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Definition: Macroprudential Analysis
Macro-prudential analysis is a method of economic analysis that evaluates the health of a financial system. It analyses the strengths and vulnerabilities of the financial system. There are two bases of financial stability. One is Micro-prudential perspective and another is Macro-prudential perspective.
Macro-prudential perspective uses the indicators that provides data on GDP growth rates, inflation, interest rates, balance of payments, exchange rates and financial institutions’ credit exposure, management performance, asset quality, capital adequacy, profitability, liquidity etc. to analyse the health of financial institutions. Macro-prudential analysis also uses qualitative tools such as institutional framework and regulations. In Macro-prudential analysis stress tests and scenario analysis are also performed to determine financial system’s sensitivity to economic crises.
Macro-prudential analysis helps limit distress to entire financial system like financial crisis rather than individual institution. It also helps prevent huge costs to the economy in terms of bailouts. It evaluates the risks that are arisen due to interaction between financial institutions.
Stress tests and scenario analysis are two major components of Macro-prudential analysis. For example, Scenario analysis will look at how the economy will cope with continuously declining currency value or low GDP growth rate and the impact of these causes on interest rate, inflation, profitability and liquidity of financial system.