Macroprudential Policy and Financial Stability: Where Do We Stand?

Abstract

Changing political and social priorities since the 2016 presidential election have strengthened efforts to reshape parts of the post-crisis macroprudential framework and to write new rules according to the administration’s “core principles. These include the fostering of U.S. economic growth, the prevention of taxpayer-funded bailouts, streamlined regulations, and public accountability of federal regulatory agencies. Basel III, Dodd-Frank, and other legislative and regulatory initiatives have significantly changed the financial ecosystem. Banks (and insurance companies) have been pressured to reduce their complexity, leverage, and riskier lines of business to decrease the chances of another financial crisis. Nonbank financial intermediaries have stepped in to fill the vacuum, and alternative financial instruments have helped to rearrange intermediation needs across different actors. Market-making activities are subject to new transparency requirements, ensuring that more financial products will be traded through exchanges, instead of over the counter. The evolving relationship between financial regulation and financial activity has also led to unanticipated consequences and reactions from market participants. From these, it is evident that further refinements to the Dodd-Frank Act, which includes the Volcker Rule, are necessary to ensure overall financial stability and not just stability within the regulatory perimeters. In this rapidly changing environment, financial market research has become overly technical and often myopically focused on refining operational procedures while the political debate on financial reforms is increasingly polarized. The Milken Institute works to facilitate a continuing dialogue among key stakeholders in this arena and to improve the established reforms, as well as those under proposal. Over the past year, the institute’s international finance and macroeconomics team held roundtables and discussions with regulators and market participants. It also published nonpartisan and data-driven research to evaluate the efficacy of the intended effects of financial reforms and point out some of their unintended consequences. Section I of this publication offers a synopsis of those discussions and summaries of five papers produced over the same period. Sections II, III, and IV comprise those papers, which highlight the impact of the current regulations, the influence of the asset management industry on financial stability, and how the strengthened role of central counterparty clearinghouses in the derivatives market affects the resilience of the financial system. Looking forward, we will continue to evaluate policy changes and study the macro-financial linkages that influence behavior in the banking industry, capital markets, and corporate finance. We will evaluate potential changes in policies that can promote more productive crossborder capital flows and broader access to capital worldwide. Our overarching objective is to encourage policies that improve the functioning of the financial system while balancing the goals of improving financial stability and fostering economic growth.