Archive for February 20th, 2009

Stress Tests and all that jazz

February 20, 2009

There is a increased focus and hope on stress tests announced in recent US Financial Stability plan. The Stress tests will help seperate good banks from bad banks.

Andrew Haldane of Bank of England has written a fantastic paper on risk management and stress tests.  Paper has good doses of humor with plenty of insight and history .

History of Stress Management:

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Iceland authorities knew things are wrong but were helpless

February 20, 2009

Ingimundur Fridriksson, Governor, Central Bank of Iceland has prepared a paper about the banking crisis in Iceland in 2008.

He says Iceland authorities were aware of the problems as issues over banks came to limelight first in 2005. He says authorities had taken some measures which led banks to be in better shape than they would have been.

The banks attracted international attention late in 2005 and early in 2006. The market became more wary of them, their CDS spreads began rising toward the end of 2005, and they received more probing and critical coverage by the media and others than they were accustomed to. The criticism was wide ranging, targeting the banks’ growth pace, risk appetite, low deposit ratios and high dependence on borrowed funds, as well as cross ownership, lack of transparency, and so on. Until that time, the banks had increasingly been active in the global bond market, with ever larger debt issues.

In February 2006, Iceland’s Prime Ministry, Ministry of Finance, Ministry of Business Affairs, Financial Supervisory Authority, and Central Bank concluded a collaboration agreement centring on financial stability and contingency measures. The government then established an advisory group on the basis of this agreement.

The Icelandic banks sought to respond in various ways to the criticism levelled at them. They greatly enhanced their information disclosure to the global marketplace, thus improving transparency in their operations. They sought  to reduce cross-ownership, improve their liquidity position and capital ratios, and took the first steps toward increasing the share of deposits on the liabilities side of their balance sheets.

Because they took this action, the Icelandic banks were perhaps better prepared than they would otherwise have been for the sudden changes that took place in the global financial markets in mid-2007.

Interesting. I am wondering how bad things could have been if the efforts not taken. Could they been any worse?

Like many others now, he says Bank of Iceland raised concerns but no one listened.

In this context, I wish to cite the Central Bank’s 2007  Financial Stability report, which appeared in April that year. It contained the following statement: “The Central Bank underlines that global market conditions can take a sudden turn for the worse and it is important to be on the alert and prepared for such a contingency.” 

The report goes on to say: “The current episode of ample liquidity and lower interest rates which has been ideal for risk-seeking investors may change unexpectedly. Short-term interest rates have been rising in most markets recently and capital costs are no longer so favourable.” With this warning, the Central Bank was merely stating what should have been obvious, at least to those engaged in banking.

He adds despite best efforts, the crisis became deeper post Lehman and as a result all things fell flat. It kicked a set of events which became difficult to reverse and Iceland had to ask for IMF help.

Interesting defence by the governor. However, Buiter would not agree. Mishkin’s report too missed Iceland trouble.

Assorted Links

February 20, 2009

1. Urbanomics has an excellent post on balance sheet deflation. It also summarises the new US homeowner plan

2. IDB on random experiments

3. Indicus Blog on India consumption story

4. Macroblo explains ARRA in pictures

5. Finprof points to an initiative by WSJ that aism to bring leaders and thinkers in finance on one forum

6. Stephanomics has a discussion on UK’s cost of taking over banks

7. CTB points to research which analyses whether we can learn anything from past financial crisis?


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