Microprudential Policy Research Articles

The Political Economy of Macroprudential Policy

In response to the lessons of the global financial crisis, macroprudential policy is now firmly established as a financial policy area to prevent excessive risk taking in the financial sector and mitigate its effects on the real economy. However, macroprudential policy is facing several challenges relating to its political sensitivity and institutional context. These include political and interest group resistance, weaknesses in the governance framework, and limited institutional memory among policy makers. This article seeks to contribute to the contextual understanding of macroprudential policy by exploring how factors relating to these challenges influence policy in the EU. More specifically, it develops and empirically tests a number of hypotheses on how wider institutional and structural factors influence the actual use of macroprudential measures across Europe. The findings yield considerable support for theoretical predictions that institutions and contexts matter - Political pressure and interest group resistance tend to influence the intensity of macroprudential policy stances. Weaker policy stances characterise countries where banking systems depend on domestic banks, whereas the opposite holds for financial systems with significant market shares of other financial intermediaries. Results on institutional arrangements show that governance arrangements on relating to transparency influence policy stances. The results also indicate that policy makers' inertia is best counteracted by appointing a single macroprudential authority. The results differ somewhat depending on whether countries are based in the Euro zone or not. This suggests that policy frameworks that are multi-layered and complex pose tricky conundrums on how to ensure sufficient institutional autonomy, policy capacity and discretion among macroprudential authorities. This also has implications on other policy areas macroprudential policy, such as microprudential policy, crisis management and fiscal policy.

The Study on the Development of the Financial Sector Early Warning System

This study tries to build the financial early warning system (EWS) of the individual financial sector such as banks, securities and savings-loans banks by applying the non-parametric signal approach and to establish a new composite EWS. The empirical results show that the financial sector’s EWSs appeared to identify the financial sector’s crisis timely and the new composite EWS seemed to be very similar with the existing EWS. This study suggests that the financial sector EWS is useful for conducting the microprudential policy based on the financial sector’s characteristics and relating to the implementation of the macroprudential policy for financial stability.

Approaches to Macrofinancial Surveillance in Article IV Reports

The Fund has made good progress over the past two years in integrating macrofinancial analysis into Article IV surveillance for a wide range of members. Building on past work to enhance financial sector analysis, Fund staff has sought to develop a consistent and forward-looking view on how the financial sector affects each member’s economic outlook with the aim of strengthening staff’s capacity to provide advice on macro-critical questions. The focus has been on developing a fuller understanding of macrofinancial linkages, and applying this analysis to inform policy advice. Staff has sought to articulate the role of the financial sector in the macroeconomic baseline, and to integrate the financial sector into the risk assessment, taking into account both the impact of macro shocks on the financial sector as well as the effect of financial shocks on macroeconomic stability. Strengthening the analytical foundations of this work has helped staff provide advice in all policy areas, including financial sector policies. Staff has tailored macrofinancial analysis to the circumstances of a diverse set of economies. Area departments have taken the lead in selecting 66 economies for enhanced macrofinancial coverage and in identifying topics, drawing on targeted support from functional departments. The choice of coverage has included legacies from the global financial crisis—such as deleveraging and stretched balance sheets in advanced economies and some emerging markets—and more recent challenges such as commodity price shocks, especially in low income countries, and the risks of housing booms. The financial sector’s contribution to growth and inclusion has become an important question in countries across all income groups. Staff sees benefits in mainstreaming this approach across the membership, while continuing to address analytical gaps and adapting to new challenges. The work of the past two years has underscored the criticality of macrofinancial analysis for a diverse range of members, and laid the basis for progressively mainstreaming macrofinancial surveillance across the membership. Building on this progress, staff sees scope for the Fund to deepen its understanding of the macroeconomic effects of financial shocks, to better adapt microprudential and macroprudential policy advice with an assessment of macro-critical risks including systemic risk, and to deepen the analysis of outward spillovers. Staff will also need to continue to adapt the focus of analysis and tools, and seek relevant data, as economic challenges evolve.

Ethical Perspective of the Financial Sector

In recent years misconduct issues have often arisen across markets and systematically important banks. As a result, there has been a notorious and exacerbated crisis of public confidence in the financial sector. It causes customers of financial services to be deterred from using the system and thus compounding the problem of stability even further. Hence, policymakers and supervisors are called upon re-thinking priorities when regulating financial business, turning to areas such as culture, conduct, integrity, and ethics, as means to guarantee the integrity of the entire financial industry. Traditionally, it has been argued that the key element to rule conduct in the financial sector is the coordination between macro and micro prudential policies, aiming at restoring public confidence and protecting market stability. The proposition is that today’s micro-prudential regulation, which is focused on individual institutions and instruments, must be strengthened and supplemented by macro-prudential regulation of the financial system. The reason is that macro-prudential regulation recognises the risks to the entire financial system, and seeks to fix the mismatch between risk-taking and risk capacity within firms, specially the highly interconnected firms. This paper proposes that such integration between macro and micro-prudential policies is complemented by means of designing and implementing a coherent risk-based approach to regulation and supervision that lies on three areas: i. comprehends the multiple dimensions of conduct risk and how it is perceived by regulators and regulated firms and individuals, ii. considers the psychological elements of the decision making process, and how human judgements about risks are affected by external factors, and iii. the two previous elements contribute to build a concept of “conduct risk” and how it could be better managed by prioritising conduct of business rules, as one of the pillars of the risk-based approach to regulation. The argument put forward here is that risk-based regimes facilitate the identification, management and mitigation of conduct risk in financial markets. Conduct risk defined as a type of operational risk that involves the actions and omissions of financial institutions and individuals within, regarded as misconduct, unethical and corrupt practices.

A Structural Model to Study the Bail-Out Process in a Bank and Its Macro-Prudential Policy Implications

In this paper, we construct a structural model to determine the costs of a bank rescue considering bail-outs and bail-ins. In our model, a government assumes the equity stake under unlimited liability upon abandonment of the original equity holders. The model determines an abandonment trigger such that if total income drops below this trigger, private shareholders abandon the bank. Given this trigger, the model also determines the bank rescue costs, the expected time to the bank rescue and the bank rescue probabilities. A static analysis of our model produces several empirically testable hypotheses. The model was explored in a sample of southern European countries considering alternative assumptions regarding parameter estimates and the behavior of operational costs. The model results regarding the rescue costs are reasonable, but the model also predicts bank rescues, estimates equity values, performs welfare analyses and estimates the impact of different macro- and micro-prudential policies. The empirical exercise we present, highlights the importance of the assumptions made regarding the behavior of the operational costs by showing dramatic differences in results in a sample of countries that otherwise appear to share important cultural and geographical proximities. JEL Classification: G21, G28, H81

Heterogeneite de la Transmission de la Politique Monetaire et Evaluation Interne du Risque de Credit : Analyse en Equilibre Partiel

This article presents a partial equilibrium model of the credit market, with banking duopoly subject to a regulatory capital. The results of the model reveal a heterogeneity of monetary policy transmission, due to the disparity of internal rating based methods used by banks to calculate risk-weighted assets and capital requirement. The comparative statics exercise shows a weakening of the credit channel because of risk estimation bias and internal rating methods variability. Thus, the article highlights the strategic issue of the “laissez-faire” given to banks in determining their regulatory capital and calls for a reconciliation between micro-prudential regulation and macroeconomic policy making so as to establish macro-prudential regulation.

Mikro- i makroostrożnościowa polityka nadzorcza względem sektora bankowego – potencjalne obszary konfliktów i sposoby ich minimalizacji

The consequences of last crisis on financial market is the promotion of the macroprudential policy as new approach in regulatory policy on the financial sector. The main ideas of goal, tasks and instruments of macroprudential policy were presented in the article. They were confronted with the goal, tasks and instruments of microprudential supervisory policy. This comparison indicates the existence of general goal of macroprudential policy but there are also some problems concerning the detailed tasks of this policy. This result causes the further problem with identification of many instruments which should be belong to the marcoprudential policy only. Lack of detailed tasks of macroprudential policy and similar instruments used by micro- and macroprudential policy may generate some tension in supervisory policy and diminish the safety of financial sector and the trust its clients. We recommend to implement the new supervisory policy on step by step basis, collecting all the time the necessary experience and to take the decision later if the institutional separation of macroprudential policy is really reasonable or it is better to divide the tasks of this policy between microprudential policy and central bank activity.

Targeting Asset Bubbles: Evolution of Policies

Before the Great Recession the policy was not to interfere with increases in asset values, and if any resulting asset bubble crashes led to financial instability, then policies would be enacted to help the recovery. The crash that led to the recent financial crisis changed the mind of many researchers as they more thoroughly investigated the present and the past crises concluding that more attention needs to be paid to financial stability. This involved microprudential policies, meaning policies that would stabilize financial firms, as well as experimentation with macroprudential policies whose purpose is to stabilize a specific sector. By stabilizing a sector, the hope is that no spill over would take place to destabilize the financial system.

Systemic risk, macro-prudential regulation and organizational diversity in banking

Since the 2007–2008 global banking crisis, systemic risk has become the central target of policy design in banking regulation in many countries. At the same time, a growing attention has been paid to the systemic importance of bank heterogeneity. The need for diversity has even found its way into official policy documents, both at the European and national level. However, most of the new thinking on the regulatory reforms targeting systemic risk has been conducted within the framework of macro-prudential regulation, which may not be adequate to deal with diversity-related causes of systemic risk. This paper aims, therefore, at contributing to the growing literature on the relationship between systemic risk and banking regulation by (i) explicating the links between systemic risk and banking diversity; (ii) discussing the adequacy of macro and micro-prudential policy instruments to address diversity-related causes of systemic risk in banking; and (iii) laying out a basic framework for diversity-enhancing policies.

Quelle sera la nouvelle norme de politiques monétaire et macroprudentielle ?

Cet article rend compte d’une table ronde du colloque du GDRE monnaie, banque, finance, qui a eu lieu à Nice en juin 2015. Le débat portait sur la nouvelle norme de politiques monétaire et macroprudentielle, après une hausse des taux directeurs au-dessus de leur borne zéro et une réduction du montant des actifs détenus par les banques centrales. En plus du comité de politique monétaire, la Banque d’Angleterre dispose d’un comité de politique financière qui a pris des premières mesures pour réduire le risque financier. Les instruments de la politique macroprudentielle, leurs effets, leur utilisation optimale et leur coordination avec les instruments de politiques monétaire et budgétaire font l’objet d’exploration en cours. En ce qui concerne la politique microprudentielle, le mécanisme de supervision unique de la zone euro se met en place. Des simulations de résistance à des crises financières ont été conduites pour la première fois dans ce cadre. L’accumulation de données permettra d’améliorer ces résultats, avec néanmoins le problème non traité du risque dans le secteur bancaire parallèle.

Jointly Optimal Regulation of Bank Capital and Liquidity

In an economy with financial frictions, banks endogenously choose excessive leverage and maturity mismatch in equilibrium, as they fail to internalize the risk of socially wasteful fire sales. Macroprudential regulators can achieve efficiency with simple linear constraints, which require less information than Pigouvian taxes. The liquidity coverage and net stable funding ratios of Basel III can implement efficiency. Additional microprudential regulation of leverage is required when bank failures are socially costly. Micro‐ and macroprudential rules are imperfect substitutes. Optimally, macroprudential policy reacts to systematic risk and credit conditions over the cycle, while microprudential policy reacts to systematic and idiosyncratic risk.

Współczesne problemy oraz wyzwania w zakresie utrzymania stabilności bezpieczeństwa systemu finansowego

Although important changes were introduced to the financial system after the recent financial crisis, there still is room for improvement in terms of stability and safety. The aim of the article is to describe those improvements, particularly in operations of central and commercial banks, and their influence on sustainable growth. The text lists systematic conditions of stability and safety of banking system and points out to the importance of trust in financial institutions, systematic risk, macroprudential policy and the need to coordinate macroprudential, microprudential and monetary policies

Analysis of the Relation between Macroprudential and Microprudential Policy

The article deals with the analysis of a relationship between macroprudential and microprudential policy on a general level and on an example of regulatorily required structure and volume of bank capital. Regulatory requirements and supervisory methods are described in connection with the institutional structure of regulation and supervision within the European economic area. An attention is paid to the development of supervision on an individual basis through consolidated supervision to supplementary supervision of financial conglomerates, which corresponds with the activity and structure of the financial sector, high rate of integration and transboundary action of financial groups headed by a bank. The European System of Financial Supervision and Single Supervisory Mechanism are presented. Development of the regulation of bank capital is analysed. The original microprudential approach is mentioned that involved macroeconomic impacts from its introduction. Based on the analysis of capital structure as conceived from Basel I to Basel III approaches of regulation to this important indicator are discussed. Instability sources and indicative instruments of macroprudential policy are analysed on an example of the excessive growth of credits and leverage as an instability source and countercyclical capital buffer, sectoral capital requirements and leverage ratio in the role of indicative instruments.

The Relation between Macroprudential and Microprudential Policy: An Example of Regulatorily Bank Capital

Abstract The article deals with the analysis of a relationship between macroprudential and microprudential policy on a general level and on an example of regulatorily required structure and volume of bank capital. Development of the regulation of bank capital is analysed. The original microprudential approach is mentioned that involved macroeconomic impacts from its introduction. Based on the analysis of capital structure as conceived from Basel I to Basel III approaches of regulation to this important indicator are discussed. Instability sources and indicative instruments of macroprudential policy are analysed on an example of the excessive growth of credits and leverage as an instability source and countercyclical capital buffer, sectoral capital requirements and leverage ratio in the role of indicative instruments.

Prudential Policy at Times of Stagnation: A View from the Trenches

In the euro area, macroprudential policy can be a powerful complement to monetary policy. However, its coordination with microprudential policy is a particularly delicate task. The coexistence of two supervisory regimes that rely on similar tools to pursue different objectives may at times give rise to conflicting decisions, or create uncertainty on the logic of the prudential framework. These risks are structurally greater in bank-based economies with highly concentrated banking sectors, and may be heightened in the contractionary phase of the cycle, when policymakers face a short-run trade-off between the resilience of the financial sector and the speed of economic recovery. This makes the micro/macro coordination problem a top priority for European supervisors today. In order to address it, supervisors must agree to rank their policy objectives and examine their interventions from a general equilibrium perspective. We remain agnostic as to how much capital European banks should ultimately be required to hold. Instead we stress that, irrespective of the target, supervisors should achieve it over the appropriate time span, minimizing any negative spillovers on credit supply and protecting the credibility of the newly-launched countercyclical macroprudential framework with all available means.

The Monetary Macroprudential Policy Stance in Safeguarding Financial Stability. The Case of Romania

During the last decades, Central banks have been preoccupied to address financial market stability by complementing the traditional microprudential policies with a macroprudential approach that allows a holistic diagnosis and treatment of systemic vulnerabilities by deploying specific instruments meant to counter financial risks. The paper discusses the effectiveness of the monetary macroprudential policy pursued by The Romanian Central Bank to ensure financial stability under the threat of contagion induced by the global financial crises. The paper concludes that timely, countercyclical macroprudential policy measures are able to maintain the balance between stability and efficiency of the financial market as prerequisites of economic growth.

Allocating Macro-Prudential Powers

Monetary, macro-prudential and micro-prudential policies are intimately linked. The macroprudential authority should be allocated to the body where the overall balance of synergies (between policy objectives) over conflicts and the required expertise are the largest. This report reviews the pros and cons of the four institutional models for the allocation of macro-prudential powers: (1) the government, (2) the central bank, (3) the financial authority and (4) a committee with representatives from these three bodies. JEL Classification: G28

Managing the risks of the new macro-prudential policy regime

The pursuit of a new “macro-prudential” policy agenda has become a call to arms for many central banks and multilateral institutions seeking to lean against financial factors that promote macroeconomic volatility. Cyclical use of prudential policy, such as variation in capital requirements, is fraught with risks. It should only be employed during extreme circumstances. In general, policy makers should focus on strengthening traditional monetary policy rules and micro-prudential policies.

Policy in Adaptive Financial Markets — The Use of Systemic Risk Early Warning Tools

How can a systemic risk early warning system (EWS) facilitate the financial stability work of policymakers? In the context of evolving financial market dynamics and limitations of microprudential policy, this study examines new directions for financial macroprudential policy. A flexible macroprudential approach is anchored in strategic capacities of systemic risk EWSs. Tactically, macroprudential applications are founded on information about the level, structure, and institutional drivers of systemic financial stress and aim to manage the financial system risk and imbalances in two dimensions: across time and institutions. Time-related EWS policy applications are analyzed in pursuit of prevention and mitigation. EWS applications across institutions are considered via common exposures and interconnectedness. Care must be taken in the calibration of macroprudential applications, given their reliance on quality of the underlying systemic risk-modeling framework.

Macroprudential and Microprudential Policies: Toward Cohabitation

Effective arrangements for micro and macroprudential policies to further overall financial stability are strongly desirable for all countries, emerging or advanced. Both policies complement each other, but there can also be potential areas of overlap and conflict, which can complicate this cooperation. Organizing their very close interactions can help contain these potential tensions. This note clarifies the essential features of macroprudential and microprudential policies and their interactions, and delineates their borderline. It proposes mechanisms for aligning both policies in the pursuit of financial stability by identifying those elements that are desirable for effective cooperation between them. The note provides general guidance. Actual arrangements will need take into account country-specific circumstances, reflecting the fact that that there is no “one size fits all.”