Financial Stability Reports: How Useful during a Financial Crisis?

Article excerpt

Many of the origins of the recent financial crisis were in the United States, beginning with subprime mortgages and mortgage securities. As the crisis spread globally, few market participants or regulatory authorities saw it coming, and all underestimated its severity.

In the United States, the crisis has sparked many proposals to address its perceived causes and prevent a recurrence. Proposals include establishing a systemic regulator, enhancing financial institution supervision and resolution authorities, creating a consumer financial protection agency, and many others.

One approach already used in many other countries is publishing financial stability reports (FSRs). These reports review the condition of the financial system, identify and assess risks to the system, and suggest market or policy changes to address significant risk concerns. They are usually prepared by the country's central bank and appear on a regular basis.

The primary goal of an FSR is to promote financial stability. It attempts to achieve its purpose by providing insights that allow the central bank, other financial supervisors, and market participants to better anticipate systemic problems and design effective policy responses.

The recent financial crisis provides an opportunity to assess the effectiveness of these reports. This article analyzes the FSRs prepared by four European countries that were affected by the financial crisis--the United Kingdom, Sweden, the Netherlands, and Spain. We examine whether the reports gave the central bankers and others useful information before and during the crisis.

The analysis finds that these four FSRs were generally successful in identifying the risks that played important roles in the crisis--although they underestimated its severity. While it is not clear that FSRs helped to reduce the damages, it would be a mistake to dismiss them as a useful tool. Overall, publishing FSRs appears to be a worthwhile exercise that encourages central banks and international authorities to identify and monitor important financial trends and emerging risks and to develop a better understanding of the underlying structure of domestic and global financial markets.

The first section of the article describes the benefits of FSRs and their general characteristics. The second section gives a brief overview of the financial crisis. The following section discusses the FSRs of the UK, Sweden, the Netherlands, and Spain. These discussions highlight the unique aspects of the crisis in each country and the risks identified by the FSRs, followed by an evaluation of their effectiveness.

I. FINANCIAL STABILITY REPORTS

Financial stability reports have become an increasingly important tool for promoting stability. One study notes that in 2005 almost 50 central banks published an FSR (Cihak). (1) The United States is the only major industrialized country that does not publish one, although the Federal Reserve and other regulatory authorities have regular surveillance and monitoring programs. (2) This section describes FSRs and discusses their potential for promoting financial stability. Next, it describes the characteristics and general structure of FSRs and how they measure and assess risk to the financial system.

Financial stability reports

Financial stability can be difficult to define and has been used to describe a wide range of conditions. Financial stability can refer to the absence of a financial crisis or the "smooth functioning of the key elements that make up the financial system." (3) Alternatively, it can apply to financial systems that are robust and able to withstand various shocks or risk exposures. One of the Bank of England's (BOE) 2009 FSRs state that a "stable financial system is able to sustain critical services to the wider economy--payments, credit provision and insurance against risk--even when it is hit by unanticipated events. …