Polish Experience in Managing Systemic Risk in the Financial System - - PowerPoint PPT Presentation

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Polish Experience in Managing Systemic Risk in the Financial System - - PowerPoint PPT Presentation

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Polish Experience in Managing Systemic Risk in the Financial System in the Financial System Piotr Szpunar and Dobromi Serwa Financial System Department National Bank of Poland Istanbul, September 2012 National Bank of Poland ational Bank

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Polish Experience in Managing Systemic Risk in the Financial System

National Bank of Poland ational Bank of Poland

in the Financial System

Piotr Szpunar and Dobromił Serwa

Financial System Department National Bank of Poland

Istanbul, September 2012

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Agenda

  • Dimensions of systemic risk management
  • Crisis management

National Bank of Poland ational Bank of Poland

  • Crisis prevention
  • Identification of risks

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Managing Systemic Risk

  • Two dimensions of managing systemic risk

Normal times Crisis times

National Bank of Poland ational Bank of Poland

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times times Crisis prevention Crisis managment

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Agenda

  • Dimensions of systemic risk management
  • Crisis management

National Bank of Poland ational Bank of Poland

  • Crisis prevention
  • Identification of risks

4

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„Confidence Package”

  • 2008 – true test
  • CP introduced in response to global market turmoil

following Lehman Brothers collapse

National Bank of Poland ational Bank of Poland

  • Two main goals:

enabling banks to obtain funds in foreign currencies enabling banks to obtain funds in PLN for periods longer than one day

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Instruments of the „Confidence Package”

  • FX swap transactions (USD, EUR, CHF)
  • Liquidity-providing fine-tuning repo operations with a 3

and 6-month maturity

National Bank of Poland ational Bank of Poland

  • Introducing so-called netting of eligible collateral used in

subsequent repo operations

  • Earlier redemption of the NBP’s 10-year bonds issued in

2002

  • Lowering the required reserve rate from 3.5% to 3.0%

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SLIDE 7

5.5 6.0 6.5 7.0

WIBOR 3M declined by

Effects of the „Confidence Package”

  • WIBOR 3M rates movements in line with policy rate

National Bank of Poland ational Bank of Poland

3.0 3.5 4.0 4.5 5.0

01-09-2008 01-10-2008 01-11-2008 01-12-2008 01-01-2009 01-02-2009 01-03-2009 01-04-2009 01-05-2009 01-06-2009 01-07-2009 01-08-2009 01-09-2009 01-10-2009 01-11-2009 01-12-2009 01-01-2010 01-02-2010 01-03-2010 01-04-2010 01-05-2010 %

WIBOR3M NBP reference rate

declined by 264 bp The reference rate was reduced by 250 bp 7 Lehman Brothers default 15.09.2008

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Effects of the „Confidence Package”

  • Higher confidence of banks due to NBP’s FX swap

window

  • Reappearance of bilateral quotations on the interbank

National Bank of Poland ational Bank of Poland

Reappearance of bilateral quotations on the interbank depo market for transactions longer than O/N

  • Redistribution of liquidity in the banking sector
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SLIDE 9

INSTITUTION ROLE

MINISTRY OF FINANCE SUPERVISORY AUTHORITY CENTRAL BANK DEPOSIT INSURANCE FUND

  • guarantees
  • Lender of Last Resort
  • assistance

What else could be done?

  • Division of functions in the Safety Net

National Bank of Poland ational Bank of Poland

CRISIS MANAGEMENT

  • guarantees
  • state support
  • nationalisation
  • rehabilitation

programmes

  • Lender of Last Resort
  • Outright buy of

Government bonds programmes

  • deposit

payout

CRISIS PREVENTION

  • regulations
  • authorisation
  • regulations and

recommendaions

  • inspections
  • sanctions
  • oversight of the

payment systems

  • financial system

analyses

  • contribution to

financial stability

  • systemic risk

reduction

9

Financial Stability Committee

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Agenda

  • Dimensions of systemic risk management
  • Crisis management

National Bank of Poland ational Bank of Poland

  • Crisis prevention
  • Identification of risks

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Main risk prior to the crisis

  • Strong growth of FX mortgage loans for households
  • Most borrowers were not hedged against exchange rate

fluctuations

  • Potential risks for financial stability:

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  • Increased credit risk due to households sensitivity to depreciation
  • Volatility of collateral value (LtV)
  • Funding and liquidity risk for banks
  • Volatility of capital requirements
  • Distorted transmission of monetary policy impulses
  • Contribution to credit booms and price bubbles
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  • Recommendations for banks introduced by the Polish

Financial Supervision Authority

  • Recommendation S – introduced in 2006, amended in 2008 and

2011 Recommendation T – introduced in 2010

Risk minimization towards FX Lending

National Bank of Poland ational Bank of Poland

  • Recommendation T – introduced in 2010
  • Increased risk weights for FX mortgages (2012)
  • NBP’s stance that FX housing loans should be a niche

product, offered only to hedged borrowers

  • Reccomendations issued in Financial Stability Reports (form of

moral suasion)

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Recommendation S Recommendation SII Recommendation T Recommendation S**

Date of issuance 2006 2008 2010 2011 Subject All types of mortgage exposures All types of mortgage exposures All retail exposures All types of exposures financing real estate Measures

  • Higher creditworthiness

requirement in case of unhedged borrowers – creditworthiness calculates under assumption that foreign interest rate is at least equal to the domestic interest rate and the loan value is 20% higher than the contractual one.

  • Stress-testing the FX exposures –

at least once a year banks should assess the credit risk posed by unhedged borrowers under

  • All measures set by

Recommendation S have been confirmed.

  • Repayment of FX

loans in foreign currency – banks should enable their borrowers to change the FX loan contracts in a way that allows

  • Assessment of the borrowers’

creditworthiness on the basis of stress-test results – banks should calculate the maximum ratio of borrowers’ debt-repayment burden to income by taking into account 400 bps increase of interest rates (floating interest rate loans) and 30% domestic currency depreciation (FX loans).

  • Maximum debt-repayment burden

– the debt-repayment burden

  • Unless otherwise stated,

the credit risk assessment in case of retail exposures financing real estate should follow guidelines set by Recommendation T.

  • Maximum maturity for

assessment of creditworthiness – in case of exposures with

National Bank of Poland ational Bank of Poland

13 13 unhedged borrowers under assumption of 30% depreciation

  • f domestic currency within a 12

months horizon.

  • Stress-testing for changes in

interest rates – in case of floating interest rate loans, at least once a year banks should assess the credit risk stemming from interest rate changes under assumption of 400 bps interest rate increase within a 12 months horizon.

  • LtV limitations – banks are

required to set maximum LtV ratios for different mortgage exposures. that allows repayment of installments direct in foreign currency. – the debt-repayment burden cannot exceed 50% of borrowers’ average net income (net income below the level of average salary) and 65% (other borrowers).

  • Additional buffer in case of FX

loans to unhedged borrowers – calculating the maximum debt- repayment burden requires increasing the outcome of the value obtained in the FX stress-test by an additional safety buffer of minimum 10% of the loan repayment value in case of loans with maturity up to 5 years and 20% otherwise. case of exposures with maturity over 25 years, calculation of borrowers’ creditworthiness should be based on maturity of 25 years.

  • Maximum debt-

repayment burden for FX loans – in case of FX exposures, the debt- repayment burden cannot exceed 42% of borrowers’ average net income.

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  • FX mortgages do not generate excessive credit risk

despite significant PLN fluctuations

  • NPL ratios for FX mortgages low and comparable to

PLN loans

Effects of the mitigating actions

7%

NPL ratio for housing loans National Bank of Poland ational Bank of Poland

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0% 1% 2% 3% 4% 5% 6% Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 PLN FX TOTAL

NPL ratio for housing loans

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  • Dynamic growth of FX loans came to a halt
  • Bulk of new loans denominated in PLN

Effects of the mitigating actions

100% 120% Annual growth of housing loans 90% 100%Currency structure of new housing loans

National Bank of Poland ational Bank of Poland

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  • 20%

0% 20% 40% 60% 80% Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 PLN FX TOTAL Source: NBP 0% 10% 20% 30% 40% 50% 60% 70% 80% Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 PLN USD EUR CHF Source: NBP

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  • Convergence process:

lower interest rates, more stable FX rates, capital inflow and increasing demand

  • Structural and demographic factors:

Risks ahead: potential for a new credit boom ?

National Bank of Poland ational Bank of Poland

increasing number of new households, poor quality of housing

  • Financial innovation and liberalization
  • Economic recovery after the financial crisis

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  • Recommended instrument:
  • Debt Service-to-Income limits
  • Other potential instruments:

How to tackle the risk of a credit boom?

National Bank of Poland ational Bank of Poland

  • Other potential instruments:
  • Loan to Value (LtV) limits
  • Countercyclical buffer

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  • As
  • f

now no formalized body responsible for macroprudential policy

  • Systemic Risk Committee operating within the NBP
  • Advanced work to introduce Systemic Risk Board (SRB)

Institutional arregments

National Bank of Poland ational Bank of Poland

  • Advanced work to introduce Systemic Risk Board (SRB)

as the authority responsible for macroprudential supervision

  • Introduction of SRB in line with ESRB recommendation
  • n macroprudential mandates of national authorities
  • NBP to play a leading role in the SRB

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Agenda

  • Dimensions of systemic risk management
  • Crisis management

National Bank of Poland ational Bank of Poland

  • Crisis prevention
  • Identification of risks

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  • In order to fulfill its functions the SRB has to timely

identify risks and vulnerabilities

  • Crucial need for economic research and analyses
  • Emphasis on forward looking analyses

How to identify risks???

National Bank of Poland ational Bank of Poland

  • Emphasis on forward looking analyses
  • Preparatory research: under-way
  • Example: model identifying credit booms

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Motivation

  • How various macroeconomic factors affect the

equilibrium value of loans to households?

  • Is credit growing to rapidly given the actual state
  • f economy?

National Bank of Poland ational Bank of Poland

  • Lending booms – good predictors of financial

crises

  • Household

loans

  • ften

initiate consumption, investment and production booms

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Identifying credit booms

  • Standard approaches:

credit growth above some threshold value deviations of credit from the long-run trend (Hodrick- Prescott filter) error correction models

National Bank of Poland ational Bank of Poland

error correction models regime switching of credit growth

  • Our approach

treshold (regime switching) error correction model

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Our regime-switching model

  • Modeling credit growth:

National Bank of Poland ational Bank of Poland

  • Long-run equilibrium
  • Short-run dynamics may change regimes

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Credit regimes

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Level of Credit in Equilibrium

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Credit regimes

National Bank of Poland ational Bank of Poland

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Credit Boom (and Bust) Level of Credit in Equilibrium

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Credit regimes

National Bank of Poland ational Bank of Poland

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Credit Boom (and Bust) Level of Credit in Equilibrium

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Modeling approach

  • Build and simulate a general equilibrium life-

cycle model of credit to households

  • Estimate long-run relationship between credit

and income, interest rate spread, housing prices

National Bank of Poland ational Bank of Poland

  • Estimate our model:

Data from OECD and EU countries Selection of threshold variables Testing the number of regimes Novel estimation techniques for dynamic panel data models

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Results

  • Three regimes – possible to identify normal and

boom regimes

  • Best threshold variable: lagged credit growth

National Bank of Poland ational Bank of Poland

  • Credit boom when:

real credit grows slightly more rapidly than GDP credit is above equilibrium

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Our regime-switching model

  • Advantages of our method

Controls for economic fundamentals Distinguishes catching-up periods from credit booms No technical problems related to filtering (ad hoc parameters, end of sample bias)

National Bank of Poland ational Bank of Poland

(ad hoc parameters, end of sample bias) Avoiding biases of one-regime models (returns to equilibrium, prolonged booms, imprecise estimates) It performs better in practice

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Related problem: how booms affect quality of loans

  • NPL ratio – popular measure of credit quality in

banks

assess quality of loan portfolios analyze lending policies and efficiency of banks price bank equity

National Bank of Poland ational Bank of Poland

price bank equity predict bank failures construct early warning systems

  • Drawbacks: difficult to compare ratios across

banks and in different times

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How credit boom affects NPL ratio

  • 5 years of 30% credit growth (housing loans)
  • Low credit risk (NPL = 1%)

1.5% 2.0%

National Bank of Poland ational Bank of Poland

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0.0% 0.5% 1.0% 5 10 15 20 25 30 35 Credit boom Impaired loan ratio

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Controling for credit booms

  • Construct an artificial NPL ratio reacting only to

credit dynamics

Calibrating the term structure of loans Using growth dynamics of the true portfolio Keep PD of each loan constant in time

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Keep PD of each loan constant in time

  • NPL index robust to credit booms

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Impaired housing loans in Poland

National Bank of Poland ational Bank of Poland

Income growth, falling unemployment rate, rapid growth of housing loans up to the year 2008 economic conditions changed during the crisis

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Thank you for your attention.

National Bank of Poland ational Bank of Poland

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References

National Bank of Poland (2011, 2012) Financial Stability Report, July 2011, July 2012. Rubaszek M., Serwa D. (2012) Determinants of credit to households in a life-cycle model, ECB WP 1420. Serwa D. (2011) Identifying multiple regimes in the

National Bank of Poland ational Bank of Poland

Serwa D. (2011) Identifying multiple regimes in the model of credit to households, NBP WP 99. Serwa D. (2012) Measuring non-performing loans during and after credit booms, mimeo. Szpunar P. (2012) System risk lessons from FX loans in Central and Eastern Europe, Central Banking Journal, May 2012.

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