FSIs for Securities Markets

The stability of securities markets can be monitored using a range of quantitative indica­tors that focus on market liquidity because of the important role that liquid securities play

Table 2.5. Insurance Financial Soundness Indicators: Core Set

Category

Indicator

Non-life

Life

Capital adequacy

Net premium/capital

X

Capital/total assets Captial/technical reserves

X

X

Asset quality

(Real estate + unquoted equities + debtors)/total assets

X

X

Receivables/(Gross premium + reinsurance recoveries)

X

X

Equities/total assets

X

X

Nonperforming loans to total gross loans

X

Reinsurance and actuarial

issues Risk retention ratio (net premium/gross premium)

X

X

Net technical reserves/average of net claims paid in last three years Net technical reserves/average of net premium received in last three

X

X

years

Management soundness

Gross premium/number of employees

X

X

Assets per employee (total assets/number of employees)

X

X

Earnings and profitability

Loss ratio (net claims/net premium)

X

Expense ratio (expense/net premium)

X

X

Combined ratio = loss ratio + expense ratio Revisions to technical reserves/technical reserves

X

X

Investment income/net premium Investment income/investment assets

X

X

Return on equity (ROE)

X

X

Liquidity

Liquid assets/current liabilities

X

X

Sensitivity to market risk

Net open foreign exchange position/capital

X

X

Duration of assets and liabilities

X

Note: Relevance to life or non-life segment of Insurance is indicated by X.

Source: Das et al. (2003). The authors also propose a set of encouraged indicators for each of the above categories in order to capture additional dimensions. These include sectoral and geographic distribution of investments and underwritten business, derivative exposures, risk weighted capital ratio, market based indicators (market/ book value, price/ earnings, and price/ gross premium ratios), and measures of Group exposures (group debts/ total assets, proportion of business from group companies (Premium + claims)/ total business.

in the balance sheets of financial institutions.18 Market liquidity can be defined as a mea­sure of volume of securities that can be sold in a relatively short period without having a significant effect on their price. The literature typically recognizes two key dimensions of market liquidity: tightness and depth. Tightness is a market’s ability to match supply and demand at low cost. The bid-ask spread FSI may serve as an approximate index of tight­ness in each market, in that a narrower spread indicates a more competitive market with a larger number of buyers and sellers providing liquidity. Depth relates to the ability of a market to absorb large trade flows without a significant effect on prices. When market participants raise concerns about the decline in market liquidity, they typically refer to a reduced ability to deal without having prices move against them; that is, they refer to reduced market depth. The FSI of market turnover (gross average daily value of securities traded relative to the stock) helps assess the liquidity of banks’ balance sheets by giving an indication of the volume of securities that institutions can liquidate in the market. Market depth also can be approximated by other volume variables, quota sizes, on-the – run-off-the-run spreads, and volatilities.

2.2.1 Market-Based Indicators of Financial Soundness

Market-based measures drawn from price and volatility measures of various capital market instruments can provide forward-looking indicators of financial soundness. For example, default probabilities (for banks and non-banks) may be computed on the basis of models of credit risk, using equity prices and balance sheet data. In some cases, volatilities and risk premiums in market prices themselves provide indicators of likelihood of default. Further discussion of those indicators is contained in chapter 3.

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