Macroprudential Surveillance

The Sri Lankan financial system has become more interconnected and complex than ever before, making the impact of a crisis, in turn, greater than ever. The 2008 global financial crisis proved the fact that a stress in one institution spread quickly to related institutions, across sectors and across jurisdictions, creating systemic issues. The financial crisis and related subsequent developments showed that microprudential supervision alone was not enough to sustain the stability of the financial system. Accordingly, the CBSL recognizes the importance of a more comprehensive macroprudential approach, which goes beyond supervision at the individual firm level to look at broad market and economic factors that could have a material impact on the overall financial system stability of the country.

The evolving organisational structure of the CBSL has reflected its explicit commitment towards institutionalizing of a comprehensive macroprudential surveillance framework.  Well before the global financial crisis, in May 2006, the CBSL set up a Financial Stability Unit (FSU) with a broad mandate of, inter alia, assessing the risks and vulnerabilities that may lead to major instabilities or imbalances in the financial system in the foreseeable future as when those are identified and recommending policies necessary to address issues relating to such instabilities. Later in August 2006, the FSU was upgraded to a separate department with a clear focus on macroprudential surveillance. 

The macroprudential surveillance framework of the CBSL has been evolving to ensure wider coverage of different sources of systemic risk. The framework depends on a wide range of data representing flow-of-funds, financial prices, monetary data, external financial data, and macroeconomic data together with banking/financial structures and qualitative information. The assessments so made are reflected in the following formats:

(a) Financial Stability Indicators and Maps

Financial Stability Indicators and Maps represent corresponding indicators of systemic stress in the financial system relative to a base year. Currently, there are four segmental indicators namely, the Macro Economic Stability Indicator (MESI), the Financial Markets Stability Indicator (FMSI), the Banking Soundness Indicator (BSI), and Licensed Finance Companies Soundness Indicator (LFCSI). These four indicators are constructed based on contemporaneous developments in a number of risk/volatility factors relevant to the financial stability from different segments of the financial system i.e. financial markets, banking sector, non-bank financial institutions sector, and the macro-economy, and statistically condensing the information in a single statistic which measures the current state of stability in each of the four segments mentioned above. The Financial Stability Indicator (FSI), the composite indicator derived using MSEI, FMSI, BSI and LFCSI. The FSI and Financial Stability Map depict the overall stability condition of the financial system.

(b) Financial Soundness Indicators

Financial soundness indicators provide insight into the financial health and soundness of the country’s financial institutions as well as corporate and household sectors.

(c) Assessment of interconnectedness of the financial sector

The analysis of financial networks is meant for measuring the systemic risk due to interconnectedness of financial institutions and its implications for the transmission of shocks and contagion risk. The analysis primarily looks into the interconnections that exists between different institutions in the financial system and tries to identify build-up of systemic risk, including the impact of contagion.

(d) Macro stress tests

Macro stress testing, quantifies the link between macroeconomic variables and the health of financial institutions and the financial system, to measure the resilience of the financial system to various stress factors. The first set of stress testing exercises use multivariate regression tools to evaluate the impact of a particular macroeconomic variable on the asset quality of banks and its capital adequacy ratio. The second set is based on a vector autoregressive (VAR) model which assesses the impact of the overall economic stress situation on the asset quality and capital adequacy of the banking system taking into account the feedback effect of the macroeconomic performance of the economy on banks’ stability.