Towards an Operational Framework for Financial Stability: 'Fuzzy' Measurement and Its Consequences

50 Pages Posted: 20 Aug 2009

See all articles by Claudio E. V. Borio

Claudio E. V. Borio

Bank for International Settlements (BIS) - Research and Policy Analysis

Mathias Drehmann

Bank for International Settlements (BIS)

Date Written: June 2009

Abstract

Over the last decade or so, addressing financial instability has become a policy priority. Despite the efforts made, policymakers are still a long way from developing a satisfactory operational framework. A major challenge complicating this task is the "fuzziness" with which financial (in)stability can be measured. We review the available measurement methodologies and point out several weaknesses. In particular, we caution against heavy reliance on the current generation of macro stress tests, arguing that they can lull policymakers into a false sense of security. Nonetheless, we argue that the "fuzziness" in measurement does not prevent further progress towards an operational framework, as long as it is appropriately accounted for. Crucial features of that framework include: strengthening the macroprudential orientation of financial regulation and supervision; addressing more systematically the procyclicality of the financial system; relying as far as possible on automatic stabilisers rather than discretion, thereby lessening the burden on the real-time measurement of financial stability risks; and setting up institutional arrangements that leverage the comparative expertise of the various authorities involved in safeguarding financial stability, not least financial supervisors and central banks.

Keywords: financial (in)stability, risk measurement, macroprudential, procyclicality

JEL Classification: E30, E44, G10, G20, G28

Suggested Citation

Borio, Claudio E.V. and Drehmann, Mathias, Towards an Operational Framework for Financial Stability: 'Fuzzy' Measurement and Its Consequences (June 2009). BIS Working Paper No. 284, Available at SSRN: https://ssrn.com/abstract=1458294 or http://dx.doi.org/10.2139/ssrn.1458294

Claudio E.V. Borio (Contact Author)

Bank for International Settlements (BIS) - Research and Policy Analysis ( email )

CH-4002 Basel, Basel-Stadt
Switzerland

Mathias Drehmann

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland

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