paul hiebert marrying the cyclical and structural dimensions of ... · pre-crisis toolkit lacked...
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Marrying the cyclical and structural dimensions of systemic risk The views expressed are those of the presenter
and not necessarily those of the ECB.
Paul Hiebert Head of Systemic Risk and Financial Institutions Division
Macroprudential policy conference – while the sun is shining, prepare for a rainy day
Copenhagen, 19 November 2018
Rubric
2
1
2
Background: Compartmentalised concepts of systemic risk
Measurement: Compartmentalised èmpirics of systemic risk: • Cyclical dimension: The financial cycle • Structural dimension: Conditional distress in banks
An approach to tackle the endogeneity of systemic risk 3
Policy considerations 4
Rubric
Page 3
Compartmentalised…
Macroprudential policies (system vs institution level)
Empirical approaches (cyclical vs structural)
Academic literature (risk buildup vs amplification/contagion)
Background
Rubric
Pre-crisis toolkit lacked instruments to tackle the financial cycle
• Buildup of country vulnerabilities
• Country spillovers and contagion
Financial system dimension
Policy domain Objective
Systemic risk
treated as
Micro-prudential supervision and
regulation
Ensure soundness of individual financial
institutions
exogenous
Macro-prudential oversight Limit systemic
risk
Increase resilience endogenous
Lean against the financial
cycle
endogenous
4
Background
Policies to tackle systemic risk in banks and financial systems
Financial institutions dimension
(Micro-)prudential regulation underestimated amplification and contagion
• Feedbacks system and bank
• Contagion across institutions
Rubric
5
Risk Build-up
Amplification of Shocks
Phase
Source: ECB Financial Stability Review (2018), May
Cyclical and structural dimensions of systemic risk
Background
Risk materialisation
Rubric
6
Source: Benoit et al (2017), “Where the Risks Lie: A Survey on Systemic Risk”, Review of Finance, 21 (1), March.
4/ ”Global measures”
3/ Interconnectedness- contagion
1/ Systemic risk indicators
2/ Amplification
Mapping the academic literature
Background
Rubric
7
1
2
Background: Compartmentalised concepts of systemic risk
Measurement: Compartmentalised empirics of systemic risk: • Cyclical dimension: The financial cycle • Structural dimension: Conditional distress in banks
An approach to tackle the endogeneity of systemic risk 3
Policy considerations 4
Rubric
Page 8
Leverage (credit and asset prices) and the build-up of system imbalances
• Leveraged bubbles (Fisher 1933; Jordà et al. 2015)
• Credit market frictions imply state of balance sheet matters for borrowing
• Leverage cycles (Geanakopolos 2010) • Real estate as collateral constraint (Iacoviello 2005) • Equity and corporate bond valuations (Gilchrist et al. 2009 and 2012)
A spectral method capturing comovement of credit and asset prices
• Narrow (credit, real estate) vs broad (credit, prices across all asset markets – i.e. real estate, equity, bond)
• Method exploiting coherence (across frequencies) and comovement (across time)
The financial cycle
“The following definition seems to capture what experts refer to as the business cycle:
The business cycle is the phenomenon of a number of important economic aggregates … being characterized by high pairwise coherences … This definition captures the notion of the business cycle as being a condition symptomizing the common movements of a set of aggregates.”
- T. Sargent (1987), Macroeconomic Theory, p. 282 [emphasis added]
Source: Schüler, Hiebert, Peltonen (2017), “Coherent financial cycles for G-7 countries: Why extending credit can be an asset” ESRB working paper No. 43.
Rubric
An estimated financial cycle for the euro area
The financial cycle
Source: Schüler, Hiebert, Peltonen (2015), “Characterising the financial cycle: a multivariate and time-varying approach” ECB Working paper 1846 Note: EA composite financial cycle in standardised growth rates, where 0.5 denotes the historical median after removing a nonlinear trend; 0 is the smallest and 1 the largest growth rate observed in a country’s history
Rubric
10
Financial cycles vs business cycles
• Longer (8-20y) vs. (2-8y) and higher amplitude
• More symmetric
• More heterogeneous across countries
• Predict banking crises better
Stylised financial cycle
The financial cycle
Rubric
11
1
2
Background: Compartmentalised concepts of systemic risk
Measurement: Compartmentalised empirics of systemic risk: • Cyclical dimension: The financial cycle • Structural dimension: Conditional distress in banks
An approach to tackle the endogeneity of systemic risk 3
Policy considerations 4
Rubric
Source: Segoviano (2006), “Consistent Information Multivariate Density Optimizing Methodology”, IMF Working Paper.
Joint distress across financial institutions
Rubric
Source: Segoviano and Espinoza (2017), “Consistent Measures of Systemic Risk”, IMF Working Paper.
Joint distress across financial institutions
Rubric
14
1
2
Background: Compartmentalised concepts of systemic risk
Measurement: Compartmentalised empirics of systemic risk: • Cyclical dimension: The financial cycle • Structural dimension: Conditional distress in banks
An approach to tackle the endogeneity of systemic risk 3
Policy considerations 4
Rubric Endogeneity of systemic risk
Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo).
Trend
Time (quarters)
Peak
Trough
High buildup of financial system vulnerability
Low buildup of financial system vulnerability
Low market-implied probability of bank distress
High market-implied probability of bank distress
Rubric
Endogeneity of systemic risk
Endogeneity of systemic risk
Adverse financial conditions
Benign financial conditions
• As financial conditions worsen the set of events where A, B and C are in default expand…
• … so does the amplification
magnitude in case of further deterioration of financial conditions
• … and banks deleveraging will further depress financial conditions
Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo).
Rubric
Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo). Note: Euro area regional financial cycle, JPoD computed for seven large euro area banks with availability of Moody’s 1 year EDF using the CIMDO approach of Segoviano and Espinoza (2017).
Endogeneity of systemic risk
Financial cycle and joint distress probability, euro area
1E-10
1E-09
1E-08
0.0000001
0.000001
0.00001
0.0001
0.001
0.01
0.1
1
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Financial cycle (lhs)
JPoD (rhs; log %)
Rubric Endogeneity of systemic risk
Financial cycle and conditional joint distress probabilities (log scale), euro area
Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo). Note: Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo). Note: Euro area regional financial cycle, JPoD computed for seven large euro area banks with availability of Moody’s 1 year EDF using CIMDO approach of Segoviano and Espinoza (2017).
Rubric Endogeneity of systemic risk
Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo). Note: Source: Segoviano, Bochmann, Hiebert and Schüler (2018), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo). Note: Euro area regional financial cycle, JPoD computed for seven large euro area banks with availability of Moody’s 1 year EDF using CIMDO approach of Segoviano and Espinoza (2017).
Financial cycle and conditional joint distress probabilities (levels), euro area
Rubric
20
1
2
Background: Compartmentalised concepts of systemic risk
Measurement: Compartmentalised empirics of systemic risk: • Cyclical dimension: The financial cycle • Structural dimension: Conditional distress in banks
An approach to tackle the endogeneity of systemic risk 3
Policy considerations 4
Rubric Policy considerations: Coherence and tradeoffs
Source: Segoviano, Bochmann, Hiebert and Schüler (2017), “Latent fragility: Conditioning systemic bank distress on the financial cycle”, IMF (Mimeo).
National financial conditions
Economic growth at risk
Vulnerability of financial
institutions
Structural macro and micro prudential policies
Cyclical macroprudential policies
Macroeconomic policies
Coherence of capital requirements?
Policy tradeoffs, lean vs clean?
Rubric
22
Source: Hiebert, Jaccard and Schüler (2018), “Contrasting financial and business cycles: Stylized facts and candidate explanations” Journal of Financial Stability, 38 (72-80) Notes: Boxplots show distribution of duration (in years) of cycle phases across 13 EU countries, 1970Q1-2013Q4
Financial cycles historically more symmetric than business cycles
Policy considerations: Asymmetries