Making macroprudential regulation operational
Anil K Kashyap , Dimitri Tsomocos, Alexandros Vardoulakis 18 July 2014
Do the extant workhorse models used in policy analysis support macroprudential and macrofinancial policies? This column argues that this is not the case and describes a new macroprudential model that stresses the special role played by banks. The model also accounts for two, often neglected, key principles of the financial systems. Some of the findings of the model could carry over to other, more general settings that satisfy these two principles.
The IMF staff (Benes et al. 2014) recently unveiled a new model that “has been developed at the IMF to support macrofinancial and macroprudential policy analysis”. In introducing the model they argue that “such new analytical frameworks require a major revamp of the conventional linear dynamic stochastic general equilibrium (DSGE) models”. We agree with Benes et al.
banks, Macroprudential policy, savers, model building
It’s time to deploy macroprudential policy: results from the Centre for Macroeconomics July Survey
Angus Armstrong, Francesco Caselli, Jagjit Chadha, Wouter den Haan 08 July 2014
How should UK policy-makers respond to potential dangers to the economy from the housing market? As this column reports, a majority of respondents to the fourth monthly survey of the Centre for Macroeconomics (CFM) think that house price dynamics do pose a risk to the UK’s recovery; and that macroprudential tools rather than traditional interest rate policy should be deployed to deal with this risk.
The Centre for Macroeconomics (CFM) – an ESRC-funded research centre including the University of Cambridge, the London School of Economics (LSE), University College London (UCL) and the National Institute of Economic and Social Research (NIESR) – is today publishing the results of its fourth monthly survey.1 The surveys are designed to inform the public about the views held by leading UK-based macroeconomists on important questions about macroeconomics and public policy.
UK, housing market, Macroprudential policy
Model risk and the implications for risk management, macroprudential policy, and financial regulations
Jon Danielsson, Kevin James, Marcela Valenzuela, Ilknur Zer 08 June 2014
Risk forecasting is central to financial regulations, risk management, and macroprudential policy. This column raises concerns about the reliance on risk forecasting, since risk forecast models have high levels of model risk – especially when the models are needed the most, during crises. Policymakers should be wary of relying solely on such models. Formal model-risk analysis should be a part of the regulatory design process.
Risk forecasting is central to macroprudential policy, financial regulations, and the operations of financial institutions. Therefore, the accuracy of risk forecast models – model risk analysis – should be a key concern for the users of such models. Surprisingly, this does not appear to be the case. Both industry practice and regulatory guidance currently neglect the risk that the models themselves can pose, even though this problem has long been noted in the literature (see for example Hendricks 1996 and Berkowitz and O’Brien 2002).
financial crises, financial regulation, forecasting, risk management, Macroprudential policy
Capital controls in the 21st century
Barry Eichengreen, Andrew K Rose 05 June 2014
Since the global financial crisis of 2008–2009, opposition to the use of capital controls has weakened, and some economists have advocated their use as a macroprudential policy instrument. This column shows that capital controls have rarely been used in this way in the past. Rather than moving with short-term macroeconomic variables, capital controls have tended to vary with financial, political, and institutional development. This may be because governments have other macroeconomic policy instruments at their disposal, or because suddenly imposing capital controls would send a bad signal.
Capital controls are back. The IMF (2012) has softened its earlier opposition to their use. Some emerging markets – Brazil, for example – have made renewed use of controls since the global financial crisis of 2008–2009. A number of distinguished economists have now suggested tightening and loosening controls in response to a range of economic and financial issues and problems. While the rationales vary, they tend to have in common the assumption that first-best policies are unavailable and that capital controls can be thought of as a second-best intervention.
IMF, capital flows, global financial crisis, capital controls, capital, Macroprudential policy
Estimating the impact of changes in aggregate bank capital requirements during an upswing
Joseph Noss, Priscilla Toffano 06 April 2014
The impact of tighter regulatory capital requirements during an economic upswing is a key question in macroprudential policy. This column discusses research suggesting that an increase of 15 basis points in aggregate capital ratios of banks operating in the UK is associated with a median reduction of around 1.4% in the level of lending after 16 quarters. The impact on quarterly GDP growth is statistically insignificant, a result that is consistent with firms substituting away from bank credit and towards that supplied via bond markets.
The recent financial crisis and economic contraction that followed highlighted the crucial role that banks play in facilitating the extension of credit and enabling economic growth. This underlies the economic rationale for imposing regulations on the banking industry, including minimum capital requirements designed to mitigate risks banks would not otherwise account for in their behaviour.
regulations, bank regulation, banking, capital requirements, banks, BASEL III, credit, Macroprudential policy, bank capital
How much is enough? The case of the Resolution Fund in Europe
Thomas Huertas, María J Nieto 18 March 2014
The European Resolution Fund is intended to reach €55 billion – much less than the amount of public assistance required by individual institutions during the recent financial crisis. This column argues that the Resolution Fund can nevertheless be large enough if it forms part of a broader architecture resting on four pillars: prudential regulation and supervision, ‘no forbearance’, adequate ‘reserve capital’, and provision of liquidity to the bank-in-resolution. By capping the Resolution Fund, policymakers have reinforced the need to ensure that investors, not taxpayers, bear the cost of bank failures.
During the crisis, individual institutions such as Hypo Real Estate required public assistance of €100 billion or more.1 So how can a European Resolution Fund of only €55 billion possibly suffice for all banks in the Eurozone?
It could, provided the Fund is part of a well-designed architecture for regulation, supervision, and resolution, that makes banks not only less likely to fail but also safe to fail – meaning that they can be resolved without cost to the taxpayer and without significant disruption to financial markets or the economy at large.
EU institutions Financial markets International finance
eurozone, regulation, banking, systemic risk, microprudential regulation, bank resolution, Macroprudential policy, bail-in, European Resolution Fund
The interaction between monetary and macroprudential policies
Stijn Claessens, Fabian Valencia 14 March 2013
Inflation targeting once seemed sufficient, but the Global Crisis showed that maintaining financial stability and price stability requires more than the monetary-policy tool. We are witnessing the rise of macroprudential policy. This column discusses how monetary and macroprudential policies interact and what it means for policy and institutional design. Regardless of whether both policies are assigned to the same authority or to two authorities; separate decision-making, accountability and communication structures are required.
In the decades prior to the crisis, macroeconomic management evolved to assign a strong role to monetary policy, with a primary focus on price stability. The framework of monetary policy was broadly converging toward one with an inflation target (explicit or implicit) and a short-term interest rate as a tool (Blanchard, Dell’Ariccia and Mauro 2010). While boom-bust cycles in asset prices and credit were observed prior to the recent crisis, these did not seriously challenge the prevailing paradigm.
Global governance Monetary policy
Macroprudential supervision in banking union
Dirk Schoenmaker 09 December 2012
Eurozone banking union discussions are full of questions about the scope of Eurozone microprudential bank supervision. Yet, this column argues that there is surprisingly little debate on the macroprudential supervision that is necessary to safeguard the wider European financial system. After all it is macro developments, such as fast rising housing prices, that lie at the heart of the ongoing crisis in Europe. To safeguard the financial system, Eurozone macroprudential tools should be under the ECB, separate from microprudential functions, with input from national central banks when differentiation is necessary.
There is a strong tendency to focus on the stability and soundness of individual banks. Supervisors may thus be bogged down by the details of these banks, while losing sight of emerging imbalances in the wider financial system. In the heated debate about the Single Supervisory Mechanism, policymakers are preoccupied with issues such as the range of supervision – all 6000 Eurozone banks, or only the large cross-border banks? – and the division of labour between the ECB and the national supervisors.
EU institutions EU policies Europe's nations and regions
Eurozone crisis, Macroprudential policy, banking union
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
Macroprudential policy: What instruments and how to use them? Lessons from country experiences
Francesco Columba, Alejo Costa, Cheng Hoon Lim 16 March 2012
In the wake of the 2008 financial crisis, there has been burgeoning interest in macroprudential policy as an overarching framework to address the stability of the financial system as a whole rather than only its individual components. This column, based on a new dataset from 49 countries, shows that some macroprudential instruments are effective in reducing procyclicality in the financial system, and thus systemic risks.
Macroprudential policy is quickly gaining traction in international circles as a useful tool to address system-wide risks in the financial sector (see for example Borio 2011, Galati and Moessner 2011, Viñals 2010, 2011). Yet the analytical and operational underpinnings of a macroprudential framework are not fully understood and the effectiveness of the instruments is uncertain. In a recent IMF working paper (Lim et al 2011), we assess the effectiveness of macroprudential instruments using three different approaches.
banks, systemic risk, Macroprudential policy