IMF Paper Studies Metrics to Assess Vulnerabilities in Banking Sector
IMF published a working paper that measures the performance of different metrics in assessing banking system vulnerabilities. The study finds that metrics based on equity market valuations of bank capital are better than regulatory capital ratios and other metrics in spotting banks that failed. The paper proposes that these market-based ratios could be used as a surveillance tool to assess vulnerabilities in the banking sector.
The approach of the study presented in this paper was to test and calibrate different metrics using the banks that both failed and survived the global financial crisis. The out of sample performance of these metrics was then assessed using the banks that have since run into trouble (as well as those that have continued operating). The results show how the metrics can be implemented in practice and what they suggest about the risk of bank failures in the current environment. The paper has confirmed results of certain previous studies, which suggest that equity market-based capital ratios would have been better at signaling bank distress in the run-up to the global financial crisis than regulatory capital ratios—particularly the tier 1 capital ratio. In addition, the study tested the market-based capital ratios against other market and balance sheet indicators and found that the market-based capital ratios would have been better at predicting bank stress than these other metrics in the pre-crisis period. The analysis showed that the market-based capital ratios also performed well in the post-crisis period. This further supports the case for using these augmented capital ratios in assessing vulnerabilities in the banking sector.
The equity market-based capital ratios suggest there are still vulnerabilities in euro area banks, some years after the end of the euro area crisis. Additionally, there are some banks in the Asia-Pacific and Other European regions that are flagged by these metrics. These measures inevitably provide a somewhat fuzzy signal, where one can expect false alarms and perhaps overshooting in its predictions in periods of market turbulence. They also do not provide a sense of exactly when problems might arise in banks and may only provide a few months, or even weeks, of advance warning of distress. They are also, obviously, only available for banks that are traded on stock markets. However, these metrics are a valuable surveillance tool for financial stability authorities assessing vulnerabilities in the banking sector.
Related Link: Working Paper
Keywords: International, Banking, Regulatory Capital, Market-based Ratios, Tier 1 Capital, Stress Testing, Capital Ratios, Research, IMF
Featured Experts
María Cañamero
Skilled market researcher; growth strategist; successful go-to-market campaign developer
Nicolas Degruson
Works with financial institutions, regulatory experts, business analysts, product managers, and software engineers to drive regulatory solutions across the globe.
Emil Lopez
Credit risk modeling advisor; IFRS 9 researcher; data quality and risk reporting manager
Related Articles
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.