The Central Bank of Armenia defines financial stability, which is the main goal in addition to price stability, as a condition where financial system is able to withstand shocks and disruptions so that the system maintains a sufficient level of liquidity, adequately performs transactions and transmissions and facilitates allocation of savings to investment opportunities in the economy.
In its most common definition, financial stability means the stability of key financial institutions and financial markets, and does not in any way rule out bankruptcy on the part of individual financial institution as well as severe fluctuations in asset values.
Financial stability implies identification of sources of major risks, imprudent financial risk management, not efficient pricing of assets and implementation of appropriate polices.
A stable financial system is a key ingredient for a healthy and successful economy. Every one needs to have confidence that the system is safe and stable, and functions are proper to provide vital services to the economy.
Safeguarding and maintaining the stability of financial system is of primary importance to central banks of most countries. This is because low inflation and unemployment and fast economic growth, as common objectives of monetary and other state authorities, cannot be achieved in the modern economy without a developed and stable financial system through which the effects of monetary policy measures can be effectively channeled to other economic sectors.
Maintaining Financial Stability as an Objective of Central Bank
Main body responsible for financial stability in Armenia is the Central Bank, as provided for by the Republic of Armenia Law “On Central Bank”. Article 4 The Central Bank's core goals and objectives 1. The main goals of the Central Bank are to ensure price stability and financial stability in the Republic of Armenia. Article 5 1. Other objectives of the Central Bank are: a) Maintaining the stability, liquidity, solvency and appropriate functioning of the financial system of Armenia. Central Bank of Armenia implements the above mentioned task through its efforts of risk assessment and risk reduction, financial system regulation and supervision functions, payment system oversight and, in exceptional circumstances, by acting as lender of last resort, and resolution work to deal with distressed banks.
Instruments used by Central Bank to maintain financial stability
The Central Bank has a variety of instruments for maintaining financial stability. Such instruments are:
- risks analyses and assessment
- market intelligence, that is creating widespread transparency with regard to central bank’s objectives, publicly identifying risks, encouraging financial market participants to increase their awareness of these risks to act accordingly
- payment system oversight and development
- market operations and liquidity assistance
- acting as lender of last resort
- financial Stability committee
In order to indentify probable risks affecting financial system, the Central Bank analyzes a number of indicators of local and external financial system, as well as of the real sector, monitors financial markets, and oversights payment systems. At this stage, the Central Bank analyses financial system pillars (financial institutions, financial infrastructure and financial markets), as well as developments in macro economy. The Central Bank draws on analysis of all factors that might directly or indirectly affect stable functioning of the financial system. Another important tool to assess financial stability is indicators of financial soundness endorsed
The Central Bank also uses internationally known stress-testing models to assess the vulnerability of financial system in time of probable risks materializing. Stress scenarios are simple “what if” events, which allows to assess the costs of financial system or individual participants.
In maintaining financial system’s stability an important aspect is risk controlling. The Central Bank carries out risk controlling by implementing prudential and macro prudential policies, as well as supervision of the financial system. Prudential regulation presumes setting a certain regulatory framework for an individual institution in order to keep risks affecting an individual institution’s stability under manageable limits. Macro prudential policy itself means using prudential instruments which will provide the stability of the financial system as a whole. Macro prudential regulation is aimed to minimize systemic risks.
Central Bank policies addressed to maintaining financial stability
Central Bank policies to maintain financial stability fall into three types.
- When the financial system is characterized as stable, or in other worlds the fluctuations of main indicators are within allowable band, a preventive policy will need to be implemented. Implementation of such a policy implies monitoring a number of macro prudential indicators on an ongoing basis. It is necessary to capture the financial sector’s direct and indirect international exposures in both quantitative and qualitative terms. Preventive policy is addressed to financial stability by using available supervisory and regulatory tools.
- When financial system fluctuations are within the target band yet tend to infringe it, which might cause high volatilities in certain financial or non financial sector, then corrective policy will be applied. Actions arising out of the above policy cover activities such as examining new financial market instruments and risk analysis methods, studying loan loss provisioning practices, discussing new capital adequacy requirements and adopting international reforms and implementing appropriate supplements. This in fact provides for an opportunity to extend available instruments and improve regulatory framework.
- In case the fluctuations of financial system are beyond the level allowed and the system is not able to perform its key functions, a recovering policy will be implemented. Recovering measures commonly include an extended variety of anticrisis measures. Extraordinary anticrisis measures taken by the Central Bank are: extended opportunities for banks to borrow from the central bank, policy of quantitative easing, emergency liquidity assistance under its function of lender of last resort, etc.
Financial stability and Special resolution committee
Financial Stability and Special Resolution Committee is a consultative body adjunct to the Chairman of the Central Bank. The main task of the Committee is assessment of financial stability. The Committee identifies probable risks that threaten the financial stability and the main transmission channels, debates the main measures addressed to the ensuring of financial stability, suggests the scope of further policy directions and other necessary actions.
The Committee is available with the structure as mentioned below:
-Chairman of Central bank
-Head of Financial system stability and development department
-Head of Financial Supervisory department
-Head of Financial system regulation department
In case of necessity, the Deputy Chairmen of the Central Bank, members of the Board, for legal consultation, the Head of the Legal Department, as well as other employees of the Central Bank's interested departments may attend the Committee meetings. While discussing certain issues, the corresponding representatives of the Ministry of Finance and Deposit Guarantee Fund, as well as other state authorities may be invited to the Committee sessions.