Given the interdependence and sophisticated interactions of the various elements of the financial system and the real economy, financial stability isn't easy to define or measure. This is often further complicated by the temporal and transnational dimensions of such interactions. Over the past 20 years, however, central bankers and other researchers have attempted to capture financial stability through various indicators of monetary system vulnerability. In fact, in their Financial Stability Reports (FSRs), many central banks try and assess risks to financial stability by focusing on a few key indicators. Additionally, there's an ongoing effort to develop a single aggregate measure that can indicate levels of financial vulnerability or stress.
A comprehensive quantitative measure of monetary system stability that could be indicative of these conditions would help policy makers and financial system participants to:
Approaches to developing these financial stability indicators have changed over the years because the focus of attention has shifted from financial stability micro-prudential to macroprudential. From analyzing early warning indicators to monitoring the health of the banking industry, particularly the danger of individual institution defaults, the main target has shifted to a broader system-wide assessment of risks to financial markets, institutions and infrastructure. Recently, the main target of analysis has shifted further to behavioural dynamics, the building instabilities and the transmission mechanisms of shocks. A key issue underlying these analytical developments is the need to fill data gaps in several areas. This is clearly an ongoing discussion and work.
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Keywords: Financial Stability, FSRs, Financial Markets, Micro-Prudential, Transmission Mechanisms.
