# **Appendix A. Suggested Financial Stability Indexes and Supporting Indicators**

This appendix provides more detailed suggestions regarding the selection of financial stability indexes and their supporting indicators. The proposals below are suggestions based on an informal comparison of various FSRs. As explained in the main text, these suggestions are not clad in stone. To ensure a good fit, it is important that the specification captures countryspecific circumstances, either by dropping indicators that are not considered important or by adding additional ones. As explained, a conceptual distinction can be made between stress indexes, vulnerability indexes, and resilience indexes.

# **_Stress Indexes_**

- _Financial conditions:_ Stress indexes look at a range of easily available high-frequency financial market indicators, capturing the sentiment in global as well as regional and local financial markets. Relevant global financial markets indicators include the Merrill Lynch Option Volatility Estimate (MOVE) and the Board Options Exchange volatility index (VIX). The MOVE index measures the implied volatility of one-month-ahead U.S. treasury options and can be considered an indicator for future volatility in the bond market. The VIX (also known as the “fear index”) denotes expected equity volatility. The JP Morgan Emerging Markets Bond Index Global (EMBI Global) tracks total returns for traded external debt instruments in the emerging markets. Country-level spreads are indicative of market perception about the riskiness of individual countries and regions.<sup>26</sup> Additional indicators include the Libor–OIS spread, measuring financial markets’ perceptions of credit risk of the banking sector.<sup>27</sup> These indicators may be supplemented by volatility indexes for local capital markets and stock exchanges, provided that there is sufficient activity in these segments to warrant the monitoring of these indicators. Closer to the (local) banking system, it may also be useful to monitor interbank lending spreads, credit default swap spreads of (parent) banks, and forex and interest rate swap spreads, where available.

# **_Vulnerability Indexes_**

- _Financial cycle_ : Vulnerability indexes contain a range of indicators aimed at assessing the stage of the financial cycle. The time-varying component of systemic risk is to a large extent driven by credit, leverage, and asset price cycles. The index should signal increasing financial stability risk in the upturn of the financial cycle, when imbalances are building up. The financial cycle index can be a helpful input for deciding whether to activate or release countercyclical financial regulation and more ad hoc lean-against-the-wind measures. As suggested by Borio (2012), the index can be constructed on the basis of a variety of indicators looking at the behavior of credit and financial assets, particularly property.

> 26 The EMBI Global includes U.S. dollar-denominated Brady bonds, loans, and Eurobonds with an outstanding face value of at least $500 million.

> 27 The London interbank offer rate (Libor) is the rate at which banks indicate they are willing to lend to other banks for a specified term of the loan. The overnight indexed swap (OIS) rate corresponds to the federal funds rate. The term Libor-OIS spread reflects what banks believe is the risk of default associated with lending to other banks.

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