Financial Stability Risks Research Articles

Central Bank Policies and Climate Change. Where Do We Stand?

The article reviews the literature on the relationship between climate change and central bank policies. Central banks conduct monetary policy and are responsible for macroprudential supervision. The article focuses on the consequences of transition and physical risks for financial stability and price stability. It also asks what role central banks can play in slowing climate change and what implications climate change has for the future strategy and for the monetary policy framework of the Eurosystem.

Climate-related Financial Stability Risks for the United States: Methods and Applications

This report has two objectives: 1. Review the available literature on Climate-Related Financial Stability Risks (CRFSRs) as it pertains to the United States. Specifically, the literature review considers several modeling approaches and aims to 1.1 Identify financial market vulnerabilities (e.g., bank leverage), 1.2 Provide an assessment of those vulnerabilities (high/medium/low) as identified by the current literature, and 1.3 Evaluate the uncertainty surrounding these assessments based on interpretation of the findings and coverage of existing literature (high/low). 2. Identify methodologies to link climate risks to financial stability and possible research paths to assess U.S. CRFSRs. The report is structured in three parts. First, it characterizes the potential financial system vulnerabilities of climate change. Second, it describes the major methodologies adopted in studying the implications of climate change and provides an assessment of financial system vulnerabilities identified by the current literature. Third, it discusses how different methodologies can be further developed or combined to assess U.S. CRFSRs.

Ireland

This technical note1 investigates the interconnectedness between the market-based finance (MBF) sector in Ireland and the rest of the financial system, with a view to assessing potential financial stability risks. The MBF sector, the largest component of the financial system, totals over 14 times GDP and is comprised of the funds sector—both money-market (170 percent of GDP) and investment funds (850 percent of GDP)— as well as other financial institutions (OFIs), which comprise of special purpose entities (SPEs, 240 percent of GDP) and a catch-all category entitled “OFI residual” (160 percent of GDP). Chapter I provides an overview of the potential financial stability risks associated with the MBF sector, with a focus on the funds sector, and places it in its domestic and global context. Chapter II maps out the interlinkages between the non-banks, banks, and the real sector using network analysis to assess the strength and direction of interconnectedness. Chapter III delves into the balance sheet exposures of major categories of Irish funds, the largest component of the MBF sector, to further assess channels of risk transmission. The analysis focuses on a network of complex inter-sectoral financial relationships, based on a range of lending and borrowing instruments, and several findings emerge.

A Heatmap for Monitoring Systemic Financial Stability Risks in Ukraine

This study presents an updated risk map of the Ukrainian financial sector – an analytical tool for identifying and monitoring the buildup and materialization of systemic risks. The risk map methodology that the National Bank of Ukraine used until 2021 has been revised to ensure that risk assessment is based on reliable quantitative indicators rather than expert judgements, as well as to extend the list of risks considered. The instrument allows the stability of the financial system to be assessed across key risks, such as macroeconomic risk, the credit risks of households and non-financial corporations, capital adequacy risk, profitability risk, liquidity risk, and foreign exchange risk. We introduce indicators that capture a wide range of economic and financial vulnerabilities and group them by risks. Each risk category contains from four to seven indicators that combine both actual data and expectations. Statistical checks show that the indicators clearly signal previous crisis episodes, as well as the buildup of vulnerabilities during the research period. We find that macroeconomic risk and foreign exchange risk have the best explanatory and predictive power, while the weaker performance of other risks could result from structural changes in the banking sector over the past decades that have affected the overall risk profile of the financial sector.

Bitcoin is so Last Decade – How Decentralized Finance (DeFi) could Shape the Digital Economy

Ever since the Global Financial Crisis, the financial system has seen an accelerated level of innovation. Bitcoin offered a decentralized alternative to money, with thousands of other cryptoassets quickly emerging. Most recently, Decentralized Finance (DeFi) promises to offer a new digital economy, with smart contracts replacing the need for financial intermediaries. This new market aims to reinvent traditional financial products in a more transparent and interoperable way. In this paper we aim to undertake an extensive literature review of the financial stability risks posed by the fast-growing DeFi market and assess these using the Financial Stability Board’s fintech framework. We find that DeFi could pose several challenges to traditional financial infrastructure, primarily by increasing interlinkages between cryptoassets and traditional financial markets. However, if DeFi evolves in a safe way, it could increase competition and financial inclusion with overall positive implications for financial stability.

The currency channel of the global bank leverage cycle

The amplitude of leverage procyclicality is heterogeneous across banks and across countries. This paper introduces international diversification of bank balance sheets as a factor in this observed heterogeneity, with a special emphasis on currency diversification. Based on a new theoretical framework, it shows that the impact of international diversification on leverage procyclicality depends on the relative performance of economies, the global business cycle and the exchange rate regime. By altering the distribution of global bank portfolios, international diversification adds a currency channel to the risk channel of the global leverage cycle. Using granular data on banks located in Prance, the paper shows that the pre-crisis international diversification of banks increased leverage procyclicality during the 2008–2009 crisis. Focusing on the currency channel, namely the valuation effect of currency diversification, my results show that it had a negative effect on leverage procyclicality during this period. The currency channel thus helped to offset part of the increased risk caused by the crisis. These findings draw attention to the specific role of balance sheet currency diversification in financial stability risk.

United Kingdom: Financial Sector Assessment Program-Financial Stability and Managing Institutional, Technology, and Market Transitions

There has been a very smooth post-Brexit transition, with no material disruption nor any crystalized financial stability risks. This was the result of the U.K. authorities’ (and in some cases the EU authorities) and firms’ extensive preparations. The U.K. authorities have been proactively engaging with the industry, monitored risks, and consistently provided necessary legal certainty in a timely manner. This approach should continue, to the extent that any risks and uncertainties from Brexit remain.

Review of The Institutional View on The Liberalization and Management of Capital Flows — Background Note on Assessing Systemic Financial Stability Risks Due to FX Mismatches

This note outlines the approach of the proposed revision to the Institutional View (IV) when assessing whether systemic financial stability risks are elevated due to foreign currency (FX) mismatches. The approach builds on the staff guidance regarding risk assessments in bilateral surveillance, while allowing for flexibility to draw on future advances in best practice. This note proposes a two-step approach to assess systemic risks from FX mismatches. This note is organized as follows. Section II outlines the sources of systemic risks stemming from FX debt and potential amplification channels. Section III outlines the risk assessment approach in practice and Section IV concludes.

How Many Single Rulebooks? The EU’s Patchwork Approach to Ensuring Regulatory Consistency in the Area of Investment Management

The principle of consistency has undergone a remarkable evolution in the European Union (EU) from a mere political objective to a justiciable constitutional principle of EU law. In the area of financial regulation, regulatory consistency plays a particularly salient role as it is considered a prerequisite for preserving financial stability. In the wake of the 2007/2008 financial crisis, EU policy makers coined the concept of the Single Rulebook, highlighting the importance of a consistent and unified regulatory framework for the EU financial sector with a view to completing the Single Market in financial services and ensuring financial stability. This article examines the progress made towards achieving the Single Rulebook in the area of investment management over a decade after the financial crisis. The post-crisis EU legislation in this area follows a patchwork approach with a multitude of Level 1 and Level 2 directives and regulations that largely rely on the contrived legal form and labels to determine the applicable rules. This form-over-substance approach has created a complicated regulatory regime that is often detached from actual risks for investors and financial stability and thus fails to achieve the overarching policy goal of ensuring regulatory consistency. The central argument put forward in this article is that the Single Rulebook would be better achieved with a substance-over-form approach that addresses substantially similar investor protection and financial stability risks in a consistent manner.

Safety Nets Work Both Ways: The Influence of Available Paid Leave on Employee Risk Taking During the COVID-19 Pandemic.

During the COVID-19 pandemic, use of symptom-screening tools to limit attendance of infected workers has been widespread. However, it remains unknown how the reliability of responses to these tools may be compromised by individual and social factors. We aimed to determine whether personal concern over lost wages impacts responses to COVID-19 symptom-screening questionnaires making them less useful in limiting person-to-person transmission. We utilized an anonymous online questionnaire, administered through personal social media networks and those of two U.S. private colleges between September 16, 2020 and November 2, 2020 and distributed to currently or recently employed individuals 18 years of age or older. Participants considered ambiguous hypothetical scenarios involving possible COVID-19 symptoms or exposure and responded to a COVID-19 symptom screen (N = 219). In response to symptom-related scenarios (i.e., elevated temperature or slight cough), respondents lacking access to paid sick leave were 2.2 to 2.7 times more likely to attend work than those with access to paid leave (p < .05). This was not true for contact-related scenarios. Pay type and income level also significantly influenced screening responses. Risk of acute wage loss and overall financial stability appear to influence work-attendance decisions with regard to COVID-19 symptom screens. Broadened availability of paid leave and additional specificity within screening questionnaires would likely improve symptom-screen reliability.

A Significance of Climate Risks for the financial Stability: What do Trends in Central Banks Communication Tell Us?

The article examines to what extent central banks transmit the significance of climate risks for the financial stability to markets. Using simple text-mining techniques the article explores Financial Stability Reports (FSR) of central banks from the sample to assess the relative importance of climate- related topics, in particular to assess an intensity and regularity of climate topics in FSRs as sub-factors of their importance. The author assumed that the great importance of climate topics in central banks communication, facilitated by their regularity, gives a strong signal to markets about the significance of climate risks for financial stability. However, the findings indicate the generally low importance of climate-related topics in central banks’ communication (by means of FSR), which remains in contrast with the great urgency of climate considerations for financial stability nowadays.

Is the Time Ripe for Helicopter Money? Growth Impact and Financial Stability Risks of Outright Monetary Transfers

Is the Time Ripe for Helicopter Money? Growth Impact and Financial Stability Risks of Outright Monetary Transfers

A Macroprudential Perspective on the Regulatory Boundaries of U.S. Financial Assets

&lt;ns3:p&gt;This paper uses data from the Financial Accounts of the United States to map out the regulatory boundaries of assets held by U.S. financial institutions from a macroprudential perspective. We provide a quantitative measure of the regulatory perimeter—the boundary between the part of the financial sector that is subject to some form of prudential regulatory oversight and that which is not—and show how it has evolved over the past forty years. Additionally, we measure the boundaries between different regulatory agencies and financial institutions that operate within the regulatory perimeter and illustrate how these boundaries potentially become blurred in the face of regulatory overlap. Quantifying the regulatory perimeter and the boundaries for macroprudential regulators within the perimeter is informative for assessing financial stability risks over the credit cycle.&lt;/ns3:p&gt;

ЕКОСИСТЕМА КРИПТОВАЛЮТ ЯК БІЗНЕС-МОДЕЛЬ ФІНАНСОВОГО ПОСЕРЕДНИЦТВА НА МАКРОРІВНІ

The paper notes that at the present stage, research primarily by foreign scientists defines decentralized finance as based on the cryptocurrency ecosystem. The development of new financial technologies, which led to the emergence of digital currency, and its attractiveness, primarily as an asset for investment, have already formed a certain ecosystem of cryptocurrencies. In particular, the functioning of crypto-exchanges, which include various participants: issuers providing mining, agents and a kind of intermediaries in cryptocurrency transactions during the circulation of stablecoins. The dynamics of market capitalization of cryptoassets was analyzed according to the statistics of the International Monetary Fund (IMF), which increased more than 10.5 times (from USD 191.6 bln at the beginning of 2020 to USD 2,027.5 bln as of the end of September 2021). At the same time, it should be noted that the structure of the cryptocurrency market is unstable, which is typical for the new market that is in its infancy. This is confirmed by the market capitalization structure of bitcoin, ethereum, and stablecoins for the above period. Based on IMF data, indicators characterizing the state of formation of the cryptocurrency ecosystem, namely, bitcoin volatility and market capitalization of tokens, are analyzed. It is noted that the fairly rapid spread in the global financial space, and especially the growing attractiveness of cryptocurrencies in emerging financial markets, require the study of possible risks, arising from the formation of an ecosystem of cryptocurrencies and decentralized finance to ensure the stability of the centralized financial system. The main financial stability risks associated with the cryptocurrency ecosystem are systematized and grouped into key blocks: operational risk, cyber risk, misappropriation, bribery and corruption, as well as risks related to financial imbalances. The emphasis is on a problem that is formed purely in the field of decentralized finance and is associated with the development of peer-to-peer lending, crowdfunding and crowdinvesting. A generalization is made about the understanding of the ecosystem in the financial system (financial ecosystem), which is used in modern research at two levels: at the micro level it reflects the business model of a financial institution, and at the macro level it reflects the transformation of the financial system under the influence of financial technology. The formation of the financial ecosystem was the result of the intensive development of financial technologies (FinTech), among which neobanks are the most popular today. In addition, a classification of neobanks is proposed with an emphasis on the level of digitalization.

Is the Time Ripe for Helicopter Money? Growth Impact and Financial Stability Risks of Outright Monetary Transfers

Is the Time Ripe for Helicopter Money? Growth Impact and Financial Stability Risks of Outright Monetary Transfers

A Balance-Sheet Analysis of the Dutch Economy

The Dutch economy is characterized by substantial financial balance sheets in the private sector. Uncommonly large gross financial assets and liabilities are found in the financial sector, whereas households own significant net financial wealth. The large gross financial assets and liabilities reflect a dominant role of multinational corporations (MNCs). Despite their size, these financial positions have not brought significant financial stability risks to the country. On the other hand, Dutch households’ long balance sheets have been associated with depressed consumption and volatile real estate investment, which has probably exacerbated the cyclicality of the economy. The expected reform of the pension system is likely to change the way household balance sheets interact with private consumption.

Why macroprudential policy matters in a monetary union

Abstract This article discusses the role of macroprudential policy in a monetary union. It focuses on three main points. First, macroprudential policy has the objective of mitigating financial stability risks by preventing the build-up of vulnerabilities and increasing resilience. Second, many vulnerabilities reflect country-specific preferences and interact with national institutions. Monitoring and addressing financial stability risks at the national level are thus important. This holds particularly in a monetary union with economies that are highly integrated financially, but heterogeneous along important dimensions that can significantly affect financial stability risks. Third, cross-border externalities and spillovers call for the coordination of national macroprudential policies at the supranational level. This includes mechanisms to account for a potential inaction bias. Methodologically, the article draws on existing literature adding new empirical evidence on financial integration and adjustment to spillovers in the euro area.

The heat is on: A framework for measuring financial stress under disruptive energy transition scenarios

This paper introduces a stress test framework designed to quantify financial stability risks related to the energy transition. As is standard in financial stress testing, we first construct various tail-event scenarios, in which we incorporate shocks to climate policy and energy technology. We then use various modeling approaches to derive macroeconomic and industry-specific implications of these shocks. To illustrate the framework, we use granular data on EUR 2.3 trillion in assets of more than 80 Dutch financial institutions. We find that financial losses due to credit and market risk could be sizeable. For instance, portfolios values can decline by up to 11%. Such magnitudes suggest that climate-transition risks warrant close attention from a financial stability perspective, while also underlining the importance of avoiding transitions that would be too late and too sudden.

Optimization of capital structure as a tool for managing the value of dairy enterprises

The article is devoted to the study of methodological and practical approaches to optimizing the capital structure as a tool for managing the value of dairy enterprises. It is established that the most common and suitable for research in the context of optimizing the capital structure are two theories: compromise and the theory of the hierarchy of funding sources. It is argued that compromise models are not designed to accurately determine the optimal capital structure of the enterprise, but allow that the owners from the standpoint of risk is most advantageous to rank sources of funding as follows: retained earnings; debt sources; equity instruments, shares. It is proved that only in the complex use of approaches of foreign theories of capital structure optimization and developments of domestic scientists taking into account the environment of business entities it is possible to develop effective tools for maximizing the market value of the enterprise, minimizing the average market value of capital and risk of financial stability. The calculation of the integrated indicator of financial stability is offered, which allows to determine the level of the financial stability reserve, which allows to take into account the industry specifics and to carry out current monitoring of financial stability at the enterprise. It is substantiated that one of the methods of quantitative assessment of capital structure and substantiation of its optimal structure is the method of capital expenditures. It is argued that the estimated weighted average cost of capital varies in a fairly narrow range, is one of the key factors in the value of business, and achieving a minimum level of such a barrier rate increases the company's ability to make effective investments. It is established that determining the optimal financial structure of capital is one of the most difficult problems of financial management of dairy enterprises. It was found that the management of the formation and use of capital of dairy enterprises is focused on meeting the needs of sources of financing of their economic activities, and to achieve a balanced structure of sources of financing of capital by economic entities is possible only on the basis of optimization criteria. It is proved that the calculation of the weighted average cost of capital based on the capital assets model (CAPM) should be used provided reliable information on intra-industry indicators, in a developed stock market and the turnover of shares in the securities market. Key words: capital structure. cost of capital, cost management, dairy enterprises.

Financial stability and liquidity risks in the banking sector across the CEMAC region

How does credit from the financial sector and claims on the central government affect banking sector liquidity and financial stability risks? This paper constructs an algorithm, which investigates the impact of domestic credit from the financial sector, bank to capital assets ratio, claims on the central government on banking sector liquidity – a proxy for financial stability. The results show a positive and statistically significant impact of the capital assets ratio on the bank's liquidity of 3.1%. It equally finds that domestic credit and claims on central government hurt bank liquidity, notably of -0.15% and -2.5%, respectively. The study recommends that commercial banks invest in higher-value domestic projects to improve their profitability over the long-run, thereby boosting financial stability. Furthermore, the central bank should make additional liquidity for banks contingent on the amount of credit they provide to the real economy.