CS/TCM/FSDSSS/V/5

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CS/TCM/FSDSSSC/V/5

October 2010

Original: ENGLISH

COMMON MARKET FOR EASTERN

AND SOUTHERN AFRICA

Fifth Meeting of the Financial System Development and Stability Sub-Committee

Lusaka, Zambia

11-12 October 2010

REPORT OF THE FIFTH MEETING OF THE

FINANCIAL SYSTEM DEVELOPMENT AND STABILITY

SUB-COMMITTEE

Oct. 2010 (IZ-mmn)

A.INTRODUCTION

  1. The Fifth Meeting of the Financial System Development and Stability Sub-Committee was heldfrom 11-12 October 2010 in Lusaka, Zambia.
  1. ATTENDANCE, ELECTIONS OF THE BUREAU, OPENING OF THE MEETING, ADOPTION OF THE AGENDA AND ORGANISATION OF WORK
  1. The meeting was attended by delegates from Central Banks ofD.R. Congo,Egypt, Kenya, Malawi, Rwanda, Sudan, Zambia, and Zimbabwe. The list of participants is in AnnexII of this report.

Opening of the Meeting (Agenda item 1)

  1. The Acting Chairman, Mr.Anthony M. Simpasaof the Bank of Zambia welcomed the delegates and called the meeting to order.

Election of the Bureau ((Agenda item 2)

  1. The following countries were elected as the members of a new Bureau:

Zambia – Chair;

Sudan – Vice Chair; and

Kenya – Rapporteur

Adoption of the Agenda and Organisation of Work (Agenda item 3)

  1. The meeting adopted the following agenda:
  1. Call of the Meeting to Order by the Chairman;
  2. Election of the Bureau;
  3. Adoption of the Agenda and Organisation of Work
  4. Consideration of the Report ofthe Regional Workshop on COMESA;Assessment Framework for Financial System Stability;
  5. Work Plan for the Financial System Development and Stability Sub-Committee for 2011;
  6. Any Other Business; and
  7. Adoption of the Report and Closure of the Meeting.
  1. ACCOUNT OF PROCEEDINGS

Consideration of the Report of the Workshop on COMESA Assessment Framework for Financial System Stability( Agenda item 4);

  1. Mr. Gift Chirozva of the Reserve Bank of Zimbabwe who was engaged by COMESA Secretariat, as a consultant to conduct the workshop presented the report.
  1. In his presentation he informed the meeting that the 14th Meeting of the COMESA Committee of Governors of Central Banks which was held in Mauritius in October 2009 approved the COMESA Framework for Assessment of Financial System Stability. He also highlighted the following key issues that were considered by the the workshop:
  2. The Governors mandated the COMESA Secretariat to organize training on Assessment of Financial Stability in order to enable member countries to implement the agreed framework.

The Secretariat therefore, organised a regional workshop on the “COMESA Financial Stability Assessment Framework”, in Lusaka, Zambia, from 4 to 8 October 2010.

I. Country Experiences on Assessment of Financial System Stability

  1. The report of the experiences on implementation of the COMESA framework on Assessment of Financial System stability is contained in annex I of this report.
  2. Based on available responses from member countries, it was noted that most countries abide with the requirement to conduct self evaluations on compliance with the 25 Basel Core Principles for Effective Banking Supervision. In many countries, the self assessments have been conducted as part of the standard IMF/World Bank FSAP evaluations.
  3. A number of countries have also fulfilled the requirement to establish an independent Financial Stability Unit within the central bank. Progress has, however, been slow on establishment of a Multi-disciplinary Financial Stability Committee as consultations are still on-going among the key stakeholders. Implementation of the COMESA Financial Stability Assessment Framework is understandably still at the infancy stage throughout the region, as some member countries are still familiarising themselves with the framework, putting in place the administrative structures and analytical competences.
  4. The consultant pointed out that following the sharing of regional experiences during the course of the workshop, it was noted that a lot of countries appreciate the need for conduct of on-going financial stability assessments. The high level of awareness is, however, not always followed by effective implementation on the ground. In practice financial stability frameworks in most central banks are largely under-developed with no clear institutional objective.
  1. He informed the meeting that the workshop agreed thatfinancial stability assessments, like any other worthwhile cause, call for aggressive implementation. In practice, this requires a paradigm shift in the mindset of supervisory and regulatory authorities. The change in mind set should start at senior management level, the top of the regulatory and supervisory authority who should champion the process in order to enforce accountability.
  1. Based on country experiences, he emphasized that building a robust financial stability assessment regime also requires an ex-ante commitment of substantial time and resources. It was noted that, unlike Risk-Based Supervision and Basel II, not much focus and resources are being committed to financial stability assessments. While a number of in-country and regional workshops have been conducted by regulatory authorities on Risk-Based Supervision and Basel II for instance, training on financial stability assessments has to date been unsystematic and scant, and often lasting one day or two.
  1. He also emphasized that there is thus need for extensive training on financial stability assessments, which may be acquired on the job within the supervisory authority or participation in courses, seminars and conferences. Active use of twinning agreements with other central banks may expedite the development of analytical competencies.
  2. He further underscored that given the multi-faceted nature of financial stability assessments, reliance should be placed on a broad range of specialist skills. As such supervisory authorities may need to rethink appropriate mix of skills and expertise and hire specialists with competences in such fields as economics, finance, banking, econometrics, statistics, law, & accounting.
  1. He pointed out that care should be taken to avoid duplication of effort. Cooperation with internal (within the institution) and external stakeholders is needed. Establishment of good working contacts with other regulatory and supervisory agencies facilitates ease exchange of information

2. Choosing an Appropriate Regulatory Structure for Assessing Financial Stability

  1. The consultant informed the meeting that regulatory structures for assessment of financial system stability vary across jurisdictions. He stated that the key issues to consider for choosing an appropriate regulatory architecture are access to data, commitment to act and independence. He informed the meeting that the financial stability units are usually established within central banks to draw on accumulated prudential and/ or financial system data as well as economic research competences
  1. He indicated that there are competing views regarding the independence of the financial stability unit (FSU). To some an independent FSU denotes a standalone FSU, while others suggest that the concept of independence denotes an identifiable unit, whether within Banking Supervision Department or Economic Research Department. Resource endowments among member countries should also be taken into account when deciding on the location of the FSU.
  1. He also informed the meeting that the workshop agreed that the issue of independence of the Financial Stability Unitbe referred to theFinancialSystem Development and Stability Sub-Committee for guidance.

Recommendation

  1. The Sub-Committee recommended that member countries should decide for themselves the most appropriate structure for establishment of a Financial Stability Unit as long as there is an identifiable unit, with clearly defined mandate on fincial stability.

3. Core Objectives of Assessment of Financial Stability

  1. The consultant informed the meeting that the core objectives of financial stability assessments include the following:
  1. facilitate early identification of sources of risks (to stability) and of potential vulnerabilities that could threaten financial stability;
  2. promote rigorous, accurate and systematic assessment of the present degree of financial stability as well as the outlook ahead;
  3. evaluate the ability of the financial system to absorb shocks should the risks identified materialise;
  4. provide lead time for appropriate policy responses; and
  5. promote adoption of preventive and timely remedial (risk mitigation) policies and/or restore the system to stability (via resolution of problems) when preventive and remedial action fail.

4. COMESA Definition of Financial Stability

  1. He informed the meeting of the COMESA definition of financial stability which reads as follows:

Financial stability means a range of conditions which should be achieved by the financial system, comprising of financial institutions, financial markets, and financial infrastructure:

  1. fulfills its key economic functions and roles with no significant failures, cascading defaults, or adverse systemic impact, current or potential, on the real and/or financial sectors;
  2. Resiliency to endogenous and exogenous shocks (current or potential);
  3. facilitation of effective assessment, pricing and management of risks; and
  4. promotion of confidence in, and collective constituents stability of, the financial system even in periods of profound structural change.

5. Architecture of the COMESA Financial Stability Assessment Framework

  1. Under architecture of the COMESA Financial Stability Assessment Framework,he briefed the meeting that there is need for systematic monitoring of the individual parts of the financial system (institutions, markets, and infrastructure); components of the real economy (households, firms, & public sector); global macro-financial developments; and event risk (e.g. catastrophes). He stated that pursuant to these requirements, and as shown on the diagram below, the COMESA Framework for Financial Stability Assessments has three mutually reinforcing building blocks, namely:

i)On-going Surveillance;

ii)Diagnostic Financial Stability Assessment; and

iii)Framework for Policy Actions / Prescriptions.

  1. Approaches used in On-going Surveillance include:

(i)Macro-level and Micro-level Surveillance;

(ii)Quantitative and Qualitative Surveillance;

(iii)Global and domestic macro-financial conditions;

(iv)Macro-financial linkages and FSIs;

(v)Financial system supervision and regulation -

  • Risk-based supervision,
  • On-site and off-site surveillance,
  • Consolidated supervision; and

(vi)Robust financial system infrastructure.

a. Financial Sector Risks & Vulnerabilities

  1. In the ideal world financial stability assessments should entail a systematic and periodic process of monitoring all sources of risk on an individual and collective basis taking account all possible domestic, cross-sector and global linkages.
  1. It was noted that in practice it is recommended that financial stability surveillance focuses on identification and assessment of key structural vulnerabilities and a small number of key or material risks that could, in unlikely but plausible adverse circumstances, have material impact on financial stability.

CS/TCM/FSDSC/III/5

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CONCEPTUAL FRAMEWORK FOR MAINTAINING FINANCIAL SYSTEM STABILITY

Source: Developed from Schinasi (2005, p13), Schinasi (2004, p5) and Hunter et al (2006, p15)

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b. Diagnostic Assessment Framework

  1. The ultimate objective of diagnostic assessment is to gauge the likelihood of identified potential risks, and determine impact thereof, on financial stability as well as the real economy, to enlighten the formulation and implementation of appropriate policy actions as determined by financial stability developments and conditions.
  2. Diagnostic assessment employs a wide range of quantitative and qualitative methodologies to evaluate stability. Some of the various techniques that feed into the financial stability assessment process were discussed in detail at the workshop.
  3. Use of models and stress testing are often required to safeguard stability of the financial system via on-going evaluation of multiple endogenous and exogenous risk factors, key structural vulnerabilities, and/or macro-financial imbalances.
  4. Some of the specific methodologies considered during the workshop are:

a.Macro-prudential analysis;

b.Macro-stress testing;

c.Distance to Default;

d.Distance to Capital;

e.Inter-bank Contagion model;

f.Logit Models; and

g.Ideal Properties of Macroeconomic Models for Financial Stability.

c. Policy Framework

  1. The workshop considered the various policy actions that are available subject to the degree of stability in the system. Of note was the need to put in place appropriate bank insolvency regime to ensure speedy resolution of challenges in the financial system.
  2. Some policy options may be subdivided into “rules versus discretion” approaches.
  3. The workshop also noted that there are sometimes discrepancies between the stated policy position and the solutions adopted during a crisis as some institutions may be considered “too big to fail” or “too many to fail.
  4. The deliberations of the workshop noted that there are calls for the establishment of formal crisis management policies and strategies.

d. Diversity, Heterogeneity versus Standardisation and Harmonisation

  1. It was noted that the COMESA framework has inbuilt flexibility, which facilitates the integration of various quantitative and qualitative financial stability analyses into a standard framework, results of which are amenable to comparison over time with a given country and across nations.
  2. As the case with other regional or international initiatives, the emphasis is on enforcement of minimum standards and adherence to international best practice. A member country may adopt stricter standards subject to the degree of sophistication of their supervisory methodologies.
  3. Notwithstanding the methodologies used in any member country, which conceivably can vary from time to time, each member country should be able to produce a financial stability report covering all the key aspects of the framework; a risk assessment matrix and a SHIELDS rating of financial stability.

e Data Availability

  1. It was noted that there are challenge in respect of data availability for assessment of the corporate, household and the non-bank financial sectors.
  2. Alternative sources of data may include:
  1. Surveys of households, corporate and financial sectors;
  2. Statistical Offices;
  3. Tax Authorities;
  4. Registrar of Companies;
  5. Consumer Council;
  6. Credit Reference Bureaus; etc

f. Financial Stability Assessment Process (FiSTAS)

  1. The consultant informed the meeting that the practical sessions during the workshop put a lot of emphasis on the full cycle of the financial stability assessment framework.
  2. He pointed out that given the multi-dimensional and multi-faceted nature of financial stability, the COMESA Framework uses a comprehensive and structured SHIELDS Rating System to facilitate the assessment of financial stability over time and across nations. SHIELDS is an acronym of the following factors: Solvency Conditions; Health of the Macroeconomy; Institutional Quality; Earnings Conditions; Liquidity Conditions; Default Conditions; and Systemic Loss. SHIELDS makes use of the GLYOR colour coding system. The acronym GLYOR stands for Green, Lime, Yellow, Orange and Red wherein Green denotes Minor or Insignificant risk; Lime – Low risk; Yellow – Moderate risk; Orange – High risk; and Red – Extreme

Overall SHIELDS Rating System

SHIELDS ASSESSMENT / Financial Stability Rating
Dec 2009 / June 2010
EVALUATION CRITERIA / INDICATORS
Solvency Conditions /
  • Current and future
  • Capital adequacy

Home Economic Conditions /
  • Home economic conditions (household, corporate, public and external)
  • Credit conditions (booms or crunches)
  • Asset quality
  • Macroeconomic imbalances
  • Hard-wired Vulnerabilities
  • Current account developments

Institutional Quality /
  • Institutional governance
  • Risk management
  • Infrastructure conditions
  • Systemic impact

Earnings Conditions /
  • Bank profitability
  • Income generation risk
  • Systemic impact

Liquidity Conditions /
  • Current & future developments in market, monetary, funding, balance sheet, and bank liquidity conditions
  • Short tem loans
  • Systemic Liquidity

Default Conditions /
  • Default Conditions
  • Impact of price changes
  • Systemic Default

Systemic Loss /
  • Systemic Loss [losses (to) depositors and creditors; deposit protection agencies; owners; the public sector fiscal accounts; on assets; and macroeconomic losses]

COMPOSITE RATING / Systemic stability

Source: Author

  1. He stated that the new approach has inbuilt flexibility, which facilitates the integration of various quantitative and qualitative financial stability analyses into a standard framework, results of which are amenable to comparison over time with a given country and across nations.
  2. The risk to financial stability arising from a given factor or event is determined by the combination of the impact (the potential harm that could be caused) and probability (the likelihood of the particular event occurring).
  3. He informed the meeting that the diagram below shows how the overall risk to financial stability may be determined using a five tier risk assessment system.

  1. Results of this evaluation are recorded in a Financial Stability Assessment Matrix. The matrix facilitates the systematic evaluation of all the key risk elements that might affect stability.

Abridged Risk Assessment Matrix as at 31 December 20XX

Source: Follows concepts in FSA (2006, pp54-55) & Schinasi (2007, 29)

  1. The consultant also informed the meeting that the SHIELDS rating system draws its conclusions from the Financial Stability Assessment Matrix, Risk Assessment Rationale and other credible analyses.

6. Implementation of the COMESA Financial System Stability Assessment Framework

  1. The consultant informed the meeting that the responsibility to implement the proposed financial stability assessment framework lies with the individual member countries with COMESA Secretariat playing a co-ordinating role. Cognisant of the multifaceted and multi-dimensional nature of financial stability member countries are required to establisha Multidisciplinary Financial Committee.
  2. He pointed out that member countries will decide composition of the committee, its terms of reference, and frequency of the meetings. Among other responsibilities, the committee also overseas internal and external presentation and/or publication of financial stability reports (FSRs).
  3. He stated that the Financial Stability Reports are a key output of the COMESA Financial Stability Assessment Framework. He pointed out that the reports should initially be published on an annual basis, and eventually semi-annually, and satisfy the following:
  4. Evaluates the overall health of the financial system
  5. Should consider institutions of systemic importance in both the banking and non-banking sector.
  6. Evaluate macroeconomic and financial developments
  7. Evaluate financial infrastructure developments;
  8. Evaluate financial sector performance over the review period;
  9. Analyse vulnerabilities formation;
  10. Identify the remedial actions that can be taken; and
  11. Propose actions for the way forward.
  12. He also pointed out that the workshop agreed on the following to be contained the inaugural Financial Stability Report.

(a)Table of Contents