Macroprudential Surveillance: Lessons from Bank of Jamaica R. Brian Langrin Head, Financial Stability Department Bank of Jamaica CARTAC/CACS/SVG FSA CREDIT UNION WORKSHOP AND REGULATORY MEETING CARIBBEAN ASSOCIATION OF CREDIT UNION SUPERVISORS 20 22 AUGUST 2014, KINGSTOWN, ST. VINCENT AND THE GRENADINES 1
Outline Presentation will be in the context of explaining the macroprudential mandate of a central bank Focus on key elements for macroprudential policy surveillance based on BOJ s experience coverage of macroprudential surveillance communication of macroprudential surveillance instituting macroprudential governance and legal frameworks 2
Coverage of macroprudential surveillance BOJ s external Financial Stability Report is the primary tool for communication to financial sector stakeholders The maintenance of financial stability by the Bank of Jamaica (BOJ) primarily concerns the safeguard of conditions which ensure the proper and efficient functioning of the financial system and consequently, the promotion of real economic activity. The financial system consists directly of three basic financial components: institutions, markets and infrastructure. These components interact with each other as well as with other indirect participants in the system such as households, nonfinancial corporations and the public sector to allocate economic resources and redistribute financial risks. 3
Coverage of macroprudential surveillance Balance sheet positions: market & liquidity risk exposures (net funding position; loan to deposit ratio by currency; assetliability maturity structure by currency; available for sale investment portfolio by currency) interest rate risk exposures (asset liability re pricing profile for interest bearing instruments by currency) foreign exchange rate risk exposures (net open position; asset liability re pricing profile by currency; breakdown of assets, liabilities & off balance sheets positions by currency) credit risk exposures (breakdown of loans by sector; breakdown of loans by classification; breakdown of loans by currency; non performing loans by sector) Macroprudential risk factors: market & interest rate risk (daily asset price changes; daily zero coupon domestic and global bond yield curves; duration of assets and liabilities; trading range for money market rates; interest rate historical correlations) credit risk (domestic & foreign currency loan rates for mortgage, commercial, installment, personal credit, domestic & foreign loan to deposit rate spreads, credit bureau data) exchange rate risk (daily exchange rates and historical correlations; loans to non foreign currency earners) Inter bank contagion risk (breakdown of asset and liability secured and unsecured exposures between each bank) Other macroeconomic data: the pace of money and credit growth which tend to precede financial crises through speculative investment by financial sector participants movements in the REER and current account balance which may reflect losses in competitiveness and vulnerability of the economy to external shocks the adequacy of foreign reserves in maintenance of a currency stability and debt servicing movements in fiscal balances and and debt ratios as well as sovereign yield spreads and credit rating migration credit, inflation and capital inflow cycles 4
Comparison of macroprudential and microprudential surveillance Objective Macroprudential Limit the likelihood of financial system wide distress and avoid significant losses in real output Microprudential Limit the likelihood of failure of individual institutions and protect consumers Focus Financial system as a whole Individual institutions View of risk Endogenous Exogenous (risk is seen as dependent on collective actions) (risk is seen as independent of individual actions) Correlations and common exposures across firms Important Irrelevant Calibration of prudential tools Top down (calibrated with respect to crosssectional and time dimensional risks) Bottom up (calibrated with respect to risks incurred by individual institutions) Source: Borio, C. (2003), Towards a Macroprudential Framework for Financial Supervision and Regulation?, CESifo Economic Studies 49, 181 215. 5
Key elements of FSR communication on macroprudential surveillance holistic outlook of the financial system, covering the components of the financial system and their interaction with the real economy aim at influencing changes in behavior of financial sector participants that may pose systemic threats and advance their risk awareness reflect measurement and assessment of the potential direct and indirect impact of macro-financial developments on financial system exposures indicate reasons that the current value of indicators substantiate (or not) the need for policy action, the rationale underpinning the selection of instruments if action is required and tracking of impact on financial stability reflect assessment and monitoring of the debt-servicing ability of the corporate, household and government sectors and the potential for debt spillovers from vulnerable sectors to the financial system. 6
Institutional coverage - assets of Jamaican financial institutions (182% of GDP) Financial sector dominated by commercial banks and securities dealers 7
Financial institutions surveillance Financial Stability Cobweb Gaps from long-term trends* Overall risk levels increased marginally 8 Volatile credit conditions *BOJ Working Paper (September 2012). Countercyclical Capital Buffers for the Jamaican Banking Sector.
Financial institutions surveillance Banking Stability Index Aggregate Financial Stability Index* Improvement in stability of the banking sector *BOJ Working Paper (August, 2010). Measuring and Forecasting Financial Stability: The Composition of an Aggregate Financial Stability Index for Jamaica. 9
Financial institutions surveillance Macrofinancial Index* Microprudential Index for banks* Improvement in stability of the banking sector 10 *BOJ Working Paper (April 29, 2002): An Early Warning System for the Prevention of Banking Sector Crisis in Jamaica.
Financial institutions surveillance CCA distance-to-default for banks* CoVaR for banks** Volatile market based systemic risk measures * BOJ Working Paper (October 2010). A Contingent Claims Approach to Measuring Insolvency Risk. ** BOJ Working Paper (September 2011). Identifying the Risk Transmission Mechanisms within the Jamaican Financial System: The Conditional 11 Value at Risk Approach.
Financial markets are active but still developing Financial Markets Money Market Foreign Exchange Market Capital Market Private Repo Market Interbank Market Commercial Paper Market Spot FX Market Equities Market Government Bond Market Corporate Bond Market 12
Financial markets surveillance Composite Indicator of Systemic Stress* Jamaica-EMBI+ Global bond spread 13 Deterioration in domestic financial market conditions Demand for FX rate hedge rises *BOJ Working Paper (October 2012). A Composite Indicator of Systemic Stress (CISS): The Case of Jamaica.
Financial markets surveillance Spreads of GOJ bond yields & 180- day Treasury bill rate TRE spread 14 Fiscal efforts drive decline in yields after both debt swaps Increase in counterparty risk coincides with tight liquidity conditions
Financial markets surveillance Amihud Index of FX market depth Amihud Index of stock market depth 0.035 0.007 25 1.4 0.03 0.025 0.006 0.005 20 1.2 1.0 Index Points 0.02 0.015 0.004 0.003 Index Points Index Points 15 10 0.8 0.6 Index Points 0.01 0.005 0.002 0.001 5 0.4 0.2 0 0 0 0.0 Monthly Avg of Daily Index (RHS) Daily Amihud Index (LHS) Annual Avg of Daily Index (RHS) Low levels of market depth Monthly Avg of Daily Index (RHS) Daily Amihud Index (LHS) Annual Avg of Daily Index (RHS) 15
Vulnerabilities of indirect financial system participants Households Non-financial firms Government NPL to loans Loan to value Debt service to income H/H credit to GDP Growth in mortgage credit NPL to loans Debt service to income Number of bankruptcies Credit concentration Firm credit to GDP Debt to GDP Debt service to revenue Ext. debt service to exports Interest payments to GDP Fiscal stability ratio Probabilities of default Exposure at default to capital of financial sectors 16
H/H sector surveillance Growth in h/h debt held by banks H/H NPLs to bank capital H/H debt as a % of disposable income Improvement in H/H loan quality despite growing indebtedness 17
Corporate sector surveillance Growth in corporate debt held by banks Corporate sector NPLs to corporate loans Leverage ratio for listed companies Improvement in corporate sector loan quality despite higher leverage BOJ Working Paper (July 2007). A VAR Analysis of the Effects of Macroeconomic Shocks on Jamaica s Banking Sector Loan Quality. 18
Public sector surveillance Growth in public sector debt Probability of sovereign default and bank exposure* Public sector debt service to budget revenue Lower GOJ probability of default reflect improvement in public sector performance *BOJ Working Paper (March 2004): The Implications of Jamaica s Debt Burden for Financial Stability: A System Dynamics Approach. 19
Financial institution stress test assessment Sources of Financial Risks Market Risk Interest Rate Risk Credit Risk Contagion Risk Liquidity Risk Equity Price Risk FX Rate Risk Value at Risk Counterparty Risk Concentration Risk Gap Risk Funding Risk 20
Market risk surveillance VaR for banks VaR for SDs (top 12) Overall increase in VaR inter quartile ranges 21
Interest rate risk surveillance IRR stress tests for banks: 1100 bps increase in domestic rates IRR stress tests for SDs (top 12): 1100 bps increase in domestic rates Decline in IIR resilience for banks and SDs 22
Credit risk surveillance Credit risk stress tests for banks: 30% increase in NPLs Reverse credit risk stress tests for banks Greater resilience of banks to credit quality shocks 23
Contagion risk surveillance Network of exposures Contagion stress test SD sector is most vulnerable to contagion 24
Liquidity risk surveillance Gap analysis for SDs Funding risk stress test for SDs: 10% withdrawal of repo liabilities Slight increase in liquidity risk exposure for SDs 25
Modern but still developing financial infrastructure Financial Infrastructure BOJ Large Value RTGS Payment and Settlement Systems BOJ CSD (GOJ and BOJ Bonds) JSE CSD (Corporate Bonds) SSS CCP ACH Retail Payment Systems Electronic Trading Platforms JSE (Equities and Corporate Bonds) Trading System Credit Bureaus Service Providers Movable Collateral Registry Credit Information Providers 26
Payments and settlement risk surveillance Risk Index of Payment Concentration Share of BOJ intraday repos for 4 of 16 institutions High liquidity concentration 27 BOJ Working Paper (March 2004): A Statistical Analysis of ACH Payment and Liquidity Concentration Risks.
Payments and settlement risk surveillance Volume of DvP trades for GOJ securities Values DvP trades for GOJ securities Hundreds GOJ FR Notes GOJ VR Notes FR USD Notes 100 90 80 70 60 50 40 30 20 10 0 Millions GOJ FR Notes GOJ VR Notes FR USD Notes 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 Sharp decline in trading sovereign bonds following the debt exchange 28
Current Regulatory Structure Financial Regulatory Council Ministry of Finance Bank of Jamaica Deposit taking Institutions Cambio & Remittance Companies Payment and Settlement Systems Primary Dealers FX Market, Money and GOJ Bond Markets Financial Services Commission Securities Dealers Insurance Companies and Brokers Pension Funds Collective Investment Schemes Jamaica Stock Exchange Jamaica Deposit Insurance Corporation Credit Unions and Other MFIs 29
Recent enhancements to BOJ macroprudential framework (1) Need for institutional requirements: 1. a clear mandate to which it can be held accountable with transparent and effective governance arrangements; 2. legal access to the necessary time-critical information especially relating to systemically important institutions, markets and infrastructure which may not otherwise be readily available; and 3. control over a sufficient set of tools to address procyclicality, and externalities, such as rules to address gaps and imbalances, as well as power to implement time-varying countercyclical capital charges and dynamic provisioning requirements, capital conservation measures, LTV and debt service-to-income limits BOJ issued a policy discussion paper that clearly articulated the need to amendment of the CB Act to codify the financial stability mandate* Comprehensive legal framework will be put in place in 2014 to underpin the Bank s responsibility for overall financial system stability Separation of decision-making (Financial Stability Committee) and policy implementation (under BOJ Act, FSC Act, statutes of other regulators) *BOJ Discussion Paper (September 2011). Institutional Arrangements for Safeguarding Financial Stability. 30
Recent enhancements to BOJ macroprudential framework (2) In order to effectively discharge the financial stability function, new draft provisions of the BOJ Act are: mandate the financial stability objective of the BOJ mandate the establishment, composition and tasks of an interregulatory financial stability committee discretionary powers to provide liquidity power to direct inspection power to request information power to issue rules, standards and codes mandate to establish and update a central financial system database mandate the publication of a financial stability report 31
Proposed Framework for Safeguarding Financial System Stability Key Elements for an Effective Macroprudential Framework Goals of macroprudential policy Powers, governance procedures and functions Macroprudential policy transmission and surveillance Communication on macroprudential issues Emergency liquidity facility Crisis resolution procedures 32
Transmission channels of shocks between the real economy and the financial sector Source: International Monetary Fund (2012), Macrofinancial Stress Testing Principles and Practices, IMF Policy Papers, Washington, DC, August. 33
Design of macroprudential policy 34
Proposed Operational Structure for Financial Stability Policy 35
Planned enhancements to framework Although significant steps have been made, BOJ s macroprudential policy framework is not yet complete calibration of macroprudential tools (discretionary vs rule-based) resolution mechanisms (eg. living wills) to minimize costs Establish macro-prudential risk oversight of SIFIs Use of bottom up stress testing results Use of real estate price indices (largest asset class) Use of household and business financial surveys Regional consistency of macroprudential policies (cross-border regulatory arbitrage) Regional MPI benchmarking Include macroprudential policy implementation developments in FSR 36
THANK YOU! Email: brian.langrin@boj.org.jm 37