West African Economic and Monetary Union: Financial Sector Assessment Program-Technical Note-Stress Tests, Credit Concentration, and Interest Rate Risks

© 2022 International Monetary Fund IMF Country Report No. 22/279 WEST AFRICAN ECONOMIC AND MONETARY UNION FINANCIAL SECTOR ASSESSMENT PROGRAM TECHNICAL NOTE ON STRESS TESTS, CREDIT CONCENTRATION, AND INTEREST RATE RISKS This technical note on Bank Stress Test for Climate Change Risks was prepared by a staff team of the International Monetary Fund and World Bank in the context of a joint IMF-World Bank Financial Sector Assessment Program (FSAP). It is based on the information available at the time it was completed in July 2022. Copies of this report are available to the public from International Monetary Fund • Publication Services PO Box 92780 • Washington, D.C. 20090 Telephone: (202) 623-7430 • Fax: (202) 623-7201 E-mail: publications@imf.org Web: http://www.imf.org Price: $18.00 per printed copy International Monetary Fund Washington, D.C. August 2022 WEST AFRICAN ECONOMIC AND MONETARY UNION FINANCIAL SECTOR ASSESSMENT PROGRAM TECHNICAL NOTE STRESS TESTS: CREDIT, CONCENTRATION, AND INTEREST RATE RISKS Prepared by Monetary and Capital Markets Department This technical note was prepared by IMF staff in the context of a Financial Sector Assessment Program (FSAP) mission to the West African Economic and Monetary Union. The note contains technical analysis and detailed information underpinning the FSAP assessment's findings and recommendations. Further information on the FSAP can be found at http://www.imf.org/external/np/fsap/fssa.aspx. July 22, 2022 WEST AFRICAN ECONOMIC AND MONETARY UNION 2 INTERNATIONAL MONETARY FUND CONTENTS Glossary ___________________________________________________________________________________________ 4 EXECUTIVE SUMMARY __________________________________________________________________________ 5 INTRODUCTION _________________________________________________________________________________ 7 MACROFINANCIAL SCENARIOS ________________________________________________________________ 8 AGGREGATION THROUGH STATISTICAL CLUSTERING ______________________________________ 13 CREDIT RISK ___________________________________________________________________________________ 14 INTEREST RATE RISK __________________________________________________________________________ 17 CONCENTRATION RISK _______________________________________________________________________ 18 MEASURES AND RECOMMENDATIONS ______________________________________________________ 19 CONCLUSION __________________________________________________________________________________ 20 REFERENCES ___________________________________________________________________________________ 20 FIGURES 1. Scenarios—Growth at Risk ____________________________________________________________________ 23 2. Scenarios—Inflation at Risk ____________________________________________________________________ 24 3. Bank Clustering ________________________________________________________________________________ 25 4. Credit Risk _____________________________________________________________________________________ 26 5. Interest Rate Risk ______________________________________________________________________________ 27 6. Concentration Risk ____________________________________________________________________________ 28 TABLES 1. Table of Recommendations ____________________________________________________________________ 6 2. Composition of Synthetic Variables—GaR Model ______________________________________________ 9 3. Composition of Synthetic Variables—IaR Model ______________________________________________ 10 4. Financial Soundness Indicators ________________________________________________________________ 29 ANNEXES I. At-risk Models on Small and Noisy Samples ___________________________________________________ 32 II. Estimating Synthetic Variables by Partial Least Squares _______________________________________ 36 III. Risk Assessment Matrix _______________________________________________________________________ 39 WEST AFRICAN ECONOMIC AND MONETARY UNION INTERNATIONAL MONETARY FUND 3 IV. Grouping Banks by Statistical Clustering ______________________________________________________ 40 V. Stress-Testing via Quantile Regressions _______________________________________________________ 42 VI. Recursive Dynamic Projection Model _________________________________________________________ 44 VII. Matrix of Banking Sector Stress Tests ________________________________________________________ 45 WEST AFRICAN ECONOMIC AND MONETARY UNION 4 INTERNATIONAL MONETARY FUND Glossary BCEAO Central Bank of West African States (In French: Banque Centrale des États de l’Afrique de l’Ouest) CBU FSAP Banking Commission of the West African Monetary Union (In French: Commission Bancaire de l’UMOA) Financial Stability Assessment Program GaR Growth at Risk GDP Gross Domestic Product IaR Inflation at Risk OLS Ordinary Least Squares PCA Principal Component Analysis PDs Probabilities of Default PLS