Measuring Financial Stability in Curaçao and Sint Maarten

Abstract Assessing the solidity of the financial system may be cumbersome since there is no single comprehensive indicator to measure financial stability. This paper presents two aggregate measures that can be deployed as early warning measures of financial stability for the monetary union of Curaçao and Sint Maarten, mainly focusing on the banking sector. As this sector comprises most of the monetary union's assets, the constructed measures are mainly focused on this sector. Following financial stability literature, we apply empirical normalization and aggregation to construct an Aggregate Financial Stability Index (AFSI) and a Banking Stability Index (BSI). These indices have been gaining popularity among central banks to assess financial stability on top of conventional measures such as Financial Soundness Indicators (FSIs) and credit cycles. The AFSI comprises banking-sector indicators, macro-financial developments, and international trends, while the BSI captures dimensions of banks' financial soundness. We benchmark the AFSI and the BSI to the period of deteriorating macro-financial conditions induced by the coronavirus crisis, and the development in the indices was as expected. Based on the robustness analyses conducted, we deem the constructed indices plausible for measuring and tracking financial stability within the monetary union of Curaçao and Sint Maarten. JEL classification numbers: C20, C45, E58, F15, G21. Keywords: Early warning indicators, Financial stability, Financial soundness indicators.