Monitoring the macroeconomic determinants of banking system stability Thierry Timmermans Over the past few years, prudential authorities and, more specifically, central banks have focused increasing attention on the macroeconomic determinants of the stability of the banking system. Banks' vulnerability to changes in the economic environment, the many structural changes within the financial markets, and the banking crises which have recently hit a number of countries (including industrialised economies) are among the main factors underlying this enhanced interest. This paper examines the ways in which these macroprudential analyses are dealt with in Belgium. These ways are partly conditioned by both the structural and the institutional environments in which the Belgian financial system operates. This general framework is examined in the first section of this paper. Notwithstanding these special national features, the theoretical foundations used for analysing the macroeconomic determinants of the stability of the banking system apply to the entire financial market. Those foundations are reviewed in the second section, which gives a brief overview of the economic literature devoted to the determinants of financial crises. The third section deals with credit and interest rate risks, which are both highlighted by these theoretical analyses and considered as the most traditional components of the risks run by credit institutions. The fourth section examines risks of a more structural nature which are also created by the interaction between the banking sector and the financial and real spheres of the economy. Banks do in fact run strategic risks in so far as they have to modify their lines of behaviour and activity in order to cope with changes in the economic and financial environment in which they operate. Furthermore, a number of recent changes, such as disintermediation and the development of new financial products, have enabled the banks to transfer part of their traditional credit or market risks to other economic agents, thereby possibly exposing the banks to other hazards, such as a weakening of the global financial resilience of customers or even reputational risks. The last section concludes. 1. Institutional and structural framework In Belgium, the NBB does not have any specific brief in connection with bank supervision. It is not, of course, the only one in such a situation, since within the European Union prudential monitoring is the responsibility of the central bank only in six countries, namely Italy, Spain, the Netherlands, Portugal, Ireland and Greece. However, in four of the six other member states (Germany, France, Austria and Finland) the central bank does have to play an important role, either by providing the chairman of the banking supervisory body or by making staff available to that body, or again by carrying out certain assignments on its behalf. Belgium, together with Luxembourg, is the EU member country in which the demarcation between the central bank and the prudential authority is most clear-cut. Despite this absence of direct responsibility, the NBB does however have various links with the body entrusted in Belgium with the supervision of banks and investment undertakings, the Banking and Finance Commission (BFC). It is thus laid down that a member of the NBB is an ex officio member of the BFC’s decision-making body. The Bank is also consulted when changes are made in the prudential regulations and the accounting principles governing the presentation of the accounts of credit institutions. Lastly, the financial information and accounts provided by the banks in order to enable the BFC to carry out its off-site analysis are communicated to the BFC via the NBB, which carries out verifications and performs validation tests in advance. This procedure enables the Bank to maintain regular contacts with the banks and the BFC, and gives it direct access to statistical data which are particularly useful for macroprudential analyses. The NBB’s relatively limited involvement in the monitoring of the banking system is also attributable to more structural causes. Since the end of World War II, the Belgian banking system has displayed a fairly high degree of soundness, in contrast with the developments observed in many other countries. According to Lindgren et al (1996), who carried out a fairly extensive survey of banking problems BIS Papers No 1 117