Discussion paper: Cobweb diagram as a tool for assesing changes in the most important financial stability risks

Executive summary

The Discussion Paper analyses a risk cobweb diagram employed as an additional analytical tool for monitoring and assessing financial stability risks in Latvia. The aim of the risk cobweb diagram is to depict the most important financial stability risks across specified risk categories and the direction of their changes in a single chart. The risk cobweb diagram and the dynamics of the index corresponding to each risk category and its components make it possible to visualise and analyse development of external and domestic macrofinancial risks and vulnerability changes of the banking sector in Latvia by assessing the credit risk of non-financial corporations and households, profitability and solvency risks of credit institutions, as well as funding and liquidity risks. The Discussion Paper gives the overview of the use of the risk cobweb diagram and its methodology in other countries. It also outlines the process of the development of such a diagram in Latvia and describes selected risk categories and indicators. The Discussion Paper concludes that the results of the back-testing of the risk cobweb diagram have been adequate. In 2008 and 2009, the risk category assessments of the risk cobweb diagram signalled threats to financial stability, while risk category indices and their components allowed the identification of the areas where accumulation and materialisation of financial stability risks occurred. Keywords: financial stability, risk cobweb diagram, risk categories, monitoring of financial system stability, assessment of financial system stability

JEL codes: E32, E44, E58, G10