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RBI working paper lays down 11 indicators of financial stress


Date: 24-09-2020
Subject: RBI working paper lays down 11 indicators of financial stress
The banking-related sub-indices are the realised volatility of the banking sector equity index, Cmax for the banking sector equity index and the banking sector beta.

Staff members at the Reserve Bank of India (RBI) have identified 11 indicators of financial stress across five market categories. All the three financial stress indicators (FSIs) were found to be negatively correlated with real economic activity (IIP growth), and can be used as a leading indicator for predicting real economic activity, said a working paper released by the central bank.

The paper, titled ‘Measuring Financial Stress in India’ and authored by Manjusha Senapati and Rajesh Kavediya, said, “The world over, central banks measure financial stress by constructing the financial stress index (FSI) to monitor the functioning and resilience of financial system. Such an index provides an aggregate measure of financial stability to policymakers.”

The paper has identified the indicators from the money market, debt market, equity market, forex market and the banking system.

The indicators in the money market sub-index are the realised volatility of the three-month interbank rate and the TED spread, or interbank spread.

The Mumbai interbank offered rate (MIBOR) is a benchmark interest rate at which banks borrow funds from the interbank market. Any financial stress is likely to emerge first in this segment, the paper said.

The TED spread is calculated as the difference between the three-month MIBOR and the three-month treasury bill (T-Bill) rate from January 2002 onwards. The widening of the spread between risky and safe assets reflects the flight to quality, implying a decline in investors’ willingness to hold risky assets. The higher the spread, higher will be the liquidity and counter-party risks in the interbank loan market.

The indicators in the debt market sub-index are the realised volatility of 10-year government bond yields and the 10-year government bond yields spread over global yields. The first is expected to measure the stress level in the government bond market. The second is calculated as the difference between 10-year government bond yields and 10-year US government bond yields.

“The yield gap between Indian and foreign government bonds is a key determinant of cross-border arbitrage flows in the bond markets and is often the source of carry trade, but from the perspective of the financial stress, elevated domestic yields often imply that global investors have gone into risk-off mode, thus contributing to financial stress in the domestic markets,” the paper said.

The equity market sub-index consists of two indicators – the realised volatility of the equity market index and Cmax for the equity market index. Crises in the equity markets can be identified by determining maximum cumulative loss over a specified period using the Cmax method, the paper said.

The banking-related sub-indices are the realised volatility of the banking sector equity index, Cmax for the banking sector equity index and the banking sector beta.

The forex market indicators are the realised volatility of the exchange rate and the Cmax for the exchange rate.

The paper found when the FSIs are above the 90th percentile, they correspond to substantial declines in IIP growth. The months when FSIs were above the 90th percentile are identified as June 2008 to May 2009, from September 2011 to January 2012 and from July to September 2013.

Source:-financialexpress.com

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