Financial Stability Policy Research Articles

Britain's Liability-Driven Investment Episode Was a Canary No One Elsewhere Bothered to Think About

Britain's liability-driven investment crisis in fall 2022 had lessons for other major financial centers that, as evidenced by the US and Swiss banking crises only a few months later, were largely ignored. They are still relevant. In this article, I first discuss what drove the British crisis before identifying lessons for the microregulation of pension funds; for financial stability policy on shadow banking and beyond; for central banking balance sheet regimes, including lending of last resort and market making of last resort; and for monetary policy when fiscal policy makers sit on their hands.

Does Macroeconomic Moderate The Effect of Risk and Diversification on Financial Stability? Evidence from Islamic Commercial Bank

<em><span>Islamic banking's financial stability can improve efficiency and health and be able to withstand shocks originating from internal and external factors. This study analyzes the impact of risk, diversification, and inflation on the financial stability of Islamic banking. By using monthly time series data from 2018–2022, the analysis method used is multiple linear regression and moderate regression analysis (MRA) using the Eviews version 10 application. The results showed that the credit risk variable (NPF) has a significant negative relationship to financial stability (Z-Score). As well as the liquidity risk variable (FDR), financing diversification has a significant positive effect on the financial stability of Islamic banking (Z-Score). Macroeconomic variables (inflation) can strengthen the effect of financing diversification and weaken the effect of liquidity risk (FDR), but inflation cannot moderate the effect of credit risk (NPF) on the financial stability of Islamic banking (Z-Score). This study introduces a new theoretical approach to the conceptual relationship between variables. The findings can serve as a reference for monetary authorities in considering the impact of inflation in setting financial stability policies.</span></em>

One money, one voice? Evaluating ideological positions of euro area central banks

We provide new insights into the effectiveness of central bank communication in the euro area relying on a novel methodology. The time-varying text based ideal point model (TV-TBIP) is used focusing on two crucial topics communicated by central bankers, namely price stability and financial stability. The methodology permits identification of the ideological position of the speaker. We find that the ECB transitions between a high ideal point state reminiscent of interventionist monetary policy and their effects on financial markets and a low ideal point state with emphasis on risks to fragmentation from monetary policy and financial stability policies. The individual euro area central banks tend to mirror the ECB’s position which suggests that some specialization/coordination of responsibilities from the communications activities of euro area national central banks takes place. National central banks’ positions change gradually and usually during crisis periods. In contrast, the ECB’s ideological position is very stable. We also conduct several econometric tests that point to national inflation rates influencing ideological positions. Additionally, we find that professional forecasts are responsive to the position taken of central bankers in their speeches.

The Impact of Financial Inclusion and Stability on Economic Growth in African Countries

This study investigates the effect of financial inclusion and financial stability on economic growth in a panel study of 30 African countries over the period between 2004 and 2020. Data were analyzed using the panel ARDL model. The panel ARDL estimation results demonstrate that financial inclusion has a statistically significant positive long-term effect on economic growth, though its short-term impact is insignificant. The study also found that the effects of financial inclusion on economic growth vary across different income levels. Specifically, there is a positive association in low-income countries, a negative association in lower-middle-income countries, and a positive but insignificant effect in upper-middle-income countries. On the other hand, the financial stability measured by the bank Z-score has a significant negative impact on long-run economic growth and a positive one in the short run. The effect is negative for low-income countries, positive for lower-middle-income countries, and negative but insignificant for upper-middle-income countries. Thus, the study findings suggest financial inclusion and financial stability policies should be tailored to the country's income level in African countries.

Financial stability policy and downside risk in stock returns

This paper investigates the impact of financial stability policy on downside risk in stock returns. Various risk measures are employed to estimate the downside risk of individual stock returns and to examine their responses subsequent to the proactive policy announcements made by China's Financial Stability and Development Committee (FSDC). The empirical results reveal significant financial stability policy effects in diminishing downside risks. Further analysis shows that direct support policies for the capital market have a more significant effect compared to proactive monetary policies and supportive credit policies. The real estate, non-cyclical consumer, and financial sectors exhibit particularly pronounced influences from financial stability policy.

Economic Development after Covid

The identification of Covid cases in China marked the beginning of a global crisis. The virus was first discovered in early 2020, leading to the lockdown of Wuhan city. Subsequently, it spread to India and the rest of the world, causing significant changes in the global economy. This article highlights various economic developments that have occurred during the Covid period, including the growth of the internet, advancements in the medical field, improvements in the IT sector, increased online transactions, enhanced family interactions, and improved healthcare for the people. However, it is important to acknowledge that the outbreak of the Covid-19 pandemic is a tragic event unfolding worldwide, reminiscent of the Spanish flu outbreak in 1918-19. Given the considerable uncertainty surrounding the economic outlook and the associated risks, quantifying the economic impact is challenging. Any unforeseen increase in uncertainty can jeopardize both economic growth and financial stability. In light of this, economists at the International Monetary Fund emphasize the need for targeted economic policies, fiscal measures, and appropriate monetary and financial stability policies to strengthen the global economy.

Response to my critics

AbstractCentral banking studies continues to consolidate around common foundations, but points of tension and disagreement persist. In this reply, I discuss three such points raised by contributors to this forum. These relate to the concept of infrastructural power, the significance of financial stability policy, and questions of historiography. I also offer some reflections on future directions for the study of central banks.

RATIONALE OF FINANCIAL STABILITY IN SOUTH AFRICA: CONSTRUCTING A FINANCIAL STRESS INDEX

The need for financial stability became apparent after the devastating events of the 2008 financial crisis. It was around this time that central banks around the world started to construct and implement scientific methods to assess financial stability. This research gives a comprehensive understanding of financial stability and makes use of scientific methodology by constructing the financial stress index for South Africa from periods 2006 through 2015 to predict and attain financial stability. After the 2008 global financial crisis, South African policymakers have put in place some policies and tools to enhance financial stability. To complement these policies, a new financial framework was developed, that is, the twin peaks model to continuously gather data and asses financial stability on a continuous basis. To put this framework into practice the financial stress indicator or index acted as a single comprehensive tool to measure and monitor stability. Included in this index are indicators that capture the different dimensions of the banking sector. The results gathered from this index contribute to the understanding of financial stability and how it is measured. It was found that the volatility or patterns of the financial stress index could be used as predictions and early warning tools for policymakers or the Central Bank to step in and contain potential risks. Moreover, from the empirical data collected the financial stability policies in South Africa are effective, as the financial stability index after the period of crises remained stable.

The Comparative Effects of Financial Stability Policies

The Comparative Effects of Financial Stability Policies

Communicating financial stability in monetary policy reports: a text-mining experiment in postcommunist countries

PurposeFinancial stability has become a focal point for central banks since the global financial crisis. However, the optimal mix between monetary and financial stability policies remains unclear. In this study, the “soft” approach to such policy mix was tested – how often monetary policy (in inflation reports) analyses financial stability issues. This paper aims to discuss the aforementioned objective.Design/methodology/approachA total of 648 inflation reports published by 11 central banks from post-communist countries in 1998-2019 were reviewed using a text-mining method.FindingsResults show that financial stability topics (mainly cyclical aspects of systemic risk) on average account for only 2%of inflation reports’ content. Although this share has grown somewhat since the global financial crisis (in CZ, HU and PL), it still remains at a low level. Thus, not enough evidence was found on the use of a “soft” policy mix in post-communist countries.Practical implicationsGiven the strong interactions between price and financial stability, this paper emphasizes the need to increase the attention of monetary policymakers to financial stability issues.Originality/valueThe study combines two research areas, i.e. monetary policy and modern text mining techniques on a sample of post-communist countries, something which to the best of the authors’ knowledge has not been sufficiently explored in the literature before.

Fiscal Space and Policy Response to Financial Crises: Market Access and Deficit Concerns

Existing literature suggests that fiscal space matters for the policy response to financial crises. High public debt levels limit countries capacity to pursue macroeconomic and financial stabilization policies and resume growth after severe crisis downturns. We examine the involved channels through which fiscal space matters for the dynamics of fiscal policy after a financial distress, namely sovereign market access and policymakers’ views, in a panel of 30 OECD countries for the period 1980–2017. We introduce a non-linear measure of fiscal space, which further considers simultaneously both the debt-to-GDP ratio capturing long-term features of countries’ policy-making processes and budgetary balances that capture recent policy decisions and persistent fiscal deficits. We document a substantially strengthened role for sovereign market access constraints in driving the policy response to distress once fiscal space non-linearity is introduced in the model, which highlights the non-linearity involved in market participants’ concerns about fiscal space. Moreover, the vulnerability of market access concerning fiscal space is affected by either the debt-to-GDP ratio or fiscal balances dominating the assessment of fiscal space. The role of fiscal health and the policymakers’ views channel is more pronounced once flows of budget deficits are at the epicenter of the assessment of fiscal space, suggesting a “deficit concerns” channel.

금융불안이 소득불평등에 미치는 영향 분석

Although recently the research on the relationship between financial instability and income inequality got deep interest, there is little study. This paper analyses the relationship between financial instability and income inequality. The Financial Stability Index (FSI) and the Financial Vulnerability Index (FVI) are used as the measure of financial instability and the income quintile share ratio is used to measure income inequality. As the result of empirical studies, the deterioration in FCI results in an increase in income inequality whreas the worsening in FVI appears not to have an impact on income inequality contemporaneously. This result is similar in the case of the GMM estimation which considers endoneous issues due to reverse causality. In the robust analysis where sufficient lags are incorporated into the FSI and the FVI, both variables appear to increase income ineqauity. We interpret that this result is because the FSI reflects current financial instability while the FVI takes into future inancial instability in terms of mid- and long-term. This result implies that the macro-prudential policy or the policy for financial stability can be useful for improving income inequality

Relationship between financial inclusion, monetary policy and financial stability: An analysis in high financial development and low financial development countries

This article studies the linkage between financial inclusion, monetary policy and financial stability in 58 countries including 31 high financial development countries (HFDCs) and 27 low financial development countries (LFDCs) from 2004 to 2020 using the PVAR method. Results of impulse – response function suggest that in LFDCs, while financial inclusion and financial stability are positively correlated, they are negatively correlated with the inflation rate and the money supply growth rate. In HFDCs, financial inclusion is positively corelated with inflation rate and money supply growth rate, while financial stability is negatively correlated with financial inclusion, inflation rate and money supply growth rate. These findings imply that in LFDCs, financial inclusion increases financial stability and reduces inflation. In HFDCs, on the contrary, financial inclusion increases financial instability, leading to long-term inflation. The results of the variance decomposition confirm the above outcomes, specifically, this relationship is clearer in HFDCs. From the above findings, we propose some policy recommendations on financial inclusion and monetary policy for financial stability for each group of countries.

Financial Stability and Monetary Framework under Interest-Free DSGE Settings for Pakistan

Various small and large, conventional and interest-free, DSGE models havebeen developed, simulated, and compared. After a large conventionalmodel, an interest-free NK model was prepared with household preferences,retail firms, and capital-producing firms. The deduction of zakat wassuggested with appropriate incidence. The model was estimated usingquarterly data for Pakistan between 1990 and 2009, a period characterizedby the consolidation of monetary and macro-prudential policies besides theopening up of the banking sector. This large-scale model included financialaccelerator, systemic risk, the inter-bank market, macro-prudential policy,and monetary policy. Both types, that is, interest-based conventional modelsand interest-free models, were estimated and compared. The welfare loss offour conventional and three interest-free models was computed andcompared, where loss decreased with monetary policy and increased withmoney in utility. The lower value of welfare loss for the large conventionalmodel exhibited effective financial stability policies in Pakistan, ascompared to the basic model. It was found that interest-free monetarymodels couldn’t reduce welfare loss, when compared with conventionalmodels. The study also evaluated three interest-free rates of return asalternatives to interest rates theorized by Khan and Mirakhor (1989). It wasfound that the shift towards an interest-free regime for entrepreneurs,banking, inter-bank operations, central banking, and policies can besimulated with Pakistan’s data. The Islamic model showed lesserconvergence, so the fit of the model was reduced.

Risk Disclosure and Earnings Quality in Indonesia Banking Industries: Fair Value, Diversification, Financial Stability

High earnings quality can reflect a company’s actual performance. Stakeholder needs high earnings quality as earnings information is used for decision-making by stakeholder. This study investigates the effect of fair value, diversification, and financial stability on earnings quality and the roles of risk disclosure in moderating these effects. This study employs secondary data sourced from annual reports available at www.idx.com. The sample used in this study is bank companies from 2016 to 2020. Using purposive sampling, the sample obtained in this study was 180 observations. The research data were analyzed using multiple linear regression for panel data. This study suggested that fair value does not affect earnings quality. Other than that, diversification positively affects earnings quality while financial stability negatively affects earnings quality. Furthermore, risk disclosure failed to moderate the effect of fair value, diversification, and financial stability on earnings quality. This study indicates that the Indonesian Financial Services Authority needs to regulate the bank's diversification and risk disclosure policies. Moreover, the Indonesian Financial Services Authority should maintain and improve the bank’s financial stability policies.

Financial networks and systemic risk vulnerabilities: A tale of Indian banks

This study identifies the nature and direction of unprecedented upheavals in the Indian banking sector which is linked to credit market asymmetry. A tail-driven network approach with a mixed sample of banks and firms exhibits the characteristics of the twin-balance-sheet syndrome. We construct the networks with a degree of interconnectedness at different quantiles and identify major systemic risk emitters and receivers. Furthermore, we find a spillover of the riskiness of deep-in-debt firms to banks. Smaller banking institutions evince a greater connection to banks and firms than larger ones. Our results are valuable for policymakers formulating financial stabilization policies and investors considering Indian markets for various opportunities.

Does financial stability matter for environmental degradation?

There is a body of evidence that financial development contributes to the quality of the environment, either positively or negatively. However, a limited number of studies consider the effect of financial stability or financial risk on environmental degradation. As part of the proposed research, the present study contributes to the existing literature on asymmetric financial stability's impact on Ireland's environmental quality, as a major gap needs to be added to the literature. Based on this aim, the present study explores the effect of financial stability on environmental degradation in Ireland while controlling primary energy consumption, economic growth, and renewable energy in Ireland. The study employs a novel Fourier autoregressive distributed lag model (FARDL) approach for Ireland, covering the period 1990Q1‐2019Q4 with quarterly data. FARDL cointegration test results indicate a long‐term relationship between financial stability, primary energy consumption, renewable energy consumption, and CO2 emissions. The outcomes from the long‐term coefficient estimation model based on the FARDL model reveal that (i) financial stability leads to a decrease in environmental degradation in Ireland; (ii) renewable energy consumption promotes environmental sustainability; (iii) primary energy consumption has a negative effect on Ireland's environmental quality. These results denote that Ireland should enhance financial stability and promote renewable energy to reduce fossil fuel consumption to achieve net‐zero targets by 2050. Ireland to implement long‐term financial stability policies to fill the emission gap and achieve a net zero emissions target by 2050. Specific policy recommendations for Ireland's environmental policies are also discussed in the study.

Understanding the current global regime shift and the standing of the macro-financial system resilience

Understanding the current global regime shift and the standing of the macro-financial system resilience

Global financial cycles since 1880

We analyse global aggregate and segment-specific cycles across credit, house prices, equity prices, and interest rates in 17 economies over 130 years using a time-varying dynamic factor model. We show that global financial cycles have gained relevance over time. For equity prices, they now constitute the main driver of fluctuations in most countries. Global cycles in credit and housing have become more pronounced and protracted since the 1980s, and their relevance has increased for a sub-group of financially open and developed economies. Panel regressions show that a country’s susceptibility to global financial cycles tends to increase with financial openness and financial integration, the extent of mortgage-related lending, and the efficiency of stock markets. Understanding changes in global co-movement over time and its heterogeneous role across countries matters for the design of financial stabilization policies.

The Identification of Seasonality in the Housing Market Using the X13-ARIMA-SEATS Model

Aim: In the conducted research, profiles of seasonality in the housing market were determined, which provided an opportunity to answer two fundamental questions: what is the nature of harmonic variation in the seasonality and periodicity of the studied components of the construction process? what parameters of the ARIMA model optimally describe the construction market? Methodology: In the conducted research, using the X13-ARIMA-SEATS model, seasonal decomposition was carried out in the various stages of the housing construction process. Results: The research process conducted to identify seasonal fluctuations in the housing construction market showed that harmonic fluctuation profiles can be identified on an annual basis. An analysis of seasonal fluctuations was carried out for each of the three stages of the housing construction process, while also checking how these profiles function for Poland in general, and for individual investors, and for those building apartments for sale or to rent. The study showed that the market for real estate development activity differs in its seasonal characteristics from that of individual investors. Implications and recommendations: The conclusions obtained from the research can provide support in the decision-making process, both from a macro and microeconomic perspective. Parameterisation of the occurring fluctuations, and taking them into account in the process of developing a forecast can provide decision-making rationale in the implementation of macroprudential and financial stability policies Originality/Value: A novelty is in the demonstration that the residential real estate market in Poland shows different seasonal parameters, divided into the market of individual investors and investors who build apartments for sale or rent.