Academic literature on the topic 'European credit and interest rate markets'

This paper investigates the valuation of European option with credit risk in a reduced form model when the stock price is driven by the so-called Markov-modulated jump-diffusion process, in which the arrival rate of rare events and the volatility rate of stock are controlled by a continuous-time Markov chain. We also assume that the interest rate and the default intensity follow the Vasicek models whose parameters are governed by the same Markov chain. We study the pricing of European option and present numerical illustrations.

Purpose This paper aims to briefly review the literature on interest rate convergence and the European debt crisis with a special focus on the current fiscal problems of some governments in Europe. Design/methodology/approach Relevant empirical papers are identified and reviewed focusing on time series analysis techniques. Findings The introduction of the euro has caused interest rate convergence among European Monetary Union (EMU) government bond yields. However, now sovereign credit risk and possibly even redenomination risk have caused divergences in European bond markets. Research limitations/implications A major limitation is that a relatively new field of the literature is surveyed. However, there are enough papers of relevance. This review paper could therefore be helpful in finding new approaches for additional empirical research examining the EMU bond market. Originality/value The results of empirical studies in a relatively new field of the literature are summarized. There meanwhile are some relevant papers. A brief survey of the results of these papers is provided. Important empirical findings with regard to interest rate convergence, sovereign credit risk and redenomination risk in the EMU are discussed and evaluated. The review is especially helpful for researchers and practitioners in the field of managerial finance and risk managers in the financial services industry.

Interbank rates are affected by the monetary policy of a country and represent a link to other financial and credit markets. In 2007, Romania became a member of the European Union and its central bank, the National Bank of Romania (NBR), joined the European System of Central Banks (ESCB) but not the Eurosystem. This paper analyses the role of the central bank and the use of its instruments concerning interbank rates. The research evaluates the influence of the Romanian Central Bank on interbank rates and shows that the policy rate and bank liquidity are among the main determinants of interbank rate movements. It is also presented that the NBR’s deposit and lending rates can limit the free movements of the interbank rate of interest. This research confirms that interbank interest rates influence bank rates strongly. The methodology used in this research includes cointegration, dynamic econometric measurement and analyses with Granger causality. Our research uses mainly ROBID and ROBOR of different maturities, showing that the influence of the Romanian Central Bank (NBR) on the interbank rate is strong, while the influence of the ECB and Fed is weak.

We describe an extension of Gaussian interest rate models studied in literature. In our model, the instantaneous spot rate is the sum of several correlated stochastic processes plus a deterministic function. We assume that each of these processes has a Gaussian distribution with time-dependent volatility. The deterministic function is given by an exact fitting to observed term structure. We test the model through various numeric experiments about the goodness of fit to European swaptions prices quoted in the market. We also show some critical issues on calibration of the model to the market data after the credit crisis of 2007.

This paper draws an empirical reassessment of the finance-growth nexus by performing a panel data econometric analysis for all 28 European Union countries over 27 years from 1990 to 2016. Since the mid-1980s, the financial system has experienced a strong liberalisation and deregulation by preventing its beneficial effects on the real economy. This phenomenon, typically called financialisation, points to a negative view of finance and contradicts the well-entrenched hypothesis on the finance-growth nexus. We estimate both linear and non-linear growth models by incorporating seven proxies of finance (money supply, domestic credit, financial value added, short-term interest rate, long-term interest rate, stock market volume traded and stock market capitalisation) and five control variables (the lagged growth rate of the real per capita gross domestic product, the inflation rate, the general government consumption, the degree of trade openness and the education level of the population). Our results show that finance has impaired economic growth in the EU countries, both in the precrisis period and in the crisis and post-crisis periods. The enormous growth of domestic credit and of the financial value added have been restraining the economic growth of the EU countries since 1990 and particularly up until the Great Recession. This implies the need to reduce the prominence of finance, i.e. socalled definancialisation, in the coming years in order to avoid the potential new ?secular stagnation? in the current age of financialisation.

This study investigates the causality between financial development, economic growth, and income inequality using panel data for 23 European Union countries over the period 1987-2017. Various proxies of financial development are chosen to represent the depth, efficiency, and stability of the banking system and stock markets. For the empirical analysis, the study performs the Granger non-causality test in heterogeneous panels. The findings are contradictory and sensitive to the measures of financial development. Most importantly, the results reveal a one-way causality from financial development to economic growth when private credit, stock market capitalization, net margin interest rate, and Z-score are chosen as financial development indicators. In addition, a two-way causality exists between bank assets, liquid liabilities, non-performing loans, and economic growth, and a one-way causality from economic growth to value traded and turnover ratio. However, the results show no causality between stock price volatility and economic growth. The results indicate a one-way causality running from income inequality to economic growth. Finally, a one-way causality runs from income inequality to financial development for most measures of financial development except for a one-way causality running from private credit to income inequality, a two-way causality between bank assets and inequality, and an absence of causality between income inequality and turnover ratio, Z-score and stock price volatility.

Challenges the European economy began to face 12 years ago raised the question about actions European Central Bank (ECB) have to undertake to maintain the financial sustainability, considering its objective to ensure price stability while coping with a changed economic environment. Provision that the ECB is obliged to take efforts to ensure financial stability as well as potentially serious consequences of crisis’ impact on the banking system and industrial production, led to an expansion of its role beyond standard monetary policy measures, with the unconventional steps being taken in addition to conventional to combat the adverse impact of the financial crisis. While reducing the interest rate, ECB also provided a cheap financial capital for banks via fixed-rate “Long Term Refinancing Operations” (LTROs), and three “Covered Bond Purchase Programmes” (CBPP). Purchases of debt securities were also conducted via “Securities Market Programme” (SMP) and, later, with then ECB’s President Mario Draghi declaring that ECB will do “whatever it takes to preserve the euro”, possibility of their increase was announced with the start of “Outright Monetary Transactions” (OMT) Programme. A mere announcement of the OMT was enough to calm financial markets, as none of the eurozone countries applied for financial support within this programme’s framework. Then ECB proceeded with a full-fledged quantitative easing, starting to buy sovereign bonds under its Public Sector Purchase Programme (PSPP), having spent 2.6 trillion € on its implementation. Understanding that a monetary union without an efficient banking union is unacceptably dangerous, the European Banking Union, under which supervision of largest eurozone banks has transferred directly to the ECB, was progressively established. While ECB’s anti-crisis policies achieved their goals, prolongation of the strategy it adopted may create new risks for the financial stability of the euro area, such as excessive dependence of credit institutions on monetary support and excessive inflationary risks under a zero interest-rate policy. Still, EU institutions’ coordinated financial management played an important role in overcoming the existing turbulence, with fiscal and monetary policy measures reinforcing each other.

This research aims to determine variables that affect the aggregate value of incoming cross-border M&As in European transitional countries. Dynamic panel models have been estimated using Arellano and Bond GMM estimator for period between year 1994 and 2008. The ratio of the total value of cross-border M&A to GDP of the country is the dependent variable. Independent variables include following indicators: lagged value of cross-border M&A to GDP, lagged GDP per capita, lagged GDP growth, inflation, interest rate spread, lagged private credit to GDP ratio, market capitalization to GDP ratio, lagged rule of law and lagged control of corruption.

This work aims to provide an efficient method to evaluate the Credit Value Adjustment (CVA) for a vulnerable European option, which is an option subject to some default event concerning the issuer solvability. Financial options traded in OTC markets are of this type. In particular, we compute the CVA in some popular stochastic volatility models such as SABR, Hull et al., which have proven to fit quite well market derivatives prices, admitting correlation with the default event. This choice covers the relevant case of Wrong Way Risk (WWR) when a credit deterioration determines an increase in the claim value. Contrary to the structural modeling adopted in [G. Wang, X. Wang & K. Zhu (2017) Pricing vulnerable options with stochastic volatility, Physica A 485, 91–103; C. Ma, S. Yue & Y. Ma (2020) Pricing vulnerable options with Stochastic volatility and Stochastic interest rate, Computational Economics 56, 391–429], we use the reduced-form intensity-based approach to provide an explicit representation formula for the vulnerable option price and related CVA. Later, we specialize the evaluation formula and construct its approximation for the three models mentioned above. Assuming a CIR model for the default intensity process, we run a numerical study to test our approximation, comparing it with Monte Carlo simulations. The results show that for moderate values of the correlation and maturities not exceeding one year, the approximation is very satisfactory as of accuracy and computational time.

博士
國立高雄第一科技大學
管理研究所
98
ABSTRACT Recently, a free global financial market has resulted in many economic uncertainties. To meet the need of hedging among more investors, financial derivatives have therefore been developed. Among those derivatives, basket warrants are of high leverage trading and options. In the evaluations of derivatives, basket warrants have long been lacking a formula to properly evaluate credit risk (Genlte, 1993; Huynh, 1994; Milevsky and Posner, 1998). In the consideration of credit risks (Klein and Inglis, 1999; Klein, 1996), current evaluation formulae are aiming at single-stock warrants and cannot be directly applied in the evaluation of basket warrants with high credit risks. Under a consecutive time model, this dissertation considers credit, interest rate risks and the relationships between properties with different risks; it also adopts martingale method to deduct an evaluation formula of call and put options of the vulnerable European basket warrants to make up for the deficiencies of basket warrants under different credit risks. Through examination, the deducted formula proposed in this dissertation proves to be a general solution to related evaluation formulae of warrants; it saves the trouble of re-deducting another new evaluation formula in the future and is more efficient in the process of calculation. Finally, this dissertation gives numerical examples and uses the interest rate model of Cox et al. (1985a) to illustrate the influences on the price range of vulnerable European basket warrants under different stock prices, weights, volatility of stock prices and asset-related conditions. The result of this evaluation formula goes as follows: the higher the price volatility of basket warrants or the percentage of stocks with high volatility, the higher the call options of basket warrants. When the debt ratio of the issuing firm is higher, the call option prices of the vulnerable European basket warrants are lower. While the value of the firm is in negative correlation with the stock price, the prices of call options of the vulnerable and non-vulnerable European basket warrants vary greatly; the higher the volatility of stock prices, the greater the prices vary. Due to the short-term validity of warrants, the value of a firm and the interest rate has limited influence on that of call options of the vulnerable European basket warrants. When the stocks targeted at by the warrants show their negative correlations, they can reduce the risks of different combinations of warrants, lowering the premium of the call options of the vulnerable European basket warrants. This evaluation formula not only combines basket warrants with different risk factors, but is more elastic and superior to the interpretation of the vulnerable European basket warrants offered by Klein and Inglis (1999) and can be more widely applied.

The issue of risk-based pricing of credit loans has become crucial for banking companies, in a context characterized by severe restriction of profitability margins also in relation to a level of market interest rates which in the Euro area is at its lowest. historical, now firmly in the negative area. The same European Authorities urge the adoption of adequate and consistent adjusted pricing frameworks with respect to the business model, risk profile and overall risk governance of the bank. The methodological and organizational process for determining the risk-adjusted pricing is further complicated by the ongoing Covid19 pandemic which, through the highly asymmetrical impacts on customer segments and industrial sectors, makes the forward-looking and macroeconomic assessment of the sectors risk even more relevant.

The deepened financial integration of EDEs has heightened their susceptibility to global financial shocks and increased the instability in their credit, assets, and currency markets. It has led to significant loss of autonomy over monetary policy and the entire spectrum of interest rates. At the same time, these countries are said to have become more resilient because they have adopted more flexible exchange rate regimes, accumulated large stocks of international reserves, and reduced their exposure to the exchange rate risk by shifting from foreign currency to local currency debt. This chapter critically examines these contentions and concludes that none of these practices provides adequate protection against external financial shocks, taking into account the new vulnerabilities entailed by the increased depth and changed pattern of integration, particularly greater presence of foreigners in domestic financial markets and of the nationals of emerging economies in markets abroad.

This chapter provides an overview of floating rate notes (FRNs). Although FRNs originated in Europe, their first introduction in the United States came in 1974 when Citicorp sold $650 million worth of its 15-year notes. Since that time, FRNs have evolved into a variety of types. FRN types covered in the chapter include the plain, capped, floored, collared, reverse, super, deleveraged, perpetual, and flip-flop. An FRN can have a maturity of up to 30 years and include periodic interest rate adjustments throughout its life. An FRN uses a reference rate, such as London Interbank Offer Rate (LIBOR), Treasury bill (T-bill) rate, prime rate, or domestic certificate of deposit rate plus a spread to determine its coupon rate. The chapter provides a discussion of such risk factors as interest rate risk, credit risk, call/reinvestment risk, liquidity risk, and market risk. Additionally, it covers FRN valuation using spread for life, effective margin, total adjusted margin, discount margin, and option-adjusted spread methods.

Credit risk pricing is perhaps an understudied topic in comparisons to its profound impact on the world’s financial markets and economies. This study uses established price discovery techniques to develop a method of price discovery for credit risk in three financial markets: equity, debt, and credit derivative. This chapter is motivated by the development of credit-related instruments and signals of stock price movements of South-Eastern European countries—Bulgaria, Croatia, Greece, Hungary, Romania, Slovenia, Slovakia, and Turkey—during the recent financial crisis. In this study, the authors evaluate the dynamics of fiscal risk or country risk measured by sovereign Credit Default Swap (CDS), liquidity risk measured bond markets, and stock markets for the monthly based September 2008 – February 2011 period. The study examines monthly data observing 38 months and 8 countries. A panel vector autoregression model is proposed for changes in Long-Term Interest Rate (LTIR), changes in CDS spreads (CDS), and changes in stock index. In conclusion, CDS markets and stock markets are more significant than bond markets in explaining the post-crisis relationship among developing South-Eastern European countries. The analysis displays that long-term monetary policy did not affect CDS premium and stock index level. A strong relationship is found between the CDS spread and stock market. During financial crisis and after the crisis, the correlations among CDS, stock, and bond markets are collapsed by panicked investors’ rapid movement and wild speculators. This risk perception can explain the difference between the finance theory and practices in the market.

‘The classical theory of option pricing’ explains the theory of arbitrage pricing, which is closely related to the Dutch Book Arguments, but which brings in a new factor: prices in financial markets evolve over time and participants are able to trade at any time, instead of just taking bets and awaiting the result. In addition to the general theory, pricing models and methods have been developed for specific markets—foreign exchange, interest rates, and credit. The binomial and continuous-time mathematical models for stock prices are introduced along with the Black–Scholes formula, the volatility surface, the difference between European and American options, and the Fundamental Theorem of Asset Pricing.

Interest rate derivatives markets have enjoyed substantial growth since the late 1990s. This chapter discusses the development of these markets since 2000 and introduces the most popular interest rate derivative instruments. Although forward rate agreements and interest rate swaps are important examples of over-the-counter (OTC) products, futures on interest rates and bonds are innovations of organized exchanges. Both OTC interest rate options and exchange-traded options on interest rate futures are discussed to illustrate an overlapping area of both types of derivatives markets. Participants in debt markets are also exposed to both interest rate and credit risk. To mitigate the latter risk, the OTC fixed income derivatives markets provide credit default swaps (CDSs). As credit derivatives are also a subset of fixed income derivatives, CDSs are discussed further.

Institutional determinants of instability in the insurance market: A case study of the holding company American International Group, Inc. The aim of the article is to analyze the institutional conditions of instability that occurred on the insurance market during the global financial crisis (GFC) on the example of the American International Group, Inc. The global financial crisis of 2007–2008 called into question the ability of liberalized financial markets to function in a stable manner in the long term and questioned the positive contribution of financial innovation to economic development. Numerous and varied factors played a role in this process: low interest rates, easy and accessible credit, loose regulations, “toxic” mortgage loans leading to high-risk financial operations in innovative products. As a result of the crisis, attention has shifted to the banking sector as it has been the most important source of instability in the financial market. The insurance sector is usually considered a minor player in the financial market but clearly regulated. The total assets of European Union banks in 2019 accounted for EUR 49.3 trillion, and the total assets of the EU insurance sector: EUR 12,706.1 billion. However, the case of AIG shows that the role of insurance companies in generating and spreading financial instability is underestimated. It can also be concluded that the insurance sector in the United States of America still remains insufficiently regulated. The collapse of AIG was a combination of defects and violations in the regulatory mechanisms and the lack of appropriate legislation, which allowed for the appearance of certain elements of fraud in the functioning of the insurance market.

This chapter discusses how, in the 1970s and 1980s, Norges Bank began to develop instruments with a view to steering economic policy under freer market conditions. However, governments of changing political hues were unwilling to let go of the low interest rate. The oil price fall in 1986 brought an abrupt change in interest rate and credit policy. The government’s tightening actions included the introduction of a more binding fixed exchange rate policy. The frequent recourse to corrective devaluations was to be a thing of the past. Hence, there was a justification for using the interest rate as an ongoing instrument to stabilize the exchange rate. This task fell to Norges Bank. The transition to an independent, active interest rate policy on the part of the central bank was abrupt and came as a surprise. Barely a year before the collapse of the oil price, the Storting had passed a law that made Norges Bank one of the least autonomous central banks in all of western Europe. Ultimately, it was the external situation, and in no sense an increase in government’s and the public’s recognition of the bank and its institutional legitimacy, that restored greater operative autonomy to Norges Bank.

Sovereign credit ratings are of great importance in terms of country's economy in recent years. Sovereign credit ratings can greatly affect both financial markets and macroeconomic balances. On the other hand, these credit ratings are closely related to the political situation of the countries. Therefore, all factors behind the credit rating announcements operating in global markets needs to be put forward. The content of this paper is to identify policy interest reaction towards sovereign credit ratings and examine of countries that experienced severe rating changes. In this bulletin, big three credit rating agencies are compared and critically assessed various credit rating of Turkey. The analyzed dataset covers sovereign rating announcements released by reputable rating agencies, stock price, Dollar / TL exchange rate, Dollar / Euro exchange rate and benchmark bond.

It is known that financial markets have important place in today's economy. Individuals could be evaluated their saving with their own research or they could be evaluated their savings with financial experts recommendations. A large portion of those funds of individual or institutional investors managed are directed to the stock market of the country. When considered in terms of Turkey, Istanbul Stock Exchange is examples for this topic. The changes in economic data, is influenced to many variables especially the stock market. It is perceived in the market as bad data that the rising in unemployment, the reduction of industrial production, the increases in interest rates and cost of credit, the increase in foreign exchange rates. In this study, it was investigated the causality of the dollar exchange rate between Istanbul Stock Exchange National 30 Index (BIST-30) with "Granger Causality Test". Monthly values are used including the period of 2009:1 (January of 2009) between period of 2014:12 (December 2014) as data set. We used the first trading day closing values in the calculation of monthly returns for the period. At the end of the study, we couldn’t find any causal relationship between the dollar exchange rate and the BIST-30 Index.

Irrespective of whether advanced economies (AEs) or emerging market economies (EMEs), the number one problem of the global economy is not being able to generate a satisfactory growth. Income levels is in some countries are barely above the per-crisis level. Despite ample liquidity due to quantitative monetary policies, consumption and investment demands are weak. Because high level of indebtedness deter economic agents from using credit. Credit markets still do not function well either. Quantitative easing policies have been successful in containing further deterioration. Despite ample liquidity inflation has not risen, but it did delivered the expected growth. Because banking system in AEs is weak and monetary transmission mechanisms are not functioning well. As for EMEs, commodity prices and World trade appears to be weak; economic growth are slowing down, capex is visibly falling in heavy industrial sectors due to already existing excess capacity. The academia as well as the business community are worried about the appropriateness of the present policies in case another recession comes, central banks will have little ammunition to deal with it. The option being talked of now is what is dubbed as “helicopter Money”. Turkey being an open economy, has been and will be effected by the developments in the global economy through trade, capital flows and expectation channels. By international standards, Turkey have a reasonable growth rate of 3 to 4 %, implying a new growth era where high growth cycle ended due to changing global financial conditions and its structural problems. Future growth performance will depend on the level of investments and savings to finance it. As her own saving is low, foreign capital flows is crucial. High inflation and interest rate are the two negatives, but it has a strong fiscal position, debt / GDP is 32.3%, the budget is almost balanced, producing primary surplus which proved it is resilience in the face of recent failed coup and the negative attitudes displayed by the rating agencies.

Learning needs of the farming community is massive but the opportunities available to address the needs are limited. Farming practices are changing very fast due to multiple reasons like climate crisis, globalization, and demands from the markets, technology advancements etc., hence the farmers learning needs are changing fast. Increasing use of mobile phones, higher penetration rate in rural India and advantages of Mobile Learning made mobile phones an effective learning tool particularly among the women farmers whose mobility and opportunities for learning is restricted due to various socio economic and cultural factors. In the year 2009 around 300 women goat rearers who are members of Self Help Groups received credit from a commercial bank for buying goats, the trust and credibility strengthened the bond and helped the women to receive continuous credit support. For better management of goat rearing and to ensure profit these women showed interest to learn about improved management practices. To meet the demands of the women goat rarers Vidiyal an NGO and Vidivelli a Community Based Organization together introduced mobile based Life long learning for Farmers (L3F) programme with the support of Commonwealth of Learning. The lessons were disseminated through simple button phones as voice messages on daily basis. With the support of the National Bank for Agriculture and Development around 2500 women goat rearers came together in 2014 and registered a Farmers Producer Organization (FPO) called ‘Theni Women Goat rearers Producer Company’. Now the company is managed by a set of women goat rearers, it has provided dividend to its shareholders for the last four years. The company is emerging as a model in the region, other 12 such FPOs in the region are now joined with this and created a consortium of FPOs for mutual learning and to leverage the scale in the business. // The paper will discuss in detail about the characteristics of the learners, learning needs of the farmers, pedagogical approach adopted, learning outcomes, access and experiences of mobile phones for learning, gender constrains etc. It will also discuss about the FPOs management, how the women farmers become corporate literates and managing the company successfully.

On the road transportation sector, considering its deep involvement with many social expectations, assumed such proportions to become one of the major source of air pollution, mainly in urban highly congested areas. The use of reciprocating internal combustion engines (ICE) dominates the sector and the environmental dimension of the problem is under a strong attention of Governments. European Community, for instance, through sequences of regulations (EURO) reduced the emission allowed of primary pollutants; more recently, the Community added limits to climate-altering gases which directly refer to fuel consumption reduction. These limits today appear the new driver of the future engine and vehicle technological evolution. Similar efforts are under commitment by other developed countries (USA, Japan, etc,…) as well as also by the other Countries whose economic importance will dominate the markets in a very near future (BRICS Countries). The need to fulfill these issues and to keep the traditional engine expectations (torque, speed, fun to drive, etc..) triggered, especially in recent decades, a virtuous cycle whose result will be a new engine and vehicle era. The evolution till had today has been driven by the EURO limits and it demonstrated surprisingly that emission reduction and engine performances can be matched without compromises in both sides. Today, adding severe limits on equivalent CO2, emissions, it appears very difficult to predict how future engines (and vehicles) will be improved; new technologies are entering to further improve the traditional thermal powertrain but the way to a massive and more convinced electrification seems to be definitely opened. The two aspects will match in the sector of energy recovery which appears one of the most powerful tools for fuel consumption saving and CO2 reduction. When the recovery is done on exhaust gases it has an additional interest, having a moderate cost per unit of CO2 saved. The potentiality of this recovery is huge: 30%–35% of the chemical energy provided by the fuel is lost with the flue gases. For different reasons engines for passengers cars or goods transportation (light and heavy unit engines) as well those used for electricity generation (gen-set) are interested to this recovery: the first sector for the CO2 reduction, the second for the increasing value of electrical energy on the market. This wide interest is increasing the probability to have in a near future a reliable technology, being different actors pushing in this direction. In recent years the literature focused the attention to this recovery through a working fluid (organic type) on which the thermal energy is recovered by increasing its enthalpy. Thanks to a sequence of thermodynamic transformations (Rankine or Hirn cycle), mechanical work is produced. Both concept (Organic working fluid used and Rankine Cycle) are addressed as ORC technology. This overall technology has an evident complexity and doesn’t match with the need to keep reduced costs: it needs an energy recovery system at the gas side, an expander, a condenser and a pump. The space required by these components represents a limiting aspect. The variation of the flow rate and temperature of the gas (typical in ICE), as well as that at the condenser, represents additional critical aspect and call for suitable control strategies not yet exploited. In this paper the Authors studied an energy recovery method integrated with the turbocharging system, which does not require a working fluid making the recovery directly on the gas leaving the cylinders. Considering that the enthalpy drop across the turbine is usually higher than that requested by the compressor to boost the intake air, the concept was to consider an additional turbine which operates in parallel to the existing one. Room for recovery is guaranteed if one considers that a correct matching between turbine and compressor is actually done bypassing part of the exhaust gas from the turbine (waste gate) or using a variable geometry turbine (VGT) which, in any case, represents an energy loss. An additional positive feature is that this recovery does not impact on engine performances and the main components which realizes the recovery (valves & turbine) are technologically proven. In order to evaluate the potentiality of such recovery, the Authors developed a theoretical activity which represents the matching between turbocharger and engine. Thanks to an experimental characterization done on an IVECO F1C 16v JTD engine, an overall virtual platform was set up. The result produced a very satisfactory representation of the cited engine in terms of mechanical engine performances, relevant engine flow rates, pressures and temperatures. The ECU functions were represented too, such as boost pressure, EGR rates, rack control of VGT, etc… Two new direct recovery configurations have been conceived and implemented in the engine virtual platform.

In the second quarter, annual inflation (9.67%), the technical staff’s projections and its expectations continued to increase, remaining above the target. International cost shocks, accentuated by Russia's invasion of Ukraine, have been more persistent than projected, thus contributing to higher inflation. The effects of indexation, higher than estimated excess demand, a tighter labor market, inflation expectations that continue to rise and currently exceed 3%, and the exchange rate pressures add to those described above. High core inflation measures as well as in the producer price index (PPI) across all baskets confirm a significant spread in price increases. Compared to estimates presented in April, the new forecast trajectory for headline and core inflation increased. This was partly the result of greater exchange rate pressure on prices, and a larger output gap, which is expected to remain positive for the remainder of 2022 and which is estimated to close towards yearend 2023. In addition, these trends take into account higher inflation rate indexation, more persistent above-target inflation expectations, a quickening of domestic fuel price increases due to the correction of lags versus the parity price and higher international oil price forecasts. The forecast supposes a good domestic supply of perishable foods, although it also considers that international prices of processed foods will remain high. In terms of the goods sub-basket, the end of the national health emergency implies a reversal of the value-added tax (VAT) refund applied to health and personal hygiene products, resulting in increases in the prices of these goods. Alternatively, the monetary policy adjustment process and the moderation of external shocks would help inflation and its expectations to begin to decrease over time and resume their alignment with the target. Thus, the new projection suggests that inflation could remain high for the second half of 2022, closing at 9.7%. However, it would begin to fall during 2023, closing the year at 5.7%. These forecasts are subject to significant uncertainty, especially regarding the future behavior of external cost shocks, the degree of indexation of nominal contracts and decisions made regarding the domestic price of fuels. Economic activity continues to outperform expectations, and the technical staff’s growth projections for 2022 have been revised upwards from 5% to 6.9%. The new forecasts suggest higher output levels that would continue to exceed the economy’s productive capacity for the remainder of 2022. Economic growth during the first quarter was above that estimated in April, while economic activity indicators for the second quarter suggest that the GDP could be expected to remain high, potentially above that of the first quarter. Domestic demand is expected to maintain a positive dynamic, in particular, due to the household consumption quarterly growth, as suggested by vehicle registrations, retail sales, credit card purchases and consumer loan disbursement figures. A slowdown in the machinery and equipment imports from the levels observed in March contrasts with the positive performance of sales and housing construction licenses, which indicates an investment level similar to that registered for the first three months of the year. International trade data suggests the trade deficit would be reduced as a consequence of import levels that would be lesser than those observed in the first quarter, and stable export levels. For the remainder of the year and 2023, a deceleration in consumption is expected from the high levels seen during the first half of the year, partially as a result of lower repressed demand, tighter domestic financial conditions and household available income deterioration due to increased inflation. Investment is expected to continue its slow recovery while remaining below pre-pandemic levels. The trade deficit is expected to tighten due to projected lower domestic demand dynamics, and high prices of oil and other basic goods exported by the country. Given the above, economic growth in the second quarter of 2022 would be 11.5%, and for 2022 and 2023 an annual growth of 6.9% and 1.1% is expected, respectively. Currently, and for the remainder of 2022, the output gap would be positive and greater than that estimated in April, and prices would be affected by demand pressures. These projections continue to be affected by significant uncertainty associated with global political tensions, the expected adjustment of monetary policy in developed countries, external demand behavior, changes in country risk outlook, and the future developments in domestic fiscal policy, among others. The high inflation levels and respective expectations, which exceed the target of the world's main central banks, largely explain the observed and anticipated increase in their monetary policy interest rates. This environment has tempered the growth forecast for external demand. Disruptions in value chains, rising international food and energy prices, and expansionary monetary and fiscal policies have contributed to the rise in inflation and above-target expectations seen by several of Colombia’s main trading partners. These cost and price shocks, heightened by the effects of Russia's invasion of Ukraine, have been more prevalent than expected and have taken place within a set of output and employment recovery, variables that in some countries currently equal or exceed their projected long-term levels. In response, the U.S. Federal Reserve accelerated the pace of the benchmark interest rate increase and rapidly reduced liquidity levels in the money market. Financial market actors expect this behavior to continue and, consequently, significantly increase their expectations of the average path of the Fed's benchmark interest rate. In this setting, the U.S. dollar appreciated versus the peso in the second quarter and emerging market risk measures increased, a behavior that intensified for Colombia. Given the aforementioned, for the remainder of 2022 and 2023, the Bank's technical staff increased the forecast trajectory for the Fed's interest rate and reduced the country's external demand growth forecast. The projected oil price was revised upward over the forecast horizon, specifically due to greater supply restrictions and the interruption of hydrocarbon trade between the European Union and Russia. Global geopolitical tensions, a tightening of monetary policy in developed economies, the increase in risk perception for emerging markets and the macroeconomic imbalances in the country explain the increase in the projected trajectory of the risk premium, its trend level and the neutral real interest rate1. Uncertainty about external forecasts and their consequent impact on the country's macroeconomic scenario remains high, given the unpredictable evolution of the conflict between Russia and Ukraine, geopolitical tensions, the degree of the global economic slowdown and the effect the response to recent outbreaks of the pandemic in some Asian countries may have on the world economy. This macroeconomic scenario that includes high inflation, inflation forecasts, and expectations above 3% and a positive output gap suggests the need for a contractionary monetary policy that mitigates the risk of the persistent unanchoring of inflation expectations. In contrast to the forecasts of the April report, the increase in the risk premium trend implies a higher neutral real interest rate and a greater prevailing monetary stimulus than previously estimated. For its part, domestic demand has been more dynamic, with a higher observed and expected output level that exceeds the economy’s productive capacity. The surprising accelerations in the headline and core inflation reflect stronger and more persistent external shocks, which, in combination with the strength of aggregate demand, indexation, higher inflation expectations and exchange rate pressures, explain the upward projected inflation trajectory at levels that exceed the target over the next two years. This is corroborated by the inflation expectations of economic analysts and those derived from the public debt market, which continued to climb and currently exceed 3%. All of the above increase the risk of unanchoring inflation expectations and could generate widespread indexation processes that may push inflation away from the target for longer. This new macroeconomic scenario suggests that the interest rate adjustment should continue towards a contractionary monetary policy landscape. 1.2. Monetary policy decision Banco de la República’s Board of Directors (BDBR), at its meetings in June and July 2022, decided to continue adjusting its monetary policy. At its June meeting, the BDBR decided to increase the monetary policy rate by 150 basis points (b.p.) and its July meeting by majority vote, on a 150 b.p. increase thereof at its July meeting. Consequently, the monetary policy interest rate currently stands at 9.0% . 1 The neutral real interest rate refers to the real interest rate level that is neither stimulative nor contractionary for aggregate demand and, therefore, does not generate pressures that lead to the close of the output gap. In a small, open economy like Colombia, this rate depends on the external neutral real interest rate, medium-term components of the country risk premium, and expected depreciation. Box 1: A Weekly Indicator of Economic Activity for Colombia Juan Pablo Cote Carlos Daniel Rojas Nicol Rodriguez Box 2: Common Inflationary Trends in Colombia Carlos D. Rojas-Martínez Nicolás Martínez-Cortés Franky Juliano Galeano-Ramírez Box 3: Shock Decomposition of 2021 Forecast Errors Nicolás Moreno Arias

Banco de la República’s main objective is to preserve the purchasing power of the currency in coordination with the general economic policy that is intended to stabilize output and employment at long-term sustainable levels. Properly meeting the goal assigned to the Bank by the 1991 Constitution critically depends on preserving financial stability. This is understood to be a general condition in which the financial system assesses and manages the financial risks in a way that facilitates the economy’s performance and efficient allocation of resources while, at the same time, it is able to, on its own, absorb, dissipate, and mitigate the shocks that may arise as a result of adverse events. This Financial Stability Report meets the goal of giving Banco de la República’s diagnosis of the financial system’s and its debtors’ recent performance as well as of the main risks and vulnerabilities that could affect the stability of the Colombian economy. In this way, participants in financial markets and the public are being informed, and public debate on trends and risks affecting the system is being encouraged. The results presented here also serve the monetary authority as a basis for making decisions that will enhance financial stability in the general context of its objectives. In recent months, several positive aspects of the financial system have preserved a remarkable degree of continuity and stability: the liquidity and capital adequacy of financial institutions have remained well above the regulatory minimums at both the individual and consolidated levels, the coverage of past-due loans by loan-loss provisions remains high, and the financial markets for public and private debt and stocks have continued to function normally. At the same time, a surge in all the types of loan portfolios, a sharp downturn in the non-performing loan portfolio, and a rise in the profitability of credit institutions can be seen for the first time since the beginning of the pandemic. In line with the general recovery of the economy, the main vulnerability to the stability of the Colombian financial system identified in the previous edition—uncertainty about changes in the non-performing loans portfolio—has receded and remains on a downward trend. In this edition, the main source of vulnerability identified for financial stability in the short term is the system’s exposure to sudden changes in international financial conditions; the results presented in this Report indicate that the system is sufficiently resilient to such scenarios. In compliance with its constitutional objectives and in coordination with the financial system’s security network, Banco de la República will continue to closely monitor the outlook for financial stability at this juncture and will make the decisions necessary to ensure the proper functioning of the economy, facilitate the flow of sufficient credit and liquidity resources, and further the smooth functioning of the payment system. Leonardo Villar Gomez Governor Box 1 -Decomposition of the Net Interest Margin in Colombia and Chile Wilmar Cabrera Daniela Rodríguez-Novoa Box 2 - Spatial Analysis of New Home Prices in Bogota, Medellín, and Cali Using a Geostatistical Approach María Fernanda Meneses Camilo Eduardo Sánchez Box 3 - Interest Rate Model for the SYSMO Stress Test Exercise Wilmar Cabrera Diego Cuesta Santiago Gamba Camilo Gómez Box 4 - The Transition from LIBOR and other International Benchmark Rates Daniela X. Gualtero Briceño Javier E. Pirateque Niño

Macroeconomic summary Annual inflation continued to rise in the first quarter (8.5%) and again outpaced both market expectations and the technical staff’s projections. Inflation in major consumer price index (CPI) baskets has accelerated year-to-date, rising in March at an annual rate above 3%. Food prices (25.4%) continued to contribute most to rising inflation, mainly affected by a deterioration in external supply and rising costs of agricultural inputs. Increases in transportation prices and in some utility rates (energy and gas) can explain the acceleration in regulated items prices (8.3%). For its part, the increase in inflation excluding food and regulated items (4.5%) would be the result of shocks in supply and external costs that have been more persistent than expected, the effects of indexation, accumulated inflationary pressures from the exchange rate, and a faster-than-anticipated tightening of excess productive capacity. Within the basket excluding food and regulated items, external inflationary pressures have meaningfully impacted on goods prices (6.4%), which have been accelerating since the last quarter of 2021. Annual growth in services prices (3.8%) above the target rate is due primarily to food away from home (14.1%), which was affected by significant increases in food and utilities prices and by a rise in the legal monthly minimum wage. Housing rentals and other services prices also increased, though at rates below 3%. Forecast and expected inflation have increased and remain above the target rate, partly due to external pressures (prices and costs) that have been more persistent than projected in the January report (Graphs 1.1 and 1.2). Russia’s invasion of Ukraine accentuated inflationary pressures, particularly on international prices for certain agricultural goods and inputs, energy, and oil. The current inflation projection assumes international food prices will increase through the middle of this year, then remain high and relatively stable for the remainder of 2022. Recovery in the perishable food supply is forecast to be less dynamic than previously anticipated due to high agricultural input prices. Oil prices should begin to recede starting in the second half of the year, but from higher levels than those presented in the previous report. Given the above, higher forecast inflation could accentuate indexation effects and increase inflation expectations. The reversion of a rebate on value-added tax (VAT) applied to cleaning and hygiene products, alongside the end of Colombia’s COVID-19 health emergency, could increase the prices of those goods. The elimination of excess productive capacity on the forecast horizon, with an output gap close to zero and somewhat higher than projected in January, is another factor to consider. As a consequence, annual inflation is expected to remain at high levels through June. Inflation should then decline, though at a slower pace than projected in the previous report. The adjustment process of the monetary policy rate wouldcontribute to pushing inflation and its expectations toward the target on the forecast horizon. Year-end inflation for 2022 is expected to be around 7.1%, declining to 4.8% in 2023. Economic activity again outperformed expectations. The technical staff’s growth forecast for 2022 has been revised upward from 4.3% to 5% (Graph 1.3). Output increased more than expected in annual terms in the fourth quarter of 2021 (10.7%), driven by domestic demand that came primarily because of private consumption above pre-pandemic levels. Investment also registered a significant recovery without returning to 2019 levels and with mixed performance by component. The trade deficit increased, with significant growth in imports similar to that for exports. The economic tracking indicator (ISE) for January and February suggested that firstquarter output would be higher than previously expected and that the positive demand shock observed at the end of 2021 could be fading slower than anticipated. Imports in consumer goods, retail sales figures, real restaurant and hotel income, and credit card purchases suggest that household spending continues to be dynamic, with levels similar to those registered at the end of 2021. Project launch and housing starts figures and capital goods import data suggest that investment also continues to recover but would remain below pre-pandemic levels. Consumption growth is expected to decelerate over the year from high levels reached over the last two quarters. This would come amid tighter domestic and external financial conditions, the exhaustion of suppressed demand, and a deterioration of available household income due to increased inflation. Investment is expected to continue to recover, while the trade deficit should tighten alongside high oil and other export commodity prices. Given all of the above, first-quarter economic growth is now expected to be 7.2% (previously 5.2%) and 5.0% for 2022 as a whole (previously 4.3%). Output growth would continue to moderate in 2023 (2.9%, previously 3.1%), converging similar to long-term rates. The technical staff’s revised projections suggest that the output gap would remain at levels close to zero on the forecast horizon but be tighter than forecast in January (Graph 1.4). These estimates continue to be affected by significant uncertainty associated with geopolitical tensions, external financial conditions, Colombia’s electoral cycle, and the COVID-19 pandemic. External demand is now projected to grow at a slower pace than previously expected amid increased global inflationary pressures, high oil prices, and tighter international financial conditions than forecast in January. The Russian invasion of Ukraine and its inflationary effects on prices for oil and certain agricultural goods and inputs accentuated existing global inflationary pressures originating in supply restrictions and increased international costs. A decline in the supply of Russian oil, low inventory levels, and continued production limits on behalf of the Organization of Petroleum Exporting Countries and its allies (OPEC+) can explain increased projected oil prices for 2022 (USD 100.8/barrel, previously USD 75.3) and 2023 (USD 86.8/barrel, previously USD 71.2). The forecast trajectory for the U.S. Federal Reserve (Fed) interest rate has increased for this and next year to reflect higher real and expected inflation and positive performance in the labormarket and economic activity. The normalization of monetary policy in various developed and emerging market economies, more persistent supply and cost shocks, and outbreaks of COVID-19 in some Asian countries contributed to a reduction in the average growth outlook for Colombia’s trade partners for 2022 (2.8%, previously 3.3%) and 2023 (2.4%, previously 2.6%). In this context, the projected path for Colombia’s risk premium increased, partly due to increased geopolitical global tensions, less expansionary monetary policy in the United States, an increase in perceived risk for emerging markets, and domestic factors such as accumulated macroeconomic imbalances and political uncertainty. Given all the above, external financial conditions are tighter than projected in January report. External forecasts and their impact on Colombia’s macroeconomic scenario continue to be affected by considerable uncertainty, given the unpredictability of both the conflict between Russia and Ukraine and the pandemic. The current macroeconomic scenario, characterized by high real inflation levels, forecast and expected inflation above 3%, and an output gap close to zero, suggests an increased risk of inflation expectations becoming unanchored. This scenario offers very limited space for expansionary monetary policy. Domestic demand has been more dynamic than projected in the January report and excess productive capacity would have tightened more quickly than anticipated. Headline and core inflation rose above expectations, reflecting more persistent and important external shocks on supply and costs. The Russian invasion of Ukraine accentuated supply restrictions and pressures on international costs. This partly explains the increase in the inflation forecast trajectory to levels above the target in the next two years. Inflation expectations increased again and are above 3%. All of this increased the risk of inflation expectations becoming unanchored and could generate indexation effects that move inflation still further from the target rate. This macroeconomic context also implies reduced space for expansionary monetary policy. 1.2 Monetary policy decision Banco de la República’s board of directors (BDBR) continues to adjust its monetary policy. In its meetings both in March and April of 2022, it decided by majority to increase the monetary policy rate by 100 basis points, bringing it to 6.0% (Graph 1.5).