Stability

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See also Financial Stability Board and Financial Stability Forum

Bank of England Stability report

Overview

The financial system has been significantly more stable over the past six months, underpinned by the authorities’ sustained support for the banking system and monetary policy measures. Low risk-free interest rates and reduced uncertainty among investors have led to a rebound in a range of asset prices. Activity in many capital markets has resumed, reducing financing risks for some borrowers. The market rally has boosted bank profits and lowered concerns about potential future losses, and banks have raised further external capital. As solvency concerns have eased, banks have been able to issue unguaranteed term debt, helping them to reduce their reliance on short-term funding.

But overstretched balance sheets will take time to adjust fully. Around the world, a number of borrowers, including in the commercial property sector, have large refinancing needs in the coming years. And while funding costs remain low, there is a risk of market participants building excessively risky positions, which could unwind abruptly when yield curves eventually rise. Banks need to reduce leverage further, extend the maturity of their funding and refinance substantial sums as official sector support is withdrawn. While their profitability is relatively buoyant and market conditions are broadly favourable, banks should take the opportunity to do so. That will reduce the risk of disruption to the flow of credit in the future.

In the medium term, the root causes of this and previous systemic crises must be tackled — excessive risk-taking in the upswing of the credit cycle and insufficient resilience in the subsequent downturn. An expectation that ‘too important to fail’ firms will receive public assistance, and that unsecured wholesale creditors will not share losses, has exacerbated both the boom and the bust. That calls for a robust multi-faceted policy response. Regulatory policies should give greater emphasis to systemic risks over the cycle and across institutions, as set out in a recent Bank discussion paper. They should be complemented by structural measures to contain the spread of risk across the system. And because failures of financial institutions cannot and should not be prevented, the resolution framework will need to be improved to limit the impact on the wider economy.

Measuring Financial Stability – a literature survey

BIS Economists Blaise Gadanecz and Kaushik Jayaram have written a superb literature survey on measures of financial stability.

This paper is a modest contribution to review the work done towards developing quantitative measures of financial stability and their use in published FSRs. The paper is structured as follows. In Section I, we look at definitions of financial stability and what they mean for identifying key variables, which we discuss in Section II. In Section III, we review how these individual variables might be combined into composite indicators for the purposes of monitoring key sectors of the economy and assigning critical values. In Section IV, we provide a comparative view of the main variables and indicators used in selected FSRs. In Section V we discuss recent attempts to construct a single aggregate measure of financial stability. The final section concludes.

Very useful primer on financial stability measures. Not surprisingly, lots of issues still remain despite loads of work. The concept of financial stability itself is in unstable stages.

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