In recent years, financial stability and the analysis thereof have become a key task not just for the CNB, but for many other national and international institutions. Detecting weak spots in the financial sector and uncovering their links to current developments in the financial markets and to economic developments in general can help to reduce the ensuing risks and ultimately make the financial system more resilient to shocks. The interest of central banks in analysing financial stability stems from their primary objectives and functions. In addition to maintaining price stability, these include promoting sustainable economic development, acting as lender of last resort and overseeing payment systems. Many central banks derive their role in the financial stability area from the fact that they perform banking supervision and see to stability of the banking sector as a whole.
The CNB first emphasised the importance of financial stability analysis when it defined its economic research priorities for 2001-2006 and published its Banking Sector Stability Report for 2003 (pdf, 361 kB).
Maintaining financial stability is defined as one of the CNB’s main tasks in Act No. 6/1993 Coll., on the Czech National Bank (pdf, 150 kB). The Act explicitly requires the CNB to set macroprudential policy by identifying, monitoring and assessing risks jeopardising the stability of the financial system and, in order to prevent or mitigate these risks, contribute by means of its powers to the resilience of the financial system and the maintenance of financial stability; where necessary, it must cooperate with the relevant state authorities in setting macroprudential policy (Article 2). In relation to the above activities, the CNB is also obliged to submit a financial stability report containing a macroprudential policy strategy to the Chamber of Deputies (the lower house of the Czech parliament) once a year (Article 3a).
The CNB’s primary objective with regard to financial stability is to foster a level of resilience of the system that significantly reduces the risk of financial instability. The key preconditions for achieving this objective are price stability and sound development of financial institutions, which are attained by means of monetary policy instruments and financial sector supervision. Cooperation with other national and international authorities is also crucial. In working to maintain financial stability, the CNB focuses on prevention and therefore informs the public in detail about potential risks and factors posing a threat to financial stability.
The global financial crisis has led not only to a strengthening of the importance of the objective of financial stability, but also to the introduction of institution of macroprudential policy designed to maintain financial stability. The main aim of this policy is to mitigate systemic risk, i.e. the risk of instability of the financial system as a whole.
Definition of financial stability
The CNB defines financial stability as a situation where the financial system operates with no serious failures or undesirable impacts on the present and future development of the economy as a whole, while showing a high degree of resilience to shocks.
Financial stability may be disturbed both by processes inside the financial sector leading to the emergence of weak spots, and by strong shocks. Such shocks may arise, among other things, from the external environment, domestic macroeconomic developments, the position of the main debtors and creditors of financial institutions, economic policies or changes in the institutional environment. Any interaction between weak spots and shocks can result in the collapse of major financial institutions and disruption of the functions of the financial system as regards financial intermediation and payments. In the extreme case, it may even lead to a financial crisis with adverse implications for the economy.
The CNB regularly monitors and closely analyses developments in all areas relevant to financial stability. The members of the CNB Bank Board meet with experts from key departments at regular meetings on financial stability issues. A wide range of information on developments of risks in the domestic financial system and abroad is presented at these meetings. The position of the Czech economy in the financial cycle is assessed and – if any risks to financial stability are identified – discussions are held regarding the use of regulatory, supervisory and other economic policy tools to suppress such risks or their potential effects.
Financial stability analysis in some respects differs significantly from other analytical activities at the CNB. Unlike banking supervision analysis, it covers not only banks, but also non-bank financial institutions (investment companies and funds, pension funds, insurance companies, capital market undertakings, etc.). The target of interest is not the stability of individual financial institutions, but the stability of the financial sector as a whole. The main difference compared to the CNB's macroeconomic analysis and forecasting is that financial stability analysis is not aimed at modelling the most probable development of the economy. Instead, it involves testing the impact of improbable, but plausible, adverse scenarios which could threaten the stability of the entire financial system.
The global nature of the financial crisis that broke out in the US sub-prime mortgage market in 2007, a crisis characterised by the transmission of risks between national financial systems, has increased the need for closer international cooperation in the financial stability area. The European Systemic Risk Board (ESRB) was established at the European level at the start of 2011. Together with three pan-European sectoral supervisory agencies (EBA, ESMA and EIOPA) it makes up the European System of Financial Supervision (ESFS). Unlike the European supervisory agencies, the ESRB focuses on the identification of systemic risks and on macroprudential policy, with the aim of safeguarding the stability of the European financial system as a whole. If it identifies increased risks of a systemic nature, the ESRB can issue warnings and recommendations to mitigate those risks. CNB representatives are involved directly in the ESRB’s work. The CNB Governor and another board member are members of the General Board, and CNB experts participate in the Advisory Technical Committee (ATC) and its working groups.
CNB experts also participate in other international activities in the field of financial stability, in particular projects of the European System of Central Banks (ESCB). This includes, for example, involvement in the Financial Stability Committee and the Macroprudential Research Network (MaRs), which was set up in 2010. Regular international cooperation has also been established at the regional level with Central European countries.
CNB experts are also involved in providing foreign technical assistance in the financial stability area, including organising regular seminars for central banks from countries of the former Soviet Union, the Southern Balkans and Central and Eastern Europe since 2008. Foreign technical assistance is often provided in partnership with other central banks or international institutions. CNB experts are also active in international financial stability forums and conferences.