26 January 2023

FSB's Knott: Daring to know in times of uncertainty and structural shifts

Financial stability is the capacity of the global financial system to withstand shocks, by containing the risk of disruptions in the financial intermediation process that would be severe enough to adversely impact the real economy.

I was asked to talk about systemic risks today. More precisely, about where the next systemic 
financial crisis might come from. And truth be told – this is hard to say. We can’t predict that
with any reliability. One only needs to recall the way that the covid pandemic hit us to know that
a crisis can emerge unexpectedly. This is exactly why predicting the next crisis is not what we
aim to do at the Financial Stability Board (FSB). Instead of predicting, our aim is to approach
financial stability with a different way of thinking. Financial stability is the capacity of the global
financial system to withstand shocks, by containing the risk of disruptions in the financial
intermediation process that would be severe enough to adversely impact the real economy.
In short: our work is about enhancing the resilience of the global financial system. So that, when
the next crisis materialises, the system as a whole can cope with it.

In order to increase that resilience, we try to know as much as possible about the vulnerabilities
in our financial system. And we do this by relying on the powers of reason, logic, cooperation
and data. In other words, by following the brothers von Humboldt, Friedrich von Schiller, and
Johan Wolfgang von Goethe in sapere aude.

So how do we go about that?
To increase the resilience of the global financial system and to enhance financial stability, we
rely on the FSB’s Financial Stability Surveillance Framework.3 Let me start by walking you
through this framework, and then I will illustrate how we apply it.

The FSB’s financial stability surveillance framework is based on four guiding principles.
First, we need to identify the vulnerabilities that may threaten global financial stability. I say
‘vulnerabilities’ instead of ‘shocks’ or ‘risks’. That is intentional.
The pandemic is a shock. The war in Ukraine is a shock. A rapid shift in financial market
conditions would be a shock. Shocks are by definition unpredictable – so they don’t offer a solid
starting point for financial stability policy. Risk – that is the risk of a shock large enough to have
a financial stability impact – is similarly very difficult to assess.

Vulnerabilities, on the other hand, can usually be measured, at least to a certain extent. Think
for instance about the build-up of imbalances, like a rise in leverage during a credit boom. And
so, they do offer a starting point for financial stability policy – policy that is aimed at reducing
these vulnerabilities. Through this approach we can mitigate potential systemic disruption, once
a shock hits our global, highly interconnected financial system.
And so, in the spirit of Alexander von Humboldt, who measured and mapped large parts of the
world, we, in turn, try to map and measure global vulnerabilities – rather than the shocks that
may or may not materialise.

Second, once mapped and measured, we monitor these vulnerabilities, taking into account the potential interactions between them. We also deploy a forward-looking perspective, by
considering emerging vulnerabilities in addition to current ones. It is better to prevent
vulnerabilities from growing in the first place, rather than having to reduce them once they  already pose a global threat...

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