A loss of solvency increases central bank vulnerability, reducing the credibility of commitments to defend a nominal regime, including an exchange rate peg. This paper develops a methodology to assess central bank solvency and exposure to risk. The measure, based on Value-at-Risk, is frequently used to evaluate commercial risk. The paper emphasizes that the ability to sustain nominal commitments cannot be gauged by focusing only on selected accounts (such as reserves), but requires a comprehensive solvency and vulnerability analysis of the monetary authorities’ complete portfolio (including off-balance-sheet operations). The suggested measure has powerful reporting value and its disclosure could improve monitoring of sovereign solvency risk.
Christoph Aymanns, Carlos Caceres, Christina Daniel, and Miss Liliana B Schumacher
Understanding the interaction between bank solvency and funding cost is a crucial pre-requisite for stress-testing. In this paper we study the sensitivity of bank funding cost to solvency measures while controlling for various other measures of bank fundamentals. The analysis includes two measures of bank funding cost: (a) average funding cost and (b) interbank funding cost as a proxy of wholesale funding cost. The main findings are: (1) Solvency is negatively and significantly related to measures of funding cost, but the effect is small in magnitude. (2) On average, the relationship is stronger for interbank funding cost than for average funding cost. (3) During periods of stress interbank funding cost is more sensitive to solvency than in normal times. Finally, (4) the relationship between funding cost and solvency appears to be non-linear, with higher sensitivity of funding cost at lower levels of solvency.
Mr. Kamiar Mohaddes, Mr. Mehdi Raissi, and Anke Weber
This paper examines whether a tipping point exists for real GDP growth in Italy above which the
ratio of non-performing loans (NPLs) to total loans falls significantly. Estimating a heterogeneous
dynamic panel-threshold model with data on 17 Italian regions over the period 1997–2014, we
provide evidence for the presence of growth-threshold effects on the NPL ratio in Italy. More
specifically, we find that real GDP growth above 1.2 percent, if sustained for a number of years, is
associated with a significant decline in the NPLs ratio. Achieving such growth rates requires
decisively tackling long-standing structural rigidities and improving the quality of fiscal policy.
Given the modest potential growth outlook, however, under which banks are likely to struggle to
grow out of their NPL overhang, further policy measures are needed to put the NPL ratio on a firm
downward path over the medium term.