Abstract
In perspective of the economic vulnerability faced by banks in financial sector, this study mirrors the methodology used by Shumway (2001) – the dynamic hazard model that is able to forecast systemic risk in financial market arena. Here, the terminology followed is based on the CAMELS framework variables: capital adequacy, asset, management, earnings, liquidity and sensitivity to market risk. The objective of this study is to construct a macroprudential indicator (MPI) for the case of Bangladeshi financial market. The result will then be tested for robustness with macro-stress test. Lagged independent variables will be used in the simple hazard model to allow early prediction of MPI in the year in which the crisis happens. The empirical findings can be used as a guideline for the Bangladesh Government and policy makers in accessing, examining and forecasting the health of the Bangladeshi financial system and formulate suitable financial system policies for control. MPI generates information about systemic risk allowing the detection of potential economic crises functioning as an early warning indicator. Government and policy makers will be able to make early preparation in cushioning any potential crises by means of the MPI. Thus the impact of the crises could be minimized and eventually reduce its impact on the Bangladesh economy. The specific objectives are to assemble a novel MPI that is able to recommend early signals of financial market vulnerability, to identify the MPI turning points and establish a comprehensive reference chronology for Bangladeshi financial market and to evaluate the predictive performance of newly constructed MPI on characterizing Bangladeshi financial sector.
Highlights
The incidence of the financial and economic crises worldwide during the past two decades has arisen concerns regarding the stability of financial system of an aggregate economy and its interdependence in accordance with other sectors of the economy
macroprudential indicator (MPI) contains CAMELS framework that will cover all the important elements that is relevant to the financial sector
MPI functions as Early Warning System (EWS) - the ability to detect future financial crisis by forecasting systemic risk
Summary
The incidence of the financial and economic crises worldwide during the past two decades has arisen concerns regarding the stability of financial system of an aggregate economy and its interdependence in accordance with other sectors of the economy. While there is no globally accepted single measure or index for the assessment of financial system soundness, central banks adopt a variety of methodologies for the construction of their own financial stability indexes on the basis of their financial and economic conditions, availability of the data as well as perceived risk of the vulnerability. In this backdrop, it may be a ideal idea to construct a composite/aggregate financial stability index for the financial system of Bangladesh on an experimental basis based on the proposed Shumway (2001) methodology
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