Analysis of FSIs for Nonfinancial Sectors

Monitoring the financial condition and vulnerabilities of the corporate, household, and real estate sectors can enhance the capacity to assess risks to the financial sector. Loans to the corporate sector typically account for a significant portion of bank loan portfolios; thus, the health of the corporate sector represents a major source of risk to the financial system.14 Households play an important role as consumers (of goods, as well as financial products and services), as depositors, and as holders of risky assets; hence, changes in their financial position can have significant effect on both the real economy and financial market activity.15 The real estate sector also has been an important source of risk because

of the key role that real estate plays as collateral, but this dimension has proved difficult to monitor because of the paucity of data on real estate prices.16

FSIs for the corporate, household, and real estate sectors can serve as early warning indicators of emerging asset quality problems. Shocks to their balance sheets, if signifi­cant, are eventually transmitted to the balance sheets of banks and other financial institu­tions. However, if one is to make effective use of FSIs for those sectors for this purpose, it is necessary to assess the exposure of the financial system to each sector (e. g., using FSIs of the sectoral distribution of lending) and to estimate how a deterioration of the financial condition of nonfinancial sectors, which would be based on FSIs for those sectors, is likely to affect banking sector asset quality. In some assessments, FSIs for corporate and house­hold sectors were made endogenous by estimating the effect on those FSIs of changes in the relative price of debt to equity, level of interest rates, cyclical position, profitability, and unemployment. The prospective evolution of corporate and household leverage can then be projected by using the above variables, and such projections can help assess likely changes in asset quality of financial firms.

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