0 2 2 0 1 1 0 2 2 0 1 0 0 0 0 0 1 1 1 1 1
1The table summarizes the main results of the VEA exercise. The colors indicate countries that were flagged as relatively vulnerable in each sector, with red, orange and green for high, medium and low vulnerabilities respectively. When "n.a.", the number of red and orange flags needed to rank a country with H or M drops accordingly.
Drawing Systemic Implications
• Spillovers and Contagion Analysis– Models Based on Market Data– Models Based on Exposures
• BIS Bank Data• Bilateral Trade Shares
• LCFI Analysis– Vulnerabilities on Individual LCFIs– Risks of Systemic Distress/Spillovers Across LCFIs
• Global Macro Models
Looking for Risk in All the Wrong Places:The Limitations of Modeling
• Models Deepen, but Don’t Widen, Understanding of Risks
• Financial Models Can Be Invalidated By Changing Human Behavior:– “I can calculate the motion of heavenly bodies but not the madness of people” – Isaac Newton
• Quantifying (e.g. VAR) Can Anchor Expectations in the Wrong Place
Going Beyond ModelsThe Consultation Process
Take stock of risk perceptions, especially contrarian views.
– Canvassing of IMF and FSB staff views
– Interactions with country authorities and FSB members
– Extensive discussions with market participants
– Conference call with leading academics
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Goals of the EWE Presentation
• Connecting the dots
• Provide unvarnished views to decision makers
• Supplement public baseline messages
• Highlight consequences of inaction
• Focus on contagion and spillovers
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The Art of Early Warning:Grabbing Their Attention (aka The
Cassandra Problem)
Yes, We Have No Crystal Balls
“It’s tough to make predictions, especially about the future”
… Yogi Berra
The IMF’s Systemic Financial Sector Surveillance
Thank You