early warning systems: can more be done to avert economic and financial crises?

Early warning systems: can more be done to avert economic and financial crises?

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All information is current as at December 2010

First published February 2011

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Early warning systems: can more be done to avert economic and financial crises? First edition

Early warning systems: can more be done to avert economic and financial crises? ISBN: 978-1-921245-79-4

3

This paper is part of a thought leadership series dedicated to helping Australian society and our next generation of business, political and social leaders remain ‘fit for the future’.

Entitled Early warning systems: can more be done to avert economic and financial crises?, the paper is the third in our series which contributes broad economic thinking and valuable insights on a range of business and social issues impacting Australia now and in the future.

As a leader in the Australian accounting profession, the Institute of Chartered Accountants in Australia (the Institute) strives to influence and shape the public policy agenda. It is in this regard that we have teamed up with Access Economics to produce this paper.

Early warning systems: can more be done to avert economic and financial crises? broadly sets out the context for timely warning signals of impending financial crises, and examines how new or unexplored indicators may help improve our understanding of the stability of the economy. These are considered at both the macro- and microeconomic levels.

Our aim is to stimulate discussion around how to strengthen our policy settings and regulatory systems and contribute to the process of improvement in the aftermath of the global financial crisis.

The Institute is pleased to have worked with Access Economics on this paper and I trust that you will find it both interesting and thought provoking. We will continue to challenge and provoke thinking on key business issues for the benefit of Australia.

Rachel Grimes FCA President The Institute of Chartered Accountants in Australia

Foreword

5

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Macro- and microeconomic indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Bridging the gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

2 Macroeconomic indicators of a crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

2.1 Design methods and issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

2.2 Finding the appropriate policy response . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

3 Microeconomic indicators of a crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

3.1 Financial ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

3.2 The evolution of the audit committee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .13

3.3 Credit rating agencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

3.4 Analysts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

3.5 Systemic risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

4 Bridging the gap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

4.1 An expanded role for auditors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

4.2 Reforming the credit ratings process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

4.3 Collaboration across institutions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

5 Addressing barriers to an EWS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

5.1 Proprietary information and company burden . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

5.2 Timely information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

5.3 The cost of collecting new information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

6 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Appendix A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Charts

Chart 1.1: The cost of financial crises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Figures

Figure 2.1: Past financial crises: triggers and underlying vulnerabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Figure 2.2: Global financial stability map . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

Tables

Table A.1: Variables commonly use in EWS models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Table A.2: Indicators of corporate distress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Contents


Financial crises typically have two components: a trigger and an underlying vulnerability. Although the trigger and timing of a crisis are difficult to predict, the underlying vulnerability should be detectable.

This paper sets out the context of financial crises with the aim of stimulating discussion on developing an effective early warning system (EWS). It looks first at macro- and microeconomic indicators of a crisis (Chapter 2 and 3). It then makes suggestions for bridging the gap between these (Chapter 4) and addressing obstacles to achieving an effective EWS (Chapter 5).

Macro- and microeconomic indicatorsThe macroeconomics literature has struggled to produce an effective EWS. Macroeconomic (whole economy) indicators commonly associated with crises include low growth in Gross Domestic Product (GDP), rapid growth in private sector debt, and prolonged periods of low interest rates.

Indicators at the microeconomic (individual company) level may provide useful information that the macroeconomic indicators fail to capture. Microeconomic indicators include financial ratios (liquidity, solvency, profitability), audit committee information, credit ratings, financial analysis (e.g. trends, forecasts), and measures of systemic risk (links between companies). However, better information could be disclosed by corporates to assist regulators’ understanding of the corporate sector’s financial position and attitude to risk.

Bridging the gapBoth macro- and microeconomic indicators provide important information, yet there is no defined channel by which these can be linked to give a broader perspective of potential crises. Ways in which this could be achieved include:

> Expanding the role of auditors to provide insights on the longer-term viability of companies and report on the effectiveness of business models used

> Reforming the credit ratings process to encourage agencies to undertake broader risk analysis and report major financial changes to regulators

> Collaborating across institutions to promote information-sharing among governments, regulators and others, and to find new sources of information.

Considerable obstacles do exist, however, to the achievement of an effective EWS – namely, the need to protect companies’ proprietary information, the difficulty of providing timely information, and the sheer cost of collecting information.

ConclusionThere is no shortage of indicators of a potential economic crisis. The problem lies in making the best use of these indicators, and there are a number of ways in which financial information could be managed to achieve this. But in the end, gathering information is no substitute for action. Having regulators with the independence and courage to call a looming disaster and take evasive action is required – a strong culture of regulatory independence is an essential aspect of any effective EWS.

Executive summary

7

1. For example, Bezemer (2009) provides a list of well-known commentators who anticipated the housing bubble bursting and leading to recession, distinguishing ‘the lucky shots from insightful predictions’.

Before the Global Financial Crisis (GFC) there were some clear warning signs of impending problems, including bubbles in credit growth and house prices in many countries, and there were reputable voices warning of these developments.1 Policy-makers and regulators may not have seen these warning signs but were likely putting less weight on them, or were wary of intervening in financial markets because of uncertainty about the effect their actions might have had. Indeed, some policy experts were supportive of Alan Greenspan’s approach − that is, leave the market to its own devices and intervene only when something has gone wrong.

The purpose of this paper is to broadly set out the context of EWS, to identify potentially new or unexplored sources of information, and to stimulate further discussion on how to improve our policy settings and regulatory systems. It is not intended to provide a complete solution – rather, to make a contribution to the process of improvement post-GFC.

Financial crises occur when there is an underlying weakness in the economy or financial system (IMF 2010). Although the weakness itself does not start the crisis – a trigger event is required – the extent and spread of the crisis are results of this weakness. The huge cost of the damage caused by the GFC and past crises (Chart 1.1), even if only measured in terms of job losses and increased government debt, has

renewed interest in identifying and remedying weaknesses in the financial system.

International institutions such as the Basel Committee on Banking Supervision (BCBS) are currently developing reforms to strengthen the resilience of financial institutions in the event of shocks to the economy and financial system:

The BCBS reforms are intended to be forward looking, making the system more resilient to future crises, whatever their source ... While we cannot with certainty predict the source of the next crisis, we can however lay the groundwork to help mitigate or minimise the impact. (Walter 2010)

Policy-makers and regulators would not just rely on new regulation to prevent future crises. Regulation is only able to address areas of weakness that have already been identified.

However, the financial system is constantly changing; new financial products and increasingly sophisticated technologies alter the way in which trade is conducted and the risks that are faced. The need for different or new regulation will not always be identified or implemented in time to prevent the emergence of weakness in the financial system. Re-examining early warning signs of financial distress or an impending crisis is thus essential if authorities are to react early and appropriately. Financial crises are

1 Introduction

Frequency of crises across countries 1972 – 2007

%*

6

5

4

3

2

1

0 Banking Currency Debt

Advanced Emerging

* Frequency of crises measured by number of crises episodes in per cent of the total number of country years in respective group samples.

Source: Ghosh et al (2009).

Average cost of banking crises 1970 – 2007

% of GDP30

20

10

0 Advanced Emerging

Fiscal cost Output cost

Chart 1.1: The cost of financial crises

While crises are more common in emerging economies, advanced economies are not immune.


frequent enough for there to be a rich literature on the predictive power of various economic and financial variables. In the wake of the GFC, authorities may be more willing to consider reacting to such warning signs.

This paper aims to collate information and raise questions to facilitate discussion on what more can be done to make improvements to early warning systems. In particular, there is a focus on two areas of literatures on early warning signals of financial stability: the economic and the financial. In addition to being important sources of information about the state of the economy and the financial system, they also provide indicators from different perspectives:

> The economic literature explores ‘macro’ or economy-wide indicators of financial distress and the state of the economy. These may not be the most timely indicators and may not fully reveal the extent to which the financial sector is exposed to unexpected changes in the state of the macro economy

> The financial indicators that are, or potentially could be, provided by a publicly listed company are valuable for understanding some aspects of the financial position of that company. However, the financial distress of a single company is not sufficient to indicate a financial crisis. This depends on the company’s contribution to systemic risk.

A link between these two areas of literatures could improve policy-makers’ understanding and knowledge of the stability of the economy. Moreover, there may be other sources of information available, or that could be made available, to further this knowledge. A list of alternative sources could include:

> Greater company disclosures via the audit committee with an expanded role for auditors

> Greater use of tax information

> Broader regulation of systemic risk

> Greater or different collaboration between regulators and all the groups involved in the capital market.

As with any change to policy, there are practical considerations in implementing any of these ideas.

Early warning signals of a financial crisis are usually searched for in the real economy. However, this may not provide a timely indication of vulnerability if it occurs on the financial side of the economy. Although there exist indicators of corporate distress for individual companies, regulators mostly focus on the trends in deposit-taking and financial institutions to inform their broader view of the economy.

Yet the systemic risk of non-financial companies should still be considered. There may also be important signs of pressure in the economy to be extracted from the activities and risk-taking behaviour of companies across industries and sectors in the economy. The audit committee and auditor are well positioned to assist in expanding understanding of a company’s financial position and attitude to risk, and this is explored further in Chapter 5. We also briefly explore in Chapter 5 the importance of non-financial broad information and indicators.

We turn now to a discussion of potential indicators of a financial crisis, beginning in Chapter 2 with macroeconomic indicators – those at the systemic level.

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2. If agents are unable to distinguish between ‘good’ and ‘bad’ institutions the failure of one institution can result in the failure of others as agents treat the ‘good’ institutions as if they are about to fail – a self-fulfilling belief.

2 Macroeconomic indicators of a crisis

Typically, an EWS has an empirical structure with indicators that contribute to a country’s vulnerability to a future crisis and may forecast the likelihood of a financial crisis. The indicators of an EWS could reveal a country’s vulnerability to a future crisis and forecast the likelihood of a financial crisis. The literature has identified indicators using EWS models based on reduced-form relationships linking a set of explanatory variables to a financial crisis measure. EWS models differ widely according to the definition of a financial crisis, the time span over which it may happen, the selection of indicators, and the statistical or econometric method used. In general, they have not been found to work well.

These models are sensitive to changes in specification and definition of variables, and as a result findings vary substantially across the literature. The design of an EWS requires consideration of how indicators combine − a variable may not be an indicator of financial crisis risk by itself but would be if observed in conjunction with other factors. Moreover, although empirical models of financial crises are able to identify indicators retrospectively, there are doubts about their ability to pre-empt a crisis – this has

considerable implications if policies are to be designed, implemented and allowed to take effect.

Early warning systems based on macroeconomic indicators have previously focused on banking crises caused by financial institutions underestimating their exposure to economy-wide systemic risk. Borio, Furfine and Lowe (2001) consider the exposure of the banking industry as a whole to macroeconomic shocks rather than the exposure of individual institutions. Consequently, they do not consider indicators for crises caused by counterparty exposure, be it actual exposure or perceived exposure.2

2.1 Design methods and issuesThere are two components of a financial crisis: an underlying vulnerability and a trigger (IMF 2010). The trigger determines the timing of the crisis and is difficult to predict − it may be a one-off unexpected event. However, the underlying vulnerability has often been present in the economy for some time and should be predictable. Figure 2.1 shows some examples of past crises and the associated triggers and vulnerabilities.

Figure 2.1: Past financial crises: triggers and underlying vulnerabilities

Crises have been caused by a variety of vulnerabilities and triggers

Crisis Vulnerability Triggers

Norway (1988)

Finland (1991)

Sweden (1991)

Credit and house price booms, overheating, thin capitalisation of banks, concentrated loan exposures, domestic lending in foreign currency, financial deregulation without strengthening of prudential regulation and supervision; weaknesses in risk management at the individual bank level

Tightening of monetary policy, collapse of trade with the Council for Mutual Economic Assistance; exchange rate depreciation

Mexico (1994) Government’s short-term external (and foreign-exchange-denominated liabilities)

Tightening of US monetary policy, political shocks

Thailand (1997) Financial and non-financial corporate sector external liabilities; concentrated exposure of finance companies to property sector

Terms of trade deterioration; asset price deflation

Indonesia (1997) Corporate sector external liabilities; concentration of banking system assets in real estate/property-related lending; high corporate debt-equity ratio

Contagion from Thailand’s crisis; banking crisis

Turkey (2000) Government short-term liabilities; banking system foreign exchange and maturity mismatches

Widening current account deficit, real exchange rate appreciation, terms of trade shock; uncertainty about political will of the government to undertake reforms in the financial sector

United States (2007)

Credit and house price boom; weaknesses in financial regulation resulting in a buildup of leverage and mispricing of risk

Collapse of the subprime mortgage market

Source: Ghosh et al (2009)


The aim of an EWS is to identify indicators that are able to provide both a timely predictor of an impending crisis and minimal false signals. These indicators are selected by examining their historical predictive power. A major obstacle in this exercise is that the underlying vulnerability in the economy may be a result of a combination of factors, including time- and country-specific factors such as institutional structure, government policy and prevailing economic sentiment. These differences across countries and time zones may make it difficult to identify suitable warning signs for future crises based on experience.

There are also different types of financial crises. Broadly speaking, a financial crisis can be categorised as a:

> Banking crisis – when there is a failure of, or run on, a bank

> Currency crisis (balance of payments crisis) – when there is a speculative attack in the foreign exchange market causing the value of a currency to rapidly change, thereby undermining its ability to serve as a medium of exchange or a store of value

> Wider (real) economic crisis – when there is a recession or prolonged downturn in economic activity.

One type of crisis can lead to another, or they can occur simultaneously; for example, currency and banking crises are commonly referred to as the ‘twin crisis’ when they occur together. Kaminsky and Reinhart (1999) found that problems in the banking sector typically precede a currency crisis but that the currency crisis deepens the banking crisis.

Early warning systems require indicators with a sufficient lead time. This has been identified as a major obstacle in EWS design (Kaminsky & Reinhart 1999). Many macroeconomic indicators often have a short forecast horizon, and data is often not available until months after the period it refers to. This is crucial because policy responses, particularly once the trigger has occurred, take time to design, implement and have an effect. For example, a large unexpected expansionary change in monetary policy may have some immediate effect as expectations adjust and sentiment rises, but it will take months before the full effect of the policy is realised. Likewise, a fiscal stimulus package needs to be designed, receive parliamentary approval and be implemented – and those receiving funding from the package must spend the money for the consequential effect. The aim of an EWS would, therefore, be to identify underlying vulnerabilities in the economy and correct them before a crisis is triggered.

2.1.1 Macroeconomic variables of interestVariables that are commonly found as predictors in EWS models are shown in the Appendix (Table A.1). These variables are selected for their theoretical appeal. For example, Gross Domestic Product (GDP) growth, which is used widely as an indicator of the health of the economy,

has been found to be associated with bank crises when low (Demirgüc-Kunt & Detragiache 2005). Yet the difficulty with using it as an early warning indicator is that it is not timely. It is typically released with a one-quarter lag, and by the time the slowdown is occurring it may be too late to identify and correct underlying vulnerabilities in the economy before a crisis begins.

Rapid growth in private sector debt is one of the few robust indicators found in the literature on early warning signs of a financial crisis (Borio & Lowe 2002; Kaminsky et al 1997). Increases in the ratio of private sector credit to GDP during pre-crisis periods, along with rapid real credit growth, indicate credit risk accumulation (Davis & Karim 2008) and may signal the under-pricing of risk.

Growth in credit stimulates aggregate demand relative to potential output, overheating the economy. As inflation and interest rates rise, economic activity slows. If this was not taken into account by borrowers, it may leave them unmanageably indebted and put the financial stability of the economy at risk (Hilbers et al 2005).

Prolonged periods of low interest rates may be a leading indicator of financial crises. During such periods, typically associated with economic booms, banks may use low-cost deposit financing to invest heavily in particular sectors which appear profitable and where collateral values are high. The banking industry may be exposed to increased interest rate risk by investing in higher-risk long-term projects without correctly pricing the probability of future interest rises. Positive correlations between real interest rates and banking crises have been found in numerous studies (e.g. Demirgüc-Kunt & Detragiache 2005; Kaminsky & Reinhart 1999).

Excessive growth in asset prices may indicate a bubble in the asset market. A bubble occurs when rapid growth in the price of a class of asset is followed by a sharp fall. The fall occurs because the asset price growth was not based on ‘fundamentals’ − the intrinsic value of the asset − but on some other factor.

There are a number of theories for the cause of bubbles in asset prices:

> The ‘greater fool’ − people knowingly buy an overvalued asset hoping to sell it to someone else who is also willing to do this

> Herding − it is better to act in the same way as your counterparts and eventually lose than appear to be missing out on gains now

> Extrapolation − price growth should continue as it has done in the past

> Moral hazard − not fully exposed to the risk so the expected value of the asset to the buyer is higher that the true expected value.

11

The bursting of a bubble typically results in a contraction or slowdown of the economy. This can be due to asset price bubbles fuelling demand through the consumption of perceived wealth; balance sheets being undermined with the collapse of the assets value, particularly if there is debt secured against it; and confidence being undermined, resulting in a contraction in activity.

House price growth in particular is an important indicator of financial crises. Barrell et al (2010), for example, found that this was an important predictor of financial crises in countries of the Organisation for Economic Co-operation and Development (OECD). Davis (1998) also sights over-investment in real estate (particularly commercial) as a well-documented feature of banking crises.

2.1.2 IMF financial soundness indicators The International Monetary Fund (IMF) uses a composite indicator of macroeconomic and prudential indicators of the soundness of financial institutions (Worrell 2004). These include variables which have:

> Direct impact on the balance sheets and profit and loss of financial institutions − interest rate changes

> Indirect effect − reduced collateral values or reduced ability of borrowers to service their obligations to banks

> Prudential indicators – of the adequacy of bank capital, the quality of bank assets, the efficiency of management, the robustness of earnings, the adequacy of liquidity, and the coverage of market risk (the CAMELS ratios)

> Measures of exposure to interbank contagion

> Measures of exposure to contagion from abroad (Worrell 2004).

Financial soundness indicators (FSIs) were determined through discussions with international agencies and member countries. In total, 39 FSIs have been agreed on. These are split into core FSIs (those relevant to all countries and which are producible given current data collection) and encouraged FSIs (only included if the country is able to produce the relevant data). Many of these indicators are financial ratios, derived from the aggregated balance sheets of individual financial companies.

2.1.3 Proposed new IMF indicators A potential solution to some of the problems posed by econometric-based EWSs might be found in designing a system that aims to identify changes in the exposure of the economy to risk, rather than precisely predict the occurrence of a crisis. The IMF (2010) has recently proposed such a type of EWS, based on an analysis of six broad types of risk:

> Macroeconomic risk

> Credit risk

> Market and liquidity risk

> Monetary and financial risk

> Risk appetite, and

> Emerging market risks.

These risks are calculated using a number of indicator variables and are combined to form a global financial stability map (see Figure 2.2 below).

Figure 2.2: Global financial stability map

Risks

Conditions

Emerging market risks Credit risks

Monetary and financial Risk appetite

Market and liquidity risks

Macroeconomic risks

April 2009 GFSR October 2009 GFSR April 2010 GFSR

Note: Closer to centre signifies less risk, tighter monetary and financial conditions, or reduced risk appetite.

Source: IMF (2010)


2.2 Finding the appropriate policy responseEmpirical tests of EWSs have found that while they are able to predict financial crises they also lead to a large number of false predictions. From a policy perspective this is a relevant issue: policy-makers and regulators need to decide whether it is worse to fail to respond to vulnerability, or to react to false signals and try to correct problems that do not exist.

Reacting to false signals is costly. It could be costly to business in terms of complying with stricter regulation, or there could be efficiency costs if the operation of markets is restricted. For example, a policy response that aims to restrict access to personal credit, because the EWS incorrectly indicates that credit growth is posing a threat to stability, would result in fewer people being able to access credit than is optimal. Formulating a policy response to a false positive is also costly in terms of the administrative cost of designing and implementing the policy.

A related question is whether or not monetary policy should respond to asset price inflation that is potentially a bubble, for example, in the housing market. Asset price bubbles are difficult to detect until they have burst. In responding to bubbles, central banks would need to make a judgment on whether the growth in asset prices was based on fundamentals or not. Gruen et al (2003) found that central bank intervention in a bubble was only optimal if the bubble was identified in its early stages and if there was less probability of the bubble bursting of its own accord. Whether or not monetary policy is able to curb a sustained upward movement in asset prices driven by excessively low risk aversion is another question. Borio and Lowe (2002) have proposed that it can, as long as the central bank is credible and is able to send a signal to the market that it is concerned about the state of the economy.

The final question for policy-makers is whether or not asset price booms and busts are in fact bad for the long-term growth of the economy. There is a trade-off between enduring periods of financial instability and exploiting growth potential, because the reduction of financial constraints during a boom allows greater investment to occur, potentially improving growth possibilities in the future.

Having now looked at a number of macroeconomic indicators, Chapter 3 examines a range of microeconomic indicators – those at the individual company level.

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3 Microeconomic indicators of a crisis

Indicators at the individual company level provide important information about the resilience of the corporate and financial sector to economic shocks. While there are macroeconomic indicators of this, an examination of micro-level information may provide important details that the aggregated information fails to capture.

Much of the micro-level information concerns what auditors examine when undertaking an audit. An auditor’s understanding of the market places them in a good position for assessing the risk appetite and risk model of the companies they audit. Credit ratings agencies are likewise able to provide an assessment of the systemic exposure of individual companies.

3.1 Financial ratios Financial ratios are useful indicators of a company’s performance and financial situation. Ratios can typically be calculated from information provided by financial statements. In their seminal research, Altman (1966), Beaver (1968) and Blum (1969) identified a number of financial variables that were significant predicators of corporate failure. Although financial indicators are not able to capture everything about a company, they provide a basis on which to assess some of the core requirements for a company to be reasonably expected to continue as a going concern. Some of these indicators are described in greater detail in the Appendix (Table A.2).

The three types of indicators identified in the literature are liquidity, solvency and profitability measures:

> Liquidity ratios provide information about a company’s ability to meet its short-term financial obligations

> Solvency ratios indicate a company’s ability to pay its obligation to creditors and other third parties in the long term

> Profitability indicators suggest whether or not a company will be able to improve its liquidity and solvency position. If a company is profitable there is a good chance that it will be able to meet its obligations, but if not then it is unlikely that it will be able to continue as a going concern for long.

These types of indicators are often found in companies’ annual reports and are used by shareholders or potential shareholders to inform their investment decisions. In terms of informing a regulator’s broader view of the economy, at most the focus would be on deposit-taking and financial institutions rather than the whole of the corporate sector.

However, the behaviour of other types of companies may still be informative for regulators. If there is change in the number of companies not doing well, particularly in the same sector or industry, it may suggest an impending problem.

Moreover, changes in attitudes to risk, and the existence of businesses with an unsustainable business model, increase the vulnerability of the economy to shocks.

A limitation of financial ratios is that they do not capture this business model risk. This type of information is difficult to capture using a single metric. Instead it requires either a comprehensive framework for assessment or substantial judgment of the information reported, in which case an external assessment would be required.

3.2 The evolution of the audit committeeAn independent audit committee is a fundamental component of a sound corporate governance structure. Importantly, it brings together non-executive directors, management, external audit, internal audit and advisors.

The role of the audit committee has evolved significantly in the last 10 years and will continue to evolve. It has moved from having a fairly limited function primarily focused on completion of audited financial statements to having a much broader and integrated focus of responsibilities. Drivers of this evolution include regulatory expectations, market expectations, and the ‘better practice’ skills that audit committee members and auditors gain through working closely together. It is clear, though, that further enhancements can and should be made to the role of the audit committee. For example, an essential element of the audit committee’s role is to interact effectively with the external auditor in order to achieve a quality audit.

Communication between auditors and the audit committee is important, as is communication between the audit committee and the company’s stakeholders. There is merit in exploring an enhanced role for the audit committee, including better disclosures of key information in the annual report, and an improved understanding of the role of audit.

Greater disclosure of key information in the annual report through the audit committee could be achieved by including:

> Indicators of the company’s future financial performance (e.g. main assumptions, key sensitivities)

> The components of the company’s business model(s) and significant inherent risks to the success of the model(s)

> Uncertainties and judgments that underlie its set of financial statements – these are typically the topics of greatest discussion between auditors and audit committees and attract the highest degree of audit focus.

These disclosures could substantially add to the value of key forward-looking information and be a valuable source of input into EWSs. The primary challenge, though, will lie in aggregating these disclosures at different levels to assist in broader analysis of EWSs.


3.3 Credit rating agenciesCredit rating agencies provide ratings to companies that want to issue debt, both for the company and the instrument. These ratings are used by investors to evaluate the relative risk of different securities. During the recent financial crisis, credit ratings agencies were heavily criticised for rating structured products, which were ultimately defaulted on, as AAA-rated.

A problem with the current ratings system is agencies providing a company with a poor rating or a downgrade can result in the so-called ‘death spiral’. The downgrade adversely affects the company’s contracts with financial institutions, increasing expenses and making it more difficult to obtain finance. This in turn can reduce its credit ratings. Debt covenants may be breached if creditworthiness falls below a certain point, with loans due in full and the company unable to refinance. The company may then be forced into administration.

Ratings agencies have a standard process of forming ratings – they avoid using judgment or information outside of scope. This improves transparency, as companies know how the ratings work and are less likely to take legal action against a negative credit rating. However, this also allows companies to modify their behaviour to meet the minimum standard required to receive their desired credit rating, and this could result in areas of weakness if the credit rating framework is in any way deficient.

3.4 AnalystsAnalysts perform a range of activities for external and internal clients. They can be classified into different points of focus, such as financial or industry, buy-side or sell-side institutions, and equity or fixed-income markets. Usually financial analysts study an entire industry, assessing current trends in business practices, products and competition. They must keep abreast of new regulations or policies that may affect the industry, as well as monitoring the economy to determine its effect on earnings.

Financial analysts use spreadsheet and statistical software packages to analyse financial data, spot trends and develop forecasts. On the basis of their results, they write reports and make presentations, usually making recommendations to buy or sell a particular investment or security. Financial analysts in investment banking departments of securities or banking firms analyse the future prospects of companies that want to sell shares to the public for the first time.

In more recent years, some analysts have become more engaged with the global financial reporting standard-setters, providing input into their deliberations. The Corporate Reporting Users’ Forum (CRUF) has developed guiding principles on good financial reporting standards.

Consideration should be given to whether there is scope for greater involvement with the analyst community, and whether the substantial levels of information they collect could assist with EWSs.

3.5 Systemic riskAn institution’s systemic risk is the risk it poses to the stability of the financial system as a result of its links with other institutions. During the GFC, a number of large companies deemed ‘too big to fail’ were bailed out by governments (e.g. American International Group, Inc. (AIG) and Royal Bank of Scotland (RBS)). This has raised the question: how should such institutions be regulated in the future, given their importance in the stability of the economy?

Financial institutions have a strong incentive to become systemically relevant because they have a higher probability of being bailed out in the case of financial distress. The consequence of this is that institutions will take on more risk than is socially optimal because they are able to pass on some of this risk to society instead of bearing it all themselves. A number of proposals to mitigate this moral hazard have been proposed, but the ones that have received the greatest attention are systemic-based capital surcharges.

The IMF (2010) has outlined two approaches to computing such surcharges:

> A standardized approach – regulators assess a capital surcharge based on a rating of systemic risk

> A risk-budgeting approach – capital surcharges are determined in relation to an institution’s additional contribution to systemic risk and its own probability of distress.

One of the difficulties associated with implementing such surcharges is identifying the degree of systemic risk. The IMF (2009) outlined four of the most common methods for assessing systemic risk:

> The network approach – using direct links in the interbank market to track the progression of a credit event or liquidity squeeze throughout the banking system

> The co-risk model – using market data to assess links among financial institutions and test the progression of an extreme event through the system

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3. Qualitative assessments of systemic impact are made in APRA’s supervisory framework, using the PAIRS/SOARS system, for the institutions that it regulates.

> The distress dependence matrix – examining the probability of distress of pairs of institutions, taking into account a set of other institutions

> The default intensity model – using historical data on defaults to measure the probability of failure of a large fraction of financial institutions due to both direct and indirect systemic links.

All of these methods rely on the selection of appropriate institutions for inclusion in the model. However, it is possible that small institutions may carry large systemic risk. A potential direction for regulators would be to develop a series of systemic risk indicators, similar to the concept of FSIs, and require all institutions to report on these indicators.3

This is, however, easier said than done − it would be difficult to monitor reporting of indicators and, like all financial reporting, there is a large amount of professional interpretation involved. Chapter 4 examines how this may be attempted, by drawing the together both the macroeconomic indicators from the previous chapter and the microeconomic indicators from this chapter.


4. The FSB-IMF (2009) report to the G20 on information gaps that need to be filled recommended better capture of the build up of risk, improving data on international financial links, monitoring the vulnerability of economies and communicating of official statistics.

4 Bridging the gap

The macroeconomic and the microeconomic indicators discussed in the previous chapters all provide important information to policy-makers and regulators. However, if the information gaps could be filled there is not an explicit channel by which these indicators are linked to form a broader perspective of the state of the economy.4 This chapter discussed potential new links, while the following chapter outlines some practical considerations.

4.1 An expanded role for auditorsIn 3.2 above there was a discussion of the evolution of the audit committee function and the potential forward-looking disclosures that they could make in the annual report. These disclosures could be highly valuable to investors and stakeholders but will require some form of assurance by the auditor. This type of function would expand the auditor’s current role.

The current role of the auditor is focused on the completed financial statements provided by the Board of Directors and management. The role of audit is primarily guided through the framework of auditing standards.

However, auditors are well positioned to provide insights into disclosures on the longer-term viability of a company. In addition to considering whether the specific requirements of accounting standards are satisfied, auditors could for example consider whether certain limited objectives behind the requirements have been met. This might be achieved by auditors reporting on the audit committee disclosures on the business model(s) of a company and its risks.

Much of corporate Australia is audited by one of ‘the big four’ accounting firms – KPMG, Ernst & Young, PwC and Deloitte. These firms have large amounts of information and data on the state of corporate Australia. In the UK, the Financial Services Authority (FSA) and Financial Reporting Council (FRC) (2010) have recommended greater collaboration between auditors and regulators, with both parties providing information to each other rather than just auditors having to report to the regulators. In Australia, significant communication already occurs between auditors and regulators such as Prudential Standard APS 310 however the merits of expanding two-way dialogues between regulators and auditors could be explored.

4.2 Reforming the credit ratings processReforming the credit rating process could potentially provide more accurate information about the risk of a company or debt instrument. If ratings agencies were required to undertake a broader analysis of risk, or report to regulators changes in the complexity of financial instruments, there may be a greater understanding of the stability of financial markets. Moreover, credit ratings could be commissioned on behalf of companies by a single body, such as the Australian Securities Exchange (ASX) in Australia, removing the incentive for the credit ratings agency to satisfy the expectations of the issuer of the debt in order to secure repeat business.

4.3 Collaboration across institutionsThere may be scope for government agencies and regulators to share more information or different information. An example might be making use of information collected, or that could be collected, by the Australian Tax Office. A sign of the financial distress of a company could be changes in the timeliness of its GST or payroll tax payment. If this information was aggregated, a change overall could indicate a weakening of the corporate sector; this could be done on an industry or sector basis to provide more detailed information.

There are other agencies besides government with access to large amounts of information about the corporate sector. For example, Genworth, an underwriter of mortgages, may have access to information about credit growth and changing risk profiles. Information collected by search engines, in particular Google, may become or already be a valuable source of information about a variety of issues, because Google records information about search terms. An example already in use is Google’s ‘flu trends’ (developed after Ginsberg et al 2009), which has found that certain search terms are good indicators of flu activity in a region. Using the frequency of certain search terms, Google is able to map flu trends around the world virtually in real time (see www.google.org/flutrends). By extension, there may be information contained in search term databases on consumer expectations, risk appetite and numerous other questions that could be useful for regulators.

Although there are many potentially interesting sources of information that may be useful, consideration needs to be given to both collecting and sharing this information. Chapter 5 looks at these and other practical considerations in relation to early warning systems.

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5. A Lickert scale is a method of collating ratings scale answers commonly used in surveys. Respondents are asked to specify their level of agreement to a statement on a scale, such as 1 to 5 possibly with verbal interpretations attached to the numbers such as strongly agree for 5 and strongly disagree for 1. Each question can be analysed separately or the responses can be combined.

5 Addressing obstacles to an effective EWS

Many of the suggestions in Chapter 4 may make sense in theory but may be difficult in practice. This chapter considers aspects of the obstacles lying in the way of developing an effective EWS.

5.1 Proprietary information and company burdenA key difficulty with sharing information is that much of it is proprietary. Even if the information is not proprietary or can be aggregated to a level so as to maintain confidentiality, there is little incentive for private companies to provide this information freely to regulators – after all they have borne the cost of collecting and collating it. Regulators would need to be willing to purchase this information, or to compel companies to report it.

Another consideration when obtaining information from private institutions is whether or not they have the capability to collect and collate information that would be relevant to regulators. If new training is required or collection is a large burden on business operations, private institutions will want to be compensated. One way of decreasing the burden on companies is through more effective use of technology, such as XBRL.

eXtensible Business Reporting LanguageeXtensible Business Reporting Language (XBRL) was introduced in Australia in July 2010 as part of the Standard Business Reporting (SBR) project. XBRL is a language that allows electronic business reporting. Its benefits include cost savings and efficiency to business because it removes the duplication that occurs in providing specialised financial reports to exchanges, regulators and government (Deloitte 2009). Instead, a single report is produced electronically from which these stakeholders are able to easily draw the information that they require.

Although the use of XBRL is still in its infancy, and has been introduced to reduce the reporting burdens on business, it is expected to rapidly improve the timeliness of financial information. As it develops there may be scope to expand the type of information that is provided, at a lower cost than would currently be possible.

5.2 Timely informationDesigning an EWS requires timely information. This is a big problem with macroeconomic data. Once data is collected the signals need to be interpreted correctly. Many of the early warning signals discussed in Chapter 2 need to be considered in the context of the rest of the economy. Predicting financial crises requires consideration of the relationship between the variables, which can be difficult to process without a model – and designing a model that works is yet to be achieved.

In practice, designing an EWS is difficult because statistical models have proven ineffective, meaning that judgment must be applied when interpreting information. The large amounts of information available make this quite difficult. There is a plethora of information at the disposal of decision-makers; the problem is that they do not necessarily know what they should be looking for.

The qualitative information that auditors have at their disposal as a profession might be very useful to regulators. However, careful consideration would need to be given to how that information can be collated and passed on. While a simple statistical measure such as a Lickert scale might be employed, this might also remove much of the useful information.5 The conundrum of predicting a crisis is that it is the information we do not know we need that may be the most important for us to receive.

Another potential barrier is whether or not individual auditors will be able to rate the activities of an individual company against some sort of perception of ‘normal’. A common problem during crises is that expectations adjust, normalising what would previously have been perceived as excessively risky behaviour. Moreover, an individual auditor only sees a small portion of the picture. Will they be able to assess companies against a central measure without a big picture view?

5.3 The cost of collecting new informationIncreasing the reporting requirements of companies would be costly to the company and, therefore, the shareholders. A consideration of whether or not there is support for such changes would need to be made. Designing a framework for reporting non-financial information would also require careful consideration. While aiming to provide a more expansive picture of the viability of the company, it could easily result in the company being able to put a positive spin on negative financial results or further disguise potential weaknesses by allowing spin to be given greater credibility.


Broad Based Business Reporting (BBBR), sometimes described as integrated reporting, is an enhanced reporting mechanism being implemented by some businesses to better meet the needs of their key stakeholders. BBBR demonstrates how a business effectively manages and uses its limited resources to deliver on its defined strategies. Analysis of this type of reporting gives investors access to more relevant information, enabling comparisons between businesses within industries and across industries, as well as enabling more informed, forward-looking capital allocation decisions.

It is clear, globally, that there will be continuing developments with BBBR, and as the model matures it should be seen as an important source of information, particularly for predictive trends and themes. The International Integrated Reporting Committee (IIRC) was launched in August 2010 to create a globally accepted framework for accounting for sustainability, a framework which brings together financial, environmental, social and governance information in a clear, concise, consistent and comparable format.

As this integrated framework matures it will contain valuable information not previously available that could be used in EWSs. There would, however, need to be some form of assurance on this integrated information.

Organising cross-institutional sharing of information is administratively costly and time consuming. It may not result in timely collation of all available information and coordination of response is not always easy – not every institution will interpret information in the same way.

19

The economics literature has struggled to produce an effective EWS. This is because statistical models capture the relationship between indicators and the start date of the crisis, but are largely unable to identify the factors that contributed to vulnerability in the economy.

Indicators at the macroeconomic level are plentiful, yet difficult to integrate in practice. They are also subject to change, as indicated by the IMF’s proposal for new financial soundness indicators to keep up with a changing and increasingly interlinked world economy.

Indicators at the individual company level provide important information about the resilience of the corporate and financial sectors to economic shocks, and examination of micro-level information reveals important detail that aggregated information fails to capture. Yet here too there is difficulty in applying information in a timely and reliable way to predict crises.

There is, however, considerable scope for discussion of an effective EWS. Better information could be disclosed by corporates to assist regulators’ understanding of the corporate sector’s financial position and attitude to risk. Credit rating agencies are also able to assess the systemic exposure of individual companies.

Another area worth exploring is the inclusion of prospective (as opposed to retrospective) information in annual reports. Companies would be required to report or disclose an assessment of their business model and potential risks. Auditors could reflect on this assessment as part of an expanded audit process. Globally this idea has begun to achieve some traction already. Furthermore, corporates may be able to contribute to policy-makers’ and regulators’ understanding of the corporate sector through the disclosure of key assumptions, judgments and sensitivities underlying financial statements.

Of course, just gathering information is no substitute for action. The political will to act in light of persuasive evidence must be present. Having regulators with the independence and courage to call a looming disaster and take evasive action is required if a better EWS model is to be found. A strong culture of regulatory independence is an essential aspect of any effective EWS.

6 Conclusion


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References

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Appendix A

Table A.1: Variables commonly use in EWS models

Indicator Description

Real economy

GDP growth Reflects the ability of the economy to create wealth and large deviations from trend indicate overheating or unsustainable growth (positive deviations) while negative deviations suggest a slow down.

Inflation High inflation may signal policy mismanagement, in the form of lax monetary policy or expansionary fiscal policy. It may also indicate asset price inflation, itself an indicator of an asset price bubble, a frequent precursor to a financial crisis.

Government’s fiscal position

A high budget deficit relative to GDP be an indicator of policy mismanagement and risk of government default. The size of the deficit will impact on the government’s ability to respond to the crisis, or signs of the crisis, potentially exacerbating the impact.

Corporate

Total debt to equity Total corporate debt to corporate equity indicates the aggregate leverage of corporations, highlighting the extent to which activities are financed through liabilities rather than own funds (IMF, 2004). Excessively high levels of leverage may signal difficulties in meeting debt obligations.

Net foreign exchange exposure

Excessive borrowing in foreign currency can increase the risks of corporate default. Large currency movements — themselves a potential indicator of financial crises — could have a substantial negative impact on the value of debt, assets or the value of a trade.

Corporate defaults Insolvencies in the corporate sector can signal future problems in the banking sector, if insufficiently provisioned to accommodate the losses resulting from default on loans.

Household sector

Private sector debt Rapid growth in private sector debt is an indicator of instability in the economy. Growth in credit stimulates aggregate demand relative to potential, overheating the economy.

External sector

Real exchange rate and commodity prices

Adverse movements in exchange rates, whether driven by fundaments such as movement in terms of trade or driven by an attack by speculators on a currency can be indicators of an impending financial crisis.

Foreign exchange reserves

The level of foreign exchange reserves held by a government or central bank can be important for the ability of a country to resist severe external shocks. With a shortfall of reserves policy makers may be unable to defend the currency. Currency and maturity mismatches have also been associated with financial crisis.

Current account/capital flow

Increased international capital mobility tends to be followed by a domestic banking crisis (Reinhart and Rogoff, 2008). A large current account deficit is usually cited as an important indicator of an impending currency crisis because as the current account deficit increases, the economy becomes more vulnerable to a decline in foreign lending.

Financial sector

Interest rates Positive correlation between real interest rates and banking crises have been found in numerous studies.

Capital adequacy and liquidity

Liquidity risk is measured by bank cash plus reserves as a proportion of total bank assets; the lower this ratio the higher the systemic liquidity risk.

Continued overleaf >


Appendix A (continued)


Financial markets

Change in share price Sudden collapses in equities prices can lead to a chain of events ending in financial crises in some cases. Households lose wealth and cut back spending leading to lower economic growth and subsequent job losses. Consumer confidence is hurt by falls in share prices.

Corporate bond spreads

Corporate borrowing rates significantly above market rates can signal the loss of confidence by market participants in the ability of each other to repay loans.

Market liquidity Market liquidity was a key determinant of the most recent financial crisis. With companies hoarding cash and unwilling to borrow, the problem can be self-fulfilling.

Volatility Periods of substantial volatility can also signal future economic or financial upheaval. Volatility clustering is an empirical regularity in financial markets. It is a proxy measure of uncertainty.

Asset price (including house price) growth

Excessive growth in asset prices may indicate a bubble in the asset market. Bubbles have been associated with many past financial crises.

Source: Access Economics.

Table A.2: Indicators of corporate distress


Liquidity

Working Capital/ Total Assets

A measure of the net liquid assets of the company relative to the total capitalisation. This indicates the liquid reserve available to satisfy contingencies and uncertainties. The ratio indicates the short-term solvency of a business and in determining if a company can pay its current liabilities when due.

Cash Flow/Total Debt This ratio provides an indication of a company’s ability to cover total debt with its yearly cash flow from operations.

Solvency (financial leverage)

Market value of equity/book value of debt

This ratio shows how much the company’s assets can decline in value before the liabilities exceed the assets and the company becomes insolvent.

Total Debt / Total Assets

Provides information about the company’s financial risk by determining how much of the company’s assets have been financed by debt.

Profitability

Earnings before interest and tax/ total assets

This is a measure of the productivity of the company’s assets, independent of any tax or leverage factors. The earning power of its assets is the basis of all profit and this ratio is thus a fundamental indicator of credit risk.

Rate of return to common shareholders

Return on equity measures the rate of return on the ownership interest (shareholders’ equity). It shows how well a company uses investment funds to generate earnings growth and thus measures a company’s efficiency at generating profits from every unit of shareholders’ equity.

Retained earnings Retained earnings measures the cumulative profitability of the company over time. It is the total amount of reinvested earnings and/or losses of a company over its entire life. Retained earnings divided by total assets measures the leverage of a company and highlights the use of low risk funds (internally generated funds) versus riskier capital (debt) to grow the business.

Total asset turnover Total asset turnover is the ratio of net sales to total assets. It compares the turnover with the assets that the business has used to generate that turnover indicating the company’s efficiency in generating a profit.

Net operating margin A measure of the operating income generated by each dollar of sales, therefore indicating the profitability of the company.

Source: Access Economics.

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Abbreviation/ acronym Name

APRA Australian Prudential Regulation Authority

BBBR Broad Based Business Reporting

BCBS Basel Committee on Banking Supervision

CAMELS ratio Capital, Asset Quality, Management, Earnings, Liquidity, and Social Impact of an organization ratio

CRUF Corporate Reporting Users’ Forum

EWS Early warning system

FSA Financial Services Authority

FSB Financial Stability Board

FSI Financial Soundness Indicator

GDP Gross domestic product

GFC Global Financial Crisis

IMF International Monetary Fund

IIRC International Integrated Reporting Committee

OECD Organisation for Economic and Co-operation and Development

SBR Standard Business Reporting

XBRL eXtensible Business Reporting Language

Acronyms

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Contact details

Access EconomicsCanberraLevel 1, 9 Sydney AvenueBarton ACT 2600

Phone +61 2 6175 2000Fax +61 2 6175 2001

MelbourneLevel 27, 150 Lonsdale StreetMelbourne VIC 3000

Phone +61 3 9659 8300Fax +61 3 9659 8301

SydneySuite 1401, Level 14 68 Pitt Street Sydney NSW 2000

Phone +61 2 9376 2500Fax +61 2 9376 2501

www.accesseconomics.com.au

The Institute of Chartered Accountants in AustraliaNational Office33 Erskine Street Sydney NSW 2000

GPO Box 9985, Sydney, NSW 2001

Service 1300 137 322Phone +61 2 9290 1344Fax +61 2 9262 1512Email service@ charteredaccountants.com.au

charteredaccountants.com.au

early warning systems: can more be done to avert economic and financial crises?

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