In response to the recent crises, many institutions have initiated or intensified work on developing macroprudential indicators and macroprudential analysis capabilities. A selection of these efforts is summarized in this section. The statistical frameworks that are in place in some of the institutions are discussed in Appendix I.
International and Multilateral Institutions
European Central Bank
Upon the request of the European Central Bank (ECB) Banking Supervision Committee (BSC), the ECB’s Working Group on Financial Fragility has carried out preliminary work on MPIs. This working group separated potential indicators into three categories: (1) systemic indicators of the health of the banking system, (2) macroeconomic factors that influence the banking system, and (3) contagion factors. With regard to the first category, it proposed the monitoring of the following variables: lending behavior, competitive conditions, liquidity situation, exposure concentrations, asset quality, profitability, capital buffers, and market assessments. The macroeconomic indicators suggested as factors that influence the banking system were income development, leverage (financial fragility), debt burden, asset prices, monetary conditions, and the external position.51
The BSC has recently established the Working Group on Macroprudential Analysis. The mandate of the working group is to develop a framework for macroprudential analysis following the approaches of several Scandinavian countries (explained below). Based on this framework, the group is to draft a report on European Union (EU)-wide MPIs that would serve as a basis for BSC discussion of the soundness and characteristics of the EU banking systems. The framework would draw on economic statistics as well as supervisory insights. Currently there are no plans to make the results of the exercise public. The BSC also operates the Cooperative Forum on Early Warning Systems, with voluntary participation by interested EU member states. Even though these projects are facilitated by the relatively high degree of harmonization of standards within the EU, comparability of indicators among member states is complicated by, among other factors, remaining differences in accounting and provisioning norms.
World Bank
The World Bank has been conducting Financial Sector Assessments (FSAs) for a number of countries where it is involved in financial sector work and where financial sector issues are considered particularly relevant to the World Bank’s lending decisions. These assessments are focused on both stability and developmental aspects of the financial sector and contain an analysis of a range of MPIs, both macro-economic indicators as well as banking indicators. The latter are drawn primarily from public data (published accounts). In order to avoid overlap and duplication of work in this area, the IMF and the World Bank have recently established a joint framework for comprehensive assessments of financial sectors, the FSAP.52
In addition to the more qualitative FSAs, the Country Credit Risk Department of the World Bank uses various risk-rating models in order to determine the likelihood of default of its borrowers. These models include a checklist model that is more complex but otherwise very similar to the ones used by rating agencies and investment banks. The main areas covered by this model are (I) structural and macroeconomic indicators of economic performance and external vulnerability, (2) external debt and its sustainabilily, (3) political risk and policy performance, and (4) World Bank exposure and history of debt service to the Bank.
The Country Credit Risk Department is also the secretarial of the Short-Term Risk Monitoring Group of the World Bank. This group is responsible for assessing and monitoring countries that are vulnerable to political, economic, or financial crises in the near term. The group reports to the senior management of the World Bank on both vulnerable countries and trends in the global economy and financial markets on a monthly basis. A country’s vulnerability to domestic or exogenous shocks is assessed using macroeconomic and policy performance indicators (including indices developed by some of the World Bank’s regional departments), financial market indicators, and qualitative assessments provided by operational and central units, including financial sector specialists. As the secretarial of the group, the Country Credit Risk Department is also responsible for assisting operational units in preparing contingency plans for countries that are considered highly vulnerable. These contingency plans are intended to ensure a broad understanding of the situation in the country concerned and to facilitate a discussion by senior management of the World Bank’s response.
G–7 and G–10 Initiatives
The G–7 endorsed, in February 1999, a proposal by Hans Tietmeyer, former president of the Bundesbank, to establish the Financial Stability Forum (FSF). The forum comprises representatives from the G–7 countries plus Australia, Hong Kong SAR, the Netherlands, Singapore, the IMF, the World Bank, the Bank for International Settlements (BIS), the OECD, the Basel Committee on Banking Supervision, the International Organization of Securities Commissions (IOSCO), the International Association of Insurance Supervisors (IAIS), the Committee on Payment and Settlement Systems (CPSS), and the Committee on the Global Financial System (CGFS). Part of the mandate of the FSF is to strengthen the monitoring and assessment of systemic vulnerabilities. The FSF has established three working groups dealing with highly leveraged institutions, capital flows, and offshore financial centers, respectively. In addition, a task force on implementation of standards and study groups on deposit insurance and insurance issues have been set up. A study paper on Internet and electronic trading in financial markets has also been commissioned. It appears that the FSF will primarily focus on specific areas of systemic vulnerability of the financial system and not on the continuous monitoring of large sets of indicators.
The CGFS has a mandate from the governors of the central banks of the G–10 member countries. It acts as a central bank forum for the monitoring and examination of broad issues relating to financial markets and systems with a view to elaborating appropriate policy recommendations to support the central banks in the fulfillment of their responsibilities for monetary and financial stability. The tasks performed by the CGFS fall into three categories: systematic short-term monitoring of global financial system conditions, so as to identify potential sources of stress; in-depth, longer-term analysis of the functioning of financial markets; and the articulation of policy recommendations aimed at improving market functioning and promoting stability. The mandate recognizes that the causes of financial instability can arise from both the behavior of markets and the complex interrelationships that exist between institutions, markets, infrastructures, and macroeconomic policy.
Non-G–10 central banks now routinely attend meetings of the CGFS and participate in its working groups. In recent public reports, the committee has focused on the nature and use of information available for banks’ country risk assessments; it has identified general principles and more specific policy recommendations for the promotion of liquid government securities markets; and it has examined the events surrounding the financial turbulence in many international markets in autumn 1998.53 One of its working groups has formulated a set of public disclosure guidelines to provide a meaningful basis for comparing levels and types of risk across institutions and across countries. This work, in turn, has been incorporated in a multidisciplinary effort comprising representatives from the banking, securities, and insurance regulators. A pilot effort involving private sector firms is to be conducted.
The G–10 Working Party on Financial Stability in Emerging Market Economies published a report on financial stability in emerging markets in April 1997. This report identifies both macroeconomic sources of vulnerability (instability, inflation, liberalization, and failures in the design of macroeconomic policy instruments), as well as sector-specific sources of vulnerability (corporate governance and management, market infrastructure and discipline, and supervision and regulation). The report also contains a list of indicators of robust financial systems. These indicators are categorized under the following six groupings: (1) legal and judicial framework; (2) accounting, disclosure, and transparency; (3) Stakeholder oversight and institutional governance; (4) market structure; (5) supervisory and regulatory authority; and (6) design of a safety net. Under these categories, the report lists areas of importance, but not specific indicators. The areas mentioned are broadly equivalent to those identified by other institutions, including the IMF.
National Central Banks and Supervisory Agencies
Until recently, relatively few countries paid in-depth attention to macroprudential analysis at the national level, although national central banks and supervisory agencies in many countries have long monitored and reported on issues relating to financial system stability. While much of this work has a macroprudential aspect, it is not necessarily carried out with a formal framework for using MPIs to assess financial system soundness.54 The complex nature of the analysis and the need for high-quality data on individual banks, collected and stored in a manner conducive to aggregation and analysis, has meant that much of the existing MPI-related work has been carried out relatively recently and mainly, but not exclusively, in the industrial countries. Within this group, the most developed approaches tend to be those by countries that have had a major financial sector crisis in recent years. Work is, however, currently under way in a number of countries to develop macroprudential data collection and analysis frameworks.
Following is a selective country-by-country summary of work that has been carried out, both with a specific focus on identifying MPIs, and with other focuses that may, nevertheless, provide a guide to possible MPIs. Table 3 gives a comparative listing of indicators used in a few selected countries. The listing is certainly not comprehensive—neither with respect to the countries nor the indicators being used. Rather, our intent is to provide a sketch of the different types of approaches and key indicators.
Comparative Listing of Indicators Used by Selected Country Authorities
Variables used to forecast bank profitability
includes separate analysis of savings banks and securities markets
The output from the Uniform Bank Surveillance System (UBSS) is inputted to the FIMS. The U8SS ranks institutions’ financial ratios relative to those of their peer groups, so as to identify which institutions are performing relatively poorly.
These variables have been tested to see if they improve model performance.
Volatile liabilities are defined as the sum of: time deposits of $100,000 or morel deposits in foreign offices: federal funds purchase and repurchase agreements; demand notes issued to the U.S. Treasury; and other liabilities for borrowed money.
Comparative Listing of Indicators Used by Selected Country Authorities
United States | |||||
---|---|---|---|---|---|
Federal Reserve | Federal Deposit Insurance Corporation | ||||
Bank of Finland1 | Norges Bank2 | Sveriges Riks bank | Financial Institutions Monitoring System | Growth Management System | |
Banking sector variables | Assessments of bank expenses Assessments of loan losses and other write-offs | Capital/assets ratios Profitability trends Return on assets Gross interest margins Spread between short- and long-term interest rates Operating costs trends Deposits/loans ratios Deposit, loan growth rates Trends in riskiness of corporate debt Sectoral debt and debt‐ servicing ratios Forecast past‐due loans Trends in bank financing from other sources | Profitability trends Return on assets Gross interest margins Spread between short‐ and long-term interest rates Operating costs trends Banks’ share prices Bankruptcy trends Trends in past due loans by sector Sectoral debt and debt‐ servicing ratios Counterparties‐risk exposure | Tangible capital/assets ratio Loans past due, 30–89 days Loans past due, 90 days or more Nonaccrual loans Foreclosed real estate Net income/assets ratio Reserves Investment securities/assets ratio UBSS asset growth percentile score3 UBSS composite percentile score3 Prior management rating Prior composite CAMEL rating | Equity/assets ratio Asset growth Loan growth Volatile liabilities/assets Loans/assets ratio Portfolio concentration4 Growth in portfolio concentration4 Equity/assets growth4 Loans/assets growth4 Volatile liabilities/assets growth4,5 |
Macroeconomic variables | Market interest and exchange rates Asset prices Output and income Savings and investment Monetary aggregates Balance of payments | Impact of interest rate changes Growth rate of lending Asset prices GDP growth Corporate debt levels | Level of real interest rates Growth rate of lending Trends in inflation and expectations Trends in intermediation and competition |
Variables used to forecast bank profitability
includes separate analysis of savings banks and securities markets
The output from the Uniform Bank Surveillance System (UBSS) is inputted to the FIMS. The U8SS ranks institutions’ financial ratios relative to those of their peer groups, so as to identify which institutions are performing relatively poorly.
These variables have been tested to see if they improve model performance.
Volatile liabilities are defined as the sum of: time deposits of $100,000 or morel deposits in foreign offices: federal funds purchase and repurchase agreements; demand notes issued to the U.S. Treasury; and other liabilities for borrowed money.
Comparative Listing of Indicators Used by Selected Country Authorities
United States | |||||
---|---|---|---|---|---|
Federal Reserve | Federal Deposit Insurance Corporation | ||||
Bank of Finland1 | Norges Bank2 | Sveriges Riks bank | Financial Institutions Monitoring System | Growth Management System | |
Banking sector variables | Assessments of bank expenses Assessments of loan losses and other write-offs | Capital/assets ratios Profitability trends Return on assets Gross interest margins Spread between short- and long-term interest rates Operating costs trends Deposits/loans ratios Deposit, loan growth rates Trends in riskiness of corporate debt Sectoral debt and debt‐ servicing ratios Forecast past‐due loans Trends in bank financing from other sources | Profitability trends Return on assets Gross interest margins Spread between short‐ and long-term interest rates Operating costs trends Banks’ share prices Bankruptcy trends Trends in past due loans by sector Sectoral debt and debt‐ servicing ratios Counterparties‐risk exposure | Tangible capital/assets ratio Loans past due, 30–89 days Loans past due, 90 days or more Nonaccrual loans Foreclosed real estate Net income/assets ratio Reserves Investment securities/assets ratio UBSS asset growth percentile score3 UBSS composite percentile score3 Prior management rating Prior composite CAMEL rating | Equity/assets ratio Asset growth Loan growth Volatile liabilities/assets Loans/assets ratio Portfolio concentration4 Growth in portfolio concentration4 Equity/assets growth4 Loans/assets growth4 Volatile liabilities/assets growth4,5 |
Macroeconomic variables | Market interest and exchange rates Asset prices Output and income Savings and investment Monetary aggregates Balance of payments | Impact of interest rate changes Growth rate of lending Asset prices GDP growth Corporate debt levels | Level of real interest rates Growth rate of lending Trends in inflation and expectations Trends in intermediation and competition |
Variables used to forecast bank profitability
includes separate analysis of savings banks and securities markets
The output from the Uniform Bank Surveillance System (UBSS) is inputted to the FIMS. The U8SS ranks institutions’ financial ratios relative to those of their peer groups, so as to identify which institutions are performing relatively poorly.
These variables have been tested to see if they improve model performance.
Volatile liabilities are defined as the sum of: time deposits of $100,000 or morel deposits in foreign offices: federal funds purchase and repurchase agreements; demand notes issued to the U.S. Treasury; and other liabilities for borrowed money.
As a general observation, to the extent that specific MPIs are identified for a given country, they tend to be aggregated microprudential indicators rather than macroeconomic indicators. This may reflect the fact that while it is generally possible to identify the ex post macroeconomic variables that have contributed to systemic problems, it is difficult, ex ante, to predict the macroeconomic developments that may trigger problems, or their precise timing. Nonetheless, it is clear that macroeconomic indicators play a central role in almost all macroprudential analysis frameworks. As a further observation, while the indicators monitored in different countries are broadly similar, where differences do arise they often reflect country-specific characteristics of past financial sector problems.
China
As with many other countries, the Chinese authorities are in the early stages of building a framework for macroprudential analysis. A range of indicators to be collected and monitored has been identified. Macroeconomic variables include GDP, inflation, monetary aggregates, the current account balance, external debt, international reserves, and the exchange rate. Aggregated microprudential indicators, building on the off-site supervision of commercial banks, include indicators of general performance (trends in total assets, loans, and deposits); safety indicators (capital adequacy, asset quality, and credit concentration); liquidity indicators (liquidity of assets, excess reserves, and liquidity of domestic and foreign currency liabilities); earnings indicators (return on equity and assets); and overall control indicators (loan to deposit ratios, proportion of interbank financing, and proportion of offshore financing).
The People’s Bank of China is currently working to further develop a framework for collecting and analyzing MPIs. The ongoing transition to a market economy means that parts of the financial infrastructure—such as accounting and auditing practices—are still being developed. In addition, prudential data quality may vary across different regions of the country. Improvements are under way in the area of regulation and supervision of financial institutions, including upgrading loan classification standards, and strengthening the supervisory capabilities of the central bank, which will enhance the quality of macroprudential analyses.
Finland
The Bank of Finland is one of the few central banks to have a framework for forecasting banking sector developments. In addition, the Bank of Finland is actively participating in the work being undertaken by the ECB in developing a system of MPIs. The banking forecast framework was developed in the wake of Finland’s banking sector crisis in the early 1990s, with a view to assisting in its resolution by analyzing likely developments in the banking sector. The framework produces a forecast of trends in banking system profitability over about a two-year time span. While the framework can highlight areas of vulnerability in the banking system through the impact on profits, it is not focused on identifying specific vulnerabilities. Potential vulnerabilities, however, are taken into consideration in the sensitivity analyses.
The framework is formally linked to the Bank of Finland’s macro forecasting model of the Finnish economy. As such, it incorporates a number of macroeconomic variables (for example, GDP growth and interest rates) as inputs to forecast the components of gross income, while the outputs of the framework (bank profitability, and bank lending and deposit interest rates) are inputs to the model. There is thus a feedback relationship between the framework and the macro model, requiring iterations between the two forecast procedures. Data inputs to the framework are used to develop forecasts of the various components of the banking system’s gross income and expenses, which are then aggregated to produce an estimated trend in banking sector profitability over the forecast time frame.
Norway
Norges Bank has produced reports on the situation and outlook for the financial sector since 1995.55 The work includes both analyses of developments in financial institutions, primarily in the banking sector, and the relationship between macroeconomic and financial sector developments. Analyses of the financial position of households and enterprises are important elements of this framework. The reports are for the internal use of the financial sector authorities and are not published. Norges Bank has published excerpts, however, in the second and fourth editions of each year’s quarterly Economic Bulletin since 1997. In keeping with the summary approach being taken, the published reports are relatively qualitative, with overall assessments of financial health rather than a focus on critical values of specific indicators.
The approach taken is to generate an initial assessment of the trends in macroeconomic variables that are of relevance to the financial sector and, in particular, to the earnings of financial institutions. These variables include economic growth, interest rates, credit growth, and sectoral debt levels. Following this analysis, a range of individual indicators of the financial health of the banking system are incorporated in the assessment (e.g., capital adequacy ratios, credit growth rates, trends in overdue loans, interest rate trends, and trends in operating costs). Specific attention is paid to the banks’ exposures to the real estate market. Given that past experience has shown that enterprise sector loans have been a major source of bank losses, attention is also paid to the exposure of banks to the enterprise sector, as well as to the ability of firms in that sector to cope with an unexpected deterioration in their financial condition and to stay current with their debt servicing. A similar sectoral analysis is conducted of the financial condition of the household sector. The analysis also covers recent trends in aggregate bank profits, including the components of earnings and expenses, and other balance sheet items. The objective is to identify trends, as well as to explain them. Finally, attention is paid to the risks arising from financial institutions’ exposure to the securities markets.
Sweden
The Swedish approach to assessing banking system health is similar to the one followed in Norway. It is somewhat more formalized but does not follow a model approach as in the case of Finland. The assessments are carried out by the Sveriges Riksbank in the context of its responsibility to promote a safe and efficient payment system, as set out in the Riksbank Act. Given the integration of the payment system with the financial system as a whole, the Riksbank’s surveillance of payment system developments encompasses systemic issues relating to banking system stability. The Riksbank’s surveillance is directed toward systems and markets and, therefore, complements the supervision of the banking system by the Swedish Financial Supervision Authority, which is primarily aimed at individual institutions.
Since 1997, the Riksbank has been publishing reviews of the banking system on a semiannual basis.56 The approach clearly starts with the payment system. It focuses on aggregated risks, rather than bank-specific issues, A major objective of the reports is to raise the financial sector’s awareness of vulnerability issues. The method is to assess risks to aggregate banking sector profits based on information from the markets, on a sector-by-sector basis. The assessments are carried out by looking at three categories of risk that affect banks’ abilities to generate profits: (1) strategic risks, or factors affecting profit generation over the longer term; (2) credit risks, or risks to profits over the medium term; and (3) counterparty and settlement risks, or risks that affect profits over short and very short terms.
A list of the variables that are examined in the Swedish approach is presented in Table 3. The list is indicative, partly because the approach incorporates a large number of variables, and partly because some aspects of the analysis are qualitative—for instance, the speed of deregulation, the degree of competition in the banking sector, and assessments of key risk management features—and, therefore, do not lend themselves to inclusion in a listing of quantitative indicators. The macroeconomic variables that are reviewed include the growth rate of aggregate lending, the rate of change in inflation, changes in inflation expectations, and the level of real interest rates. Several banking sector variables are also reviewed, including profits, the degree of disintermediation, bankruptcies, loan performance by sector, and debt-servicing capabilities by sector.
United Kingdom
Under a 1997 Memorandum of Understanding between the United Kingdom Treasury, the Bank of England, and the Financial Services Authority, the Bank of England is responsible for the stability of the financial system as a whole.57 A Standing Committee of the Treasury, the Bank of England, and the Financial Services Authority meets monthly to discuss developments relevant to financial stability. One of the tasks that the Bank of England undertakes to discharge its responsibility is the surveillance of financial stability conditions, including the assessment of actual or potential shocks, and of the system’s capacity to absorb shocks. The Financial Stability Area of the Bank of England undertakes a monthly assessment of financial stability and produces a variety of more narrowly focused notes. A more thorough review of the financial stability conjuncture and outlook is undertaken every six months and a version is published in the Bank of England’s Financial Stability Review.58 The review also includes articles relating to the assessment of risks to financial stability. While the monthly assessments are used to inform some other public documents, the assessments themselves are not published.
Rather than use complex models, the Bank of England’s approach is to review a range of information from the United Kingdom, industrial economies, and emerging market economies and try to identify key developments, vulnerabilities, and risks that could affect financial stability. While the Bank of England is exploring the use of aggregated microprudential data covering groups of institutions in this work, and financial market data naturally play a key role, macroeconomic indicators are also regarded as important for financial-stability analysis (e.g., saving-investment balances and external balance sheets).
There are some problems with compiling aggregated microprudential data, as the existing data reporting systems were designed to support the supervision of individual institutions rather than surveillance of the system as a whole. Work is being undertaken by the Bank of England, together with the Financial Services Authority, to address this issue so that, for example, better analysis of peer groups of banks can be carried out. In addition to its work in this area, the Bank of England is seeking to develop its use of MPIs. This work includes identifying MPIs that might be useful in general, rather than specifically for the United Kingdom, and reviewing general issues relating to macroprudential surveillance.59
United States
The three institutions that have responsibility for different aspects of banking supervision—the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve, and the Office of the Comptroller of the Currency (OCC)—have, over time, developed similar models and indicators aimed at assessing the overall health of individual banks based on summary data submitted by the banks as part of their off-site supervision exercises. Aggregating the information for individual banks can provide assessments of the health of significant components of the financial system. Work has also been carried out, for example, by the Federal Reserve, to identify macroeconomic variables that could be incorporated in predictive frameworks. While individual variables have been found to be significant within sample, none have significantly improved out-of-sample predictive power.
In general, the variables used in the assessments of the future health of individual banks by the supervisory institutions in the United States are proxies for the various factors taken into account when performing a full ex post CAMELS rating. These variables for an individual bank may be useful as MPIs when one or more banks individually are sufficiently large to have systemic implications. At an aggregated level for the banking system, the variables that have been found to be significant in assessing the current health of a bank may be used as MPIs. As an example, the variables used by the Federal Reserve in its Financial Institutions Monitoring System (FIMS) exercise to assess the current health of a bank are included in Table 3 (see page 21).60
As an extension of the assessments of current health of individual banks, the U.S. supervisory agencies have also worked on models for assessing the current riskiness of banks that can generate probabilities of future failure. To the extent that these models perform successfully, they can be used to focus scarce on-site supervision resources on those banks judged to be at the highest risk, and to take early steps to reduce those risks. Again, the variables used could be useful as MPIs. As an example of the MPIs that might be derived from this approach, the variables used by the FDIC in its Growth Management System (GMS) to assess probabilities of future bank failures are also provided in Table 3,61 Some of the variables that are being examined for possible future inclusion in the FDIC model are included in this table as well.
The computerized statistical system that supports the work of the three agencies permits joint collection of income, operating activity, and balance sheet data for individual banks, which are roughly disaggregated into national and worldwide components. The system generates statistics for a variety of purposes by each agency, such as supporting the supervision of individual institutions, econometric research, and aggregation into macroeconomic statistics. The data are regularly used for multivariate cross-section or time-series analyses of income or balance sheet items. Also, the data are aggregated by the Federal Reserve into the sectoral balance sheets used in the flow of funds and the national accounts. Thus, it is a fully integrated system that permits supervisory, statistical, and econometric analysis of microdata, sectoral structural data, and macroeconomic data.
Indicators Used by Investors and Rating Agencies
Private investors such as banks, securities firms, and investment funds use various indicators to evaluate the vulnerability of financial systems. The primary purpose is to determine the creditworthiness of borrowers and issuers that have significant exposure to a particular financial system.62 Such analysis is generally based on three kinds of indicators:
Indicators- published by official sources—the government and central bank, as well as international financial institutions, such as the IMF, the World Bank, and the BIS.
In-house analyses of vulnerability of financial systems. This type of analysis, which some financial institutions conduct, is often based on well-established indicators such as CAMELS ratings, rather than on comprehensive macroprudential models. Main sources for the indicators are IMF or World Bank publications. Indicators of the vulnerability of individual borrowers and issuers—an area where financial institutions do have a comparative advantage through their business relationship—are considered proprietary information and are usually not publicly available.
Creditworthiness ratings by credit rating agencies. Most investors still regard ratings as the best available indicators of vulnerability, even though the limitations of ratings are well recognized.
For most investors, credit rating agencies are the primary source of information on the creditworthiness of individual financial institutions (issuer and debt ratings), and on the creditworthiness of the government (sovereign risk ratings). Both ratings taken together can serve as an indicator of market perceptions of the vulnerability of a country’s financial system.
For sovereign ratings, the most commonly used indicators are recent economic performance, the quality of economic and financial management, the depth and sophistication of markets, the stability of economic policy, the stability and effectiveness of the political system, and long-term trends and expected future performance. Particular emphasis is often given to the quality of economic management, the stability of policy, and the depth and sophistication of local markets. Some agencies use methodologies geared more toward macroeconomic indicators such as income and economic structure, economic growth prospects, fiscal flexibility, public debt burden, price stability, balance of payments flexibility, and external debt and liquidity, as well as political risk. Recent studies have found that creditworthiness ratings appear to be determined primarily by economic events, rather than political variables. Moreover, following the Asian crisis, rating agencies are placing greater emphasis on factors such as external debt and liquidity, banking soundness, and corporate leverage.63
For bank ratings, indicators include quantitative factors such as asset quality, capital adequacy, profitability and liquidity, as well as qualitative factors such as environment, business franchise values, management quality, hidden strengths and reserves, and hidden weaknesses and overvalued assets.64 In addition to publishing issuer ratings, rating agencies also compile ratings of particular debt issues. In the case of bank debt issues, their usefulness as an MPI may be limited by the fact that these ratings usually incorporate an evaluation of the likelihood of government support.65 Therefore, in addition to those traditional ratings, some agencies have developed ratings that are designed to indicate financial strength on a stand-alone basis.66 Such ratings reflect the probability that outside assistance will be needed, but not the probability that it will be provided. In practice, financial strength ratings primarily look at bank-specific elements such as financial fundamentals, franchise value, and business and asset diversification, but also take into account the bank’s operating environment, including the strength and prospective performance of the economy, as well as the structure and relative fragility of the financial system, and the quality of banking regulation and supervision.