Framework for Macro-prudential Policies for Emerging Economies in a Globalized Environment

The sources and the propagation of the financial crisis have proven the need for macro prudential policies to address systemic risk, as well as take into account the interplay between the financial system and the real economy. One important operational tool to characterise systemic risk is to model bank defaults. The results of the Contingent Claims Approach (CCA) model suggest that valuable indications of vulnerabilities can be derived from the use of individual balance sheet data of financial institutions. Also, the deterioration in financial markets and economy tend to increase bank’s default probabilities. The main aim of this project is to carry out systemic risk assessments in real time to support policy discussions. In this aspect, the CCA framework has proven useful in quantifying systemic risk on the banking sector. Ultimately, the results of the CCA framework could be used to assess the impact of banking sector vulnerabilities on the real economy. Most importantly, the CCA framework could be extended to serve as a building block of a broader macro prudential framework. The goal is to unify the results of the CCA framework with other quantitative models (i.e. network model) to sharpen risk assessment across the banking system. The idea is to integrate different sources of risk into a single model architecture that uses behavioural rules to model bank’s behaviour that allows various feedback from banks. The single model architecture is envisioned to map out the topography of financial stability risk across the banking system. In monetary policy context, inflation risk is mapped out in a “fan chart” (probability density function). The fan chart is based on a macro model which draws on a wide range of information. The macro model is a framework ensuring information is assembled and accounted for in a consistent manner. The ambition is to develop an equivalent model framework for aggregating and assessing financial stability risk for macro prudential purposes.