Philipp Hartmann

European Central Bank, DG Research

Office of Financial Research and Financial Stability Oversight Council conference on “The Macroprudential

Toolkit: Measurement and Analysis”,

Washington (DC), 1-2 December 2011

Framework, Data and Models for Macropru: A European Perspective

Disclaimer: Any views expressed are only the speaker’s own and should not be regarded as views of the ECB, the Eurosystem

or the ESCB

1

European System of Financial Supervision

Analytical, logistical, statistical & administrative supportAnalytical, logistical, statistical & administrative support

...

MicroMicro--prudential informationprudential information Information on systemic risksInformation on systemic risks

Early risk Early risk warnings warnings

&&policy policy

recommendations*recommendations*EEUU

CCOOUUNNTTRRIIEESS

Source: Author

based

on European Council

(2010)

European Systemic Risk Board (ESRB)

Adv. TechnicalCommittee Chair

EuropeanCommission*

27 NCBGovernors

…

3 ESA Chairs

Adv. ScientificCommittee Chair& 2 Vice Chairs

National Supervisory Authorities…

Chair of Economic &Financial Committee

ECB PresidentVice-President

Chair: ECB President

European Banking Authority (EBA)

European Insurance & Occupational Pensions

Authority (EIOPA)

European Securities & Market Authority

(ESMA)

National Banking Supervisors

National Insurance Supervisors

National Securities Supervisors

European Supervisory Authorities (ESAs)

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European Central Bank

* Potential recipient of policy recommendations with respect to * Potential recipient of policy recommendations with respect to EU legislationEU legislation

EEUURROOPPEEAANN

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2

Introduction

•

Key area of financial stability policy to be particularly developed further is macroprudential

supervision and regulation

•

Public oversight and regulation that aims at identifying and containing systemic risk

(rather than risks of individual

intermediaries or markets)•

One definition of systemic risk (ECB 2009): Risk that financial instability becomes so widespread that it impairs the functioning of a financial system to the point where economic growth and welfare suffer materially

•

Can involve all components of financial systems (“horizontal”)…–

Intermediaries (including so-called shadow banks),

–

Markets and–

Market infrastructures

…and two-way relationship with the economy at large (“vertical”)•

Today: Go from an economic framework, to the data needed and to the analytical tools to be fed with the data

3

Forms of systemic risk and analytical approaches

• SR 1: Contagion –

Contagion

and spillover models• SR 2: Endogenous build-up and unravelling of widespread imbalances

–

Early warning indicators and models• SR 3: Aggregate shocks –

Macro stress testing models

Source: Author based on de Bandt, Hartmann and Peydró

(2009) and ECB (2010a)

The systemic risk cube:

Analytical models/tools for systemic risk:

4

Range of data needed for macropru

•

Wide set of information–

Standard financial and macroeconomic data and statistics–

Supervisory data (in particular individual data) and statistics–

Market intelligence•

Range of financial (incl. supervisory) and macroeconomic data

(close to “ideal” list)–

Macro data/national accounting: Growth and components (aggregate shocks, real transmission), credit aggregates (widespread imbalances), flow of funds (real transmission), public finances (widespread imbalances), global imbalances (widespread imbalances, aggregate shocks)

–

Financial market data: asset prices (incl. high frequency or real estate), volatility

and interest rates (widespread imbalances, aggregate shocks, contagion), credit spreads (widespread imbalances, aggregate shocks), risk premia, attitudes towards risk (widespread imbalances, aggregate shocks), ratings (contagion), market activity (incl. high frequency; widespread imbalances)

–

On and off-balance sheet data

(incl. P&L; sufficiently timely and frequent)•

Financial intermediaries (incl. shadow banks, hedge funds etc.):

individual data (supervisory for regul. firms), granular breakdowns (items, maturities, exposures (direct and geogr.), currencies), default risk (contagion, widespread imbalances)

•

Non-financial firms: default risk, investment (aggregate shocks, real transmission)•

Households: wealth (incl. real estate), default risk, consumption (aggregate shocks, real transmission)

–

Payment and settlement data: Direction of flows, reconstruction of exposures (contagion)

•

Often multiple inputs for quantitative indicators or analytical models

5

Selected data challenges

•

Unavailability/gaps versus costs of reporting–

Financial institutions (e.g. shadow banks, hedge funds)

–

Financial markets (e.g. repo

markets, financial innovation)–

Granularity of off-

and on-balance sheet data

•

Confidentiality

versus access (e.g. EBA et al. 2011)–

Safety

–

Complicated use, irregular or no access–

Example: Direct exposures across intermediaries (key data!)

•

Standardisation

across sectors, authorities and databases–

Example: Statistical versus supervisory data (definitions, concepts, valuation rules etc.; e.g. ECB and CEBS 2010)

–

Legal identification and matching of entities and instruments (see next session, Gross 2010)

•

International issues: See above, US or EU should not go alone•

ESRB regulation provides it with the right to receive all the information it needs to fulfil its tasks (in particular from ECB

and

ESAs)•

Once ESRB/ESAs

agreed, Europe advanced very quickly

6

Composite indicator of systemic stress (“CISS”)

•

Scope: Equity, bond, money and FX markets plus banking (various sub-items) -

real time•

Basic sub-measures

include volatilities, trends, spreads, recourse to marginal lending (weekly data)•

Normalisation

between 0 and 1 and aggregation

weighted with correlations (“systemic”)

Source: Hollo, Kremer and Lo Duca (2010)

0.00

0.20

0.40

0.60

0.80

1.00

Januar

y-99

April-99

July-

99

October

-99

Januar

y-00

April-00

July-

00

October

-00

Januar

y-01

April-01

July-

01

October

-01

Januar

y-02

April-02

July-

02

October

-02

Januar

y-03

April-03

July-

03

October

-03

Januar

y-04

April-04

July-

04

October

-04

Januar

y-05

April-05

July-

05

October

-05

Januar

y-06

April-06

July-

06

October

-06

Januar

y-07

April-07

July-

07

October

-07

Januar

y-08

April-08

July-

08

October

-08

Januar

y-09

April-09

July-

09

October

-09

Januar

y-10

April-10

July-

10

October

-10

Januar

y-11

April-11

July-

11

October

-11

0

1

September11, 2001

WorldCom

Reported problems inbanks' investment and

hedge f nds

Lehman Brothers

Start of sovereign debt problems

peak of "dot.co

m bubble"

7

Widespread financial instability and the macroeconomy

•

Example from the ESCB Macroprudential

Research (MaRs) network (see Annex)

•

How is systemic financial instability transmitted through the aggregate economy: For example September/October 2008

•

Answers needed, inter alia, for –

forecasts

–

regulatory impact assessments•

Bayesian multivariate Markov-switching vectorautoregression

model

(Hartmann, Hubrich, Kremer and Tetlow

2011)•

Key ideas:–

Introduce a true indicator of systemic financial instability in an empirical macro model (Composite Indicator of Systemic Stress)

–

Allow for non-linearities/“phase transitions” in parameters and error variances (both can switch regime)

•

Variables: production, inflation, 3-month MM rate, loan volume and CISS

•

Data: euro area, monthly, 1987-2010

8

Impulse response functions of 1 SD increase of systemic stress on industrial production (shock much smaller than September 2008)

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0 10 20 30

months

Normal timesHigh financial stress

Source: Hartmann, Hubrich, Kremer and Tetlow

(2011)

percentagepoints

Impact of systemic stress on growth

9

Selected references 1

•

Alessi

and Detken (2009), ‘Real time’ early warning indicators for costly asset price boom/bust cycles: A role for global liquidity, ECB Working

Paper, no. 1039, March

•

Allen and Gale (2000), Financial contagion, Journal of Political Economy•

Bank of England (2009), The role of macroprudential

policy, Discussion Paper, November

•

Borio

(2003), Towards a macroprudential

framework for financial supervision and regulation?, CESifo

Economic Studies•

Castrén and Sydow

(2010), A sector-level CoVaR

for the euro area, mimeo., ECB, October

•

Constâncio

(2010), Macro-prudential supervision in Europe, Dinner Address at the ECB-CEPR-CFS Conference on “Macro-prudential Regulation as an Approach to Contain Systemic Risk: Economic Foundations, Diagnostic Tools and Policy Instruments”, Frankfurt, 27 September

•

Crockett (2000), Marrying the micro-

and macro-prudential dimensions of financial stability, Remarks before the Eleventh International Conference of Banking Supervisors, Basel, September

•

De Bandt

and Hartmann (2000), Systemic risk: A survey, ECB Working Paper, no 35, November

•

De Bandt, Hartmann and Peydró

(2009), Systemic risk: An update, Berger et al. (eds.), Oxford Handbook of Banking, Oxford University Press

•

Demirgüc-Kunt

and Detragiache

(1998), The determinants of banking crises in developing and developed countries, IMF Staff Papers

10

Selected references 2

•

EBA, EIOPA, ESMA and ESRB (2011), Agreement between the European

Banking Authority and the European Insurance and Occupational Pension Authority and the European Securities Markets Authority and the European Systemic Risk Board on the establishment at the ESRB secretariat

of specific confidentiality procedures in order to safeguard information regarding individual financial institutions and information from which individual financial institutions can be identified, November

•

European Central Bank (2009), The concept of systemic risk, Financial Stability Review, December

•

European Central Bank (2010a), Analytical models and tools for the identification and assessment of systemic risks, Financial Stability Review, June

•

European Central Bank (2010b), Towards macro-financial models with realistic characterisations of financial instability, Financial Stability Review, December

•

European Central Bank (2010c), New quantitative measures of systemic risk, Financial Stability Review, December

•

European Central Bank (2011), Systemic risk methodologies, Financial Stability Review, June

•

European Central Bank and Committee of European Banking Supervisors (2010), MFI balance sheet and interest rate statistics and CEBS’

guidelines on FINREP and COREP: Bridging reporting requirements –

methodological manual, Frankfurt, February

•

European Systemic Risk Board (2011), Decision of the European Systemic Risk Board of 21 September 2011 on the provision and collection of information for the macro-prudential oversight of the financial system within the Union (ESRB/2011/6), Frankfurt

11

Selected references 3

•

Evanoff, Hartmann and Kaufman (eds., 2009), The First Credit Market Turmoil of the 21st Century, World Scientific Publishers

•

Fecht, Grüner

and Hartmann (2006), Financial integration, specialization and systemic risk, forthcoming Journal of International Economics

•

Ferguson, Hartmann, Panetta and Portes

(2007), International financial stability, Geneva Report on the World Economy, no. 9, November

•

Gross (2010), Micro-data as a necessary infrastructure –

Standardisation of reference data on instruments and entities as a starting point: Need for a reference data utility, paper presented at the IFC conference on

initiatives to address data gaps revealed by the financial crisis, BIS, Basel, 25-26 August

•

Hartmann, Hubrich, Kremer and Tetlow, Widespread financial instability and the macroeconomy, mimeo., October 2011

•

Hartmann, Straetmans

and de Vries

(2004), Asset market linkages in crisis periods, Review of Economics and Statistics

•

Hartmann, Straetmans

and de Vries

(2006), Banking system stability: A cross-

Atlantic perspective, Carey and Stulz

(eds.), The Risks of Financial Institutions, NBER and Chicago University Press

•

Hollo, Kremer and Lo Duca

(2010), CISS –

A composite indicator of systemic stress in the financial system, ECB, mimeo., March

•

Gorton (1988), Banking panics and business cycles, Oxford Economic Papers•

Kindleberger

(1978), Manias, Crashes and Panics: A History of Financial Crises, Macmillan

•

King and Wadhwani

(1990), Transmission of volatility between stock markets, Review of Financial Studies

12

Selected references 4

•

Minsky

(1977), A theory of systemic fragility, in Altman and Sametz

(eds.), Financial Crises: Institutions and Markets in a Fragile Environment, Wiley

•

Trichet

(2009), Systemic risk, Clare Distinguished Lecture in Economics

and Public Policy, Cambridge University, 10 December

•

Trichet

(2010), Opening remarks at the ECB-CEPR-CFS Conference on “Macro-

prudential Regulation as an Approach to Contain Systemic Risk: Economic Foundations, Diagnostic Tools and Policy Instruments”, Frankfurt, 27 September

•

Trichet

(2011), Intellectual challenges to financial stability analysis in the era of macroprudential

oversight, Banque

de France Financial Stability Review, no. 15, February

Annex

14

Powerful feedbacks and amplification:

Non-linearities/ regime changes

Ultimate sources of systemic risk

Information intensity

of financial contracts

Balance-

sheet structuresof inter-

mediaries

High degree of

connected-

ness

SPECIAL FEATURES OF THE FINANCIAL SYSTEM

Incomplete markets

Externalities

Asymmetric and imperfect information

Public good characterof systemic stability

Multiple equilibriaMA

RK

ET

IM

PE

RF

EC

TIO

NS

Source: Author based on de Bandt

and Hartmann (2000)

15

Macroprudential

oversight: process

Policy assess-ment

Monitoring impact of warnings, follow-up on recommendations and assessing policy impact

Monitoring impact of warnings, follow-up on recommendations and assessing policy impact

Market imperfections,features of financial systems and natureof shocks w.r.t.•intermediaries, •markets, •infrastructures

Risk assess-ment

Feedback to risk monitoring and analysis

Feedback to risk monitoring and analysis

Risk identifi-cation

No

Yes

Vulnera-bility

No

Yes

MaterialRisk

Models and tools toidentify and assess risks of:

•contagion, •imbalances, •aggregate shocks

Pote

ntia

l sou

rces

of

sys

tem

ic r

isk

Policy Implementation

Risk Warnings

Policy Recommendations

Source: ECB (2010a)

16

Sector-level aggregate spillover

measure

•

Contribution of a given sector to the overall risk of all sectors in the euro area economy

(∆CoVaR)

•

Sector and total system asset values derived from Merton credit risk model using financial accounts

•

CoVaR

measure inspired by Adrian and Brunnermeier

(2010) for individual banksSource: Castrén and Sydow

(2010)

-

500

1,000

1,500

2,000

2,500

3,000

Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10

Government sectorHousehold sectorMFI sector

Turmoil begins

Bear Stearns

Fannie Mae /Freddie Mac

Lehman Brothers

T. Geithner announces Financial Stability Plan

Greek fiscal problems gain media attention

European Financial Stabilisation Fund established

Index 100=July

2010

17

“Global” credit gap as EWI for asset bubbles

•

—— De-trended private credit to GDP ratio (GDP-weighted average across countries)•

– – “Optimal” signal threshold (each time 70th percentile –

“quasi” real time)•

Widespread mortgage/equity bubble episode (≥8 countries 1.75 SD above trend)•

“Costly” bubbles (followed by 3 years of GDP growth 3 p.p. below

potential)

Source: Alessi and Detken (2009)

-1.5

-1

-0.5

0

0.5

1

1.5

1979Q1 1983Q1 1987Q1 1991Q1 1995Q1 1999Q1 2003Q1 2007Q1

Housing/Savings and Loans

dot.com Credit

18

Macroprudential

regulatory instruments 1

•

To contain contagion

risks–

Enhance capital for counterparty exposures, introduce capital surcharge or levy for systemic risk

–

Move derivatives trading on central clearing counterparties–

Introduce procedures for orderly resolution of gone concern (incl. living wills, bail-in debt)

•

To prevent the build-up of widespread imbalances–

Counter-cyclical capital requirements and dynamic provisioning

–

Balanced accounting approach (market prices, liquidity)–

Limit leverage, maturity and currency (emerging economies) mismatches

–

Influence compensation practices to remove incentives for risk taking and herding

–

Loan-to-value ratios and debt-to-income limits (e.g. Korean and Hong Kong experiences)

19

Macroprudential

regulatory instruments 2

•

Ensure resilience against unexpected aggregate shocks

–

High capital and liquidity levels (e.g. based on stress tests)

–

Additional contingent capital (going concern)

–

Foreign currency lending limits (emerging economies)

•

Challenges (related to research and also data gaps)

–

Transmission channels not well understood (impact assessments)

–

Calibration of individual instruments difficult

–

Interaction of different instruments

–

Level playing field across financial sub-sectors and avoidance of regulatory arbitrage (shadow banking)

–

Effects on overall economy (benefits and costs)

20

Macroprudential

Research (MaRs) network

•

Approved by General Council of the ECB in spring 2010 for 2 years

•

Central bank research network at the level of the European Union

(27)

•

Objective: Develop core conceptual frameworks, models and/or tools that would provide research support to improve macro-prudential supervision in the EU

•

Three work streams–

WS1: Macro-financial models linking financial stability and the performance of the economy (fundamental, slow moving)

–

WS2: Early warning systems and systemic risk indicators (operational, fast moving)

–

WS3: Assessing contagion risk (very data dependent)

•

Currently:–

118 projects (WS1: 57, WS2: 47, WS3 17)

–

About 200 economists involved

•

Consultant: Xavier Freixas

(U. Pompeu

Fabra)

•

Reports to ESCB Heads of Research and General Council

•

Final report in 2012

21

Progress of MaRs

one year on

•

WS1: Macro-financial models linking financial stability and the performance of the economy –

Several theories integrating financial instability in aggregate models, putting some emphasis on defaults and nonlinearities

–

Novel explanations for the leverage cycle

–

New approaches illustrating interactions between monetary and macroprudential

policies

–

Joint coordinated cross-country project on “a canonical model for macroprudential

policy”

•

WS2: Early warning systems and systemic risk indicators–

A number of new methodologies

–

Improved use of data

–

Novel visualisations of risks

–

Some of the new tools are already in use in the respective central banks

•

WS3: Assessing contagion risks –

Joint coordinated cross-country project assessing interconnectedness among EU banks and estimating interbank

exposures using TARGET2

data–

New results on interlinkages

in interbank

markets and differentiating

short-term contagion from long-term integration