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Prelims

Indranarain Ramlall (University of Mauritius, Mauritius)

The Corporate, Real Estate, Household, Government and Non-Bank Financial Sectors Under Financial Stability

ISBN: 978-1-78756-838-9, eISBN: 978-1-78756-837-2

Publication date: 4 December 2018

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Citation

Ramlall, I. (2018), "Prelims", The Corporate, Real Estate, Household, Government and Non-Bank Financial Sectors Under Financial Stability (The Theory and Practice of Financial Stability, Vol. 3), Emerald Publishing Limited, Leeds, pp. i-xxi. https://doi.org/10.1108/978-1-78756-837-220181020

Publisher

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Emerald Publishing Limited

Copyright © 2019 Emerald Publishing Limited

Half Title Page

THE CORPORATE, REAL ESTATE, HOUSEHOLD, GOVERNMENT AND NON-BANK FINANCIAL SECTORS UNDER FINANCIAL STABILITY

Series Page

Complete Volumes On Theory and Practice of Financial Stability

Volume 1: Understanding Financial Stability
Volume 2: The Banking Sector under Financial Stability
Volume 3: The Corporate, Real Estate, Household, Government and Non-bank Financial Sectors under Financial Stability
Volume 4: Economic Areas under Financial Stability
Volume 5: Tools and Techniques for Financial Stability Analysis

Praise for The Theory and Practice of Financial Stability

Indranarain Ramlall’s proposal is a great attempt at giving a comprehensive view of financial stability from a theoretical, practical and policy perspective. It aims at providing future students with the tools to understand the framework in which financial stability is assessed and understood today by international organisations and central banks across the world. To my knowledge, this is the only book that covers such a wide range of topics related to financial stability. It, therefore, has the potential to become a good reference book on the topic. I believe that Indranarain Ramlall has made a great proposal to provide a ‘big picture view’ on financial stability. I look forward to reading the textbook!

Celine Tcheng, Central Bank of France

Financial stability has become a major concern for central banks, after the 2008 global financial crisis. More and more research is tackling topics regarding the role of the financial system in macroeconomic models and the implementation of macroprudential policy. Therefore, a comprehensive overlook of financial stability issues, such as the one offered by The Theory and Practice of Financial Stability can prove particularly useful for experts working in the financial system, central bankers included. The textbook covers a diverse set of topics from policy matters to risk assessment analysis.

Elena Banu, Central Bank of Romania

This book is a comprehensive work on one of the most actual topics in the aftermath of the Great Recession. It covers a wide range of topics on financial stability complementing theoretical frameworks with practical examples.

Starting with a conceptual description on financial stability, the book overviews a history of the major financial crises and Basel regulation rules. Particularly useful is an inquiry of the financial stability perspectives across different asset classes and economy sectors. Another beneficial feature of this book is a complete oversight of stress testing methodologies.

The book is a thorough compilation of topics on financial stability and definitely deserves a place on the bookshelves of central bankers, government and private institutions’ officials.

Vaidotas Sumskis, Bank of Lithuania

Dr Indranarain’s book is an actual textbook for interpreting interrelations between all aspects and sectors of the international economy and will surely be a highly useful tool for credit institutions, investors, practitioners as well as academics. From a Central Bank’s point of view this book provides an integrated approach to macroeconomic environment and the interactions between the various factors and an actual tool for assessing and measuring leading circumstances and indicators that affect financial stability and may cause vulnerabilities.

Vasiliki Vlachostergiou, Central Bank of Greece

This is a monumental work! I didn’t find anything missing. I think it will be useful for students, economic and finance professionals and policymakers.

Christophe Andre, OECD

Financial stability was always a priority for financial sector regulators and it has surpassed other objectives since the global financial crisis. Given various complexities associated with the financial stability and rapid developments over time, existing literature tends to deal with specific aspects of financial stability. It is very difficult to get a comprehensive book dealing with the wide range of concepts, different segments of financial sector, ever increasing variety of financial instruments and regulations associated with financial stability. The current book is a very good attempt to fill this gap through its comprehensive coverage of almost the entire gamut of financial stability related topics. This book should be useful for financial sector regulators, related ministries in the governments, researchers, multilateral institutions, other financial sector stakeholders and general public who are interested to know the complexities of the financial sector and financial stability.

Ajay Prakash-an expert in Financial Stability

Title Page

THE THEORY AND PRACTICE OF FINANCIAL STABILITY VOLUME 3

THE CORPORATE, REAL ESTATE, HOUSEHOLD, GOVERNMENT AND NON-BANK FINANCIAL SECTORS UNDER FINANCIAL STABILITY

BY

INDRANARAIN RAMLALL

University of Mauritius, Mauritius

United Kingdom – North America – Japan – India – Malaysia – China

Copyright Page

Emerald Publishing Limited

Howard House, Wagon Lane, Bingley BD16 1WA, UK

First edition 2019

Copyright © 2019 Emerald Publishing Limited

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No part of this book may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Centre. Any opinions expressed in the chapters are those of the authors. Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use.

British Library Cataloguing in Publication Data

A catalogue record for this book is available from the British Library

ISBN: 978-1-78756-838-9 (Print)

ISBN: 978-1-78756-837-2 (Online)

ISBN: 978-1-78756-839-6 (Epub)

Dedication

Dedicated to God for making me an instrument of his own

List of Figures

Chapter 1
Figure 1.1 Composition of Household Debt. 1
Figure 1.2 Three-pronged Classification of National Balance Sheets. 5
Figure 1.3 Interaction of the Household Sector with the Banking Sector, Public Sector, Corporate Sector and Real Estate Sector. 7
Chapter 2
Figure 2.1 Composition of the Corporate Sector. 13
Figure 2.2 Weak and Strong Levels of Financial Intermediation. 15
Figure 2.3 Types of Firms in an Economy. 15
Figure 2.4 Quantitative Aspects of Debt. 20
Figure 2.5 Crowding Out of Funding for Corporate Sector by the Public Sector. 23
Figure 2.6 Illustration of Different Types of Risks. 24
Figure 2.7 Currency Risk for Corporates. 26
Figure 2.8 Interest Rate Risk for Short-term Debt. 27
Figure 2.9 Indications for Maturity Profile of Corporate Debt. 27
Figure 2.10 Risk Treatment for Different Risk Types. 28
Figure 2.11 Relationship between Health of Corporate Sector Balance Sheet and Macroeconomic Activity. 29
Figure 2.12 Demand for Liquidity by Corporates. 31
Figure 2.13 Choice of Investments by Corporates. 32
Figure 2.14 Impact of Shift from Low Interest Rates to High Interest Rates. 35
Figure 2.15 Structure of Corporate Deposits. 36
Figure 2.16 Link between Corporate Sector and Banking Sector. 38
Figure 2.17 Sources of Company Risk. 45
Figure 2.18 Balance to be Struck by Macroprudential Authorities. 58
Figure 2.19 Leakages for Corporate Borrowing. 60
Figure 2.20 Cyclical and Structural Forces Inducing Higher Corporate Debt. 66
Figure 2.21 Cyclical and Structural Forces Deterring Higher Corporate Debt. 66
Figure 2.22 Impact of US Financial Crisis on Corporate Sector in Other Economies. 67
Figure 2.23 Interaction between Non-financial Corporate Sector and the Banking Sector. 68
Figure 2.24 Significance of Corporate Sector in Financial Crises. 70
Figure 2.25 Crisis-induced Hike in Public Debt and Fall in Private Debt. 71
Figure 2.26 Crisis-induced Changes. 72
Figure 2.27 Demand and Supply Forces behind Hike in Debt Issuance. 80
Figure 2.28 Types of Debt for Corporates. 81
Figure 2.29 Factors Driving Corporate Leverage in Emerging Economies. 84
Figure 2.30 Channels in which Accommodative Monetary Policy Induces Leverage Growth in Emerging Markets. 85
Figure 2.31 Corporate Governance at Country and Firm Level. 86
Figure 2.32 Transmission of Corporate Sector Distress to the Banking Sector and Public Sector. 87
Figure 2.33 Transmission Mechanism of Corporate Debt on Financial Stability. 88
Chapter 3
Figure 3.1 Forces which Impound on Property Price Fluctuations. 104
Figure 3.2 Composition of the Real Estate Sector. 105
Figure 3.3 A Flower Model for Financial Stability. 117
Figure 3.4 Systemic Risk Analysis in Real Estate Sector. 118
Figure 3.5 Financial Accelerator on the Upside. 122
Chapter 4
Figure 4.1 Composition of Public Sector. 138
Figure 4.2 Components of External Debt. 142
Figure 4.3 Central Bank and Public Debt. 144
Figure 4.4 Interaction between Debt Management and Macroeconomic Policy Framework. 148
Figure 4.5 Strategic Public Debt Benefit in Developing Countries: Private Sector Paying the Costs. 160
Figure 4.6 Phases of the Business/Economic Cycles. 162
Figure 4.7 Interaction between Banks’ Income and Public Debt. 163
Figure 4.8 Trade-off between Cost and Risk. 165
Figure 4.9 Debt Portfolio Links to Monetary and Fiscal Policies. 168
Figure 4.10 Interaction among Ministry of Finance, Debt Management Office and Central Bank. 169
Figure 4.11 Public Debt Analysis during Crisis Conditions. 176

List of Tables

Chapter 1
Table 1.1 Balance Sheet of Indonesia’s Household Sector. 6
Chapter 2
Table 2.1 Composition of the Corporate Sector in an Economy: Total Assets of each Category as a Percentage of GDP. 16
Table 2.2 Distinction between Equity Financing and Bond Financing. 21
Table 2.3 Bank-based versus Market-based Economies in the World. 23
Table 2.4 Impact Sheet of Risks on Corporate Sector. 28
Table 2.5 Variables used by Liang et al. (2016). 52
Table 2.6 Machine Learning Techniques with Corresponding Parameters. 53
Table 2.7 Difference between Advanced and Emerging Economies for the Corporate Sector. 64
Table 2.8 Annual Issuance of Bonds by Emerging Market and Developing Economies. 73
Table 2.9 Non-financial Corporates Bond Issuance in Europe. 73
Table 2.10 Country Sample and Issuance Activity by Emerging and Developing Economies Entities. 75
Table 2.11 Country Sample and Issuance Activity by Emerging and Developing Economies Entities. 78
Table 2.12 Level of Corporate Bond Market Development for Different Countries. 82
Table 2.13 Total Debt by Sector (Excluding the Financial Sector) as a Percentage of GDP. 93
Table 2.14 Total Debt by Sector (Excluding the Financial Sector) as a Percentage of GDP. 95
Chapter 3
Table 3.1 Financial Assets versus Non-financial Assets.
Chapter 4
Table 4.1 Sources of Income in a Bond. 132
Table 4.2 Calculation of Net Debt. 137
Table 4.3 Total Borrowing Requirements. 141
Table 4.4 Examples of Past Debt Crisis Periods. 161
Table 4.5 Data for Duration Computation. 182
Chapter 5
Table 5.1 Framework of Risk Indicators for the Shadow Banking System. 189
Table 5.2 Insurance Financial Soundness Indicators: Core Set. 190

List of Acronyms

BIS

Bank for International Settlement

ECB

European Central Bank

GDP

Gross Domestic Product

IMF

International Monetary Fund

SDRs

Special Drawing Rights

IADB

Inter-American Development Bank

MDGs

Millennium Development Goals

WACC

Weighted Average Cost of Capital

DSCR

Debt Service Coverage Ratio

CCA

Contingent Claims Analysis

DB

Distress Barrier

FDI

Foreign Direct Investment

FVCs

Financial Vehicle Corporations

SPVs

Special Purpose Vehicle

FSB

Financial Stability Board

ACE

Allowance for Corporate Equity

LTV

Loan To Value

DTI

Debt To Income

DeMPA

Debt Management Performance Assessment

REITs

Real Estate Investment Trusts

HIPC

Heavily Indebted Poor Countries

NPV

Net Present Value

PD

Probability of Default

DSTI

Debt Service To Income

TFFS

Task Force of Finance Statistics

Preface

Sound financial stability assessments necessitate intensive analysis of different sectors, namely, the banking sector, the household sector, the corporate sector, the real estate sector, the government sector and the non-bank financial sector. Based on the fact that most economies are imbued with a bank-based financial system, a meticulous approach is adhered to when analysing the banking sector. Micro-prudential and macro-prudential regulations are widely discussed as they constitute core ingredients to ensure a sound and smooth functioning financial system. Households represent important players in any economy. For example, household debt represents a coveted economic indicator because it is often linked to the building up of financial instability pressures. The real estate sector is often related to the prevalence of financial crises through asset price bubbles. The corporate sector constitutes another important sector for financial stability risk analysis. For example, the balance sheets of the corporate sector are widely examined to uncover feasible risks to financial stability. The government sector is also given due consideration with particular emphasis being laid on public debt management. The non-bank financial sector has gained prominence worldwide as it ensures that deleveraging by banks does not gnaw at the level of economic activities. In a nutshell, a systematic approach to risk assessment is being undertaken for each sector. In general, this book undertakes a complete analysis of all sectors which fall under the purview of financial stability risk assessments.

The book has been written as a reference material to cater for the needs of both new and experienced professionals such as central bankers, researchers, economists and policy-makers who are involved in the field of financial stability. As a matter of fact, many central banks now have a financial stability unit or a department but so far there is no textbook which weaves through the various aspects of financial stability. Central bankers can use the book to beef up the analytical part of their financial stability reports by incorporating new tools of assessments. The book appeals to courses/programmes on financial stability as provided by Yale School of Management (Macroprudential Policy or Financial Stability Regulation/Master of Management studies in Systemic Risk), Goethe Business School (Financial Stability and Regulation/Executive Education course) and Florence School of Banking and Finance (Banking and Financial Stability course). To date, there are no textbooks or referenced materials which undertake an intensive and coherent approach to financial stability. For example, there is no such framework as to how financial stability, as a process, should be performed. This book attempts to provide all key issues in a highly comprehensive and critical manner. In that respect, the book is expected to be widely used worldwide, both by professionals and researchers.

The author expects the book to be particularly useful to economists, policy-makers, researchers and students in effectively gaining insight on financial stability. As at date, there is no textbook on financial stability which weaves through all aspects of financial stability from theory to practice. This series of five books on financial stability attempts to fill in such a vacuum. Comments and suggestions can be made to .

The author seizes this opportunity to thank an anonymous referee from the London School of Economics for his suggestions and reviews made by professionals from central banks and reputable organisations.

Dr Indranarain Ramlall

June 2018

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