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International Monetary Fund. Monetary and Capital Markets Department

Abstract

Risks to global financial stability have declined since the October 2010 Global Financial Stability Report, helped in part by improving macroeconomic conditions. However, sovereign balance sheets remain under strain in many advanced economies, structural weaknesses and vulnerabilities in the euro area pose significant risks to bank balance sheets, credit risks remain high, and capital inflows to emerging markets could strain their absorptive capacity.

International Monetary Fund. Monetary and Capital Markets Department

Abstract

Risks to global financial stability have declined since the October 2010 Global Financial Stability Report, helped in part by improving macroeconomic conditions. However, sovereign balance sheets remain under strain in many advanced economies, structural weaknesses and vulnerabilities in the euro area pose significant risks to bank balance sheets, credit risks remain high, and capital inflows to emerging markets could strain their absorptive capacity.

Mr. Renzo G Avesani

Abstract

The chapter presents the basic CreditRisk+ model along with extensions suggested in the existing literature and proposes some modifications. The purpose of these models is to determine the probability distribution of the losses on a portfolio of loans and other debt instruments so that they could be used for stress testing in the IMF’s Financial Sector Assessment Program, as a benchmark for credit risk evaluations. First, we present the setting and basic definitions common to all the model specifications used in this chapter. Then, we proceed from the simplest model based on Bernoulli-distributed default events and known default probabilities to the full-fledged CreditRisk+ implementation. The latter is based on the Poisson approximation and uncertain default probabilities determined by mutually independent risk factors. As an extension, we present a Credit-Risk+ specification with correlated risk factors as in Giese (2003). Finally, we illustrate the characteristics and the results obtained from the different models using a specific portfolio of obligors.

Mr. Eugenio M Cerutti

Abstract

This chapter presents a stylized analysis of the effects of ring-fencing (i.e., different restrictions on cross-border transfers of excess profits and/or capital between a parent bank and its subsidiaries located in different jurisdictions) on cross-border banks. Using a sample of 25 large European banking groups with subsidiaries in Central, Eastern, and Southern Europe (CESE), we analyze the impact of a CESE credit shock on the capital buffers needed by the sample banking groups under different forms of ring-fencing. Our simulations show that under stricter forms of ring-fencing, sample banking groups have substantially larger needs for capital buffers at the parent and/or subsidiary level than under less strict (or in the absence of any) ring-fencing.

Gregorio Impavido

Abstract

This chapter describes the basic mechanics of defined benefit (DB) plan liability valuation and how to conduct simple stress tests of the solvency ratio. We first review the essential building blocks of liability valuation of DB plans and then, using an Excel-based template with institution-specific data, we take readers through the basics of liability valuation and stress testing of assets and liabilities of a typical DB plan. The template is by no means a substitute for a proper actuarial evaluation, but the simplifications introduced do not affect its usefulness to evaluate sensitivity of the funding ratio.

Marco A Espinosa-Vega

Abstract

The global financial crisis that erupted in 2007 prompted policymakers and financial stability practitioners to intensify their search for a better understanding of how and when financial linkages could pose systemic risks. Hence, it is not surprising that there has been a surge of work in this area seeking to address some of the key conceptual aspects of financial interconnectedness. However, an ongoing challenge for policymakers has been the difficulty in turning rather theoretical proposals into methodologies that can be applied to detect and assess important linkages on an ongoing basis.

Marco A Espinosa-Vega

Abstract

Effective cross-border financial surveillance requires the monitoring of direct and indirect systemic linkages. This chapter illustrates how network analysis could make a significant contribution in this regard by simulating different credit and funding shocks to the banking systems of a number of selected countries. After that, we show that the inclusion of risk transfers could modify the risk profile of entire financial systems, and thus an enriched simulation algorithm able to account for risk transfers is proposed. Finally, we discuss how some of the limitations of our simulations are a reflection of existing information and data gaps and thus view these shortcomings as a call to improve the collection and analysis of data on cross-border financial exposures.

Chan-Lau Jorge A.

Abstract

The 2008–9 financial crisis highlighted the importance of evaluating vulnerabilities owing to interconnectedness, or too-connected-to-fail risk, among financial institutions for country monitoring, financial surveillance, investment analysis, and risk management purposes. This chapter illustrates the use of balance sheet–based network analysis to evaluate interconnectedness risk, under extreme adverse scenarios, in banking systems in mature and emerging market countries, and between individual banks in Chile, an advanced emerging market economy.

Chan-Lau Jorge A.

Abstract

For stress testing purposes, it is necessary to measure the default risk of individual financial and nonfinancial institutions and to assess how this risk changes under different scenarios. Once the default risk of individual institutions is measured, it is possible to analyze the credit exposures and potential losses and construct bottom-up measures of systemic risk under different stress scenarios.