Tools and Techniques for Financial Stability Analysis

Ratios/Metrics of Financial Stability Assessment

Indranarain Ramlall,
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To cite this document: Indranarain Ramlall, "Ratios/Metrics of Financial Stability
Assessment" In Tools and Techniques for Financial Stability Analysis. Published online:
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 Chapter 5

Ratios/Metrics of Financial Stability

Assessment

5.1. Metrics of Assessments

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The objective of this chapter is to generate a holistic approach to metrics pertaining

to different sectors or areas of an economy. At the outset, it is important to bear in
mind that some metrics may be more important to an economy than others. It all
depends on the type of economy under focus. For instance, securitisation as a per-
centage of GDP will be an important ratio for advanced economies relative to
developing countries. In the same vein, a growing level of non-banking financial
sector will imply more focus on risk indicators pertaining to the non-bank sectors.
Metrics are provided for the financial system, the banking sector, the household
sector, the corporate sector, the real estate sector, the government sector, the sha-
dow banking sector, the insurance sector and investment funds. Interpretation of
the metrics is left as an exercise to the readers to best appreciate their significance.
This chapter is considered to be highly useful to financial stability analysts in terms
of acting as a referenced chapter for key ratio analysis for different components of
the financial system. However, the ratios are also useful for researchers who intend
to generate financial stability index by combining data from various sectors of the
economy into one single index. In general, metrics, ratios or risk indicators are par-
ticularly useful to flag out imbalances likely to show risks to financial stability.

5.2. Metrics for the Financial System

• Credit as a percentage of GDP.
• Loans and deposits as a percentage of GDP.
• Compute each sector’s net deposits or net lending from the banking sector.
• Assess the composition of total loans of the banking sector into different sectors.
• Assess the composition of total collaterals furnished for loans by the banking
sector.
• Calculate the aggregate maturity transformation for the financial sector and
also for the non-financial sector.
• Gross value added of the financial sector is captured by the value of gross out-
put of the financial sector less the value of intermediate consumption.
• Securitisation as a percentage of GDP.
• Compare the ratio of capital investment over GDP against the ratio of credit
extension over GDP.
 92 Tools and Techniques for Financial Stability Analysis

• Use method of Financial Intermediation Services Indirectly Measured.

• Myopic assessment of investments: degree to which investors hold their secur-
ities short-term, the degree to which investors practise momentum trading and
the extent to which fee structure is related to short-term performance.
• Trend growth in credit is compared to trend growth in deposits.
• Banking sector composition versus non-banking sector composition of the
whole gamut of the financial system.
• Mortgage credit to GDP.
• Level of rent extraction.

5.2.1. Macroeconomic Metrics

• Euro zone business confidence index.
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• US business confidence index.

• Euro zone consumer confidence index.
• Country Stress Index: Weighted average of broad indicators that comprise of
stock market volatility (can use GARCH measure), the bond spread, the basis
spread and the exchange rate volatility (GARCH measure can be used again).
Consider the obtained values from their long-term average based under a HP-
filtered series.
• Output gap.
• Budget deficit/GDP, public debt/GDP, primary surplus/deficit, private sector
debt/GDP: debt metrics.
• CPI inflation.
• Core CPI is defined as total HCPI excluding energy, food, alcohol and tobacco.
• Sectoral contribution to GDP.
• Savings to GDP
reater role of domestic savings in funding investments,
chiefly when most countries have already passed on the threshold of external
debts.
• Unemployment level.
• Private debt to GDP; private sector debt usually consists of household debt
and non-financial firms’ debt.
• NEER/REER analysis.
• Credit growth to the private sector.

• Income velocity of money circulation = GDP M2 :
• Δreserve money = Δnet foreign assets þ Δnet local assets.
• Reserve money = monetary base.
• hReserve money i= currency in circulation + commercial banks’ reserves.
Reserve money
• 1÷ broad money = Money Multiplier.
• Net international investment position (metric to gauge on foreign debtor pos-
ition): Difference between its assets and liabilities vis-à-vis non-residents. It
constitutes a vital indicator of the sustainability of a country’s financial bal-
ances. This metric can be used with external balances metric (current account/
GDP, capital account/GDP, BoP/GDP) to derive an overall macroeconomic
balance metric.
 Ratios/Metrics of Financial Stability Assessment 93

• Credit Gap: Defined as the distance from the underlying trend in total debt in
relation to GDP. Debt consists of both private sector and public sector debts.
The trend can be derived under a HP-filtered approach. This metric constitu-
tes a good proxy for predict crisis problems whereby longer periods of positive
credit gaps spark off imbalances in the financial system. It is also used by
Basel III regulations in case of deciding when banks need to have additional
capital under countercyclical capital buffers.
• Credit card lending (consider whole amount, since these cards are issued not
only by banks but also by financing companies). Two main components of
credit card receivables:

Rollover amount which represents the amount within total receivables
which the card holder has not fully repaid but has at least made the min-
imum amount of payment available.
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Delinquency amount represents the total amount of credit card receivables

overdue for more than 90 days.

Utilisation ratio which represents the ratio of total outstanding amount
divided by total liabilities.

5.2.2. Financial Market Indicators

• Credit default swaps.
• Ten-year sovereign spread with German bond (basis points).
• Government interest rates.
• Risk premium in Interbank Market.
• Money market rate captured by three-month interbank rate.
• Foreign holdings of government securities to total government securities.
• Sovereign risk: Sovereign spreads with Germany to look at how risks are
evolving.
• Turnover in the interbank foreign exchange market.

5.3. Metrics by the World Bank/the IMF (2005)

The World Bank/the IMF (2005) in their Financial Sector Assessment: A
Handbook pointed out that Financial Soundness Indicators (FSIs) are used to
gauge on financial stability risks. Two sets of FSIs are reported by the World
Bank/the IMF (2005), namely the core set of FSIs and the encouraged set of
FSIs (Tables 5.1 and 5.2).

5.4. Banking Sector Metrics

• Metrics for banks (Metrics can be split as per large banks, small banks, for-
eign banks and overall banking system).
• Net interest income = Interest received minus Interest paid on deposits.
 94 Tools and Techniques for Financial Stability Analysis

Table 5.1. The Core Set of Financial Soundness Indicators.

Indicator Indicates Comment

Regulatory capital to risk-
weighted assets
Regulatory Tier 1 capital to
risk-weighted assets
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Capital Broad measure of capital, including
adequacy items giving less protection against
losses, such as subordinated debt,
tax credits and unrealised capital
gains
Capital Highest quality capital such as
adequacy shareholder equity and retained
earnings, relative to risk-weighted
assets

Non-performing loans net of Capital Indicates the potential size of

provisions to capital adequacy additional provisions that may be
needed relative to capital
Non-performing loans to Asset Indicates the credit quality of
total gross loans quality banks’ loans
Sectoral distribution of loans Asset Identifies exposure concentrations
to total loans quality to particular sectors
Return on assets and return Earnings Assesses scope for earnings to
on equity and offset losses relative to capital or
profitability loan and asset portfolio
Interest margin to gross Earnings Indicates the importance of net
income and interest income and scope to
profitability absorb losses
Non-interest expenses to Earnings Indicates extent to which high non-
gross income and interest expenses weakens earnings
profitability
Liquid assets to total assets Liquidity Assesses the vulnerability of the
and liquid assets to short- sector to loss of access to market
term liabilities sources of funding or a run on
deposits
Net open position in foreign Exposure Measures foreign currency
exchange to capital to FX risk mismatch

Source: The World Bank/the IMF. (2005). Financial Sector Assessment: A Handbook.

• Non-interest income = Fees, commissions and net profit or loss on financial

operations.
• Check if performance is broad-based: Banking sector balance sheet posted
sizeable growth which was broad-based meaning across distinct income-
earning assets.
 Ratios/Metrics of Financial Stability Assessment 95

Table 5.2. The Encouraged Set of FSIs.

Indicator Indicates Comment

Corporate sector
Total debt to equity
Return on equity
Earnings to interest and
principal expenses
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Leverage Provides an indication of credit risk
because a highly leveraged corporate
sector is more vulnerable to shocks
Earnings Indicates the extent to which earnings
and are available to cover losses
profitability
Debt service Indicates the extent to which earnings
capacity available to cover losses are reduced

by interest and principal payments

Corporate net foreign Foreign Reveals corporate sector vulnerability
exchange exposure to equity exchange to exchange rate movements
risk

Number of applications for protection from creditors

Capital to assets
Geographical distribution
of loans to total loans
Gross asset position in
financial derivatives to
capital
Gross liability position in
financial derivatives to
capital
Large exposures to capital
Trading income to total
income
Personnel expenses to
non-interest expenses
Spread between reference
lending and deposit rates
Spread between highest and Liquidity
lowest interbank rate
Customer deposits to total
(non-interbank) loans
Foreign currency-
denominated loans to total
loans
Capital Broad measure of capital adequacy,
adequacy which is a buffer for losses
Asset quality Identifies credit exposure
concentrations to particular countries
by the banking system
Exposure to Provides a crude indicator of exposure
derivatives to derivatives
Exposure to Provides a crude indicator of exposure
derivatives to derivatives
Asset quality Identifies credit exposure to large
borrowers
Earning and Indicates the dependence on trading
profitability income
Earning and Indicates the extent to which high
profitability non-interest expenses reduces earnings
Earning and Indicates level of competition in the
profitability banking sector and the dependence of
earnings on the interest rate spread
Market indicator of counterparty
risks in the interbank market
Liquidity Assesses the vulnerability to loss of
access to customer deposits
Foreign Measures risk to loan portfolios from
exchange foreign exchange movements
risk
 96 Tools and Techniques for Financial Stability Analysis

Table 5.2. (Continued )

Indicator Indicates Comment

Foreign currency- Foreign Measures extent of dollarisation
denominated liabilities to exchange
total liabilities risk
Net open position in Equity Measures exposure to equity price
equities to capital market risk movements
Market liquidity
Average bid-ask spread in Foreign Indicates liquidity in the securities
the securities market exchange market
risk
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Average daily turnover Foreign Indicates liquidity in the securities

ratio in the securities exchange market
market risk

Other financial corporations

Assets to total financial Size Indicates size and significance within
system assets the financial sector
Assets to GDP Size Indicates size and significance within
the financial sector

Households
Household debt to GDP
Household debt service and
principal payments to
income
Leverage Provides an indication of credit risk
because a highly leveraged household
sector is more vulnerable to shocks
Debt service Indicates a household’s ability to
capacity cover its debt payments

Real estate markets

Real estate prices Real estate Measures trends in the real estate
prices market
Residential real estate loans Exposure to Measures banks’ exposure to the
to total loans real estate residential real estate sector
Commercial real estate Exposure to Measures banks’ exposure to the
loans to total loans real estate commercial real estate sector

Source: The World Bank and The IMF in their Financial Sector Assessment: A Handbook in 2005.

• Equity investments to total assets; level of exposure to equity markets.

• Operating expenses = Staff costs + Property costs.
• Decline in the net worth of different classes of borrowers.
• Decomposed return on equity for banks to sieve out any building up of risk.
 Ratios/Metrics of Financial Stability Assessment 97

Total assets Tier 1 capital

Return on Equity = ×
Tier 1 capital Common equity
Net Income Risk Weighted Assets
× ×
Risk Weighted Assets Total assets
Return on equity = Financial leverage × Common equity margin
× Return on Risk Weighted Assets × Unit risk

A bank can increase its return on equity by acting on any of these four
ratios.
• Qualitative approach to banking crisis-forced closures, government takeover,
mergers, bank runs and government assistance.
• Deviations of actual credit to GDP ratio from the trend in credit to GDP
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ratio.
• Analysis of banks’ share prices: sensitivities factors in Greek letters such as
delta, theta, gamma, vega and rho, downside risk based on returns which are
found below a targeted mean return, value at risk (VaR) and expected
shortfall.
• Rising stock prices of banks in the building-up phase of the crisis to then fall
down.
Net cash flow from operating activities
• Cash debt coverage ratio =
Bank’s total liabilities
• Ratio of banks’ claims on the central bank as a percentage of total assets.
• Net stable funding ratio.
• Commercial bank excess liquid assets reflected the banks preference for short-
term assets.
• Spread between the one-year interbank rate and the one-year Treasury bill
rate reflects a measure of banking sector credit risk.
• Herfindahl
Hirschman Index (HHI) of loans and deposits in the banking sec-
tor; some banks may be under-pricing risks due to stiff competition.
• Large amounts loaned to a single borrower or to a specific sector of the
economy.
• Ratio of repayments to disbursements.
• Share of provisions and regulatory reserves as a share of total outstanding
loans.
• Probability of default.
• Non-performing loans/total assets.
• Issuance of medium-term unsecured bonds by euro-area banks: Higher these
issuances signify subsiding risks.
• Look at non-performing loans of specific sectors (corporates, households) as a
percentage of total loans granted to all sectors.
• Ratio of impaired and past due loans to total loans.
• Loan loss provisions to total assets.
• TED Spread: to gauge on the level of stress in the banking system.
• Non-interest Income
Non-interest Expenses = Net Non-interest Income.
• Net Interest Income + Net Non-interest Income = Net Operating Income.
 98 Tools and Techniques for Financial Stability Analysis

• Metrics for non-interest income components:

Net Non − Interest Income
Net Operating Income

Net Commission and Fee Income

Net Operating Income

Net Trading Income

:
Net Operating Income
• Impaired financial assets to total assets.
• Total loans/total assets.
•
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Total loans/total deposits.

• Loan losses/total assets.
• Funding gap: difference between loans and deposits for a given specific bor-
rowing group, like SMEs in a bank.
• Total exposure of banking sector to public sector: sudden change could signal
potential problems in the wholesale funding market.
• LIBOR-OIS spread: shows major banks’ willingness to lend and is usually
deemed as a measure of health of the banking system.
• Foreign currency loans/total loans.1
• Tier 1 capital (most pure form of capital ratio).
• Free capital of a bank defined as equity less fixed assets can be used as a FSI
in the event of any shock.
• Total equity/total loans.
• Currency risk as gauged on by Net Open Foreign Exchange position.
• Age analysis of loans and advances in terms of total loans and advances, past
due and impaired.
• Look at growth rate in household indebtedness (loans given to households as
a percentage of total loans).
• Downgrade risk for rated corporates.
• Country risk for foreign companies.
• Total loans/total equity = to capture capacity of bank capital to absorb loan losses.
• Foreign currency loans/total loans; high value indicative of currency risk.
• Level of household indebtedness.
• Key Risk Indicators by European Banking Authority as depicted in Table 5.3.
• Credit exposures to risky sectors/total credit exposures.
• Loan to value ratio; below 70% means comfortable buffer for the banks.
LTVs can be differentiated across locations and borrower types.
• Interest rate risk measured as difference between the average repricing periods
for asset and liability.

1
The ratio of foreign currency deposits (whole being denominated in US dollar) over
total deposits is used to capture the level of dollarisation in the economy.
 Table 5.3. The KRI Database.

Number KRI Code KRI name Numerator Denominator

1 1 Tier 1 capital ratio as in Total original own funds for general solvency Total capital requirements × 12.5
Basel 2.5 purposes
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2 Total Total own funds for Total capital requirements × 12.5 2

capital solvency purposes
ratio as in
Basel 2.5

Ratios/Metrics of Financial Stability Assessment

3 3 CET1 ratio (was T1 Total original own funds for general solvency Total capital requirements × 12.5
excluding hybrids until purposes-Hybrid instruments in Minority
Q4 2013) interests- Hybrid instruments in 1.1.4.1a
Hybrid instruments- (-) Excess on the limits for
hybrid instruments
4 13 Impaired loans and past Row: Loans and advances Column: Net
due (>90 days) loans to carrying amount of the impaired assets Row:
total loans Loan and advances specific allowances for
individually assessed financial assets and
specific allowances for collectively assessed
financial assets Column: Closing balance Row:
Loans and advances Columns: > 90 days ≤
180 days; > 180 days ≤ 1year; > 1year
5 14 Coverage ratio (specific Row: Loan and advances Specific allowances
allowances for loans to for individually assessed financial assets and
total gross impaired Specific allowances for collectively assessed
loans) financial assets Column: Closing balance
6 18 Impaired financial assets Row: Total Column: Net carrying amount of
Total loans advances (Rows: loans and
advances AFS, loans and receivables, HTM)
Row: Loan and advances specific allowances
for individually assessed financial assets and
Specific allowances for collectively assessed
financial assets Allowances for incurred but not
reported losses on financial assets Column:
Closing balance
Row: Loans and advances Column: Net
carrying amount of the impaired assets Row:
Loan and advances specific allowances for
individually assessed financial assets and
specific allowances for collectively assessed
financial assets Column: Closing balance
Total assets

99
to total assets the impaired assets
 Table 5.3. (Continued )

100
Number KRI Code KRI name Numerator Denominator

Tools and Techniques for Financial Stability Analysis

7 20 Accumulated Row: Loan and advances, Debt instruments Total Assets Row: Loan and advances, Debt
impairments on specific allowances for individually assessed instruments specific allowances for individually
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financial assets to total financial assets and specific allowances for assessed financial assets and specific allowances
(gross) assets collectively assessed financial assets for collectively assessed financial assets
Allowances for incurred but not reported Allowances for incurred but not reported losses
losses on financial assets Column: Closing on financial assets Column: Closing balance
balance
8 21 Impairments on Impairment on financial assets not measured at Total operating income: rows: interest income;
financial assets to total fair value through profit or loss interest expenses; expenses on share capital
operating income repayable on demand; dividend income; fee and
commission income; fee and commission
expenses; realised gains (losses) on financial
assets and liabilities not measured at fair value
through profit or loss, net; gains (losses) on
financial assets and liabilities held for trading,
net; gains (losses) on financial assets and
liabilities designated at fair value through profit
or loss, net; gains (losses) from hedge
accounting, net; exchange differences, net; gains
(losses) on derecognition of assets other than
held for sale, net; other operating income; other
operating expenses
9 22 Return on equity Total profit or loss after tax and discontinued Total equity (period average)
operations (annualised)
 Table 5.3. (Continued )

Number KRI Code KRI name Numerator Denominator

10 24 Cost
income ratio Rows: Administration costs; depreciation Total operating income: rows: interest income;
interest expenses; expenses on share capital
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repayable on demand; dividend income; fee and

commission income; fee and commission
expenses; realised gains (losses) on financial
assets and liabilities not measured at fair value

Ratios/Metrics of Financial Stability Assessment

through profit or loss, net; gains (losses) on
financial assets and liabilities held for trading,
net; gains (losses) on financial assets and
liabilities designated at fair value through profit
or loss, net; gains (losses) from hedge
accounting, net; exchange differences, net; gains
(losses) on derecognition of assets other than
held for sale, net; other operating income; other
operating expenses
11 26 Net interest income to Rows: Interest income; interest expenses Total operating income as above
total operating income
12 27 Net fee and commission Rows: Fee and commission income; fee and Total operating income as above
income to total commission expense
operating income
13 33 Net income to total Total profit or loss after tax and discontinued Total operating income as above
operating income operations
14 34 Loan-to-deposit ratio Total loans advances (Rows: Loans and Total deposits (Rows: Deposits held for
advances held for trading, designated at fair trading, designated at fair value through profit
value through profit or loss, AFS, Loans and or loss, measured at amortised cost)

101
receivables, HTM)
 Table 5.3. (Continued )

102
Number KRI Code KRI name Numerator Denominator

Tools and Techniques for Financial Stability Analysis

15 35 Customer deposits to Total deposits (other than from credit Total liabilities
total liabilities institutions) (Rows: deposits (other than from
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credit institutions) held for trading, designated

fair value through profit or loss, measured at
amortised cost)
16 36 Tier 1 capital to (total Original own funds Total assets
intangible assets
assets
intangible
assets)
17 45 Debt to equity ratio Total liabilities Total equity
18 46 Off-balance sheet items Loan commitments given, financial guarantees Total assets
to total assets given

Source: EBA Risk Dashboard, European Banking Authority (2014).

 Ratios/Metrics of Financial Stability Assessment 103

• Interest rates on new bank loans to firms.

• Debt service coverage ratio (flow metric) under repayment capacity assess-
ment (or loan affordability assessment). Monitoring repayment risks apply
chiefly for loans which have bullet or balloon repayment terms.
• Debt to equity ratio (static metric) under repayment capacity assessment.
• Non-deposit borrowing to total assets.
• Term deposits/total deposits; the higher the ratio, the better for financial sta-
bility as it shows more resilient funding structure.
• Priority in redemption of collateral for loans secured by real estate: there are
risks when banks enter several mortgages on the same real estate so that
banks with no priority in redemption bear higher risks. The ratio of the value
of all securities/collaterals encumbered under a first rank position as a per-
centage of the value of total loans backed by real estate can be useful. Above
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all, the redemption of collateral is difficult in case of low real estate market
liquidity and protracted legal proceedings.
• Information from Quarterly Bank Lending Surveys can also be very useful.
þ CAR
• Bank Z-score = ROA
SDROA .

ROA: Return on Assets.

CAR: Ratio of total equity over total assets.
SDROA: Standard deviation of ROA.
• Level of default rates.
• Values for collaterals.
• Core capital ratio (ratio of Tier 1 Capital to risk-weighted assets); check
whether improvement in capital ratio has been brought out by higher capital
or by a fall in risk-weighted assets.
• Concentration in credit-focus on household debt.
• Retail loan composition: mortgage, automobile, personal and credit card.
• Balance sheet structure
look at the main drivers for the growth on both the
assets and liabilities side.
• Loan to deposit ratio; an increase in the loan to deposit ratio implies that
lending activities generate pressures on the core deposits as the latter consti-
tute the source of funding for loans. Loan (or credit) to deposit ratio constitu-
tes a useful indicator of a bank’s liquidity adequacy. The credit to deposit
ratio should also be watched and should hover around tolerable level.
• Ratio of wholesale deposits to retail deposits; an increase in the ratio implies
that deposit base is being financed by volatile wholesale funding.
• Ratio of individual deposits to total deposits; the larger this ratio, the more
stable the bank deposits.
• Ratio of local currency deposits to total deposits; the higher the ratio, the
more stable the bank deposits.
• Sectoral breakdown of impaired loans is also vital; indirectly helps to sieve
out those sectors which have been hardest hit by the financial crisis. Impaired
loans reflect NPLs on which payments of interest or repayments of principal
are 90 or more days past due.
 104 Tools and Techniques for Financial Stability Analysis

• Look at P/E ratio of listed banks compared to historical averages.

• Funding sources of a bank: deposits, borrowings, reserves and capital.
• Composition of deposits in terms of individuals, financial institutions, govern-
ment, non-bank financial institutions; can be subdivided into two major
classes: retail versus wholesale deposits.
• Ratio of assets over liabilities.
• ROA.
• Net interest margin.
• Capital adequacy ratios relative to the regulatory minimum.
• Return on equity.
• Share of loans classified as difficult loans to total loans: Difficult loans are
considered as bad debts, substandard loans, past due loans plus restructured
loans.
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• Cost to income ratio; a proxy for operational efficiency.

• Rate of loan growth compared to growth in properties prices, usually works
well as an early warning signal for weakening credit quality and banking crises.
• Net interest income to total operating income.
• Systemic risk: assessed by using the Joint Probability of distress which esti-
mates the likelihood that several banks simultaneously face problems. (See
Italian FSR November 2011 for more details). Default based on value of
assets being lower than that of the liabilities.
• Net fee and commission income to total operating income; usefulness to
gauge robustness of profitability during crisis times.
• CAMELS framework:
Capital represents the first layer of defense for a bank. Capital adequacy relates
to a bank’s buffer or capacity to bear with both expected and unexpected losses.
Asset quality: debt to equity ratio, debt service coverage ratio, non-performing
loans, sectoral credit concentration, foreign currency denominated lending,
risk-weighted assets over total assets and concentrated lending.
Management soundness: qualitative and quantitative features pertaining to
management.
Earnings: return on equity, ROA and cost to income ratio.
Liquidity: loans to deposits ratio, central bank credit to financial institutions.
Sensitivity to market risks: commodity price risk, equity price risk, interest
rate risk and currency risk.

5.5. Household Sector Metrics

Different risk metrics prevail for the household sector as stated as follows.

• Deviation of household debt from its steady state ratio.

• Trend of housing price index and interest rates.
• Household wealth to debt ratio: gauge on household level of creditworthiness,
credit bureaus should be able to capture household wealth.
• Ratio of household debt to net disposable income.
 Ratios/Metrics of Financial Stability Assessment 105

• Ratio of household debt to GDP.

• Trends of household credit.
• Fall in household net savings rate indicates a gradual increase in the propor-
tion of households who live from hand to mouth (that is, use of current
income for current consumption).
• Ratio of total credit card receivables to GDP.
• Household financial data as a percentage of disposable income.
• Household net wealth as a percentage of disposable income.
• Household deposits over total financial assets.
• Household gross financial assets to gross disposable income: in case of fall in
general market share prices, this is expected to generate a fall in the value of
this metric.
• Employment data and wages: two vital metrics used to gauge on household
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income and repayment capacity. To analyse wages onto repayment capacity,

other metrics should also be looked upon like international food prices, infla-
tion, interest rate movements, any feasible currency risk effect and the level of
household indebtedness.
• Household gross financial liabilities to gross disposable income: gross financial
liabilities measured as mortgage loans plus consumer credit and other loans.
• Household debt as a percentage of gross disposable income.
• Fischer index computed by Bank of Slovenia to show evolution of housing
prices.
• Debt servicing on mortgage loans by income class.
• Value of households’ assets to disposable income.
• Gearing of household sector (ratio of debt to assets).
• Household net worth to disposable income.
• Ratio of mortgage loans to GDP.
• Average maturity of home mortgage loan.
• Average down payment for home mortgage loan.
• Divide households into six income brackets (percentiles).
• Mortgage loans as a percentage of total outstanding consumer loans.
• Household debt to nominal GDP to capture the level of household leverage
level.
• Total liabilities to income: degree to which income can cover liabilities (a ratio
to uncover mismatch).
• Total bank liabilities to income (a ratio to uncover mismatch).
• Debt service coverage ratio (total income over total principal and interests
instalments; a solvency ratio).
• Total liabilities over total assets (gearing ratio).
• Total liabilities to current assets (gearing ratio).
• Total liabilities to fixed assets(gearing ratio).
• Bank deposits over total value of financial assets (extent to which households
do not have knowledge of equities or bonds instruments). This ratio also
shows the degree to which a shock in household sector will impact on the
banking sector.
• Total bank liabilities to total liabilities of households.
 106 Tools and Techniques for Financial Stability Analysis

• Ratio of household bank loans to GDP and ratio of household savings in

banks to GDP.Nominal household credit to GDP gap.
• Nominal household gross debt-to-income ratio.
• Household debt service ratio.
• Household loan demand.
• Household residential mortgage NPLs.
• Aggregate household balance sheet data.
• Household debt decomposed as per the type of debt to sieve out any boom-
bust cycle in each debt category.
• Banking policies vis-a-vis households such as Loan to Value ratios, debt ser-
vice repayment capacity thresholds, prudential limits, all for each category of
household debt.
• How household debt responds to changes in interest rates?
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5.6. Corporate Sector Metrics

• Tobin’s Q value to gauge on investments level.
• Weighted average cost of capital.
• Net debt to EBIT.
• Foreign currency composition of corporate debt.
• Maturity composition of corporate debt; short-term corporate debt, long-term
corporate debt.
• In Sweden, there is no aggregate index for corporate bonds representing the
credit market. Consequently, the interest rate differential between mortgage
bonds and government bonds is used for Sweden.
• Expected default frequencies of non-financial corporations: computed on the
basis of monthly price and volatility of the shares of the companies to which
they pertain to, calculate the probability that the market value of assets will
be lower than that of liabilities at a one-year horizon.
• Level of bond issuance to corporate debt.
• Tax rate within and across countries.
• Number of corporate bankruptcies.
• Corporate loans to GDP- Demand for loans by non-financial firms reflects
the demand for investments.
• New number of commercial licenses issued for construction.
• Number of construction permits issued by municipalities.
• High corporate debt levels but low DSCR.
• Default rate for non-financials: defined as number of defaults among non-
financials divided by total number of companies.
• Debt at risk through Interest rate coverage ratio being below 1.5.
• Regime shifts in interest rates.
• Structure composition of corporate deposits: local versus foreign currency.
• Maturity composition of corporate deposits.
• Corporate deposits from carry trade.
• Flow of funds data for the corporate sector.
 Ratios/Metrics of Financial Stability Assessment 107

• Leverage level of corporate sector.

• Sensitivity analysis of the corporate sector with respect to changes in interest
rates.
• Corporate debt to equity ratio.
• Debt to assets ratio.
• Effective interest cost:
Total interest expenses
Total debt
• Debt overhang = Total net debt − n2 × EBITDA.
• Financial expense/value added.
• Ratings changes.
• Debt to gross operating surplus.
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Net Lendingð þ Þ
• Financing gap = Net Borrowingð − Þ to GDP.
• Share of vulnerable firms in the corporate sector.
• Debt Service Coverage Ratio
• Current ratio = Current
Current assets
liabilities
ðCurrent assets − Stocks − Prepaid itemsÞ
• Acid-test ratio = ðCurrent liabilities − Accrued itemsÞ

• Interest Coverage ratio = EBDIT

Interest expense

• Cash flow interest cover = Operating Cash Flow3

Cash interest paid
profit × 100%
• Operating profit to sales = OperatingSales
× 100%
• Net profit to sales = Net profit
Sales

• -term debt þ Short-term debt × 100%

Debt ratio = LongTotal debt þ Shareholder’s Equity

Or
• Debt-equity ratio = Total debt
Shareholder’s Equity
•
% Change in Operating Income
Degree of Operating Leverage Leverage =
% Change in Sales Units
ðSelling Price − Variable CostÞQuantity
=
ðSelling Price− Variable CostÞ
Quantity −Fixed costs
ðSP− VCÞQ
=
ðSP− VCÞQ −FC

2
n can be any number such as 4.
3
Operating cash flow is equal to cash from operations plus fixed charges plus tax
payments.
 108 Tools and Techniques for Financial Stability Analysis

• where:
SP: selling price per unit of good/product;
VC: variable cost per unit of good/product;
Q: quantity sold/units to be sold; and
FC: total fixed costs.
• Degree of Financial Leverage (financial costs under scrutiny)
% Change in Net Income
Degree of Financial Leverage =
% Change in Operating Income
ðSelling Price per unit − Variable Cost per unitÞ
Quantity − Fixed costs
=
ðSelling Price per unit − Variable Cost per unitÞ
Quantity − Fixed costs − Interests
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ðSP − VCÞQ − FC
=
ðSP − VCÞQ − FC − Int

where:
SP: selling price per unit of good/product;
VC: variable cost per unit of good/product;
Q: Quantity sold/units to be sold;
FC: total fixed costs; and
Int: interests.

• Degree of total leverage (fixed operating costs and financial costs under
scrutiny):
Degree of Total Leverage = Degree of Operating Leverage × Degree of
Financial Leverage
• Value creation model to evaluate the performance of companies.
Value creation = Operating income minus (WACC*Average net assets)
Operating income = Sales minus operating costs (fixed and variable costs)
Net income = Operating income
Interests
Tax
• Vulnerability ratio = Interest expenses
EBITDA

• Vulnerable = Interest expenses

EBITDA > 50%
Interest expenses
• Risky 0:5 ≤ EBITDA <1
Interest expenses
• Very Risky EBITDA > 1; inability to cover interest expenses with present
operating income.
• Debt-to-equity ratio: Share prices fall and fall in real estate prices (in case of
property investments); both expected to trail behind rises in debt to equity
ratios. High leverage thwarts corporate growth since it involves heavy burden
of servicing the high debt.
• Evolution of interest rates on corporate loans.
 Ratios/Metrics of Financial Stability Assessment 109

5.7. Real Estate Sector Metrics

• Trends in housing starts.
• Trends in investments in dwellings.
• Trends in the contribution of dwellings to GDP.
• Number of building permits issued.
• Nominal real estate price gap.
• Bank credit to real estate sector over GDP.
• Commercial real estate lending to residential mortgage lending.
• Commercial real estate lending to nominal GDP.
• Real estate prices.
• House price-to-income ratio.
• House price-to-rent ratio.
•
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Housing affordability:

Ratio of housing prices to the yearly moving average of net monthly
wages; best done on a region wise basis.

Ratio of net disposable income to the price of a square meter of housing.
• Lending standards for real estate lending.
• Metrics to gauge on whether house prices are overvalued/undervalued.

P/E ratio for housing: Ratio of housing prices to rents; best taken over a
longer time frame.

Ratio of housing prices to fundamental prices.
• Countries which had the highest growth in residential real estate prices prior
to the crisis also saw the largest falls: Ireland, Slovakia, Spain, Slovenia and
Cyprus.
• Transactions in house: Number and values of transactions related to flats and
houses on real estate market.
• Stock of housing loans to stock of construction loans: Use such a ratio to
know whether banks are more willing to finance demand for housing loans
than to finance the supply of real estate.
• Non-resident demand: Non-resident demand for real estate in the country.

5.8. Public Debt Metrics

• Sovereign risk/credit ratings.
• Debt to GDP ratio.
• Debt to budgetary revenues.
• Interests/GDP.
• Oversubscription/Undersubscription of instruments issued.
• External debt/exports.
• Net international reserves/External debt.
• Yield curve/Term structure of interest rates.
• Percentage of government revenues used to service debt.
• External debt to export earnings.
• Debt service to GDP.
• Debt service to revenues.
 110 Tools and Techniques for Financial Stability Analysis

• Debt service to expenditures.

• Banks’ total lending to treasury/banks’ total lending.
• Interest on treasury bills (and other government instruments)/total interest for
banking sector.
• Total external debt in per cent of exports of goods and services.
• Total external debt service payments in per cent of exports of goods and
services.
• Debt redemption profile (indicator of rollover/refinancing risk).
• Currency composition of the portfolio or foreign to domestic debt ratio.
• Floating rate instrument composition of the portfolio or floating/fixed rate ratio.
• Short-term composition of the portfolio.
• Average time to maturity (indicator of rollover risk).
• Share of debt falling due in one or two years.
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• Average time to re-fixing (indicator of interest rate risk).

• Duration (indicator of interest rate risk).
• DV01 (indicator of interest rate risk).
• Convexity (indicator of interest rate risk).
• Other indicators can also be used as shown as follows:
• Sensitivity of debt portfolio to changes in interest rates.
• Sensitivity of debt portfolio to changes in exchange rates.
• Deviation of debt servicing flows from targeted path due to shock in interest rates.
• Deviation of debt servicing flows from targeted path due to shock in exchange
rates.
• Standard index of government quality provided by the International Country
Risk Guide published by Political Risk Services (2011).

5.9. Non-bank Financial Sector

Risk indicators pertaining to the shadow banking sector are depicted in
Table 5.4.
Table 5.4. Framework of Risk Indicators for the Shadow Banking System.

Maturity transformation Short-term assets/total assets MAT1

Long-term assets/total assets MAT2
Short-term liabilities/short-term assets MAT3
Long-term assets/short-term liabilities MAT4
Liquidity transformation (Total assets
liquid assets)/total assets LIQ1
Short-term liabilities/liquid assets LIQ2
Short-term assets/short-term liabilities LIQ3
(current ratio)
Liquidity mismatch: liquid liabilities less LIQ4
liquid assets, as share of total assets
(Deposits with MFIs + short-term debt LIQ5
holdings + equity holdings)/NAV
 Ratios/Metrics of Financial Stability Assessment 111

Table 5.4. (Continued )

Leverage Leverage = Loans received/total liabilities LEV1

Leverage multiplier = total assets/equity LEV2
Credit intermediation Loans/total assets CRE1
‘Credit assets’ (loans and debt securities)/ CRE2
total assets

Interconnectedness with Assets with credit institution counterpart/ INT1

the regular banking total assets
system

Liabilities with credit institution INT2

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counterpart/total assets

Source: Agresti and Brence (2017).

Risk indicators pertaining to the insurance sector are depicted in Table 5.5.

Table 5.5. Insurance Financial Soundness Indicators: Core Set.

Category Indicator
Capital adequacy Net premium/capital
Capital/total assets
Capital/technical reserves
Asset quality (Real estate + unquoted equities +
debtors)/total assets
Receivables/(gross premium +
reinsurance recoveries)
Equities/total assets
Non-performing loans to total gross
loans
Reinsurance and actuarial issues Risk retention ratio (net premium/gross
premium)
Net technical reserves/average of net
claims paid in last three years
Net technical reserves/average of net
premium received in last three Years
Management soundness Gross premium/number of employees
Assets per employee (total assets/number
of employees)
Earnings and profitability Loss ratio (net claims/net premium)
Expense ratio (expense/net premium)
 112 Tools and Techniques for Financial Stability Analysis

Table 5.5. (Continued )

Category Indicator
Combined ratio = loss ratio + expense
ratio
Revisions to technical reserves/technical
reserves
Investment income/net premium
Investment income/investment assets
Return on equity (ROE)
Liquidity Liquid assets/current liabilities
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Sensitivity to market risk Net open foreign exchange position/

capital
Duration of assets and liabilities

Source: Das, Davies, and Podpiera (2003).

5.10. Metrics for Investment Funds

• Composition of asset placement; tilted towards local or foreign markets.
• Composition type of asset placement-shares, bonds or bank deposits.
• Holdings structure of fund shares/units (perspective of investor type); whether
tilted towards local investors or foreign investors/ residents or non-residents.
• Funding structure: fund shares/units.
• With respect to investment funds, the ESRB (2016) proposed the following
risk indicators:

Maturity transformation: Long-term assets over total assets.

Liquidity transformation: (total assets
liquid assets) total assets.

Financial leverage: loans received/total liabilities.

Credit intermediation: (loans + bonds)/total assets.

Interconnectedness: exposure to local banks/total assets.
5.11. Payment and Settlement System Metric
A key metric in the payment and settlement systems is the turnover ratio.
Value of total payments made
Turnover ratio =
Overnight reserves þ Intraday credit
A low turnover ratio is symptomatic to an inefficient payment and settlement
system but a safer system as banks hold higher reserves to avert any feasible
liquidity shocks. The turnover ratio is useful to gauge on developments in the
payment and settlement system over time.
Systemic risk in the payment system sieved out via Herfindahl
Hirschman
Index. Second metric used is the level of transactions accounted for by the five
largest participants (excluding the Central Bank).
 Ratios/Metrics of Financial Stability Assessment 113

5.12. Key Metrics for Reserves Assessments

Real robustness showed in the light of the crisis via increase in net foreign
reserves.
Import cover is used to sieve out the number of months which can be
endorsed by the current reserves levels.
Ratio of reserves to short-term debt.
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