Indicators should cover funding sources and capture large maturity mismatches. Initially solvent financial institutions may be driven toward closure by poor management of short-term liquidity. Compared with most other indicators, trends in profitability can be more difficult to interpret-for instance, unusually high profitability can reflect excessive risk taking. Chronically unprofitable financial institutions risk insolvency. Several indicators, however, can jointly serve-as, for instance, efficiency measures do-as an indicator of management soundness. It is primarily a qualitative factor applicable to individual institutions. Sound management is key to bank performance but is difficult to measure. The solvency of financial institutions typically is at risk when their assets become impaired, so it is important to monitor indicators of the quality of their assets in terms of overexposure to specific risks, trends in nonperforming loans, and the health and profitability of bank borrowers-especially the corporate sector. Thus, it is useful to track capital-adequacy ratios that take into account the most important financial risks-foreign exchange, credit, and interest rate risks-by assigning risk weightings to the institution's assets. Capital adequacy ultimately determines how well financial institutions can cope with shocks to their balance sheets. One commonly used framework for analyzing the health of individual institutions is the CAMELS framework, which looks at six major aspects of a financial institution: capital adequacy, asset quality, management soundness, earnings, liquidity, and sensitivity to market risk. Indicators of the current health of the financial system are derived primarily by aggregating data on the soundness of individual financial institutions. Financial crises often occur when both types of indicators point to vulnerabilities-that is, when financial institutions are weak and face macroeconomic shocks.ĬAMELS framework. MPIs comprise both aggregated microprudential indicators of the health of individual financial institutions and macroeconomic variables associated with financial system soundness (see table). The state of knowledge in these areas and proposals for further work were also discussed at a meeting of the IMF's Executive Board in January 2000. High-level experts from central banks, supervisory agencies, international institutions, academia, and the private sector discussed their experiences in using, measuring, and disseminating MPIs. A consultative meeting on MPIs was held at IMF headquarters in September 1999. The IMF has been building up experience with MPIs for some time as part of its surveillance and research, and more recently in the context of the FSAP. The latter is crucial in view of the magnitude and mobility of international capital, and the risk of contagion of financial crises from one country to another. In addition, if the indicators are comparable across countries -which is possible if countries adhere to internationally agreed prudential, accounting, and statistical standards-they facilitate monitoring of the financial system, not only at the national but also at the global level. If MPIs are made publicly available, they enhance disclosure of key financial information to the markets. They allow for assessments to be based on objective measures of financial soundness. These macroprudential indicators (MPIs) matter for several reasons. The ability to monitor financial sector soundness presupposes the existence of valid indicators of the health and stability of financial systems. Many other national and international institutions have also initiated or intensified monitoring work. This process is now well under way as part of the joint World Bank-IMF Financial Sector Assessment Program (FSAP), introduced in May 1999. The IMF has been called upon to assess financial system soundness in its member countries as part of its surveillance work, including through the preparation of Financial System Stability Assessments. The international community has identified a number of priorities, including the need to enhance its own-and the markets'-ability to monitor the health of financial systems. The international financial turmoil of the second half of the 1990s has provoked much reflection on ways to strengthen the global financial system. In recent years, an increasing amount of work has been done on such indicators as part of efforts to strengthen the international financial architecture. Macroprudential indicators-defined broadly as indicators of the health and stability of the financial system-can help countries assess their banking systems' vulnerability to crisis. Paul Hilbers, Russell Krueger, and Marina Moretti New Tools for Assessing Financial System Soundness
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