Macroprudential Regulation Research Articles

Cheap but flighty: A theory of safety-seeking capital flows

We offer a model of financial intermediaries as safe-asset providers in an international context. Investors from countries exposed to expropriation risk seek to invest in safe-haven countries in order to satisfy a demand for safety. Intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While these safety-seeking inflows allow developed countries to lower their funding cost and expand investment, risk-intolerant investors achieve safety by withdrawing even under minimal residual risk. As a result, safety-seeking inflows into developed countries not only reallocate but also create risk. Early liquidation inefficiently diverts scarce resources from productive uses, so a domestic planner wishes to contain the scale of safety-seeking inflows. A macroprudential regulator imposes a Pigouvian tax on safety-seeking inflows.

Risk-taking Channel of Bank Liquidity Creation Affecting Real Economy: Recommendation to tobacc industry

Objection: We investigate whether risk-taking channel exsits in the interaction of monetary policy, macroprudential regulation, liquidity creation and enterprise output. Methods: We adopt the mediating effect model with stepwise regression, Sobel and Bootstrap test to identify risk-taking mechanism of liquidity creation impact on real economy. Results: We find that pricing tools of monetary policy and macroprudential tools can inhibit the changes of risk-taking and liquidity creation caused by quantitative tools. In particular, the increasing systemic risk arises the off-balance-sheet liquidity creation. Consequently, risk-taking is an important channel for regulating affect liquidity creation. We also find that liquidity creation can increase business income through credit line. Conclusions: Reducing the internal conflict between monetary policy and macroprudential regulation and improving the banks’ soundness is beneficial to liquidity creation, further stimulating the sustainable development of enterprises. In particularly, bank should innovate credit products, for example tobacco loan in Yunnan or Gui Zhou, to support of regional economic growth.

Macroprudential Policy Interlinkages

Emerging markets are concerned about sudden stops in international capital flows, which may lead to severe recessions associated with vicious spirals of currency depreciations and tightening borrowing constraints. A common prescription is to impose macroprudential policies, including prudential capital controls, to limit international borrowing especially in foreign currency. This paper analyzes the supportive role of macroprudential policies geared toward the domestic financial market, suggesting that emerging markets should resort to a wide mix of policies, even when the domestic financial market is frictionless. A simple formula provides further insights: domestic and international macroprudential policies are imperfect complements rather than substitutes, due to distinctive characteristics of foreign and domestic currency bonds. Furthermore, the relative importance of domestic macroprudential regulation increases in the return of domestic bonds.

FINANCIAL AND LEGAL ASPECTS OF ECONOMIC SECURITY OF THE STATE

Abstract. The problem of elaborating the comprehensive state policy on regulatory and legal provision of the financial security at all levels of economy is significantly important for Ukraine. It is crucial to ensure development and implementation of the legislative framework that would determine the types of internal and external threats to the stability of financial activity and the means of counteracting these threats; the full power and responsibility of state authorities concerning the financial and legal regulation aimed at warranting order in financial sphere; the mechanism of financial control organization as the means of preventing financial offences. The aim of the research is to outline the essence of new threats to the economic and financial security of the state under modern economic conditions and search for the required mechanisms and means of regulatory and legal provisioning of the financial security of Ukraine. In the course of research, the general scientific and theoretical methods have been applied. These include systemic analysis (for defining the object and the subject of research); abstract and logical method (for preparing the scientifically justified generalizations and conclusions about the essence, the mechanism of provisioning financial security of the state, and the factors that designate it); graphic method (for representing visually the mechanism of ensuring financial security of the state). The article introduces improvements to the list of modern internal and external threats to the financial and economic security of the state with respect to the immanent nature of the World Band and the International Monetary Fund. It has been emphasized that the new list of indicators and sources of initial information about the constituent components of financial security should be developed and approved because the current list was outlined in the end of 2013 and does not take into account modern realia. It is necessary to determine the functions of the Ministry of Economy of Ukraine in the realm of monitoring and regulating financial stability of the state, particularly in the real economy sector. It has been specified that scientific development of the range of problems related to the methodology and legal regulation of the state security provisioning, as well as the means and methods of preventing and mitigating the threats, is tightly connected with the development of macroprudential supervision and regulation under the aegis of the National Bank of Ukraine. The introduction of new indicators by the Bank (such as the level of non-performing loans, the financial stress index, and others) is the positive step. Nonetheless, the large quantity of private indicators interferes the process of elaborating the set of measures for financial and legal regulation of the financial security level. The new methodological approach to development of the integrated indicator of financial stability at the macro level has been suggested. The research results enable the possibility of improving the mechanism of state financial security and justifying the set of measures for its reinforcement. The review and improvement of the current legal framework in the area of financial and regulatory economic security, and development of the new integrated indicator of financial security level are necessary. Keywords: financial security; internal and external threats; legal mechanism of security provision, macroprudential regulation. JEL Classіfіcatіon: О12, Е59 Formulas: 0; fig.: 2; tabl.: 1; bibl.: 16.

On the Construction of a Leading Indicator Based on News Headlines for Predicting Greek Deposit Outflows

Employing data in a monthly frequency, with a sample period spanning from 2002 to 2018, the purpose of this study is twofold. First, we construct a novel leading indicator based on news headlines drawn from Bloomberg, and second, examine whether this leading indicator able to capture agents’ sentiment affects Greek bank deposit flows’ trajectory. Employing alternative econometric methodologies, we find that this index proxies for depositors’ crisis sentiment and the higher this index becomes, the higher the depositors’ negative sentiment becomes, leading them to withdraw their bank deposits. Overall, in this work, we show that the last decade’s advances in internet technology, which permit us to have direct access to a vast amount of information such as news headlines, offers the possibility of forecasting critical measures in the economy’s banking system, such as the number of bank deposits, which are of crucial importance. Monetary poly authorities or macroprudential regulators could adapt our model to assess the resilience of a bank or the whole banking sector.

Macroprudential regulations and systemic risk: Does the one-size-fits-all approach work?

This study empirically investigates whether systemic risk varies among countries with different income levels in response to macroprudential policy instruments (MPIs). The results suggest a negative association between overall MPIs and systemic risk using a sample of 68 countries covering the period between 2000 and 2017. However, not all instruments show intended stability benefits, especially for low and lower-middle-income economies. A comparative analysis reveals that upper-middle-income and high-income countries do receive stability benefits from MPIs. However, low and lower-middle-income economies show unintended instability costs in connection with MPIs, suggesting that a one-size-fits-all approach to macroprudential regulations is not beneficial. Low and lower-middle-income countries should carefully ascertain the choice, implementation, and monitoring of macroprudential policies.

Do bank regulations matter for financial stability? Evidence from a developing economy

PurposeThis paper aims to establish the effect of bank regulations on financial stability in Kenya. Specifically, the study seeks to uncover the effect of micro and macro prudential regulations on financial stability and their trade-offs or complementarities.Design/methodology/approachUsing annual time series data over the period 1990–2017, the study uses structural equation model (SEM) estimation technique. This solves the problem of approximating measurement errors, using both latent constructs and indicator constructs.FindingsStudy findings reveal that macro and micro prudential regulations are significant drivers of financial stability. Further, prudential regulations are more effective when they complement each other.Research limitations/implicationsThis study centers on how bank regulations affect financial stability. Future research could be carried out on the effect of Non-Bank Financial Institutions regulations on financial system stability.Practical implicationsComplementing macro and micro prudential regulation is more effective and efficient in ensuring stability of the financial system other than letting the two policy objectives operate independently.Social implicationsRegulatory authorities should introduce prudential regulations that would encourage innovations in the banking sector. This ensures easy deposit mobilization that enhances financial inclusion. Prudential regulations that ensure financial stability will be effective when low income earners are included in the financial system.Originality/valueTo the best of the authors’ knowledge, this study is the first to investigate the role of banking regulations on financial stability. This study is also pioneering in the use of SEM estimation technique, in examining how prudential regulations affect financial stability. Previous cross-country studies have focused on macro prudential regulations ignoring the importance of micro prudential regulations.

International financial positions and macroprudential policy

The increasing financial integration in the Euro Area brings numerous advantages for the national and worldwide economies. However, it also entails the risk of fast crisis contagion and widespread economic and financial destabilization. Thus, there is an important role for macroprudential policy in this context, to ensure a sustainable and stable financial integration. But the economic and financial stabilization properties and spillovers of macroprudential regulation vary across borders. Using a two-country new Keynesian model for a monetary union I find that the international financial positions of the economies might determine the macroprudential policy effects after a symmetric financial shock.

How does the interaction of macroprudential and monetary policies affect cross-border bank lending?

We combine a rarely accessed BIS database on cross-border lending flows with cross-country data on macroprudential regulations. We find significant interactions between the monetary policy of major international currency issuers (USD, EUR and JPY) and macroprudential policies in source (home) lending banking systems. Consistent with the bank lending channel, macroprudential easing in a home country amplifies the effect of currency issuers' monetary policy on lending. For instance, UK macroprudential easing amplifies the negative impact of US monetary policy tightening on USD-denominated cross-border bank lending outflows from UK banks. Vice versa, tighter macroprudential policy mitigates these effects.

Impact of income diversification strategy on credit risk and market risk among microfinance institutions

PurposeThis study explores the effect of income diversification strategy on credit risk and market risk of microfinance institutions (MFIs) in Ghana as an emerging market.Design/methodology/approachThe study is based on quarterly data of averagely 271 MFIs that have operated from 2016 to 2018. The dataset is unbalanced and pooled cross-sectional with 3,259 data points. The study measures the diversification strategy using income diversification indices, and accounting ratios to measure the other variables. We utilised the weighted least squares (WLS) approach to explore the nexus.FindingsThe findings show that income diversification is associated with better loan quality and credit risk management. Market risk increases with the level of income diversification of microfinance firms. It is evident that large MFIs can manage their credit risks well and can have a low default rate, depicting an overall U-shaped nexus. On the other hand, the effect of size on market risk is an inverted U-shaped. The effect of asset tangibility on credit risk is positively significant while the effect on market risk is negatively significant. High profitability enhances credit risk management leading to lower loan losses while in the case of diversified and profitable MFIs, they tend to invest more in government securities. The results suggest that MFIs that hold more cash and cash equivalents tend to have high loan loss provision and more government securities suggesting much attention should be paid to optimal cash management.Practical implicationsThe results throw light on the credit risk and market risk profile of the firms and the effect of diversification strategies on them. The findings are relevant for effective macroprudential regulation, market regulation and prudential regulation of the microfinance sector.Social implicationsThe findings reveal the nature of income diversification strategy of MFIs in emerging markets such as Ghana, pointing out how they affect the risk exposure of MFIs that lend to the pro-poor population.Originality/valueThis is a premier formal assessment of the nexus between income diversification strategies and risk management among MFIs that serve the pro-poor population in the emerging market context.

Macroprudential regulation in the post-crisis era: Has the pendulum swung too far?

This paper presents an institutional model to investigate the cooperation between a government and a central bank. The former selects the monetary policy and then delegates the organization of macroprudential policy to the latter. Their policy stances are the result of sequential constrained utility maximization. Using indirect inference, we find a set of coefficients that can capture the UK policy stances for 1993–2016. This suggests post-crisis regulation has been overly intrusive. Finally, we show that this regulatory dilemma can be avoided by committing to a highly stabilizing monetary regime that uses QE extensively.

Credit access, macroprudential rules and policy interventions: Lessons for potential first time buyers

Given the increased popularity of macroprudential measures in the aftermath of the great financial crisis (GFC), a key policy question to arise in certain mortgage markets is whether a significant access to credit issue exists amongst prospective homeowners because of these new policies. In this paper we assess whether such a problem arises in the context of the Irish mortgage market – a market particularly adversely impacted by the GFC. We use a microsimulation model to estimate the level of latent credit demand that could be serviced by the market given prudent credit risk assessment and the current macroprudential regulations. We then compare this demand to current market provision to explore whether a credit gap exists. Finally, we simulate how a public mortgage credit scheme or equity “help-to-buy” type instrument may help credit access. We find both instruments to be effective but would lead to somewhat higher house prices.

Attenuating international financial shocks: the role of capital controls

PurposeBy reinforcing monetary policy independence, reducing international financing pressures and avoiding high-risk takings, capital controls strengthen the stability of the financial system and then reduce the volatility of capital inflows. The objective of this study was to conduct an empirical examination of this hypothesis. This topic has received strong support in the theoretical literature; however, empirical work has been quite limited, with few empirical studies that provide direct empirical support to this hypothesis.Design/methodology/approachThis study analyzed quarterly data of 32 emerging economies over the period between 2000 and 2015 and proposes two methods to identify capital control actions. Using panel analysis, Autoregressive Distributed Lag and local projections approaches.FindingsThis study found that tighter capital controls may diminish monetary and exchange rate shocks and reduce capital inflows volatility. Furthermore, capital controls respond counter-cyclically to monetary shocks. Under capital controls, countries with floating exchange rate regimes have more potential to buffer monetary shocks. We also found that capital controls on inflows are more effective for reducing the volatility of capital inflows compared to capital controls on outflows.Originality/valueThis study contributes to the question of the effectiveness of capital controls in attenuating the effects of international shocks and reducing the volatility of capital flows. Previous studies have mostly focused on the role of macroprudential regulation; however, there is a lack of systematic effects of capital controls on monetary and exchange rate policies. To our knowledge, this is the first preliminary study to suggest that capital controls may buffer monetary and exchange rate shocks and reduce the volatility of capital inflows. This study investigates the novel notion that capital controls allow for a notable counter-cyclical response of monetary and exchange rate policies to international financial shocks.

Foreign Currency Intermediation: Systemic Risk and Macroprudential Regulation

Despite the progress made on the empirical front, normative analyses are still lacking when it comes to foreign currency intermediation (partial dollarization of the domestic banking system) and the ways to address its systemic risks implications. In this paper, we make a comprehensive analysis of the liquidity and the foreign exchange (FX) systemic risks implied by foreign currency intermediation. We explain the trade-off between the positive effect of foreign currency intermediation on growth in tranquil times and its negative effect in terms of financial fragility. We review the narrative and econometric country studies that have been done so far to assess the effectiveness of FX-related macroprudential measures. Through the results of past studies and a comparison of the experiences of Latin American and transition European economies, we show the advantages of administrative macroprudential measures over price-related measures in dealing with liquidity and FX systemic risks. We show that neutralizing those systemic risks is possible without aiming at directly limiting or banning foreign currency intermediation (i.e., dedollarizing). We argue that dedollarization is a more ambitious target that must be justified by the other inconveniences of foreign currency intermediation, and we stress that sound monetary management should be a prerequisite to dedollarization.

Capital account liberalization and the composition of bank liabilities

Using a sample of almost 600 banks in Latin America, we show that capital account liberalization lowers the share of equity and raises the share of interbank funding in total liabilities of the banking system. These shifts are mostly due to large banks; smaller banks, instead, increase their resort to retail funding by offering higher average deposit interest rates than larger banks. We also find significant differences in the behavior of banks with seemingly greater information opacity. These findings have positive implications for macro-prudential regulation.

Overcoming the loan-to-deposit ratio by a financial intermediation measure — A perspective instrument of financial stability policy

In cognizance of the role that the traditional loan-to-deposit (LTD) ratio fulfils for financial stability policy, the paper proposes extending this metric of liquidity and funding towards measuring attainment in financial intermediation. The proposed metric, financial intermediation measure (FIM), is a normative indicator and amends the descriptive nature of the LTD ratio, and is thus more suited to the needs of macroprudential regulation of financial systems. The metric is grounded in ideas of data envelopment analysis and is developed in conjunction with a data set on structural indicators provided by the World Bank. The FIM focuses upon the banking part of financial intermediation and measures whether a financial system is successful in transforming (bank) deposits into loans subject to feasibility restrictions applied to both the banking and securities markets. Utilization of the FIM is demonstrated for 48 financial systems of the world using data from 1993 to 2016 under different classifications applied to financial systems. The demonstration shows that the FIM is useful also for performance assessments of market-based financial systems without distinction.

Can “Concerted” Macroprudential Policies Mitigate Cross‐border Contagion of Financial Risks? Evidence from China and Its Financially Connected Economies

AbstractWe construct a connected network between China and the economies that are financially linked to it, based on the network topology of variance decompositions, and measure the cross‐border contagion of financial risks among these economies. We then examine whether the concerted use of macroprudential policies mitigates the cross‐border contagion of financial risks. The empirical results show that the tightening of macroprudential policies, especially counter‐cyclical capital buffers and limits on credit growth, in economies with net spillover risk (e.g. the US and China), can reduce the cross‐border spillover of domestic financial risks to other economies. The concerted use of macroprudential policies can contribute to global financial stability. However, the tightening of “capital” macroprudential policy tools will increase domestic cross‐border absorption of financial risks. Hence, macroprudential regulation of cross‐border capital flows must be strengthened.

Does governance quality enhance the efficacy of macroprudential policy?

This paper explores the role of governance quality (GQ) in assisting macroprudential regulations (MPRs) to minimize the financial risk (FR). We collect data of 124 countries over 2000–2017 years and estimate the joint-impact of GQ and MPRs applying advanced econometric methods that deal with the endogeneity and ensure the robustness. Our results confirm that the role of GQ in MPRs–FR interaction depends on the nature of MPR instruments. These findings are critical for devising policies to preserve financial stability (FS).

The International Aspects of Macroprudential Policy

Countries are making more active use of macroprudential tools than in the past with the goal of improving the resilience of their broader financial systems. A growing body of evidence suggests that these tools can accomplish specific domestic goals and should reduce a country's vulnerability to many domestic and international shocks. The evidence also suggests, however, that these policies are not an elixir. They will not insulate economies from volatility, and they generate leakages to the nonbank financial system and spillovers through international borrowing, lending, and other cross-border exposures. Some of these unintended consequences can mitigate the effectiveness of macroprudential policies and generate new vulnerabilities and risks. The COVID-19 crisis provides a lens to evaluate the effectiveness of current macroprudential regulations during a period of extreme market volatility and economic stress. The experience to date suggests that macroprudential tools provide some benefits and should remain a focus of macroeconomic policy, but with realistic expectations about what they can accomplish.

The Strategic Response of Banks to Macroprudential Policies: Evidence from Mortgage Stress Tests in Canada*

Abstract Following the crisis, macroprudential regulations targeting mortgage-market vulnerabilities were widely adopted, their success often relying on the response of financial intermediaries. We provide evidence from Canada suggesting banks may have behaved strategically to limit the effectiveness of recently implemented mortgage stress tests. Before implementation, borrowers had to prove they could make mortgage payments based on the interest rate specified in the contract. The new tests require borrowers to show they can afford payments based on a typically higher qualifying rate, derived from the mode of 5-year rates posted by the six largest banks. The government’s objective was to cool credit markets, but, since many mortgages are government-insured, the big banks’ interests were not aligned. We find evidence of rate manipulation using a difference-in-differences approach comparing changes in spreads for 5-year mortgages with 3-year spreads, unaffected by the policy. The qualifying rates were lowered encouraging continued borrowing, muting the tests’ impact.