This paper explains the treatment of sovereign risk in macroprudential solvency stress testing, based on the experiences in the Financial Sector Assessment Program (FSAP). We discuss four essential steps in assessing the system-wide impact of sovereign risk: scope, loss estimation, shock calibration, and capital impact calculation. Most importantly, a market-consistent valuation approach lies at the heart of assessing the resilience of the financial sector in a tail risk scenario with sovereign distress. We present a flexible, closed-form approach to calibrating haircuts based on changes in expected sovereign defaults affecting bank solvency during adverse macroeconomic conditions. This paper demonstrates the effectiveness of using extreme value theory (EVT) in this context, with empirical examples from past FSAPs.
Superficial examination of aggregate gross cross-border capital inflow data suggests that there
was no substitution between portfolio inflows and bank loans in recent years. However, our
novel analysis of disaggregate inflows (both by types of instrument and borrower) shows
interesting heterogeneity. There has been substitution of bank loans for portfolio debt securities
not only in the case of corporate and sovereign borrowers in advanced countries, but also
sovereign borrowers in emerging countries. In the case of corporate borrowers in emerging
markets, the relationship corresponds to complementarity across types of gross capital inflows,
especially during periods of positive capital gross inflows after the global financial crisis. A
large part of these patterns does not seem to be driven by a common phenomenon across
countries associated with the global financial cycle, but rather by country-specific factors.
Deniz Anginer, Mr. Eugenio M Cerutti, and Mr. Maria Soledad Martinez Peria
This paper examines the association between the default risk of foreign bank subsidiaries in developing
countries and their parents during the global financial crisis, with the purpose of determining the size and
sign of this correlation and, more importantly, understanding what factors can help insulate affiliates from
their parents. We find evidence of a significant and robust positive correlation between parent banks’ and
foreign subsidiaries’ default risk. This correlation is lower for subsidiaries that have a higher share of
retail deposit funding and that are more independently managed from their parents. Host country bank
regulations also influence the extent to which shocks to the parents affect the subsidiaries’ default risk. In
particular, the correlation between the default risk of subsidiaries and their parents is lower for
subsidiaries operating in countries that impose higher capital, reserve, provisioning, and disclosure
requirements, and tougher restrictions on bank activities.
Foreign bank lending has stopped growing since the global financial crisis. Changes in
banks’ business models, balance-sheet adjustments, as well as the tightening of banking
regulations are potential drivers of this prolonged slowdown. The existing literature
however suggests an opposite effect related to regulation, with tighter regulations
encouraging foreign lending through regulatory arbitrage. We investigate this question
using new survey data on regulations specific to banks’ international operations. Our
results show that regulatory tightening can explain about half of the decline in the foreign
lending-to-GDP ratio between 2007 and 2013. Regulatory changes in home countries have
had a larger effect than those in host countries.
Mr. Pau Rabanal, Mr. Christopher W. Crowe, Mr. Giovanni Dell'Ariccia, and Ms. Deniz O Igan
The financial crisis showed, once again, that neglecting real estate booms can have disastrous consequences. In this paper, we spell out the circumstances under which a more active policy agenda on this front would be justified. Then, we offer tentative insights on the pros and cons as well as implementation challenges of various policy tools that can be used to contain the damage to the financial system and the economy from real estate boom-bust episodes.
Mr. Giovanni Dell'Ariccia, Mr. Pau Rabanal, Mr. Christopher W. Crowe, and Ms. Deniz O Igan
DISCLAIMER: This Staff Discussion Note represents the views of the authors and does not necessarily represent IMF views or IMF policy. The views expressed herein should be attributed to the authors and not to the IMF, its Executive Board, or its management. Staff Discussion Notes are published to elicit comments and to further debate.
This paper examines the implications of the Fund accepting membership in the Financial Stability Board (“FSB”). The FSB Charter (the ?Charter?) explicitly contemplates the possibility of the Fund and the other international financial institutions becoming members but notes that ?the acceptance of membership by the international financial institutions (IFIs) in the FSB is subject to the approval of their respective governing bodies.? An Executive Board decision is required for the Fund to accept membership and is proposed below.
This paper provides a brief overview of the latest research on the ability of forecasters to predict recessions. The paper highlights that few recessions have been forecast before their onset. Forecasters tend to be excessively cautious and do not revise their forecasts promptly and sufficiently to reflect incoming news. Nor do they fully take into account interdependence among economies. This paper also focuses on robust growth determinants highlighting that a fundamental problem confronting researchers is the lack of an explicit theory identifying the determinants of growth.