FSIs for Banking

Banking sector FSIs can provide useful quantitative information on the stability or vul­nerability of the banking system.16 Banking sector FSIs can be grouped according to six key areas of potential vulnerability in the CAMELS (Capital adequacy, Asset quality, Management soundness, Earnings and profitability, Liquidity, and Sensitivity to market risk) framework. Most FSIs are compiled by aggregating microprudential indicators for individual institutions to produce a measure for key peer groups such as domestically owned banks, local branches, foreign subsidiaries, state-owned banks, complex groups, or the entire banking system.17 Non-bank FSIs (such as those for the corporate and house­hold sectors or those for insurance) can be used to assess credit risks arising for banks from their credit and other exposures to non-bank sectors.

Each of the six subgroups of bank FSIs has a different part in the stability assessment. Indicators of capital adequacy can be used to measure the capacity of the sector to absorb losses. Because risks to the solvency of financial institutions most often derive from impairment of assets, the second category of FSIs is asset quality. FSIs in this category monitor loan quality and exposure concentrations of bank asset portfolios. Indicators of management efficiency are used to capture the importance of sound management in ensuring the health and stability of banks. A variety of data on margins, income, and expenses can be used to measure earnings and profitability because earnings indicate the ability to absorb losses without drawing on capital. In contrast, rapid growth in earnings or profits may also signal excessive risk taking. Measures of liquidity indicate the ability of a banking system to withstand shocks to cash flows. FSIs for liquidity measure the liquid assets available to a bank in the event of a loss of market funding or an outflow of depos­its. Market liquidity measures also can be included to monitor the liquidity of the main securities held by banks. Banks are then exposed to market risk from their increasingly diversified operations and positions in financial instruments. Sensitivity to market risk (changes in market prices, particularly interest rates and exchange rates and, occasionally,

equity prices) can be measured using information on net open positions, durations, and stress test results.

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