Front Matter

Front Matter

Garry Schinasi
Published Date:
December 2005
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© 2006 International Monetary Fund

All rights reserved.

Production: IMF Multimedia Services Division

Cover design: Lai Oy Louie

Cover photo: Bruno Budrovic, ©

Cataloging-in-Publication Data

Schinasi, Garry J.

Safeguarding financial stability : theory and practice / Garry J. Schinasi — Washington, D.C.: International Monetary Fund, 2005.

p. cm.

Includes bibliographical references and index.

ISBN 1-58906-440-2

1. Finance. 2. Banks and banking, Central. 3. Risk. I. International Monetary Fund.

HG101.S35 2005

Disclaimer: The views expressed in this work are those of the author and do not necessarily represent those of the IMF or IMF policy.

Price: $28.00

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I dedicate this book to my parents, Jack (deceased) and Josephine Schinasi.

Here’s what the experts are saying about

Safeguarding Financial Stability

Theory and Practice

By Garry J. Schinasi

“Safeguarding Financial Stability explicates why financial stability matters, what it means, and the challenges in securing it.... [It is] a thoughtful and thought-provoking volume that is a must read not just for central bankers but for all concerned with financial stability—and if you are not concerned about the latter, you soon will be!”

—Gerard Caprio, Jr., World Bank

“Garry Schinasi provides a unique and comprehensive framework for understanding financial stability and for assessing the risks posed by new financial instruments in increasingly unregulated markets in an increasingly globalized world. The channels of monetary policy management have changed tremendously, as anyone who follows the striking stability of long-term bond yields in the face of rising short-term interest rates will attest. The global business cycle is maturing, entering into a period of high financial risk, as discussed by Dr. Schinasi. Anyone who does not read this book today will regret not doing so, as the next financial shock and test of the stability of the global financial system is not long in coming.”

—Gail D. Fosler, The Conference Board

“The economic and institutional transformation of central banking that has taken place over the past four decades has been driven mainly by monetary policy issues. However, it has profoundly affected another historical mission of central banks—the preservation of financial stability. Financial stability is gradually emerging as a distinct policy function, requiring its own body of scholarship, not to be confused with monetary policy on the one side, and supervision on the other side, although it is related to both.

“Building an analytical approach and a policy paradigm consistent with this new setting as well as with the changing landscape of financial markets and institutions is one of the tasks of today’s research and policy agenda.

“Garry Schinasi takes us a big step forward in the fulfilment of this task. His book Safeguarding Financial Stability represents a brilliant attempt to provide solid and updated foundations to policies aiming at financial stability. The book is based on a thorough acquaintance with the literature, understanding of the real world, analytical skill, sense of the policy issues, familiarity with the diversity of country situations, and good judgement.

“The book can already be considered required reading for anyone interested in the subject of financial stability. Its clarity makes it accessible to practitioners as well as policymakers. At the same time, the book will stir debate and further research in academic circles.”

—Tommaso Padoa-Schioppa, European Central Bank

“…this is a great book. It synthesizes a large literature on financial stability,… and it fills in a number of crucial holes…. I think it will be remembered as the first concrete attempt to analyze, define, and move toward operationalizing assessment of financial stability.”

—R. Todd Smith, University of Alberta



This book was written because I could not find one like it in bookstores or in central bank libraries. In effect, it fills a gap—albeit imperfectly—in the existing policy, academic, and commercial literatures on financial stability issues.

The motivation for undertaking this project came to me in early 2003, after having spent nearly 10 years engaging in international capital market surveillance—first in the IMF’s Research Department (both as Deputy Chief and Chief of the Capital Market and Financial Studies Division) and then in the newly created International Capital Markets Department (as Chief of the Financial Markets Stability Division). Part of the challenge of the job was to understand the implications of structural changes in finance (including financial institutions, markets, and infrastructures), which required talking to market participants and the relevant authorities (including central banks and supervisory authorities). The job always entailed keeping management and colleagues well informed about capital market developments, prospects, issues, and most important, sources of risks and vulnerabilities.

The time spent searching for potential risks and vulnerabilities (or “potholes” as we called them) in the international monetary and financial system, especially in the more mature markets, challenged my colleagues and me to search continuously for new ways of understanding how calm market conditions can lead to turbulence, why changes in market sentiment often occur without much warning, and how the private and official sectors can adapt and learn to prevent and better cope with financial difficulties and crises. By mid-2003 I felt it was time to step back from the events as they were occurring and to reflect more systematically—and with less pressure—on what kind of framework would advance the understanding of financial stability issues, how to communicate the importance of these issues, and how to encourage and energize a greater focus on optimizing the benefits of finance for societies at large.

Before actually reaching the decision to take a one year sabbatical from the IMF, I challenged myself to produce an outline of a study on financial stability issues that I was fairly certain I could write, if given sufficient free time. Instead, I produced an outline of a book that I wanted to read, but which I was uncertain I was capable of writing. I will leave it to the reader to decide whether the outcome was worth the effort. My only hope in publishing this study is that practitioners—that is, those who safeguard financial stability—will be motivated to think about these issues in a new and more productive way and that the relevant professions will be encouraged to develop useful, policy-oriented frameworks for achieving and maintaining national and international financial stability.


This study was researched and partly written during a one-year sabbatical from the International Monetary Fund (IMF). I gratefully acknowledge the IMF’s generous financial support under its Independent Study Leave Program.

I also gratefully acknowledge the support and encouragement of the European Central Bank (ECB) and De Nederlandsche Bank (DNB) while visiting them in 2003 and 2004, and would like to thank especially Tommaso Padoa-Schioppa, Mauro Grande, and John Fell at ECB and Henk Brouwer, Jan Brockmeijer, Aerdt Houben, and Jan Kakes at DNB.

Chapters 2, 3, 5, and 6 are based, in part, on material researched and presented in various drafts of several papers (which were later revised and repackaged and issued as IMF Working Papers WP/04/101, WP/04/120, and WP/04/187). These and other related papers benefited from discussions with, and comments from, many colleagues both within and outside the IMF. These include Bill Alexander, Ivan Alves, Michael Bordo, Burkhard Drees, Christine Cumming, Udaibir Das, Phil Davis, Charlie Kramer, Myron Kwast, John Fell, Bob Flood, Andy Haldane, Aerdt Houben, Jan Kakes, Russell Kincaid, Donald Mathieson, Leena Mörttinen, Tommaso Padoa-Schioppa, Lars Pedersen, Eric Peree, and James R. White. I also received useful comments during seminars at ECB, DNB, the European Investment Bank, the University of Hong Kong, and from other IMF colleagues during the review process for IMF working papers.

The chapters presented in Part III of this study are based, at least in part, on material that was originally cowritten with IMF colleagues and published in various editions of the IMF’s International Capital Markets—Developments, Prospects and Key Policy Issues during 1995–2001, and Global Financial Stability Report during 2002–2003. I would like to acknowledge the following coauthors for their contributions to this earlier work and the more recent manifestations of it presented in this study: Charlie Kramer (Chapters 9, 10, and 11); Burkhard Drees (Chapter 9); Todd Smith (Chapter 10); Peter Breuer (Chapter 11); and Oksana Khadarina provided essential assistance in preparing the quantitative part of Chapter 8. I am also grateful to my coauthors Aerdt Houben and Jan Kakes (of DNB) for allowing me to use material from our joint IMF Working Paper WP04/101 and DNB Occasional Paper, “Toward a Framework for Safeguarding Financial Stability,” which we jointly researched, brainstormed, and drafted during a four-month period ending in mid-February 2004, and which makes up part of Chapter 6. I am grateful to my coauthor John Fell for allowing me to use material from our joint paper, “Assessing Financial Stability: Exploring the Boundaries of Analysis,” published in a special financial-stability edition of National Institute Economic Review (April 2005). I am especially grateful to John Fell for providing a fertile environment at ECB for the early stages of my work and for his persistent encouragement to complete this project. In all other instances in which I use material drawn from the work of colleagues both within and outside the IMF it is acknowledged in footnotes. I am grateful to Oksana Khadarina for untiring efforts in producing and updating the tables and charts and also to Yoon Kim for assisting in a part of this effort. Special thanks to Margo and Tom Vuicich for providing a sunny environment for thinking and writing part of this study.

Thanks are due also to Jeanette Morrison, Anne Logue, and Sherrie Brown for their editorial and publishing expertise. I am particularly grateful to Sean M. Culhane for providing expert professional advice and encouragement during each phase of the editorial and production process.

I owe thanks to Michael Mussa (IMF Economic Counsellor and Director of Research, 1993–2001) and David Folkerts-Landau (Assistant Director of Research until 1998) for providing me with the opportunity to be a part of the IMF’s international capital markets surveillance team in 1994–95.

Finally, I thank Katherine, Jack, and Sarah for their loving support throughout these and many other efforts.



alternative risk transfer


collateralized debt obligation


credit default swaps


Commodity Futures Trading Commission


Continuous Linked Settlement


Employee Retirement Income Security Act


funding arrangements


Financial Sector Assessment Program


gross domestic product


guaranteed investment contracts


ruble-denominated discount instrument


Hong Kong Monetary Authority


International Association of Insurance Supervision


International Swaps and Derivatives Association


London Inter-Bank Offer Rate


Long-Term Capital Management


nondeliverable forward (market)


Office of the Comptroller of the Currency


ruble-denominated coupon bonds


over the counter


Special Administrative Region (Hong Kong)


Securities and Exchange Commission


special purpose vehicle


Trans-European Automated Real-Time Gross Settlement Express Transfer System

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