London, England: central banks can play an important role in reducing risks to the financial system (photo: Toby Melville/Reuters)
MACROPRUDENTIAL POLICY
The research examines the evidence these policies help reduce the risk of crises, and the institutional changes needed for them to be used most effectively.
The global crisis has taken a huge economic and human toll. Macroprudential policy is designed to help countries lessen risks to their financial system as a whole, not just to individual banks, and reduce the frequency and severity of financial crises.
Macroprudential policy looks at a wide range of indicators to assess the resilience of the financial system to shocks, the availability of funding in financial markets, market participants’ connections to each other, private sector debt, and international capital flows.
The list of macroprudential policy tools available to governments includes, for example, countercyclical capital requirements, loan-to-value ratios that help prevent the out-of-control credit growth that led to recent housing bubbles, and systemic capital and liquidity surcharges to address financial institutions’ contribution to risks.
Road map
Macroprudential policies are most effective when well coordinated with monetary and fiscal policies and adjusted to a country’s economic circumstances. The research finds there is no one-size-fits-all approach for countries to organize these policies and their implementation. The IMF’s latest research found some general lessons.
• The central bank should play an important role in macroprudential policy to harness its incentives to reduce systemic risk, as well as its expertise in reducing risks to the financial system and to ensure coordination with monetary policy.
• A lead authority or committee vested with a mandate and powers to conduct macroprudential policy helps ensure accountability and results.
• Complex arrangements aren’t likely to detect risk as effectively and can create frictions in decision-making and implementation of policies.
• The Treasury’s participation in crisis prevention is useful, but a leading role poses risks. The Treasury needs to play a strong role in crisis management and resolution. Separate institutional arrangements for macropudential policy and for crisis management are therefore useful in many cases.
Crisis prevention policies work
The working paper on macroprudential policy tools is a comprehensive analysis of their use and effectiveness, examining a broad range of instruments, risks, and countries.
The study finds that many of the most frequently used macroprudential instruments, such as caps on the loan-to-value ratio, caps on the debt-to-income ratio, and dynamic provisioning, are effective in mitigating systemic risk in both emerging and advanced countries.
The paper finds emerging economies have tended to make greater use of macroprudential tools than advanced economies. However, the evidence shows their effectiveness does not depend on the level of economic development, the exchange rate regime, or the size of the financial sector. The analysis does suggest, however, that different types and sources of risks call for different instruments.
Countries use a variety of macroprudential tools to address risks, including credit-related, liquidity-related and capital-related measures, as well as those mentioned above. They often use these in combination to complement other economic policies, such as monetary policy. They also adjust them to economic conditions to prevent a country from suffering the negative effects of a crisis.
The design and calibration of the measures also need to take into account
• The ability of the financial system to circumvent them, as well as bear the cost of additional regulation
• The quality of supervision and enforcement
• The governance and accountability arrangements regarding macroprudential policy.
Not all models are created equal
The staff analysis and accompanying working paper on institutions assesses different models for organizing and implementing macroprudential policy.
The IMF found that arrangements need to be tailored to local conditions, and some institutional arrangements could be further strengthened by addressing the following issues:
• If the institutional structure is too fragmented, no one institution may have all the information needed to analyze all interlinked aspects of systemic risk. Problems can easily fall through the cracks.
• Macroprudential policy tends to be subject to strong lobbying by the financial industry and can also be politically unpopular. This can create a bias against forceful and timely action, especially since the potential benefit reduction in the probability and severity of future crises will often remain uncertain. Where multiple government agencies are involved, this can reduce accountability and incentives to act.
• Macroprudential policy should not undermine the operational independence of established policy functions, such as monetary and microprudential policy.
The road ahead
The analysis is expected to help countries as they review their existing macroprudential frameworks.
Macroprudential policies should not be viewed as a panacea able to prevent all future crises.
In order to be effective, macroprudential policies need to be complemented by strong supervision of individual financial institutions, and policies to resolve failed banks and financial institutions that help ensure that no one is too important to fail in order to be effective.
Ahead of this week’s Group of Twenty advanced and emerging economies leaders’ summit in Cannes, France on November 4, the IMF published a progress report with the Financial Stability Board and the Bank of International Settlements on macroprudential policy. Part of this detailed research was included in the report.
