requirements Mathias Drehmann and Mikael Juselius Bank for International Settlements Understanding Macroprudential Regulation Norges Bank Oslo 2930 November 2012 2 ID: 573687
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Slide1
Improving early warning indicators for banking crises – satisfying policy requirements
Mathias
Drehmann
and Mikael
Juselius
Bank for International
Settlements
“Understanding Macroprudential Regulation”
Norges
Bank, Oslo, 29–30
November
2012
Slide2
2
CGFS report No
48
Operationalizing
the selection and application of macroprudential
instruments Slide3
Operationalising macroprudential policies
Report
focusses on
3 high-level
criteria that are key in determining instrument selection and application in
practice
The ability to determine the appropriate timing for the activation or deactivation of the instrumentThe effectiveness of the MPI in achieving the stated objectiveThe efficiency of the instrument in terms of a cost-benefit assessment
3Slide4
Report ends with 9 questions and answers
To what extent are vulnerabilities building up or crystallising?
How (un)certain is the risk assessment?
Is there a robust link between changes in the instrument and the stated policy objective?
How are expectations affected?
What is the scope for leakages and arbitrage?
How quickly and easily can an instrument be implemented?What are the costs of applying a macroprudential instrument?How uncertain are the effects of the policy instrument?
What is the optimal mix of tools to address a given vulnerability?
4Slide5
Report analysis three groups of macroprudential
instruments
C
apital-based
tools (countercyclical capital buffers, sectoral capital requirements and dynamic provisions
)
Liquidity-based tools (countercyclical liquidity requirements)Asset-side tools (loan-to- value (LTV) and debt-to-income (DTI) ratio caps)For all tools report proposes ‘transmission maps’5Slide6
Increase
resilience
Impact on the credit cycle
↑ lending spreads
dividend and bonuses
Undertake SEOs
1
credit demand
Options to address shortfall
Asset prices
Loan market
Increase
capital requirements or provisions
credit supply
Voluntary buffers
Arbitrage away
Leakages to non-banks
Expectation channel
Reprice loans
assets, especially with high RWA
↑
Loss Absorbency
Tighter risk management
Transmission map for capital
based tools Slide7
7
Improving early warning indicators for banking crises – satisfying policy requirements Slide8
Introduction
CGFS (2012):
Policymakers
need to be able to
determine
the appropriate timing
for the activation or deactivation of the instrumentIn this paper we want to find reliable early warning indicators (EWIs) for systemic banking crisesWhat policy requirements do EWIs need to satisfy?Need to be evaluated with preference free methodology
Need to have right timing
Need to be
stable
Need
to be
robust
Need to be understood by policymakers
8Slide9
We assess a broad range of indicators
We find
Credit-to-GDP gap best indicator for predicting crises 2-5 years in advance
Debt service ratios highly successful indicator for predicting crises 1-2 years in advance
Implementing the framework
9Slide10
To fully evaluate quality of a signal would need to know preferences of policymakers, which are
unknown (
eg
CGFS (2012))
What are costs of
acting on
wrong signals (false positives)?What are the benefits of
acting on correct
signals (true positives)?
→
Need to evaluate signalling quality independent of preferences
10
How to evaluate the goodness of an EWI? Slide11
11
The ROC curve
Policymakers receive noisy signal S
S higher → higher risk
of a crisis
At which threshold you policymakers
act? Slide12
Area under ROC curve as measure of signalling quality
Area under the ROC curve (AUROC) provides summary measure of the classification ability
(
eg
Jorda
and Taylor, 2011): AUROC=0.5 →
uninformative
indicator
AUROC=1
→
fully
informative indicator
AUROC ideal measure if preferences are not known
Benefits
Can be estimated non-
paramterically Has convenient statistical properties
12Slide13
Timing of ideal EWIs
Ideal EWI needs to signal crisis early enough
Likely to be 1-2 year lead-lag relationship (e.g. countercyclical capital buffers)
Policymakers tend to observe trends before reacting (e.g. Bernanke, 2004)
Ideal EWI signal crises not too early
Introducing buffers too early may undermine effectiveness (e.g. Caruana, 2010)
We look at individual quarters within a 5 year horizon
13Slide14
EWIs need to be stable and robust
Policymakers adjust policy stance gradually
Optimal for MP (Bernanke, 2004,
Orphanides
, 2003)
Indictor should issue consistent signals
Consistency of signal tied to persistency of underlying series (
eg
Park and Phillips (2000))
High degree of persistency problematic for statistical inference
Non-parametric approach
EWIs need to be robust to different samples and specifications
14Slide15
Interpretability of EWI
Evidence that practitioners value sensibility of forecasts more than accuracy (Huss, 1987) adjust forecasts if the lack justifiable explanations (Onka-Atay et al (2009)
Purely statistical approaches are not suitable for policy purposes and communication
Our indicators reflect
excessive leverage and asset price booms (Kindleberger, 2000, and Minsky, 1982)
non-core deposits (Hahm et al, 2012)
the business cycle
15Slide16
Analysing potential EWIs
We construct and test a range of potential early warning indicators building on Drehmann et al (2011)
We select indicator variables from...
Credit measures: Credit-to-GDP gap and real credit growth
Asset prices: Real property and equity price gaps and real property and equity price growth
None-core bank liabilities (
Hahm
, Shin, and Shin (2012)):
GDP
growth
History of financial crises
...and add one new measure:
Debt service ratio (DSR) (Drehmann and Juselius (2012)): interest payments and repayments on debt divided by income
16Slide17
17
We analyse quarterly time-series data from 27 countries.
The sample starts in 1980 for most countries and series, and at the earliest available date for the rest
Use balanced sample
We follow the dating of systemic banking crises in
Laeven
and Valencia (2012)
We ignore crises which are driven by cross-boarder exposures
We adjust dating for some crisis after discussions with
CBs
Analysing potential EWIs (II)Slide18
Several of the variables display dynamics which are hard to distinguish from I(2) process
Indicators which have performed well in the past are more
persistent
→
Benefits of a non-parametric approach
Persistency
18Slide19
Behaviour around systemic crises
19Slide20
ROC curves for 2 year forecast horizon
20Slide21
ROC curves over time
21Slide22
Combining variables
22
Credit to GDP gap and property price gap
Credit to GDP gap and DSR
DSR and property price gapSlide23
Robustness checks
Robust across samples
Robust
to different crisis dating
Robust to balanced versus unbalanced
samples
Robust if partial ROC curves are used
23Slide24
We argue that EWIs need satisfy six policy requirements:
Need to be evaluated with preferences free methodology
Need to have right timing
Need to be stable
Need to be robust
Need to be understood by policymakers
Appliying
this approch to data from 27 countries we find that:
The DSR and the credit-to-GDP gap dominate other EWIs
The DRS dominates at shorter horizons and the credit-to-GDP gap dominates at longer ones
Conclusion
24