Credit risk management and financial stability.

The International Banking and Finance Institute (IBFI) of the Banque de France organised its sixth International Monetary Seminar on the subject of “Credit risk management and financial stability” from 7 to 11 June 2004. This seminar, opened by Governor Christian Noyer, brought together forty five representatives from central banks in developed and emerging countries and from international organisations (such as the Bank for International Settlements and the European Central Bank), as well as twenty speakers from central banks, international institutions and the private sector. The first two days of the seminar were devoted to conferences on: • risks and sources of macro-financial vulnerability, the latest developments on credit risk transfer markets and the presentation of the findings of the cross-sectoral survey on credit derivatives in France; • the technical, financial and legal aspects of securitisation and credit risk management; • the presentation of the French and European experiences with respect to the role of central banks in rating companies and their contribution to financial stability; • bad debts and their impact on financial stability (case of Japan); • Basel II, a prudential framework which better reflects credit risk, and the effect of ratings on market dynamics; • lastly, the macro-financial consequences of risk transfers from the perspective of financial interdependence. Over the next two days, participants attended two workshops on the subjects of “Basel II, credit risk provisioning and accounting standards” and “Credit risk management and its macro-financial consequences”. These gave rise to intensive and fruitful discussions on the following four points: 1. identification of the sources of risk or financial vulnerability 2. credit risk assessment 3. credit risk management 4. implications for economic policy This article summarises the debates held in the workshops and the round table discussions on the last day.

A primer on the subprime crisis.

The catalyst of the current financial turmoil has been the losses on the subprime mortgage market. However, the low quality of these partly collateralised housing loans was known for a while and the default on subprime mortgages largely expected. Therefore, how to account for the fact that an expected shock on a small segment of the US mortgage market turned into a major financial crisis, causing the near-collapse of the Commercial Paper and of the interbank lending markets, that is to say of two of the most liquid financial markets? Banks have transferred risks to special entities, the so-called “conduits”, SIV (Special Investment Vehicles) and SPV (Special Purpose Vehicles). Such a practice gave the false impression that credit risk was transferred from banks outside the financial system. This was indeed not the case. The funding needs associated in particular with backup lines of credit for off-balance sheet vehicles generated pressures on the the interbank markets and led central banks to massively intervene. The roots of the current turmoil are therefore of a deeper and structural nature. For that reason, it is necessary to assess, from a longer term perspective, what are the main consequences of the recent structural changes on financial markets in order to have a good grasp on the current financial market dynamics and clarify what is meant nowadays by liquidity.

Valuation and fundamentals.

The aim of this article is not to provide a comprehensive overview of the financial crisis that began a year ago. This has already been done quite extensively and in a neat way, in particular by Borio (2008), Brunnermeier (2008), Crouhy et al. (2008) and Calomiris (2008) among others, who all describe and analyse the numerous triggers and mechanisms through which the crisis unfolded and spread to the main developed financial markets. Instead, we would like to focus on what we believe is one of the core issues of this crisis and which has not been addressed yet: valuation. Valuation is at the interplay between market dynamics, economic behaviour, accounting standards and prudential rules. The multiple, and even systemic –as far as the current episode is concerned–interactions between all these elements, associated with the inability of market participants to value complex financial instruments in illiquid/stressed markets, have resulted in a fi nancial meltdown that is already considered by many observers as the worst financial crisis since the Great Depression.

Price Stability and The ECB's Monetary Policy Strategy

This paper focuses on the price stability objective within the framework of the single monetary policy strategy. It starts by reviewing what this objective, which is common to all central banks, means. Secondly, this paper will focus exclusively on the anchoring of short- to medium-term inflation expectations (Part 2). Several measures show that this anchoring is effective. Modern New Keynesian theory is an appropriate framework for analysing the impact that this anchoring of expectations has on the determination of the short- to medium-term inflation rate. From this point of view, observed inflation in the euro area seems to be in line with the theory and the ECB's action seems to be very effective. Thirdly, we will focus on the other aspect of monetary stability: the degree of price-level uncertainty and the anchoring of inflation expectations in the medium to long term. Even though this assessment is more difficult than it is in the short to medium term, since we only have a track record covering five years, various indicators from the theoretical analysis paint a fairly reassuring picture of the effectiveness of the device used by the ECB.Monetary policy ; European Central Bank ; Inflation

To be or not to be in monetary union: A synthesis

Monetary union can benefit countries suffering from policy credibility problems if it eliminates the inflation bias and also allows for more efficient management of certain shocks. But it also carries costs as some stabilization may be feasible even in the absence of credibility, and this may be more than what an individual country can hope for in a monetary union. In this paper, we combine the stabilization and credibility branches of the currency union literature and construct a simple welfare criterion that can be used to evaluate alternative monetary arrangements. We produce examples where monetary union may be welfare improving even for low-modest levels of inflation bias (2-3%) as long as business cycles are not too a-synchronized across countries.Currency union, credibility, stabilization, inflation bias.

Asset-price boom-bust cycles and credit: what is the scope of macro-prudential regulation?

Over the recent months, several initiatives have taken place to develop macro-prudential regulation in order to prevent systemic risk and the built-up of financial imbalances. Crucial to the success of such policy is the ability of the macro-prudential authority to identify in due time such imbalances, generally featured by asset-price boom-bust cycles. In this paper, we investigate the possibility of detecting asset-price booms according to alternative identification strategies and assess their robustness. We infer the probability that an asset-price boom turns into an asset-price bust. In addition, we try to disentangle costless or low-cost from costly asset-price booms. We find some evidence that house price booms are more likely to turn into costly recession than stock price booms. Resorting both to a non-parametric approach and a discrete-choice (logit) model, we analyze the ability of a set of indicators to robustly explain costly asset-price booms. According to our results, real long-term interest rates, total investment, real credit and real stock prices tend to increase the probability of a costly housing-price boom, whereas real GDP and house prices tend to increase the probability of a costly stock-price boom. Regarding the latter, credit variables tend to play a less convincing role. From this perspective, we specify the scope of macro-prudential regulation as a set of tools aiming at avoiding "costly" asset-price booms. In doing so, we try both to make the case for state-contingent macro-prudential regulations and to set out clear delineation between monetary and financial stability objectives.Early Warning Indicators , Discrete-Choice Model , Asset Price Booms and Busts , Macro-prudential Regulation , Leaning Against the Wind Policies.

Understanding Asset Prices: Determinants and Policy Implications.

The paper provides an overview of recent asset price developments in France in the light of analytical research carried out at the Banque de France. Like in many other countries, historically low interest rates have boosted asset price dynamics in France over recent years. The paper attempts to shed light on the main driving factors and assesses, in particular, the role played by "excess liquidity" in shaping current developments. Additional factors related to fierce competition in the French banking sector have also contributed to the upswing in residential property prices, exacerbating households' demand through credit expansion and leading to a sharp and unprecedented increase in household debt, consistent with a financial-accelerator-like mechanism. On several occasions over the past two years, the Banque de France has expressed its concerns about lending for housing purchase and housing price developments, both from a monetary and a financial stability perspective. Finally, the paper presents some views, based on in-house research, on the role, if any, that asset prices could play in the setting of monetary policy.Asset prices ; Monetary policy.

The future of monetary policy Summary of the conference held in Rome on 30 September and 1 October 2010.

The recent economic and financial crisis does not call for a change in monetary policy strategy, but rather better integration of financial conditions and financial-crisis risks in the implementation of this strategy: this appears to be the main conclusion of a conference organised by the Banque de France, the Banca d’Italia and the Einaudi Institute.asset price bubbles, financial crisis, interbank market, macroprudential policy, monetary policy.

Les stratégies de politique monétaire après la crise.

L’objet de cet article est de présenter les principales conclusions du panel, organisé lors des VIIIe « Journées » de la Fondation Banque de France pour la recherche en économie monétaire, bancaire et financière le 21 juin 2010, sur le thème des stratégies de politique monétaire après la crise.