Macroprudential Authorities Research Articles

Leveraging data for financial stability monitoring

Financial regulators and supervisors have increased their demands for data from the private sector since the recent financial crisis, at times straining resources and challenging regulatory reporting practices that were historically designed for specific purposes. There is a growing consensus that these data should be considered assets that should be actively managed, illustrated by the increasing employment of Chief Data Officers and the creation of macroprudential authorities focused on analyzing threats to financial stability. Thus, a more holistic approach is needed to classify, collect and analyze data. This article describes how data and information standards, along with the use of newer technologies, can help improve the quality of data and make data more useful to firms and regulators, and allow for financial stability monitoring, without imposing undue burden on financial institutions.

Risk management through the lens of macroprudential policy

Before the beginning of the crisis in 2007–8, regulation failed to cope with the complexities of modern finance and paid insufficient attention to systemic risk. Similarly, risk managers in financial institutions tended to focus on risks in their financial institutions, neglecting systemic risk. Regulators worldwide are now addressing these deficiencies. One important dimension of regulatory reform is the creation of macroprudential authorities, such as the European Systemic Risk Board (ESRB), specifically tasked to focus on systemic risk. To address such risks, the ESRB has issued recommendations that will influence the behaviour of financial institutions. Work is ongoing to develop fully fledged macroprudential policies, which in combination with other regulation will help prevent or mitigate future crises.

The Macro-Prudential Authority

Neither the achievement of price stability, via the Monetary Policy Committee (MPC), nor the application of micro-prudential oversight, via the Financial Services Authority (FSA), led to overall financial stability. There is a gap that needs to be filled by a macro-prudential authority (M-PA), the Financial Policy Committee (FPC) in the United Kingdom. The only macro-prudential instrument used heretofore has been the publication of Financial Stability Reviews (FSR). While worthy, these have been ineffective. The M-PA should have the following powers: First, the power to alter the composition of Central Bank (CB) assets, by adding to (subtracting from) its holdings of claims on the private sector. The argument that such actions are ‘quasi-fiscal’, and should therefore not be undertaken, is not supported. Second, the power to adjust margins (Capital adequacy ratios, liquidity ratios, loan-to-value ratios, etc.) to influence the conduct of financial intermediation. The argument that the use of such powers puts the FPC in a difficult conflict with the Monetary Policy Committee (MPC) is not supported...

Central Bank Involvement in Macro-Prudential Oversight

This working paper addresses the institutional arrangements for the performance of macro-prudential oversight of the financial system in the European Union with focus on the functions of the central banks. The first section of the paper outlines the evolution of the EU’s supervisory arrangements which led to the establishment of the European Systemic Risk Board (ESRB) as the body responsible for EU macro-prudential oversight. This section also describes the ESRB’s institutional links to the European System of Central Banks (ESCB), which comprises the European Central Bank (ECB) and the national central banks (NCBs) of the EU Member States. In the second section, the paper describes the supporting role played by the ECB and the NCBs in the performance of the ESRB’s functions. Such support is provided at each stage of the macro-prudential oversight process, which comprises: (i) risk surveillance by the collection of market data; (ii) risk identification and evaluation by analytical reviews of the information collected; and (iii) risk mitigation by actions such as issuing risk warnings and recommendations. In the third section, the paper’s analysis of the institutional arrangements at the EU level is complemented by a review of the main current models for cooperation at the national level between national macro-prudential authorities and their respective NCBs. In conclusion, the paper points to the need to establish robust legal safeguards to ensure the effectiveness of central bank involvement in the performance of macro-prudential oversight of the financial system, including establishing reliable data collection channels and respect for central bank independence.

Monetary and Macroprudential Policies

We use a dynamic general equilibrium model featuring a banking sector to assess the interaction between a countercyclical macroprudential policy and monetary policy. We find that in “normal” times (when the economic cycle is mainly driven by supply shocks) macroprudential policy generates only modest benefits relative to a “monetary policy-only” world. In fact, without strong coordination with monetary policy, situations of conflict between the two policies can arise, in which macroprudential policy becomes pro-cyclical and monetary policy strongly countercyclical. The benefits of introducing a macroprudential policy become sizeable when the economy is hit by financial or housing market shocks, that severely affect the supply of loans. In these cases, a cooperative central bank “lends a hand” to the macroprudential authority, taking care of broader objectives than price stability in order to improve the overall stability of the economy.

Macroprudential Policy - Taxonomy and Challenges

There is increasing recognition that prior to the global financial crisis financial regulation had lacked a macroprudential perspective. There has since been a strong effort to make a new macroprudential orientation operational, including through the establishment of new macroprudential authorities or ‘committees’ in a number of jurisdictions. These developments raise — and this paper explores — the following three questions. First, what distinguishes macroprudential policy from microprudential policy and what are its key tasks? Second, what powers should be given to macroprudential authorities and what should be their mandate? Third, how can governance arrangements ensure that macroprudential policies are pursued effectively? While arrangements for macroprudential policy will to some extent be country-specific, we identify three basic challenges in setting up an effective macroprudential policy framework and discuss options to address them.

Warding Off Financial Market Failure: How to Avoid Squeezed Margins and Bad Haircuts

Regulators aiming to ward off the next financial market failure need to implement rules to smooth the boom-bust cycle in margin requirements and haircuts used in securities financing and derivative transactions, which seriously exacerbated the last financial crisis. In this study, the author argues that key elements in a system-wide regulatory framework should include rules to mitigate swings between loose terms for margins and haircuts in boom times, and tightened terms during busts. Longworth emphasizes through-the-cycle haircuts and initial margins, the potential use of add-ons to haircuts and margins by macroprudential authorities, and market practices that are less procyclical than they were before and during the crisis.

Shadow Banking in the Euro Area: An Overview

Shadow banking, as one of the main sources of financial stability concerns, is the subject of much international debate. In broad terms, shadow banking refers to activities related to credit intermediation and liquidity and maturity transformation that take place outside the regulated banking system. This paper presents a fi rst investigation of the size and the structure of shadow banking within the euro area, using the statistical data sources available to the ECB/Eurosystem. Although overall shadow banking activity in the euro area is smaller than in the United States, it is significant, at least in some euro area countries. This is also broadly true for some of the components of shadow banking, particularly securitisation activity, money market funds and the repo markets. This paper also addresses the interconnection between the regulated and the non-bank-regulated segments of the financial sector. Over the recent past, this interconnection has increased, likely resulting in a higher risk of contagion across sectors and countries. Euro area banks now rely more on funding from the financial sector than in the past, in particular from other financial intermediaries (OFIs), which cover shadow banking entities, including securitisation vehicles. This source of funding is mainly shortterm and therefore more susceptible to runs and to the drying-up of liquidity. This finding confirms that macro-prudential authorities and supervisors should carefully monitor the growing interlinkages between the regulated banking sector and the shadow banking system. However, an in-depth assessment of the activities of shadow banking and of the interconnection with the regulated banking system would require further improvements in the availability of data and other sources of information.

Asset-Price Boom-Bust Cycles and Credit: What is the Scope of Macro-Prudential Regulation?

Over the recent months, several initiatives have taken place to develop macro-prudential regulation in order to prevent systemic risk and the built-up of financial imbalances. Crucial to the success of such policy is the ability of the macro-prudential authority to identify in due time such imbalances, generally featured by asset-price boom-bust cycles. In this paper, we investigate the possibility of detecting asset-price booms according to alternative identification strategies and assess their robustness. We infer the probability that an asset-price boom turns into an asset-price bust. In addition, we try to disentangle costless or low-cost from asset-price booms. We find some evidence that house price booms are more likely to turn into recession than stock price booms. Resorting both to a non-parametric approach and a discrete-choice (logit) model, we analyze the ability of a set of indicators to robustly explain asset-price booms. According to our results, real long-term interest rates, total investment, real credit and real stock prices tend to increase the probability of a housing-price boom, whereas real GDP and house prices tend to increase the probability of a stock-price boom. Regarding the latter, credit variables tend to play a less convincing role. From this perspective, we specify the scope of macro-prudential regulation as a set of tools aiming at avoiding costly asset-price booms. In doing so, we try both to make the case for state-contingent macro-prudential regulations and to set out clear delineation between monetary and financial stability objectives.