Transparency, risk management and international financial fragility / Mario Draghi, Francesco Giavazzi, Robert C. Merton.

Format:

Book

Author/Creator:

Draghi, Mario.

Contributor:

Giavazzi, Francesco.

Merton, Robert C.

International Center for Monetary and Banking Studies.

Centre for Economic Policy Research (Great Britain)

Series:

Geneva reports on the world economy ; 4.

Geneva reports on the world economy ; 4

Language:

English

Subjects (All):

Country risk.

Risk management.

Deposit insurance.

Loans--Government guaranty.

Loans.

Debts, Public--Accounting.

Debts, Public.

Financial statements.

Financial crises.

Financial institutions--Accounting.

Financial institutions.

Physical Description:

xx, 69 pages : illustrations ; 25 cm.

Place of Publication:

Geneva, Switzerland : International Center for Monetary and Banking Studies ; London [England] : Centre for Economic Policy Research ; [Washington, D.C.]: [Distributed by the Brookings Institution Press], [2003?]

Summary:

Discussions of the role of derivatives and their risks, as well as discussions of financial risks in general, often fail to distinguish between risks that are taken consciously and ones that are not. To understand the breeding conditions for financial crises, the prime source of concern is not risk per se, but the unintended, or unanticipated accumulation of risks by individuals, institutions or governments including the concealing of risks from stakeholders and overseers of those entities. This report, the fourth in the ICMB/CEPR series of Geneva Reports on the World Economy, analyses specific situations in which significant unanticipated and unintended financial risks can accumulate. The focus is, in particular, on the implicit guarantees that governments extend to banks and other financial institutions, and which may result in the accumulation, often unrecognised from the viewpoint of the government, of unanticipated risks in the balance sheet of the public sector.

Using the structural analogy between guarantees and options, the report shows that a government's exposure to risk arising from a guarantee is non-linear. For instance, in the case of a government which guarantees the liabilities of the banking system, the additional liability transferred onto the government's balance sheet by a 10% shock to the capital of firms is larger the lower that capital is to start with. Recognising this non-linearity in the transmission of risk exposures is essential to the reduction of the accumulation of unanticipated risks on the government's balance sheet. Analyses of recent international financial crises recognise that the implicit guarantees governments extend to banks and corporations create the potential to greatly weaken their balance sheets. The attention, however, has mostly focused on the reasons why such guarantees exist, rather than on measurement of the exposures they create. This report offers just such a framework for measuring the extent of a government's exposure to risk and how that exposure changes over time. The report also discusses ideas on how risk exposures can be controlled, hedged and transferred through the use of derivatives, swap contracts, and other contractual agreements.

Contents:

1 Risk and Transparency

1.1 Risk and derivatives 1

1.2 Transparency and accounting principles 3

2 Risk and (Lack of) Transparency in US Balance Sheets: the Economic Effects of the Accounting Treatment of Defined-Benefit Pension Plans 5

2.1 GAAP Rules and companies' exposure to risk via the pension plans they sponsor 5

2.2 Pension plans, income statements and bonuses 6

2.3 The transfer of risks onto the government 10

3 Balance Sheets and Financial Guarantees 13

3.1 Loans and guarantees 13

3.2 Transferring risk onto the government 14

3.3 Using option theory to measure the exposure to risk 16

3.4 The non-linear transmission of risk from corporate balance sheets to the government 20

3.5 Financial guarantees and negative feedback loops 20

4 Sovereign Spreads, Macroeconomic Volatility and Debt Maturity 21

5 Observations for the Correct Evaluation of a Country's Exposure to Risk and for the Design of Prudential Rules for Financial Institutions and their Shareholders 27

5.1 Balance sheets and financial crises 27

5.2 Government exposure to the financial system: computing a country's value-at-risk 29

5.3 The valuation of banks' assets 31

5.4 Can equity and/or subordinated debt substitute for risk monitoring? 32

5.5 Hedging macro risks 32

5.6 Foreign ownership of an emerging country's banks 33

5.7 Guarantees and governments' financial policies 34

5.8 Observations on Basel II 35

5.9 Capital controls 35

6 Managing Risk to Reduce Financial Fragility 37

6.1 Equity swaps as an instrument to diversity risk internationally 38

2 First Panel Discussion - What is the problem? What can be done about it? 53

3 Second Panel Discussion - Risk assessment in balance sheets: Basel and other approaches 60.

Notes:

"July 2003"--Foreword.

Includes bibliographical references (pages 67-69).

ISBN:

1898128685

OCLC:

54934409