MDSX m06 Slides

Macroeconomic Diagnostics (MDSx)
Module 6
Macrofinancial Linkages
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Course: MDSx
Module: 6
Section: 1
Video #: 1
Video Title: Introduction to macrofinancial linkages
Video Type: Text
Introduction to macrofinancial linkages
Macrofinancial linkages
 Have not always been recognized
 Are bi-directional Required Negative
Space
(Not for instructor
notes.)
 Can be positive, negative, or neutral
Please do not adjust
text field positions.
 Our focus:
(Highly) negative finance to macro linkages
Force us to consider macro to finance
Not always recognized
“Traditional” or “Idealized” view
“Surplus Units” “Deficit Units” Required Negative

Space
Savers Capital (Not for instructor
notes.)
Households investors Please do not adjust
Firms text field positions.
 No role for finance: meeting, contracting,

agreeing, and complying is costless
Role of finance in macro is now clearer
Real World: with frictions
“Surplus Units” “Deficit Units”

Savers Capital investors Required Negative
Space
Households Firms (Not for instructor
notes.)
Uncertainty
Imperfect competition text field positions.
Imperfect information
Opportunistic behavior
Agency problems
Finance
Course: MDSx
Module: 6
Section: 1
Video #: 2
Video Title: Roadmap and motivation
Video Type: Text
Roadmap for this Module
 What is a banking crisis?

 Our diagnostic goal Required Negative
 Introducing FSIs—levels
Space
(Not for instructor
notes.)
 One step further: variability Please do not adjust
 A peek at stress testing text field positions.
 Wrap-Up
Why should we care?
Diagnosis of financial sector→ take corrective

action if needed
Required Negative
1. Financial accelerator: mutual reinforcement of Space
(Not for instructor
macro & finance notes.)

2. Macro-financial vulnerabilities: identify early

on, to avoid negative repercussions
 Can financial sector withstand shocks in
other sectors?
Course: MDSx
Module: 6
Section: 2
Video #: 1
Video Title: What is a banking crisis?
Video Type: Text
What is a banking crisis?
 Signs of banking system distress

 Bank runs
 Losses Required Negative
Space
(Not for instructor
 Liquidations notes.)
 Banking policy intervention measures Please do not adjust

 Liquidity support
 Bank restructuring or nationalizations
 Guarantees or deposit freezes/bank holidays
 Asset purchases
Two cases (all figures in %)

120
Argentina 2001-03 Thailand 1997-2000
100 Required Negative
Space
(Not for instructor
80 notes.)

60 text field positions.
40
20
0
Peak NPLs Fiscal costs Increase in public Liquidity support Output loss
debt
Our focus:
 Losses
Required Negative
 NPLs Space
(Not for instructor
notes.)
 Liability runs Please do not adjust
But, ultimately it boils down to:

 Insolvency/Loss of bank capital
Course: MDSx
Module: 6
Section: 2
Video #: 2
Video Title: Our diagnostic goal
Video Type: Text
Our diagnostic goal
To detect vulnerabilities, early signs of

distress before a crisis actually happens
Required Negative
Space
“How did you go bankrupt?” (Not for instructor
notes.)

“Two ways. Gradually, then all of a
sudden”
Ernest Hemingway, The Sun Also Rises

Our diagnostic goal
To detect the possibility that bank capital

could be wiped out (default):
K = A – L Required Negative
Space
(Not for instructor
notes.)
 Insolvency occurs when A < L
 How likely is this?
 How close are we to this possibility?

Graphical representation
Value of
Assets, Distribution of Asset value at T
Liabilities, Expected Required Negative
Capital asset Space
growth (Not for instructor
notes.)

Liabilities
A0
K0
L0
Probability of default
T Time
Our diagnostic goal
What determines probability of default?
 How much capital you have today: K0

Required Negative
 The volatility of A Space
(Not for instructor
notes.)
 By how much you expect A and L to grow Please do not adjust
Note:
 A is measured imprecisely (Book Value)
 We’ll focus on different balance sheet items
 FSIs give first approximation
Our diagnostic goal
We’ll highlight the relevance of selected

Financial Soundness Indicators (FSIs)
 Capital adequacy Required Negative
Space
(Not for instructor
 Asset quality notes.)

 Earnings and profitability text field positions.
 Liquidity
 Sensitivity to exchange rates
Course: MDSx
Module: 6
Section: 3
Video #: 1
Video Title: Capital adequacy
Video Type: Excel demo
Course: MDSx
Module: 6
Section: 3
Video #: 2
Video Title: Asset quality 1
Course: MDSx
Module: 6
Section: 3
Video #: 3
Video Title: Asset quality 2
Course: MDSx
Module: 6
Section: 4
Video #: 1
Video Title: Earnings
Course: MDSx
Module: 6
Section: 4
Video #: 2
Video Title: Liquidity runs
Course: MDSx
Module: 6
Section: 4
Video #: OPT
Video Title: Interest rate risk
Course: MDSx
Module: 6
Section: 4
Video #: 3
Video Title: Exchange rate risk
Course: MDSx
Module: 6
Section: 5
Video #: 1
Video Title: Variability and Z-score
Video Type: Power Point/Excel demo
Now we introduce variability
Will help assess whether a given FSI level

is appropriate
 First, combine capital adequacy and Required Negative
Space
profitability (Not for instructor
notes.)
K Please do not adjust

 ROA text field positions.
 Z-score: z A
 ROA
 Often called “distance to distress”

Now we introduce variability
For Bankistan
Required Negative
 K/A = 8.1%, ROA = 1.3% Space
(Not for instructor
notes.)
 From historical series (1996-2010): sROA = 2.3%
 It would take a (negative) profitability shock equal to
4.16 s’s to wipe out capital
 How likely?
 If ROA follows normal distribution, p = 0.002%

Course: MDSx
Module: 6
Section: 5
Video #: 2
Video Title: Variability and further questions
Video Type: Power Point/Excel demo
Alternative ways of looking at this
 Probability that a (-) earnings shock will:

 Bankrupt the system: 0.002%
 Push the system below K/RWA = 8% Required Negative
Space
(Not for instructor
notes.)
 What is the minimum amount that I Please do not adjust

should expect to lose x% of the time?
 Value at Risk (VaR)
Course: MDSx
Module: 6
Section: 6
Video #: 1
Video Title: A Peek at Stress Testing
Video Type: Text
A peek at stress testing
Surprise: you’ve already gotten it!

What would happen to the banking system
if: Required Negative
Space
(Not for instructor
 All NPLs have to be written off notes.)

 NPLs increase rapidly text field positions.
 There is a run on deposits (or other liabilities)
 Earnings fall (by a multiple of s)
 There is a large depreciation

Course: MDSx
Module: 6
Section: 6
Video #: 2
Video Title: Wrap-Up
Video Type: Excel
Wrap-Up
We’ve assessed:
 Capital adequacy Shocks to:

 Asset quality And  Borrower defaults Required Negative
 Earnings vulnerabilities  Earnings fall Space
 (Not for instructor
Liquidity to:  Deposit run notes.)
 Sensitivity to ER  Exchange rates
 Government default
Other
 Loan concentration
vulnerabilities we  Bank interlinkages
could analyze:  Off-balance sheet
 Non-bank institutions
Wrap-Up
 MF linkages: not obvious, bi-directional,

good, bad, neutral
 Amplification: financial accelerator Required Negative
Space
 Tail (rare) events: banking crises (Not for instructor
notes.)
 Analysis of crisis/distress Please do not adjust

 Boils down to capital
 FSIs: 1st approximation, then complement:
 Volatilities (Ex: z-score)
 Stress Tests
 Value at Risk

MDSX m06 Slides

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Macroeconomic Diagnostics (MDSx)

“Traditional” or “Idealized” view

“Surplus Units” “Deficit Units” Required Negative

 No role for finance: meeting, contracting,

Real World: with frictions

“Surplus Units” “Deficit Units”

 What is a banking crisis?

 A peek at stress testing text field positions.

Diagnosis of financial sector→ take corrective

Please do not adjust

2. Macro-financial vulnerabilities: identify early

 Signs of banking system distress

 Banking policy intervention measures Please do not adjust

Two cases (all figures in %)

Please do not adjust

But, ultimately it boils down to:

To detect vulnerabilities, early signs of

Please do not adjust

Ernest Hemingway, The Sun Also Rises

To detect the possibility that bank capital

 How likely is this?

 How close are we to this possibility?

Please do not adjust

What determines probability of default?

 How much capital you have today: K0

We’ll highlight the relevance of selected

Please do not adjust

Will help assess whether a given FSI level

K Please do not adjust

 Often called “distance to distress”

 If ROA follows normal distribution, p = 0.002%

 Probability that a (-) earnings shock will:

 What is the minimum amount that I Please do not adjust

Surprise: you’ve already gotten it!

Please do not adjust

 There is a run on deposits (or other liabilities)

 Earnings fall (by a multiple of s)

 There is a large depreciation

 Capital adequacy Shocks to:

 MF linkages: not obvious, bi-directional,

 Analysis of crisis/distress Please do not adjust

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