Overview of the “Case Study for Macro Stress Testing and Forward Looking Financial Stability Reports” By Charles Augustine Abuka Director , Financial Stability Department Bank of Uganda COMESA Course on Forward Looking Financial Stability Reports 1 st November 2012 KSMS, Nairobi, Kenya
37
Embed
Overview of the “Case Study for Macro Stress Testing and Forward Looking Financial Stability Reports” By Charles Augustine Abuka Director, Financial Stability.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Overview of the “Case Study for Macro Stress Testing and Forward Looking Financial Stability Reports”
ByCharles Augustine Abuka
Director , Financial Stability DepartmentBank of Uganda
COMESA Course on Forward Looking Financial Stability Reports
• Banking sector dominated by the three big banks (95
percent of market share).
• Small open economy.
– Natural resource based.
• Banking sector - crucial role for financial intermediation.
• Financial system - heavily influenced by the international
financial markets.
• Significant growth of the economy over the last 12
years.
16
Background
• The global financial and economic crisis threatens Azaland
firms significantly.
• Negative impact on household disposable income .
• Rapid credit growth and overheating in the domestic
economy over the past six years.
• Foreign exchange loans to households - currency mismatch
on households’ balance sheets.
• Asset bubble on the property market financed by foreign
exchange loans.
• 15 percent of corporates are currently involved in the real
estate business. 17
Background
• Political instability, populist steps were taken by
government in response.
• Fiscal deficit - currently hit 6 percent of GDP.
• Government debt reached 60 percent of GDP.
• The growing budget deficit – exerts a negative
impact on government bonds risk premium.
18
Macro scenarios• Macro economic scenarios:
Baseline, Adverse.
• Annual data, current year’s values and projections for one year.
• Macroeconomic variables included in scenarios: GDP, Interest rate (3M interbank rate), Unemployment rate, Nominal exchange rate index
(increase=depreciation), Real estate prices index (commercial and
resident housing markets).19
Assumptions• One year horizon for stress testing.• Credit risk:
Credit portfolio was split into-corporate, retail, other, PD and LGD projection based on simple sensitivity
approach: PD-corporate-projection is linked to GDP, PD-retail-projection is linked to unemployment, PD-other- relative change is assumed the same
as for corporate, LGD-projection is linked to real estate price index.
• Credit growth: Projection is linked to GDP, Simple sensitivity approach - corporate, retail and
other.
20
Assumptions• Basel II formula used for credit risk calculation.• Average duration-used for interest rate risk
calculation: On balance sheet- securities, Off balance sheet.
• Foreign exchange risk: Foreign exchange assets and liabilities set
up as a share on total.• Capital requirement:
Increase of capital requirement for market and operational risks is assumed to grow at the same rate as capital requirements for credit risk.
21
Implementation
• Credit risk,
• Foreign exchange risk,
• Interest rate risk,
• Income and capital modeling.
22
Credit Risk
• Assumptions about credit growth projection are
employed:
• Expected Loss is calculated;
EL=EAD*PD*LGD– EAD=Exposure at Default, PD Probability of default, LGD Loss given defaul.t
• Non performing loans are projected based on
expected PD.
• Capital requirements are calculated by Basel II
formulas.
23
Basel II Concept for Credit Risk
• Under scenarios:
PDs increase,
Risk weighted assets could increase due to
higher PD or decrease due to
deleveraging.
• Banks use their incomes to keep the capital
adequacy ratio at the same level.
24
Foreign Exchange Risk
• Total net open foreign exchange position:
On balance sheet,
Off balance sheet.
• Foreign exchange shock based on the given
scenario,
• Foreign exchange risk = foreign exchange
shock*total net open foreign exchange position.
25
Interest Rate Risk
• Change in values:
On balance sheet ,
Off balance sheet.
• Assets held to maturity are deducted from total
assets.
• Interest rate shock based on the given scenario.
• IR risk = IR shock*average duration*value of
securities* (I-share of assets held to maturity).
26
Income and Capital Modeling• Income
Net income and net non-interest income is projected as an average of the last 3Y,
Impact of IR change is considered under the baseline scenario,
Total net expected income after the above shocks,
Income – the first level of defense against the shocks.
• Capital after shock is considered under baseline and adverse scenarios.
27
Task and Allocation to Groups• Group Work• 3 Working Groups (A,B and C)• Allocation of Tasks to Working
Groups• Discussion of Results
28
Task and Allocation to Groups
Groups A, B, C1. What are the main threats to financial stability in Azaland?2. Which macroprudential (economic and financial) indicators
should the Central Bank of Azaland consider for its financial stability assessment and for identifying the vulnerabilities to the financial system?
Group A3. How do you assess the overall design of the stress testing
framework of the Central Bank of Azaland? You may like to analyze the advantages and disadvantages, in particular, of the following:
– appropriateness of the time horizon, – top-down versus bottom up approach, – Projections of credit risk parameters – (PD and LGD),– Assessment of other risks.
29
Task and Allocation to GroupsGroup B4. Is the stress test framework of the Central Bank of Azaland
comprehensive enough to capture the major risks of the banking sector? Are you satisfied with the adequacy, integrity, depth and scope of the data use?
Group C5. How do you analyze and assess the stress test results under
the baseline and adverse scenario for the banking system in Azaland? What are the issues that you would like to raise in your discussions with the management of Ambro, BancFirst and Community? You may like to consider the following:– The central bank’s perspective on the system-wide
impact,– Impact of the stress test on each individual bank,– Management response to the stress test findings.
30
Task and Allocation to Groups
Optional question6. Do you agree that the scenario developed by the
Central Bank of Azaland is severe but plausible? How would you define a severe but plausible stress testing scenario? How should the stress test results be utilized in supervisory policy?
Groups A, B, C 7. Sketch a proposed outline of a Forward looking
Financial Stability Report for Azaland. Indicate the risks that you might emphasize in the stress tests, what might be the transmission channels. What measures would you propose to deal with these risks?
31
STRESS TESTS: CHALLENGES AND FURTHER WORK
32
Stress tests: Challenges and further work
33
Stress tests: Challenges and further work• Quality of underlying data,• Improvements required in scenario
• Central banks in the short term need to conduct stress tests on a more regular basis and include them as part of the general macroprudential analysis framework.
• It is important to include cross - border exposure and associated risks in stress testing.
• Countries need to develop macro - financial stress testing models and start to consider forecasting model projections as inputs to the analysis.