Annex - Methodology underlying the Foreign Credit exposure and Rollover risk analysis24
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Patrick McGuire is at the Bank for International Settlements (Centralbahnplatz 2, Basel 4002, Switzerland). We would like to thank Markus Brunnermeier, Giovanni Dell’Ariccia, Robert Heath and Arvind Krishnamurthy for their helpful comments and suggestions. A shorter version of this paper will be issued in a volume as part of the NBER Systemic Risk Measurement Initiative.
Attention to systemic risk assessment and contagion has dramatically increased with the global financial crisis, although a precise definition of systemic risk is still lacking. See Borio and Drehmann (2009) and Kaufman and Scott (2003) for a discussion of the definition, and de Bandt et al (2009) for a recent literature survey.
Examples of such quantitative approaches are Boss et al (2006) and Alessandri et al (2009) for Austria and UK respectively. Much of the work done under the Financial Stability Assessment Program (FSAP)—a joint IMF/World Bank effort introduced in 1999—has documented and analyzed such risks in individual countries. And global systems risks are being analyzed in the joint IMF-FSB Early Warnings Exercise (IMF, 2011b).
The crisis also showed that international institutions’ surveillance was often not effective in bringing about policy adjustment in key countries and did not highlight enough global risks (IMF 2011a).
A domestic central bank can supply liquidity in its domestic currency. But liquidity provision in foreign currencies is limited by the available foreign exchange reserves or borrowing capacity of the central bank.
Market frictions, illiquid asset markets or government interventions can limit an institution’s ability to unwind intra-group funding and/or transfer funds across locations, especially during times of financial turmoil. Cerutti et al (2010) document that some host regulators in Eastern Europe ring-fenced foreign affiliates in their territory during the recent crisis. They quantified that banking groups’ inability to re-allocate funds from subsidiaries with excess capital to those in need of capital would imply substantially larger capital buffers at the parent and/or subsidiary level. Similarly, the crisis showed that netting a bank’s balance sheet positions across offices, through consolidating statements, can mask funding risks (Fender and McGuire, 2010).
For example, while a group is fully exposed to all losses at its local branches and through direct cross-border exposures, its losses from subsidiaries are capped by the parent’s equity plus any non-equity intra-group claims. For more details on the differences between branches and subsidiaries, see Cerutti et al (2007).
Other examples of studies using bank-level data are Peek and Rosengren (2000a), which relied on US Call reports and Japanese parent bank reports to show that Japanese banks transmitted shocks from Japan to the United States in early 1990s, and Goldberg (2002), which used US Country Exposure Reports to assess whether US banks transmitted US business fluctuations to their foreign borrowers.
Using stock-market data, Lehar (2005) and Bartram et al (2007) estimate default probabilities for globally active financial institutions to derive measures of systemic risk. Segoviano and Goodhart (2009) exploit the information embedded in large, international banks’ credit spreads to construct a banking stability index and estimate cross-border interbank dependence for tail events. González-Hermosillo and Hesse (2009) examine when key global market conditions (e.g., VIX, forex swap, TED spread) move into a high volatility regime. Lopez et al (2011), extending the CoVAR methodology of Adrian and Brunnermeier (2009) to 54 international banks, find the short-term debt to assets ratio to affect systemic risk, with no evidence that bank size increases systemic risks. Other recent market based models are Acharya et al. (2010) and Huang et al. (2009).
See Cerutti (2011) for more detail on the exposure calculations and the differences between branches and subsidiaries. While parent banks have supported foreign subsidiaries beyond their legal obligation, this is not always the case. Hryckiewicz and Kowelewski (2011) documented 149 episodes when subsidiaries were abandoned between 1997 and 2009. Regarding branches, some countries (e.g., U.S.) have explicit provisions establishing that parent banks are not required to repay the obligations of a foreign branch if the branch faces repayment problems due to extreme circumstances (such as war or civil conflict) or due to certain actions by the host government (e.g., exchange controls, expropriations, etc.). This aspect was not considered in the analysis.
Information on the branch/subsidiary structure in not included in the BIS CBS statistics. For this analysis, as detailed in the Annex, proxies are derived using bank-level data by subtracting total customer deposits in the subsidiary from total assets of the subsidiary, and then aggregating to the level of banking systems.
As detailed in the annex, the adjusted rollover risk measure sums direct cross-border claims and affiliates’ claims that are not financed by local consumer deposits, the latter proxied by the bank-level deposit to loan ratio of foreign subsidiaries and affiliates. This rollover risk measure could, in principle, also be calculated by combining the BIS locational banking statistics by nationality and consolidated statistics (immediate borrower basis). However, a complete picture is possible only for those countries which are reporters of BIS data, which excludes many emerging markets.
The change in foreign claims is calculated after correcting the data for breaks in series, an expansion in the population of reporting banks and for movements in exchange rates. The BIS reports 41 series breaks during the 2007-09 period in the BIS consolidated banking statistics, many of which are large (e.g., the Italian 2007Q1 USD 622 billion and US 2009Q1 USD 903 billion break-in-series due to the coverage expansion).
Estimates (McGuire and von Peter (2009)) suggest that the wholesale US dollar funding needs of many European banks during the crisis greatly exceeded the dollar lending capacity of their home central banks.
Figure 5 implicitly assumes that deleveraging occurs proportionally across domestic and foreign assets. In practice, when deleveraging, banks often liquidate more risky assets first. This can be captured by assuming that banks disproportionately liquidate claims on more vulnerable countries or sell all types of foreign assets first.
In the IMF model, scenarios are calculated for those countries for which consolidated BIS banking statistics on an ultimate risk basis are currently available (Austria, Belgium, Canada, France, Germany, Greece, Ireland, Italy, Japan, Netherlands, Portugal, Spain, Sweden, Switzerland, UK and US). The deleveraging impact is, however, estimated for almost all 180 countries, except for the potential additional impact triggered by funding shocks, which are only calculated for the domestic consolidated banking sector of BIS-reporting countries.
Comprehensive international data on banks’ consolidated balance sheets which follow the BIS CBS aggregation structure but include banks’ domestic positions (i.e., positions vis-à-vis residents of the home country) is not yet available. Only the ECB-Banking Supervision Committee, which reports a national balance sheet for the aggregated domestically-owned consolidated banks in each EU state, provides national aggregates similar to BIS CBS for some concepts, such as Tier I capital and capital ratios, and total bank assets. In other cases, it is necessary to sum individual domestically-owned consolidated banks’ balance sheets, or alternatively, depending on the number of foreign subsidiaries, subtract from national aggregates foreign-owned subsidiaries’ balance sheets.
There are some additional data limitations: (i) the counterparty-sector breakdown is available only for total foreign claims, but not separately for the components of foreign claims (i.e., cross-border claims and local claims); (ii) maturity breakdowns are available only for international claims (immediate borrower basis), which include both cross-border claims (in all currencies) and locally extended claims in foreign currencies; and (iii) the interaction between funding and deleveraging risks is restricted to those countries that report BIS data on an ultimate risk basis (for several important markets, e.g., China, Brazil, Korea, such data are not available).
Access to supervisory data is limited outside the home country. In some cases Memorandums of Understanding allow specific data to be exchanged between two countries. Also, in some cases, data are made available to teams conducting the joint IMF-World Bank Financial Sector Assessment Program (FSAP).
See BIS (2011), Cecchetti et al (2010) and Fender and McGuire (2010) for a discussion of how well-designed aggregate statistics can enhance the monitoring of systemic risks, and for more detailed discussion on the structure of banks’ international operations as revealed in the BIS banking statistics.
The FSB-IMF initiative described above focuses on bank-level worldwide consolidated data, and thus will not contain information on the positions of the individual banks’ entities.
See Cerutti (2011) for more details about the foreign credit exposure and rollover risk analyses, including information about necessary corrections for breaks in series and exchange rate movements.
In the cases where affiliates’ bank level data are not available, borrower country national deposit to loan ratio is used in order to have larger country coverage. Using affiliates’ total assets minus deposits, like in the case of the foreign default exposure to subsidiaries, as the proxy of the amount of lending by affiliates funded by their parent banks produce similar results but lower country coverage.
Financial institutions are assumed to be able to sell their assets at book value. Fire sales at below book value may amplify deleveraging.