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Connecting the Dots: From Systemic Risk Indicators to Policy Tools that Work

Connecting the Dots: From Systemic Risk Indicators to Policy Tools that Work. Laura E. Kodres Assistant Director Monetary and Capital Markets Department May 3, 2013. Messages. Many systemic risk indicators and models are already available. Need more answers to:

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Connecting the Dots: From Systemic Risk Indicators to Policy Tools that Work

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  1. Connecting the Dots: From Systemic Risk Indicators to Policy Tools that Work Laura E. Kodres Assistant Director Monetary and Capital Markets Department May 3, 2013

  2. Messages Many systemic risk indicators and models are already available. Need more answers to: Which ones are useful for early warning? Which ones are useful for prompt cleanup? How well can they be tied to policy tools that “work”? (Need to define “work”)

  3. Messages Where should we focus our attention? Biggest issues (highest probability of crisis or largest losses given crisis). Easiest tools to implement (incentive compatible?) and enforce (market discipline?). Be cognizant of (but not paralyzed by) limitations.

  4. Early Warning: Combine Indicators(to differentiate healthy vs unhealthy growth of credit) Probability of systemic banking crisis (in percent) Source: GFSR 2011 Source: Arregui et al, forthcoming Equity Price Growth House Price Growth

  5. Early WarningUse of Thresholds Credit aggregates are key. Low chance of missing a crisis: change in Credit/GDP >3-5 pp (IMF GFSR,2011) Low chance of overregulation ”gap”>1.5 s.d. & growth>10% (Dell’Ariccia et al, 2012) Range better than one threshold Flag risks at the lower (GFSR) threshold and escalate concerns and implement policies by the Dell’Ariccia et al threshold (Arregui et al, forthcoming) All sources of credit, not just from banks

  6. Not so early warningNear-Coincident Indicators Performance of market-based indicators Source: Arsov, Canetti, Kodres, and Mitra (forthcoming)

  7. Put the “tools” into macro models to directly test their economic effects. • Risks are highest for credit (however defined) so more effort to find good tools to get at systemic risk without sacrificing good growth. • Some tools can be applied to “markets” to limit credit and leverage—not much is known about how they should/could work. • Through-the-cycle margin/haircuts • Market infrastructure changes (triparty repos, CCPs) Where Should We Focus? (I)

  8. Cross-section/interconnectedness tools underdeveloped. • How do we formulate a tool that is easy and practical to implement and enforce? • Liquidity/Funding issues • Liquidity charge/premium • So far, these tools tend to be more complex, but more precisely aimed at underlying externality. • Their effectiveness is largely unknown. Where Should We Focus? (II)

  9. Existing Limitations/Challenges • Most tools tested in emerging economies; can they be expected to work in advanced economies? • Macroprudential policies must complement (not substitute) for micro-prudential and monetary policy. • May never know effectiveness, if crisis ends up being mitigated. • Seeing (short-term, constant) costs and not (long-term) benefits will make policies difficult to keep intact even if effective. • We need credible measures of benefits.

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