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Grading Central Banks on their Financial Stability Reports

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
November 2006
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Over the past decade, many central banks, especially in high- and medium-income countries, have sharpened their focus on financial sector soundness. They have highlighted this reorientation through the publication of financial stability reports, but to date, remarkably little has been done to systematically analyze these reports.

A new IMF Working Paper attempts to fill this void. In a survey of 160 documents from 47 countries, the study analyzes the structure and content of these financial stability reports, attempting to identify common trends, issues, and gaps. To assess quality, the study examines five elements of the reports: objectives; overall assessment; range of issues covered; data, assumptions, and tools used; and other features, such as structure. For each of the five elements, three basic characteristics—clarity, consistency, and coverage—are graded on a scale from 1 (noncompliant) to 4 (fully compliant).

Room for improvement

The study finds that these reports provide useful insights into how central banks analyze financial stability, but there is room for improvement (see chart). To bolster the usefulness of these reports, the paper recommends clarifying the reports’ aims, providing an operational definition of financial stability, ensuring the “core analysis” is presented consistently in time, making underlying data readily available, discussing risks and exposures in the financial system more candidly, making greater use of disaggregated data, focusing more on forward-looking indicators (rather than backward-looking descriptions), and presenting a richer set of stress tests that, among other things, includes scenarios, liquidity risks, and contagion and is comparable across time.

A number of factors explain the differences in the quality of the financial stability reports. Using a panel data regression, the study finds that grades improve with time, which most likely reflects the central bank’s increasing experience with analyzing financial stability and presenting the results to the public. Grades are also positively correlated with economic and financial development. Interestingly, central banks that are not directly involved in day-to-day supervision have higher grades—most likely because the arm’s-length distance allows these reports to be more candid.

Implications for the IMF

The wider publication of financial stability reports also has implications for the IMF’s financial sector work. With the increasing availability of these reports, more information is on hand for the IMF and others to analyze. And where these reports play a role in the authorities’ financial sector stability framework, they may need to be part of financial sector assessments (for example, in the IMF-World Bank Financial Sector Assessment Program).

Clearer aims needed

Financial stability reports can benefit from improvements on several fronts, notably more clearly delineated goals.

Citation: 35, 20; 10.5089/9781451968835.023.A012

(grading)

Note: Grading runs from 1 (noncompliant) to 4 (fully compliant).

Data: Author’s calculations based on information from individual central banks.

For its part, the IMF’s financial sector work can complement the analyses carried out by central banks, including issues involving several agencies, such as a systemic liquidity or crisis management framework; assessing compliance with international standards and codes; cross-country analysis of financial soundness indicators; and system-focused stress testing. The IMF can play a role in transferring knowledge from countries that carry out financial soundness analyses and publish reports to countries that do not yet do so.

Finally, as the scope and the quality of financial stability work by country authorities increase, the IMF’s financial sector analysis will be judged against a higher standard. This may require more staff training, increased research and other analytical work, and a greater focus on the IMF’s strengths and comparative advantages.

Martin Čihák

IMF Monetary and Capital Markets Department

This article is based on IMF Working Paper No. 06/163, “How Do Central Banks Write on Financial Stability?” by Martin Čihák Copies are available for $15.00 each from IMF Publication Services. Please see page 324 for ordering details. The full text is also available on www.imf.org.

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