Macroeconomic Stability Map
The Macroeconomic Stability Map is based on seven sub-indices, each pertaining to a specific area of macroeconomic
risk. Each sub-index on macroeconomic risk includes select parameters representing risks in that particular field.
These sub-indices have been selected based on their impact on macroeconomic or financial variable such as GDP,
inflation, interest rates or assets quality of banks. The seven sub-indices of the overall macroeconomic stability
index and their components are briefly described below:
Global Index: The global index is based on output growth of the world economy. A fall in output growth affects
overall sentiments for the domestic economy in general and has implications for demand for domestic exports,
in particular. Capital flows to the domestic economy are also affected by growth at the global level. Therefore, a
fall in output growth is associated with increased risks.
Domestic Growth: The domestic growth index is based on growth of gross domestic product. A fall in growth,
usually, creates headwinds for bank asset quality, capital flows and over-all macroeconomic stability. Hence, a fall
in growth is associated with increased risks.
Inflation: Wholesale Price Index Inflation is used to arrive at the Inflation Index. Increase in inflation reduces
purchasing power of individuals and complicates investment decision of corporate. Therefore, an increase in
inflation is associated with higher risks.
External Vulnerability Index: The Current Account Deficit to GDP Ratio, Reserves Cover of Imports and ratio
of Short Term Debt to Total Debt are included in the external vulnerability Index. Rising CAD and ratio of short
term debt to total debt and falling Reserves Cover of Imports depict rising vulnerability.
Fiscal Index: The fiscal index is based on fiscal deficit and primary deficit. Higher deficits are associated with
higher risk. High government deficit, in general, reduces the resources available to the private sector for
investment and also has implications for inflation.
Corporate Index: The health of the corporate sector is captured through profit margin[ EBITDA (Earnings before
Interest, Tax, Depreciation and Amortisation) to Sales], the interest coverage ratio [EBIT (Earnings before Interest,
Tax) to Interest Payments]. A lower profit margin and lower interest coverage ratio are associated with higher
risks.
Household Index: This Index is based on retail non performing assets. Increase in retail NPAs is associated with
higher risk.
Financial Markets Stability Map
With the objective to measure stability of the financial market, Financial Market Stability Map has been prepared
based on the indicators of four sectors/markets namely banking sector, foreign exchange market, equity market
and debt market. The indicators selected from various sectors/markets are following; i) Banking Sector: Beta
of CNXBANK Index and NIFTY Index, CD Rate and CD rate minus Implied Forward rate, ii) Foreign Exchange
Market: CMAX of daily INR-US Dollar exchange rate, which is defined as Xt/Max(Xi, i=1,2,..upto one year). Where,
Xt is the INR-US Dollar exchange rate at time t, and 25 Delta Risk Reversals of foreign exchange rate, iii) Equity
Market: Inverse of NIFTY CMAX and India VIX, and iv) Debt Market: Corporate bond which is average return of
corporate bonds rated A, AA, and AAA, 10-years Government bond yield and CP Rate.
Variance-equal transformation has been used to convert the indicators at same level before construction of the
Map. Four indicators for the four selected sectors/market were prepared based on simple average of elementary
indicators which are presented as a cobweb map.
Systemic Liquidity Index
Systemic liquidity in the financial system refers to the liquidity scenario in the banking sector, non-banking
financial sector, the corporate sector and prevailing foreign currency liquidity. Current needs for liquidity are
also influenced by expectations about availability of funds and their rates in future. The Systemic Liquidity
Index(SLI) was constructed using the following four indicators representing various segments of the market:
- Weighted Average Call Rate minus RBI Repo Rate
- 3 month Commercial Paper (CP) Rate minus 3 month Certificate of Deposits (CD) Rate
- 3 month CD Rate minus 3 month Forward Implied Deposit Rate
- Weighted Average Call Rate minus 3 Month Overnight Index Swap (OIS) Rate
The SLI was derived as a simple average of the Standard normal or Variance-equal transformed values of the
above mentioned indicators.
Banking Stability Map and Indicator
The Banking Stability Map and Indicator (BSI) present an overall assessment of changes in underlying conditions
and risk factors that have a bearing on stability of the banking sector during a period. Following ratios are used
for construction of each composite index:
Table : Indicators used for construction of Banking Stability Map and Banking Stability Indicator |
Dimension |
Ratios |
Soundness |
CRAR |
Tier-I Capital to Tier-II Capital |
Leverage ratio as Total-Assets to Capital and Reserves |
Asset-Quality |
Net NPAs to Total-Advances |
Gross NPAs to Total-Advances |
Sub-Standard-advances to
gross NPAs |
Restructured-Standard-Advances
to Standard-Advances |
Profitability |
Return on Assets |
Net Interest Margin |
Growth in Profit |
Liquidity |
Liquid-Assets to Total-Assets |
Customer-Deposits to Total-
Assets |
Non-Bank-Advances to
Customer-Deposits |
Deposits maturing within-1-year
to Total Deposits |
Efficiency |
Cost to Income |
Business (Credit + Deposits) to staff expenses |
Staff Expenses to Total Expenses |
The five composite indices represent the five dimensions of Soundness, Asset-quality, Profitability, Liquidity and
Efficiency. Each index, representing a dimension of bank functioning, takes values between zero (minimum) and
1 (maximum). Each index is a relative measure during the sample period used for its construction, where a high
value means the risk in that dimension is high. Therefore, an increase in the value of the index in any particular
dimension indicates an increase in risk in that dimension for that period as compared to other periods. For each
ratio used for a dimension, a weighted average for the banking sectors is derived, where the weights are the
ratio of individual bank asset to total banking system assets. Each index is normalised for the sample period
as ‘Ratio-on-a-given-date minus Minimum-value-in-sample-period divided by maximum-value-in-sample-period
minus Minimum-value-in-sample-period’. A composite measure of each dimension is calculated as a weighted
average of normalised ratios used for that dimension, where the weights are based on the marks assigned for
assessment for CAMELS rating. Based on the individual composite indices for each dimension, the Banking
Stability Indicator is constructed as a simple average of these five composite sub-indices.
Banking Stability Measures (BSMs) – Distress Dependency Analysis
In order to model distress dependency, methodology described by Goodhart and Segoviano (2009) has been
followed. First, the banking system has been conceptualised as a portfolio of banks(BIs). Then, the PoD of the
individual banks, comprising the portfolio, has been inferred from equity prices. Subsequently, using such PoDs
as inputs (exogenous variables) and employing the Consistent Information Multivariate Density Optimizing
(CIMDO) methodology (Segoviano, 2006), which is a non-parametric approach based on cross-entropy, the banking
system’s portfolio multivariate density (BSMD) have been derived. Lastly, from the BSMD a set of conditional
PoDs of specific pairs of BIs, and the banking system’s joint PoD(JPoD) are estimated.
The BSMD and thus, the estimated conditional probabilities and the JPoD, embed the banks’ distress dependency.
This captures the linear (correlation) and non-linear dependencies among the BIs in the portfolio, and allows for
these to change throughout the economic cycle. These are key advantages over traditional risk models that most
of the time incorporate only correlations, and assume that they are constant throughout the economic cycle.
Network Analysis
Matrix algebra is at the core of network analysis, which is essentially an analysis of bilateral exposures between
entities in the financial sector. Each institution’s lending and borrowings with all others in the system are
plotted in a square matrix and are then mapped in a network graph. The network model uses various statistical
measures to gauge the level of interconnectedness in the system. Some of the most important are as follows:
Connectivity: This is a statistic that measures the extent of links between the nodes relative to all possible links
in a complete graph.
Cluster Coefficient: Clustering in networks measures how interconnected each node is. Specifically, there
should be an increased probability that two of a node’s neighbours (banks’ counterparties in case of the financial
network) are also neighbours themselves. A high clustering coefficient for the network corresponds with high
local interconnectedness prevailing in the system.
Shortest Path Length: This gives the average number of directed links between a node and each of the other
nodes in the network. Those nodes with the shortest path can be identified as hubs in the system.
In-betweeness centrality: This statistic reports how the shortest path lengths pass through a particular node.
Eigen vector measure of centrality: Eigenvector centrality is a measure of the importance of a node (bank) in a
network. It describes how connected a node’s neighbours are and attempts to capture more than just the number
of out degrees or direct ‘neighbours’ a node has. The algorithm assigns relative centrality scores to all nodes in
the network and a bank’s centrality score is proportional to the sum of the centrality scores of all nodes to which
it is connected. In general, for an NxN matrix there will be N different eigen values, for which an eigen vector
solution exists. Each bank has a unique eigen value, which indicates its importance in the system. This measure
is used in the network analysis to establish the systemic importance of a bank and by far it is the most crucial
indicator.
Tiered Network Structures: Typically, financial networks tend to exhibit a tiered structure. A tiered structure is
one where different institutions have different degrees or levels of connectivity with others in the network. In
the present analysis, the most connected banks (based on their eigen vector measure of centrality) are in the
inner most core. Banks are then placed in the mid core, outer core and the periphery (the respective concentric
circles around the centre in the diagrams), based on their level of relative connectivity. The range of connectivity
of the banks is defined as a ratio of each bank’s in degree and out degree divided by that of the most connected bank. Banks that are ranked in the top 10 percentile of this ratio constitute the inner core. This is followed by
a mid core of banks ranked between 90 and 70 percentile and a 3rd tier of banks ranked between 40 and 70
percentile. Banks with connectivity ratio of less than 40 per cent are categorised as the periphery.
Solvency Contagion analysis
The contagion analysis is basically a stress test where the gross loss to the banking system owing to a domino
effect of one or more bank failing is ascertained. We follow the round by round or sequential algorithm for
simulating contagion that is now well known from Furfine (2003). Starting with a trigger bank i that fails at time
0, we denote the set of banks that go into distress at each round or iteration by Dq, q= 1,2, …For this analysis,
a bank is considered to be in distress when its core CRAR goes below 6 per cent.
Liquidity Contagion analysis
While the solvency contagion analysis assesses potential loss to the system owing to failure of a net borrower,
liquidity contagion estimates potential loss to the system due to the failure of a net lender. The analysis is
conducted on gross exposures between banks. The exposures include fund based and derivatives. The basic
assumption for the analysis is that a bank will initially dip into its liquidity reserves or buffers to tide over a
liquidity stress caused by the failure of a large net lender. The items considered under liquidity reserves are (a)
excess CRR balance; (b) excess SLR balance; (c) available marginal standing facility and (d) available export credit
refinance. If a bank is able to meet the stress with the liquidity buffers alone, then there is no further contagion.
However, if the liquidity buffers alone are not sufficient, then a bank will call in all loans that are ‘callable’,
resulting in a contagion. For the analysis only short term assets like money lent in the call market and other very
short term loans are taken as callable. Following this, a bank may survive or may be liquidated. In this case there
might be instances where a bank may survive by calling in loans, but in turn might propagate a further contagion
causing other banks to come under duress. The second assumption used is that when a bank is liquidated, the
funds lent by the bank are called in on a gross basis, whereas when a bank calls in a short term loan without
being liquidated, the loan is called in on a net basis (on the assumption that the counterparty is likely to first
reduce its short term lending against the same counterparty).
Macro Stress Testing
To ascertain the resilience of banks against macroeconomic shocks, macro stress test for credit risk was conducted.
Here, the credit risk indicator was modeled as function of macroeconomic variables, using various econometric
models that relate banking system aggregate to the macroeconomic variables. The time series econometric
models being used are; (i) multivariate regression in terms of the slippage ratio; (ii) aggregate VAR using slippage
ratio; (iv) quantile regression of slippage ratio, (v) multivariate panel regression on bank-group wise slippage
ratio data; and (vi) multivariate regressions for sectoral NPAs. The banking system aggregates includes current
and lagged values of slippage ratio, while macroeconomic variables include GDP growth, short term interest rate
(call rate), WPI inflation, exports-to-GDP ratio (Ex/GDP), gross fiscal deficit-to-GDP ratio (GFD/GDP) and REER.
While the multivariate regression allows evaluating the impact of selected macroeconomic variables on the
banking system’s NPA and capital, the VAR model reflects the impact of the overall economic stress situation on
the banks’ capital and NPA ratio, which also take into account feed-back effect. In these methods, conditional
mean of slippage ratio is estimated and assumed that the impact of macro variables on credit quality will
remain same irrespective of the level of the credit quality, which may not always be true. In order to relax this
assumption, quantile regression has been adapted to project credit quality, in which, in place of conditional
mean the conditional quantile has been estimated.
The Modelling Framework
The following multivariate models were run to estimate the impact of macroeconomic shocks on the GNPA ratio/
slippage ratio (SR)1:
• Sectoral multivariate regression
The impact of macroeconomic shocks on various sectors was assessed by employing multivariate regression
models using aggregate NPA ratio for each sector separately. The dependent variables consisted of lagged
NPAs, sectoral GDP growth, inflation, and short-term interest rate.
Derivation of the NPAs and CRAR from the slippage ratios, which were projected from the above mentioned
credit risk econometric models, were based on the following assumptions: credit growth of 15 per cent;
recovery rate of 5.6 per cent, 6.3 per cent, 6.3 per cent and 9.6 per cent, during June, September, December
and March quarters, respectively; write-offs rate of 3.3 per cent, 3.8 per cent, 4.6 per cent and 5.2 per cent,
during June, September, December and March quarters, respectively; risk weighted assets growth of 18 per
cent, and profit growth assumed to be at 15 per cent, 5 per cent and -5 per cent under baseline, medium
risk and severe risk, respectively. The regulatory capital growth is assumed to remain at the minimum by
assuming minimum mandated transfer of 25 per cent of the profit to the reserves account. The distribution
of new NPAs in various sub-categories was done as prevailing in the existing stock of NPAs. Provisioning
requirements for various categories of advances are 0.4 per cent for standard advances, 20 per cent for substandard
advances, 75 per cent for doubtful advances, and 100 per cent for loss advances. The projected
values of the ratio of the non-performing advances were translated into capital ratios using the “balance
sheet approach”, by which capital in the balance sheet is affected via the provisions and net profits. It is
assumed that the existing loan loss provisioning coverage ratios remain constant for the future impact.
Single Factor Sensitivity Analysis – Stress Testing
As a part of quarterly surveillance, stress tests are conducted covering credit risk, interest rate risk, liquidity risk
etc. Resilience of the commercial banks in response to these shocks is studied. The analysis covers all scheduled
commercial banks..
Credit Risk
To ascertain the resilience of banks, the credit portfolio was given a shock by increasing NPA levels, for the
entire portfolio as well as for select sectors, along with a simultaneous increase in provisioning requirements.
For testing the credit concentration risk, default of the top individual borrower and the largest group borrower is
assumed. The estimated provisioning requirements so derived were adjusted from existing provisions and the
residual provisioning requirements, if any, were deduced from banks’ capital. The analysis was carried out both
at the aggregate level as well as at the individual bank level, based on supervisory data as on March 31, 2013. The
scenario assumed enhanced provisioning requirements of 1 per cent, 30 per cent and 100 per cent for standard,
sub-standard and doubtful/loss advances, respectively. The assumed increase in NPAs was distributed across substandard,
doubtful and loss categories in the same proportion as prevailing in the existing stock of NPAs. The
additional provisioning requirement was applied to the altered composition of the credit portfolio.
Interest rate risk
The fall in value of the portfolio or income losses due to the shifting of INR yield curve are accounted for the
total loss of the banks because of the assumed shock. The estimated total losses so derived were reduced from
the banks’ capital.
For interest rate risk in the banking book, Duration Analysis approach was considered, for computation of
the valuation impact (portfolio losses) on the investment portfolio. The portfolio losses on investments were
calculated for each time bucket based on the applied shocks. The resultant losses/gains were used to derive
the impacted CRAR. The valuation impact for the tests on banking book was calculated under the assumption that the HTM portfolio would be marked to market. In a separate exercise for interest rate shocks in trading
book, the valuation losses were calculated for each time bucket on the interest bearing assets using duration
approach.
Liquidity Risk
The aim of liquidity stress tests is to assess the ability of a bank to withstand unexpected liquidity drain without
taking recourse to any outside liquidity support. The analysis is done as at end-March 2013. The scenario depicts
different proportions (depending on the type of deposits) of unexpected deposit withdrawals on account of
sudden loss of depositors’ confidence and assesses the adequacy of liquid assets available to fund them.
Assumptions in the liquidity stress test are as follows:
- It is assumed that banks would meet stressed withdrawal of deposits through sale of liquid assets only.
- The sale of investments is done with a hair cut of 10 per cent of their market value.
- The stress test is done on a static mode.
Stress Testing of Derivatives Portfolio of Select Banks
The stress testing exercise focused on the derivatives portfolio of a representative sample set of top 22 banks in
terms of notional value of derivatives portfolio. Each bank in the sample was asked to assess the impact of stress
conditions on their respective derivatives portfolios.
In case of domestic banks, the derivatives portfolio of both domestic and overseas operations was included. In
case of foreign banks, only the domestic (i.e. Indian) position was considered for the exercise. For derivatives
trade where hedge effectiveness was established was exempted from the tests, while all other trades were
included.
The stress scenarios incorporated four sensitivity tests consisting of the spot USD/INR rate and domestic interest
rates as parameters
Table: Shocks for Sensitivity Analysis |
|
Domestic Interest Rates |
Shock 1 |
Overnight |
+250 bps |
Upto 1yr |
+150 bps |
Above 1yr |
+100 bps |
|
Domestic Interest Rates |
Shock 2 |
Overnight |
-250 bps |
Upto 1yr |
-150 bps |
Above 1yr |
-100 bps |
|
Exchange rates |
Shock 3 |
USD/INR |
+20 per cent |
|
Exchange Rates |
Shock 4 |
USD/INR |
-20 per cent |
Scheduled Urban Co-operative Banks
Credit Risk
Stress tests on credit risk were conducted on Scheduled Urban Co-operative Banks (SUCBs) using their asset
portfolio as at end-March 2013. The tests were based on single factor sensitivity analysis. The impact on CRAR
was studied under two different scenarios. The assumed scenarios were as under:
- Scenario I: 50 per cent increase in gross NPAs.
- Scenario II: 100 per cent increase in gross NPAs.
Liquidity Risk
Liquidity stress test based on cash flow basis in 1-28 days time bucket was also conducted, where mismatch
[negative gap (cash inflow less than cash outflow)] exceeding 20 per cent of outflow was considered stressful.
- Scenario I: Cash out flows in 1-28 days time bucket goes up by 50 per cent (no change in cash inflows).
- Scenario II: Cash out flows in 1-28 days time bucket goes up by 100 per cent (no change in cash inflows).
Non-Banking Financial Companies
Credit Risk
Stress tests on credit risk were conducted on Non-Banking Financial Companies (includes both Deposits Taking
and Non-Deposit taking and Systemically Important) using their asset portfolio as at end-December 2012. The
tests were based on single factor sensitivity analysis. The impact on CRAR was studied under two different
scenarios;
- Scenario I: GNPA increased two times from the current level.
- Scenario II: GNPA increased 5 times from the current level.
The assumed increase in NPAs was distributed across sub-standard, doubtful and loss categories in the same
proportion as prevailing in the existing stock of NPAs. The additional provisioning requirement was adjusted
from the current capital position. The stress was conducted at individual NBFCs as well as at an aggregate level.
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