Macroprudential policy: Economic rationale and optimal tools
Giovanni Favara, Lev Ratnovski 06 August 2012
Macroprudential policy is meant to reduce the risks from the financial sector spilling over to the wider economy. But the debate over how to do so goes on. This column argues that macroprudential policy can be analysed through the prism of market failures that it is supposed to address.
The purpose of macroprudential policy is to reduce ‘systemic risk’. While hard to define formally, systemic risk is understood as 'the risk of developments that threaten the stability of the financial system as a whole and consequently the broader economy” (Bernanke, 2009). The notion is meant to include the types of financial imbalances that led to the 2007-2008 bust.
systemic risk, macroprudential regulation, Macroprudential policy
A new eReport: Excessive risk-taking by banks
Richard Baldwin 30 March 2012
Risk-taking by banks played a critical role in the global crisis and Eurozone crisis. This column introduces a new eReport that focuses on four aspects of excessive risk-taking by banks, highlighting the causes and the cures. The eReport applies the best available theory and data, bringing together the main insights and views that have emerged from the crisis.
For many, the global crisis was caused by the interlinked fragilities that arose in the banking and financial sectors; these themselves were created by mindless deregulation and permissive monetary policy. By the late 2000s, the system was so precarious that shocks from many directions could have triggered the economic conflagration we witnessed.
Global crisis Global economy Microeconomic regulation
risk-taking, cross-border banking, macroprudential regulation
On the tradeoff between growth and stability: The role of financial markets
Alexander Popov, Frank Smets 03 November 2011
Well-developed financial systems play a crucial role in stimulating growth but are associated with more frequent financial shocks and higher macroeconomic risk, as the financial crisis of 2007–09 reminded us. This column argues that the goal of financial regulation must be to reduce systemic risk without eliminating the financial sector’s contribution to long-term economic growth.
In the two decades leading to the Great Recession, academics had mostly converged on Schumpeter’s view that well-developed financial systems play a crucial role in stimulating economic growth. A host of academic papers had concluded that deeper domestic financial markets improve economic efficiency, lead to a better allocation of productive capital, and increase long-term economic growth (see Levine 2005 for a recent review).
growth, volatility, Finance, macroprudential regulation
The Dodd-Frank Act, systemic risk and capital requirements
Viral Acharya, Matthew Richardson 25 October 2011
Macroprudential regulation aims to reduce systemic risk by correcting the negative externalities caused by breakdowns in financial intermediation. This column describes the shortcomings of the Dodd-Frank legislation as a piece of macroprudential regulation. It says the Act’s ex post charges for systemic risk don’t internalise the negative externality and its capital requirements may be arbitrary and easily gamed.
The economic theory of regulation is clear. Governments should regulate where there is a market failure. It is a positive outcome from the Dodd-Frank legislation that the Act’s primary focus is on the market failure – namely systemic risk – of the recent financial crisis. The negative externality associated with such risk implies that private markets cannot efficiently solve the problem, thus requiring government intervention.
Financial markets International finance
capital requirements, Dodd-Frank Act, macroprudential regulation
Destabilising market forces and the structure of banks going forward
Arnoud Boot 25 October 2011
The financial sector has become increasingly complex in terms of its speed and interconnectedness. This column says that market discipline won’t stabilise financial markets, and complexity makes regulating markets more difficult. It advocates substantial intervention in order to restructure the banking industry, address institutional complexity, and correct misaligned incentives.
The financial services sector has gone through unprecedented turmoil in the last few years. We see fundamental forces that have affected the stability of financial institutions. In particular, information technology has led to an enormous proliferation of financial markets, but also opened up the banks’ balance sheets by enhancing the marketability of their assets. As a matter of fact, a fundamental feature of recent financial innovations – securitisation, for example – is that they are often aimed at augmenting marketability.
Financial markets International finance
complexity, Too big to fail, systemic risk, macroprudential regulation