Country risk: macro-financial economic model and crises

Extract

[...] Dynamics of the credit activity? Indicators to investigate : Structure and dynamics of credit Share of credits (as % of assets)? Share of foreign-currency denominated credits (as % of total credits) Growth rate of credit (en Also, relative to GDP growth Concentration in a few, specific sectors Credit allocation by sector (as % of total credit)? Related to a specific market (e.g., real estate)? Share of loans to the public sector in total assets? Asset/Liability Management Efficiency of the management? [...]

[...] Three dimensions of the systemic risk: Existence of contagion effects Vulnerability to common / macroeconomic shocks Emergence of financial disequilibria + risk of an abrupt burst New indicators of systemic risk following the last financial crisis: Indicators for the risk coming from individual institutions (value-at-risk, contagion value-at-risk, expected shortfall . ) Indicators for the resilience of the market system to shocks (organization of clearing activities) Central issue of the diagnosis: Is the banking sector vulnerable to a destabilization risk? How is financed the economy: intermediated financing or not (financing through financial markets vs. banks)? Is the banking system stable? Screen the quality of bank intermediation, and of the asset/liability management. How efficient are prudential regulation and banking supervision? What is the role of monetary policy? [...]

[...] Investors and depositors might lose confidence and run-on banks and the economy Risk and liquidity premiums rise, and the financial system stops working This inability of the financial system to work efficiently ends in a strong contraction of output. Feedback mechanisms of financial crises Measuring a country's vulnerability Identify macroeconomic challenges Analyze the political response to these challenges How relevant is this response Establish a recommendation based on this diagnosis Key structural indicators : General economic situation (GDP, GDP per capita) What are the sources of growth/specialization? [...]

[...] Through which channels financial development enhances economic growth? By supporting productivity growth and a better allocation of resources (financing investment in human and physical capital) Financial intermediaries and markets decrease information asymmetries and the incentive distortions created by them (moral hazard and adverse selection) Increases efficiency of monetary policy Decreases constraints on fiscal policy Information and market imperfections Credit is based on information, before getting a credit banks screen their borrowers and evaluate their creditworthiness by scoring models Granting or guaranteeing a credit implies to take a risk; the credit might not be repaid; the borrower might engage in moral hazard. [...]

[...] If they are large, a country is vulnerable to social unrest and political pressures. Inequality often arises from « bad » institutions that end up in corruption and unequal systems In addition to income distribution, on must examine as well: Human capital inequalities Access to basic government services Access to infrastructure Health and education services Diagnosing the financial sector Why diagnose the financial sector is important Financial and economic deregulation wave starting in the 1980s: - Financial markets are easier to access, deregulation of activities, competition with banks, financial innovation - What are the expected gains? [...]