The Role Of Central Banks In Financial Stability And Supervision Flashcards
Define financial stability
The condition in which the financial system is capable of withstanding shocks.
Why should we want financial stability?
So the financial system can still provide crucial services during good and bad times. If not it can exacerbate negative effects
Talk about the evolution of Central Bank’s function.
Evolved over time. Financial stability used to be an ancillary role to price stability but following the 2008 GFC, financial stability became a specific branch of regulation - macro prudential policy.
How does macro prudential policy shift the focus from micro supervision?
Shifts the focus from stability of an institution to stability of the financial system as a whole.
Focussed on material risks that can affect the real economy coming from the financial system
Attention to all actors. Financial and non financial agents and their interactions
What’s the key idea about the financial system and how it’s linked to crises and instability?
EXTERNALITIES
Pro-cyclicality: bank’s liquidity is worse during tough times when it’s called upon. This can exacerbate fluctuations
Interconnection: there are links between actors and exposure to common risks.
Talk about what macro prudential policy entails.
Identify and monitor vulnerabilities. Assess systemic risks
Identify and calibrate macro prudential instruments to:
- prevent excessive build-up of risk
- make sector more resilient and lkmit contagion effect
- create right incentives
Manage dynamically instruments when risk materialises
What sort of risks do we analyse in macro prudential policy?
Credit risk, market risk, interest rate risk, new and emerging risk
Give some macro prudential instruments
CAPITAL
- counter-cyclical Buffett
- additional reserves for banks too big to fail
- general buffer
CREDIT
- borrower based measures (DTI, LTV)
Talk about the roles and institutional setting with macro prudential risk.
You need to assess stability, set policy and monitor.
Sometime this is all done in CB or sometimes there are independent institutions.
Talk about pros and cons of having all macro prudential roles in the CB
Pro: easy to coordinate
Cons: conflict of interest. CB may want to increase lending but macroprud may want to increase buffers.
What is a stress test?
A simulation to assess how financial institutions respond to adverse conditions.
Bottom-Up vs Top-Down Stress Tests
Bottom up:
- devise constrains and situation then have institutions project results using their own models.
-get results, quality assurance and apply potential consequences
-quick, easy, equal treatment
Top-down
-authority does everything using their information
-time consuming and costly
What are the issues with micro prudential stress tests?
Well, to assess financial stability you need to look at interconnections and pro-cyclicality. This doesn’t happen
What do macroprudential stress tests account for? What’s the methodology? What does this achieve?
-Interconnectivity
-non-bank financial institutions
-intermediary reactions
-Generally top down using bottom up inputs
- Assesses system’s resilience.
