Journal Issue

IMF Occasional Paper: Macroprudential indicators can play crucial role in measuring health of financial systems

International Monetary Fund. External Relations Dept.
Published Date:
January 2000
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Following the severe financial crises that characterized the 1990s, identifying and assessing financial sector vulnerabilities has become a key priority of the international community. The costly disruptions in global markets underscored the need to establish a set of monitorable variables that could be used to evaluate strengths and weaknesses in financial institutions and alert authorities to impending problems. These variables—indicators of financial system health and stability—are known collectively as macroprudential indicators. They are the subject of a new IMF Occasional Paper, Macroprudential Indicators of Financial System Soundness, by a staff team led by Owen Evans, Alfredo M. Leone, Mahinder Gill, and Paul Hilbers of the Monetary and Exchange Affairs Department and the Statistics Department.

Work on the paper was initially undertaken in preparation for an IMF consultative meeting on macroprudential indicators in September 1999. At that meeting, experts from central banks, supervisory agencies, international financial institutions, academia, and the private sector exchanged information and compared experiences on the use of macroprudential indicators. Work in this area, including the results of the meeting, was discussed by the IMF Executive Board in January 2000.

Financial Sector Assessment Program

As part of the IMF’s broader surveillance work, the institution has been charged with evaluating the soundness and vulnerability of financial systems within the framework of its Article IV consultations with individual member countries. In this context, the IMF and the World Bank launched a joint program in May 1999 called the Financial Sector Assessment Program, which was designed to identify financial system strengths and weaknesses and help countries develop appropriate policy responses. The IMF uses the program to derive Financial Sector Stability Assessments that focus on the aspects of the financial system that are significant for macroeconomic performance and policies. The program seeks to identify vulnerabilities early on and develop prompt responses, thus averting costly crises. These reports are presented to the IMF’s Executive Board for discussion within the context of Article IV surveillance. At the World Bank, the program becomes the basis for formulating development strategies for the financial sector.

Identification and development of a core set of indicators for evaluating financial system soundness will go a long way toward supporting the institutions in their work. International institutions, of course, are not the only agents interested in using macroprudential indicators. Countries themselves want to improve their monitoring abilities, and the private sector is interested in internationally comparable sets of data so that evaluations can be made easily across countries. Macroprudential indicators would capture key financial information that is potentially very valuable for the markets in evaluating both national and global financial system stability.

How is soundness measured?

Macroprudential indicators that are currently being used comprise two sets of measures: one at the level of aggregated financial sectors and another at the macroeconomic level. The authors provide a breakdown of the two sets of indicators with explanations of specific variables in the following categories.

Indicators used at the micro level, taken together, are called aggregated microprudential indicators. These indicators have been developed on the basis of the CAMELS framework—an acronym representing six separate groupings for analyzing individual financial institutions. The groupings are measures of capital adequacy, asset quality, management soundness, earnings and profitability, liquidity, and sensitivity to market risk. Although not part of the CAMELS framework, a seventh group included at the aggregated micro level is market-based indicators, which provide information on such measures as the price of financial instruments and the creditworthiness ratings of institutions and corporations.

Tracking developments at the macroeconomic level is also crucial. Macroeconomic indicators assess developments that can affect the health of the financial system, measuring levels of economic growth, balance of payments, inflation, interest and exchange rates, lending and asset price booms, and potential contagion effects. The paper notes that recent empirical analysis has shown that banking crises have often been predated by particular macroeconomic developments; clearly, financial systems and institutions are affected by changes in overall economic activity.

Financial crises often occur when both aggregated microprudential indicators and macroeconomic indicators identify vulnerabilities and weaknesses in financial institutions as well as shocks to the economy. The authors point out that although macroprudential indicators are critically important quantitative measures, they make up only one part of a balanced evaluation of financial system soundness. Qualitative information also needs to be included, such as institutional circumstances, supervisory and regulatory frameworks, accounting standards, disclosure requirements, and the legal infrastructure.

What is known

The paper reviews the current knowledge about macro-prudential indicators and issues related to their analysis, identification, and measurement—thus providing a reference source for national authorities and for other public and private sector users of such indicators. After examining macroprudential indicators that have been identified through IMF surveillance work, the paper reviews work done at other selected international and multilateral institutions and considers statistical issues in compiling the data and possibilities for their future dissemination. To date, research has not yet produced a consensus on a core set of indicators. The authors, however, include a comprehensive literature review of theoretical and empirical work that would support selection of a core set of macroprudential indicators.

The experiences of national central banks and supervisory agencies in several countries are recounted for a comparison of the different approaches and indicators used. Much of the existing work has been done relatively recently and for the most part, but not exclusively, in industrial countries. Knowledge of macroprudential indicators is still limited, and national authorities and policymakers need to understand the importance and usefulness of these indicators more thoroughly. Work is under way in a number of countries to develop macroprudential data collection and analysis frameworks. Besides data collection and analysis concerns, authorities will also need to work on measurement issues.

The paper examines key issues affecting statistical accuracy, usefulness, and international comparability of macroprudential indicators. Reliable statistics in assessments of the financial sector are of utmost importance; clear warnings of emerging problems cannot be obtained without timely and accurate statistics. The paper notes that if macroprudential indicators were comparable across countries, their usefulness would be greatly increased. Comparability would be fostered by countries’ adherence to internationally agreed prudential, accounting, and statistical standards that provide clear rules for both compiling and interpreting such measures. Standardizing these indicators would facilitate monitoring the financial systems at the national and global levels and further strengthen the international financial architecture.

Development and dissemination

Significant work lies ahead in identifying a core set of macroprudential indicators for financial system surveillance and in resolving statistical measurement issues.

The paper concludes by raising the question of whether and how to disseminate the high-quality data—after various technical problems have been resolved—to the public in timely and informative ways. As part of the effort to better understand national practices and the needs of users, the IMF has sent a survey to its member countries on the use, compilation, and dissemination of macroprudential indicators. The Occasional Paper was sent along with the survey to provide respondents with background information. Respondents, in turn, will provide the IMF with information that improves the quality and development of macroprudential indicators and enhances the ability to measure the health of financial systems at the national, regional, and global levels.

Copies of IMF Occasional Paper 192, Macroprudential Indicators of Financial System Soundness, by a staff team led by Owen Evans, Alfredo M. Leone, Mahinder Gill, and Paul Hilbers, are available for $18.00 each (academic rate: $15.00) from IMF Publication Services. See page 223 for ordering information.

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