## _110614 - EXECUTIVE SUMMARY ## Source details **Canonical URL:** [_110614 - EXECUTIVE SUMMARY](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_110614.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_110614.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_110614.pdf.json) --- ### Overview and purpose - Purpose: Provide guidance to facilitate the staff’s advice on macroprudential policy in Fund surveillance, elaborating on principles in “Key Aspects of Macroprudential Policy” and accounting for work of international standard setters and evolving country experience. - Scope: Operational advice on use of macroprudential tools; how advice should vary across country circumstances and interact with other policies; principles for institutional frameworks. - Administrative: MCM staff contact referenced as MCMMacropruGuidance. Date: November 6, 2014. ### Objectives and rationale for macroprudential policy - Definition: Macroprudential policy is the use of primarily prudential tools to limit systemic risk. - Systemic risk: Disruptions to the provision of financial services caused by impairment of all or parts of the financial system, with serious negative consequences for the real economy. - Three systemic externalities motivating intervention: - (i) the tendency of the financial system to amplify adverse aggregate shocks; - (ii) macro-financial feedback mechanisms that increase exposure (e.g., build-up in leverage or erosion of credit standards); - (iii) linkages within the financial system that increase vulnerability to idiosyncratic or aggregate shocks. - Three intermediate objectives ("tasks"): - Increase resilience by building buffers. - Contain build-up of systemic vulnerabilities over time (reduce procyclicality, contain leverage and volatile funding). - Control structural vulnerabilities from interlinkages and systemically important intermediaries. ### Key operational issues for staff advice - Core questions addressed: - When should macroprudential tools be activated and tightened? - What issues arise when implementing macroprudential tools? - When and to what extent should tools be relaxed? - How should macroprudential policy be communicated? - How can leakages be addressed? - Analytical starting point: - Begin with comprehensive and rigorous analysis of systemic vulnerabilities across time and structural dimensions. - Time-dimension vulnerabilities to assess include: - (i) economy-wide vulnerabilities from excessive growth in total credit; - (ii) sectoral vulnerabilities from growing household credit; - (iii) sectoral vulnerabilities from corporate exposures; - (iv) vulnerabilities from excessive maturity and FX mismatches. - Structural-dimension vulnerabilities: linkages across intermediaries and market infrastructures. ### Mapping vulnerabilities to tools (tool categories and examples) - Broad-based tools: - Examples: countercyclical capital buffers (CCBs) and dynamic provisions. - Effects: increase resilience and may moderate pro-cyclicality; where pass-through is weak, consider additional tools, potentially including caps on credit growth. - Household-sector tools: - Examples: sectoral capital requirements (risk weights), loan-to-value (LTV), debt-service-to-income (DSTI) ratios. - Can be adjusted to target FX mortgage risks. - Corporate-sector tools: - Examples: sectoral capital requirements (risk weights), exposure caps; for CRE lending, LTV limits. - Liquidity tools: - Examples: liquid asset buffers, stable funding requirements, limits on open currency positions; nonbank liquidity tools available. - Structural tools: - Examples: capital and liquidity surcharges for systemically important institutions; measures to control interlinkages in funding and derivatives markets. ### Indicators signaling need for action (time-dimension focus) - Use multiple indicators per vulnerability: core indicators (starting point) and additional indicators. - Where indicators cannot be constructed, encourage collection and sharing of relevant data. - Assess both level and evolution; rapid increases generally signal rising systemic risk. - Interpreting indicator “colors”: - “Flashing red” on most indicators: generally strong case for recommending measures, but use judgment. - Mixed red/green: weaker case; consider alternative policy actions. - Mostly “yellow”: recommend gradual approach; intensify supervisory scrutiny; consider partial activation where predefined ranges exist (e.g., CCB). - “Yellow” or “green”: encourage monitoring and establishment of legal/operational basis for action. - Table 1 (selected core/additional indicators — time-dimension only) — core indicators include: - Broad-based (Capital) tools: Credit/GDP gap. - Household tools: Household loan growth; Increasing house prices (nominal and real growth). - Corporate tools: Corporate loan growth; Increasing commercial property prices. - Liquidity tools: Increasing loan-to-deposit (LTD) ratio; Increasing share of noncore funding to total liabilities. ### Assessing structural risks (three analytical steps) - Step 1: Analyze financial system composition using aggregate sector information and sectoral flow of funds to identify key systemic linkages. - Step 2: Identify systemically important banks and assess tools (enhanced supervision, resolvability measures, greater loss absorbency). - Step 3: Expand analysis to nonbank financial institutions and market infrastructures and consider further structural tools. ### Implementation: costs, benefits, effectiveness, and sequencing - Benefits of tightening: reduction in probability and severity of crises; reduced negative spillovers. - Costs: circumvention/distortions; borrower costs; adjustment costs for financial industry; potential output costs. - Empirical observations: - All tools likely help build resilience. - Capital buffers may not markedly slow credit growth when demand is strong (examples cited: Israel, Sweden and Switzerland). - Tools acting on credit demand (LTV and DSTI) are generally more effective in curbing excessive credit dynamics. - Tightening liquidity requirements can also slow credit growth though precise effects are uncertain. - Effectiveness can be undermined by leakage (arbitrage) or strong credit drivers; structural tools face leakage risk shifting activity to nonbank sector. - Promoting effective use of multiple tools: - Complementary tools can increase effectiveness and reduce leakage costs; marginal benefit of tightening a single tool decreases due to distortions and circumvention. - Examples of complementarities: - Sectoral tools (LTV, LTI, DSTI) complement capital tools (CCB) when housing booms accompany broader credit booms. - DSTI limits enhance LTV effectiveness by containing use of unsecured loans for down payments. - In low interest rate environments, LTI limits or stressed DSTI ratios can complement LTV caps. - Efficiency and sequencing: - Prefer tools that work through prices (capital tools) before quantitative constraints (LTV, LTI, DSTI) to reduce distortions. - Move to quantitative restrictions when price tools insufficient. - Targeted measures are typically more efficient but require more information and can be harder to enforce. - Adjustment costs and phase-in: - Phase-in or step-wise tightening can mitigate adjustment costs; BCBS recommends notice period of up to 12 months to meet a CCB. - Examples: - Korea: ceiling on the LTD ratio announced December 2009, initially to be met by end-2013 (brought forward to June 2012). - New Zealand: minimum core funding ratio initially 65 percent in 2010, raised in two steps in 2011 and 2013 to reach 75 percent. - Measures targeting flows of new lending/funding: - Should take immediate effect to avoid frontloading; flow-targeting measures can be tightened more sharply but warrant caution due to transmission uncertainty. ### Assessing potential costs to output - Balance sheet tools often have weak effects on loan rates and credit volume, implying weak effects on output, though effects can be larger when tightening forces credit cuts or occurs during financial stress. - Flow tools (LTV, DSTI) expected to have greater impact on output; variation in LTV affects consumption and investment meaningfully. - Recommendation: phase in balance sheet tools gradually and ahead of stress; tighten flow tools gradually, especially when the economy is weak or monetary policy is constrained. - Cautious, iterative tightening with real-time assessment and repeated stress testing recommended. ### Cross-border spillovers and coordination - Some tools have domestic effects (e.g., CCB, LTV, DSTI); others (liquidity tools, capital surcharges) apply to all assets of international banking groups and can cause cross-border deleveraging. - Timing and phase-in are important to avoid unintended cross-border effects. - Regional coordination mechanisms can help assess and mitigate spillovers. - Staff should discuss full range of spillovers and recommend alternative policies that achieve objectives at reduced costs to other countries. ### When should macroprudential tools be relaxed? (principles and indicators) - Objective: avoid credit crunches that curtail credit and create adverse feedback loops depressing activity while maintaining resilience. - Relaxation justified when: - Systemic risk dissipates; or - Systemic risk materializes and financial conditions tighten in a way that threatens real activity. - Cautions: - Softening of aggregate demand alone is not sufficient justification; macroprudential policy should not be used to manage business cycles. - Premature relaxation can reignite risks; respect prudential minima. - Structural tools will rarely need relaxation. - Indicators guiding relaxation differ from activation indicators: - Stock variables (credit-gap) useful for detecting build-up; market-based and flow variables better capture turning points. - Instrument-specific indicators (selected examples): - Capital tools: increases in bank CDS spreads; increases in lending rates/spreads; slowing credit growth; increasing default rates and NPLs/arrears. - Household tools (LTV, DSTI): decreasing house prices; decreasing real estate transactions; increasing mortgage spreads; slowing net household loan growth; increasing household NPLs/arrears. Note: a fall in house prices alone is not sufficient to justify relaxation. - Corporate tools: corporate CDS spreads; bond yields; decreasing corporate loan growth; increasing corporate default rates/NPLs/arrears. - Liquidity tools: increasing spread between interbank rate and policy/swap rate; increasing wholesale funding costs; increased recourse to central bank liquidity windows; reversal of gross capital inflows. - Decision to relax requires judgment using market intelligence, supervisory assessments and stress tests; early-warning signs may give false alarms. ### Creating policy space for relaxation - Ensure adequate buffers built in good times so relaxation does not fall below levels safe in downturns. - Staff recommendations: - Encourage a sufficient range of variation of CCBs (beyond the commonly used benchmark of 2.5 percent of risk-weighted assets) and dynamic provisions to create policy space for relaxation. - Encourage authorities to define maximum LTV and DSTI ratios considered safe in downturns (perhaps around 85 percent and 45 percent, respectively) to provide space for tightening in good times and relaxation in stress. - Encourage liquidity ratios to be calibrated more tightly (e.g., net stable funding ratio) to create space for relaxation while respecting prudential minima. ### Principles and effects of relaxation - Relaxations confined to new exposures have less effect on banks’ resilience. - Relaxation of caps on LTV and DSTI that apply only to new loans preserves resilience of existing exposures. - Stamp duty relaxation can support housing markets and should be considered before relaxing LTV/DSTI because it does not reduce resilience of borrowers or banks. - Effectiveness of relaxation depends on how binding the tool was and on banks’ responses; empirical literature not inconsistent with symmetric effects of tightenings and relaxations, but evidence is limited. ### Sequencing during stress - Sequence response to source of stress: - If solvency weakens without liquidity stress → prioritize relaxation of capital or housing-related tools. - If liquidity stresses emerge first → prioritize relaxation of liquidity tools. - If liquidity stresses arise from global shock → consider relaxing liquidity tools while increasing capital buffers or tightening other measures to restore investor confidence. - Relaxation of liquidity tools may need to be complemented by emergency liquidity assistance, monetary policy accommodation, and measures to maintain confidence (e.g., stress testing). ### Communication of macroprudential policy - Clear communication recommended to improve transmission and public acceptance. - Recommended communications tools: - A policy strategy establishing predictability while retaining discretion. - Regular (periodic) risk assessments and ex post assessments of measures’ effectiveness. - Publication of a record of meetings to enhance transparency and accountability, while avoiding detailed minutes that risk frontloading or adverse market reactions. - Limits to transparency: advise weighing benefits of openness against risks of frontloading and adverse reactions; avoid routine publication of detailed deliberations. ### Leakages: assessment and containment strategies - Leakages: migration of activity outside scope or enforcement, domestic (to nonbanks) or cross-border (to foreign providers). - Staff should assess leakages ex ante and monitor ex post; monitor nonbank activity and cross-border credit flows. - Strategies to contain leakages: - Expand scope to domestic nonbanks, connected entities, and foreign providers where feasible, recognizing legal and operational challenges. - Tool-specific containment: - Broad-based and corporate tools: consolidation requirements for connected nonbank entities; reciprocity arrangements; host-control; CFMs; fiscal measures. - Household tools (LTV, DSTI): apply borrower eligibility criteria across products; harmonize eligibility standards between government and private securitization channels; cooperation among supervisory agencies; expansion of licensing if needed. - Liquidity tools: extend liquidity requirements to nonbank maturity transformers; use international principles (Basel Concordat) to apply liquidity requirements to foreign subsidiaries and branches; central banks can apply reserve requirements to nonbank financial companies (examples: Turkey and Serbia). - Box 2 (cross-border leakages — summary): - Reciprocity: Basel III CCB reciprocity up to 2.5 percent of risk-weighted assets; above 2.5 percent reciprocity voluntary. No international mandate for reciprocity in sectoral risk weights; staff should encourage bilateral/regional agreements. - Greater host control: encourage subsidiaries rather than branches where feasible; legal constraints can prevent conversion in some jurisdictions. - CFMs and fiscal policy: CFMs may limit inflow-driven credit growth from international nonbank investors; alternatives include taxation and measures correcting tax biases. ### Country characteristics shaping advice - Staff advice must account for: - (i) availability of data and strength of supervisory capacity; - (ii) level of debt to GDP and pace of credit growth; - (iii) economic structure and degree of diversification; - (iv) degree of capital account openness and financial integration. - Data and supervisory capacity constraints: - Lack of data/supervisory capacity hampers vulnerability assessment and tool deployment; priority may be improving these areas. - Effective enforcement of borrower-targeted tools (LTV, DSTI) relies on credit registers at borrower level. - Where data is unavailable, emphasize permanent capital buffers to increase resilience. - Credit/GDP analysis: - The credit-to-GDP gap is the best single early-warning indicator of crises, signaling crises five to three years in advance; requires quarterly series of credit aggregates and GDP of at least ten years. - Where such data unavailable, start with other credit measures such as annual growth in credit/GDP. - Country-specific factors that support healthy deepening: legal framework improvements, better borrower information, improved market infrastructures. - Factors increasing systemic risk: rapid credit growth fueled by financial and capital account liberalization, increased competition, deterioration of lending standards, greater wholesale funding use. - Where financial and business cycles move in lockstep or are driven by volatile external factors (e.g., resource-rich countries), emphasize high resilience, rules-based approaches, automatic stabilizers (dynamic provisioning, conservative LTV/DSTI) and complementary fiscal buffers. - Capital account liberalization increases need for macroprudential policy and raises potential for cross-border leakages; proceed gradually and combine with strong macroprudential measures. - Structural-dimension considerations: - Large, interconnected systems warrant structural measures (capital surcharges on domestic systemically important institutions, measures to contain knock-on defaults). - Highly concentrated systems may require structural measures even if interconnectedness is low. ### Interaction with other policy settings - Macroprudential policy should complement, not substitute for, macroeconomic or structural policies. - Monetary policy considerations: - Accommodative monetary policy in weak economies can build financial stability risks; tighten LTV/LTI and apply (stressed) DSTI ratios where such developments occur in real estate markets. - Small open/emerging economies: differentials between domestic and foreign policy rates increase FX and liquidity risks; use FX-targeted macroprudential tools and liquidity risk tools (differentiated reserve requirements, core funding ratios, levies on FX wholesale funding). - Currency unions and pegs: macroprudential policies needed at national level and must be coordinated; strong countercyclical fiscal policy also required where exchange rate flexibility absent. - Other policies reducing burden on macroprudential policy: - Tighter monetary policy when monetary stance is loose. - Fiscal stance adjustments to reduce need for prolonged low policy rates. - Structural reforms and tax reforms to correct biases favoring debt financing. - Strong ex ante fiscal and resolution frameworks to prevent sovereign–financial feedback loops. - Policy responses beyond macroprudential tools may be needed for systemic liquidity risks in nonbank markets. ### Institutional framework: assuring willingness, ability, and cooperation - Importance: Strong framework needed to overcome biases for inaction, assure access to information, assign powers, and foster cooperation while preserving policy autonomy. - Assuring “willingness to act”: - Assign macroprudential mandate to a body/committee to ensure responsibility and accountability. - Central bank desirable as key participant for expertise, coordination, and shielding from political interference. - Three institutional models: - Model 1: Mandate to central bank (Board/Governor) — complement with coordination mechanisms where supervision outside central bank. - Model 2: Dedicated committee within central bank — includes supervisory agencies and external experts. - Model 3: Committee outside central bank with central bank participation — useful when ministry of finance role or legislative changes needed. - Mitigants to MoF dominance: central bank chairmanship, strong central bank voice, veto for central bank, independent central bank analysis. - Well-defined objectives in law and accountability mechanisms recommended. - Institutional support: dedicated financial stability units, working-level subcommittees, independent offices in treasury where relevant. - Assuring “ability to act” (powers needed): - Information powers, calibration powers, designation powers. - Hard (direct) powers: direct control, avoid implementation delays; useful for rapid time-dimension tools and designation of SIFIs. - Semi-hard powers: formal recommendations with ‘comply or explain’. - Soft powers: opinions/recommendations without ‘comply or explain’; useful for legislative engagement or cross-government measures. - Combination of powers often most effective. - Fostering cooperation in risk assessment and mitigation: - Resolve legal impediments to data sharing. - Involve supervisory/regulatory agencies in decision-making bodies. - Include financial stability objectives in mandates of separate regulators. - Overlapping membership between monetary and macroprudential bodies and common analysis can foster coordination without eroding monetary policy independence. - Crisis management requires dedicated arrangements distinct from macroprudential framework, with overlapping membership to coordinate actions (monetary easing, emergency liquidity, resolution, fiscal support). *Source: STAFF GUIDANCE NOTE ON MACROPRUDENTIAL POLICY, International Monetary Fund, Executive Summary and excerpts (November 6, 2014).* ### EXECUTIVE SUMMARY ### _110614 - EXECUTIVE SUMMARY ### Overview - Purpose: Provide guidance to facilitate the staff’s advice on macroprudential policy in Fund surveillance, elaborating on principles in “Key Aspects of Macroprudential Policy” and accounting for work of international standard setters and evolving country experience. - Scope: Operational advice on use of macroprudential tools, how advice should vary across country circumstances and interact with other policies, and principles for institutional frameworks. - Administrative details: MCM staff contact referenced as MCMMacropruGuidance. Date: November 6, 2014. ### Objectives and Rationale for Macroprudential Policy - Definition: Macroprudential policy is the use of primarily prudential tools to limit systemic risk. - Systemic risk defined as disruptions to the provision of financial services caused by impairment of all or parts of the financial system, with serious negative consequences for the real economy. - Three sets of systemic externalities motivating intervention: - (i) the tendency of the financial system to amplify adverse aggregate shocks; - (ii) macro-financial feedback mechanisms that increase exposure (e.g., build-up in leverage or erosion of credit standards); - (iii) linkages within the financial system that increase vulnerability to idiosyncratic or aggregate shocks. - Three intermediate objectives ("tasks") of macroprudential policy: - Increase resilience of the financial system to aggregate shocks by building buffers. - Contain build-up of systemic vulnerabilities over time (reduce procyclicality, contain leverage and volatile funding). - Control structural vulnerabilities arising from interlinkages and systemically important intermediaries. ### Key Operational Issues for Staff Advice - Core operational questions the note addresses: - When should macroprudential tools be activated and tightened? - What issues arise when implementing macroprudential tools? - When and to what extent should macroprudential policy tools be relaxed? - How should macroprudential policy be communicated? - How can leakages of macroprudential policy tools be addressed? - Mapping vulnerabilities into policy recommendations: - Staff advice should start with comprehensive and rigorous analysis of systemic vulnerabilities and recommend well-targeted tools to address material risks. - Evaluate multiple indicators to assess need for activation and tightening; core indicators are a useful starting point. - Where information is missing, encourage collection and sharing of relevant data. - When multiple indicators point to risk build-up, stronger case for activation/tightening, but recommendations should be supported by in-depth analysis. - Encourage establishment of a macroprudential toolkit even where crisis seems distant. ### Guidance on Activation and Tightening - Use of indicators: - Evaluate multiple indicators (core and additional) to form judgment on systemic risk and timing of activation/tightening. - Approach to policy design: - Well-tailored design and step-wise tightening can help achieve benefits while mitigating costs to borrowers, financial industry adjustment costs, and potential output costs. - Emphasis on continuous risk assessment: - Macroprudential policy should be based on “guided discretion” rather than strict rules because indicators cannot capture all information and sources of systemic risk can shift. - Judgment requires access to data, qualitative information, and analytical capacity. - Simpler approaches (automatic stabilizers, resilience measures) may be preferable where informational environment or analytical capacity is weak. ### Implementation Issues - Interaction with other policies: - Macroprudential policy should complement other macroeconomic and financial sector policies. - Should not substitute for appropriate macroeconomic or structural policies addressing real external or internal imbalances. - Overlap with capital flow management measures (CFMs): CFMs limit capital flows; macroprudential measures limit systemic vulnerabilities. Where capital flows cause systemic risks, tools can be both CFMs and macroprudential measures; using both requires understanding of effectiveness and interactions. - Boundary with microprudential policy: Significant tool overlap can create tensions; appropriate institutional arrangements and strengthened financial stability objectives in supervisory mandates can help manage tensions. - Reliance on strong microprudential supervision: - Strong supervision is essential for macroprudential policy effectiveness, for data access and enforcement; increased supervisory scrutiny is often a useful prior step to tightening macroprudential rules. - Where supervisory/enforcement capacity is lacking, improving these should be a priority. - Perimeter of application: - Macroprudential policy must look beyond banks as risks can migrate into nonbank financial sector; expanding the perimeter faces legal and operational challenges and requires greater cooperation among supervisory agencies. ### Relaxation of Time-Varying Tools - Justifications for relaxation: - Can be justified when risks materialize or when risks recede, and to avoid credit crunches that curtail credit and create adverse feedback loops depressing activity. - Cautions on relaxation: - Premature relaxation can reignite risks and should be avoided; any relaxation needs to respect prudential minima to ensure resilience against future shocks. - Structural tools aim mainly to increase resilience and will rarely need relaxation. ### Communication of Macroprudential Policy - Clear communication is essential to achieve effective transmission when measures are taken or relaxed. - Recommended communications tools: - A policy strategy that establishes predictability while retaining discretion. - Regular assessments of risk and impacts of measures taken. - Records of meetings of macroprudential policymakers. ### Addressing Leakages - Staff should assess potential for leakages and advise on strategies: - Domestic leakages (e.g., migration to nonbanks) and cross-border leakages can, in principle, be addressed by expanding scope of macroprudential intervention, which may require domestic and international coordination. - Scope for and practical challenges in addressing leakages differ across tools; advice should be adjusted accordingly. - Box referenced: “Strategies to Address Domestic and Cross-Border Leakages.” ### Country Characteristics and Policy Interactions - Staff advice must account for country-specific circumstances: - Consider availability of data, strength of supervisory capacity, stock of private sector credit, degree of economic diversification, and extent of financial integration. - Where the financial system is large, interconnected, or concentrated, greater need for structural measures. - Policy mix considerations: - Where monetary policy is appropriately set for price stability, macroprudential policies should contain adverse side effects for financial stability. - Structural and fiscal policies can reduce risks (by addressing real imbalances and incentives to take undue risk); staff should encourage action across policy fields to avoid overburdening macroprudential policy. ### Institutional Framework Guidance - Need for strong institutional framework to overcome biases favoring inaction: - Framework must assure willingness to act, ability to act, and cooperation in risk assessment and mitigation. - Policymaker should have clear objectives, necessary legal powers, and foster cooperation among supervisory and regulatory agencies. - Where effective institutional arrangements are lacking, staff should recommend ways to strengthen the framework to ensure conditions for effective policy. ### Supplementary Notes and Tools - An accompanying note provides detailed guidance on specific macroprudential tools across categories: broad based tools, corporate sector tools, household sector tools, liquidity tools, and structural tools. - Separate considerations for low income countries are available under separate cover. *Source: STAFF GUIDANCE NOTE ON MACROPRUDENTIAL POLICY, International Monetary Fund, Executive Summary (November 6, 2014).* ### 13. While the main note is intended as a “primer,” the advice on potential tools needs to ### 110614 - 13. While the main note is intended as a “primer,” the advice on potential tools needs to ### Overview and purpose (paras 13–15) - The main note is intended as a “primer,” but advice on potential tools must be shaped by the specific set of vulnerabilities prevailing in any given country (para 13). - An accompanying note provides detailed guidance on using the macroprudential toolkit to address specific vulnerabilities; further considerations for low income countries are available in a separate note (para 13). - The notes are meant to foster a structured dialogue on macroprudential policy in Fund surveillance, equip staff with an agenda for dialogue, and provide a structure to think through trade-offs and policy choices (para 14). - The guidance is a living document intended to be updated periodically as country experience and research accumulate (para 15). ### When should macroprudential tools be activated and tightened? — analytical starting point (paras 16–17) - Advice should start with a comprehensive and rigorous analysis of systemic vulnerabilities. - Time-dimension vulnerabilities to assess: - (i) economy-wide vulnerabilities from an excessive growth in total credit; - (ii) sectoral vulnerabilities from growing credit to the household sector; - (iii) sectoral vulnerabilities from exposures to the corporate sector; - (iv) vulnerabilities from excessive maturity and foreign exchange (FX) mismatches within the financial sector. - Analysis should consider potential feedback between asset prices and credit (para 16). - Structural-dimension vulnerabilities to assess: - linkages within and across key classes of intermediaries and market infrastructures (para 16). - Staff advice should map in-depth vulnerability analysis into tailored policy recommendations and consider transmission mechanisms of tools (para 17). ### Mapping vulnerabilities to macroprudential policy tools (para 17) - Broad-based tools (address credit booms affecting all bank credit exposures): - Examples: countercyclical capital buffers (CCBs) and dynamic provisions. - Effects: increase system resilience and may moderate pro-cyclicality of credit. - Where pass-through is weak, consider additional tools, potentially including caps on credit growth (Detailed Guidance: Broad-based tools). - Household-sector tools (address excessive household credit and procyclical credit–asset price feedback): - Examples: sectoral capital requirements (risk weights), loan-to-value (LTV), and debt-service-to-income (DSTI) ratios. - Can be adjusted to target FX mortgage risks (Detailed Guidance: Household sector tools). - Corporate-sector tools (address corporate leverage, CRE lending, FX lending to corporates): - Examples: sectoral capital requirements (risk weights) and exposure caps. - For CRE lending, LTV limits can also be used (Detailed Guidance: Corporate sector tools). - Liquidity tools (address systemic liquidity and currency risks): - Examples: liquid asset buffers, stable funding requirements, limits on open currency positions. - Can also affect credit booms via constraints on bank funding; nonbank liquidity tools available (Detailed Guidance: Liquidity tools). - Structural tools (address contagion via interlinkages): - Examples: capital and liquidity surcharges for systemically important institutions; measures to control interlinkages in funding and derivatives markets (Detailed Guidance: Structural tools). ### Indicators signaling need for policy action (paras 18–21; Table 1 summary) - Use multiple indicators per vulnerability: core indicators (starting point) and additional indicators (to supplement) (para 18). - Where indicators cannot be constructed, staff should encourage collection and sharing of relevant data (paras 19). - Assess both level and evolution of indicators; rapid increases generally signal rising systemic risk (para 20). - Thresholds estimated in cross-country research (e.g., credit-to-GDP gap) are indicative and should be tailored to country circumstances (para 20). - Interpreting indicator “colors” (para 21): - “Flashing red” on most indicators: generally strong case for recommending measures, but use judgment. - Mixed red/green indicators: weaker case; consider alternative policy actions (example: elevated housing prices with subdued mortgage lending could imply supply constraints or cash demand). - Mostly “yellow”: recommend gradual approach; intensify supervisory scrutiny and issue supervisory guidance; consider partial activation where predefined ranges exist (e.g., CCB) (para 21). - When “yellow” or “green”: encourage monitoring and establishment of legal/operational basis for action (para 21). - Table 1 (time-dimension focus) — selected core and additional indicators (exact headings preserved): - Broad-based (Capital) tools: - Core indicator: Credit/GDP gap - Additional indicators: Growth in credit/GDP; Credit growth; Asset price deviations from long-term trends; Under-pricing of risk in financial markets (low volatility/spreads); DSTI ratios; Leverage on individual loans or at the asset level; Increasing wholesale funding ratio (noncore funding); Weakening exports and resulting current account deficits - Household tools: - Core indicators: Household loan growth; Increasing house prices (nominal and real growth); House price-to-rent and house price-to-disposable income ratios; Increasing share of household loans to total credit - Additional indicators: Increasing house prices by region and by types of properties; Deteriorating lending standards; High LTV ratio; High loan-to-income (LTI) ratio; High DSTI ratio; Share of FX loans and interest only loans - Corporate tools: - Core indicators: Corporate loan growth; Increasing share of corporate loans to total credit; Increasing commercial property prices; Increasing commercial real estate credit - Additional indicators: Increasing share of FX loans; Increasing corporate leverage (debt to equity ratio); Corporate credit gap; Increasing debt-service ratio; Deteriorating lending standards; Average DSTIs on commercial real estate loans; Average LTVs on commercial real estate loans; Share of FX loans and extent of natural hedges - Liquidity tools: - Core indicators: Increasing loan-to-deposit (LTD) ratio; Increasing share of noncore funding to total liabilities - Additional indicators: Decreasing share of liquid assets; Worsening maturity mismatches; Increasing securities issuance; Increasing unsecured funding; Increasing FX positions; Increasing gross capital inflows - Note: Table 1 focuses on assessment of risks in the time dimension only (Table 1 note). ### Assessing the need for action in the structural dimension (para 22) - Three analytical steps: - Step 1: Analyze financial system composition using aggregate sector information and sectoral flow of funds to characterize the financial network and identify important sectors for systemic linkages. - Step 2: Identify systemically important banks and assess tools needed to improve resilience (enhanced supervision, measures to improve resolvability, greater loss absorbency). - Step 3: Expand analysis to consider further tools to address structural risks covering relevant nonbank financial institutions and market infrastructures (Detailed Guidance: Structural tools). ### Implementation issues: costs, benefits, and effectiveness (paras 23–26) - Tightening macroprudential levers has benefits and costs (para 23): - Benefits: reduction in probability and severity of crises and reduced negative spillovers. - Costs: circumvention leading to distortions; costs to borrowers from reduced availability of services; costs to financial industry adjusting to constraints; potential costs to output growth. - Precise quantification of benefits and costs is unlikely to be feasible for staff (para 23). - Assessing benefits via intermediate objectives (para 24): - Time-dimension tools (e.g., CCB, caps on LTV and DSTI) aim to: - Increase financial system resilience as risks build; and - Contain procyclical feedback between credit and asset prices and unsustainable increases in leverage. - Structural tools (e.g., capital surcharges for systemically important institutions) aim to increase resilience to shocks. - Empirical observations on tool effects (para 24): - All tools likely help build resilience (examples: capital buffers, liquidity tools, LTV, DSTI). - Capital buffers may not markedly slow credit growth when demand is strong (examples cited: Israel, Sweden and Switzerland). - Tools acting directly on credit demand (LTV and DSTI) are generally more effective in curbing excessive credit dynamics (Detailed Guidance: Household sector tools). - Tightening liquidity requirements (e.g., net stable funding, reserve requirements) can also slow credit growth though precise effects are uncertain (Detailed Guidance: Liquidity tools). - Effectiveness can be undermined by leakage (arbitrage) effects or strong underlying drivers of credit growth, though resilience benefits remain. - Structural tools face leakage risk if tightening banking sector tools shifts activity to nonbank sector; global capital flows and market structure changes can also undermine effectiveness (para 24). - Real-time assessment challenges and the role of stress testing (para 25): - Assessing effects in real time is difficult; repeated stress testing (e.g., Comprehensive Capital Analysis and Review in the U.S.) can gauge resilience gains. - Close surveillance of indicators that motivated measures and other influencing variables is needed after measures are introduced (para 25). - Promoting effective and efficient use of multiple tools (para 26): - Use of multiple complementary tools can increase effectiveness and reduce leakage costs; marginal benefit of tightening a single tool decreases due to distortions and circumvention incentives. - Examples of complementarities: - Sectoral tools (LTV, LTI, DSTI) address credit demand and complement capital tools (CCB) acting on supply when housing booms accompany broader credit booms. - LTV and DSTI limits complement each other: as house prices increase an LTV cap may be less binding, while DSTI or LTI caps tie credit to income. - DSTI limits enhance LTV effectiveness by containing use of unsecured loans for down payments. - In low interest rate environments, LTI limits or stressed DSTI ratios can complement LTV caps to contain household leverage increases. - Thorough exploration of interactions between tools should be tailored to country-specific circumstances (para 26). *Source: STAFF GUIDANCE NOTE ON MACROPRUDENTIAL POLICY (excerpt).* ### 27. Efficiency considerations can also inform the design and sequencing of tools. While the ### 27. Efficiency considerations can also inform the design and sequencing of tools. While the ### Efficiency and sequencing of instruments - Selection and sequencing should depend on the nature and extent of the risk. - To reduce potential distortions, it can generally be desirable to first introduce tools that work through prices (e.g., capital tools that affect bank’s incentives to lend) before introducing quantitative constraints (e.g., LTV, LTI and DSTI limits). - Caps on exposure to particular borrower types (e.g., caps on exposure to high LTV ratios, as in New Zealand) constrain but do not prohibit such credit provision. - Staff should encourage authorities to move beyond price-based tools to quantitative restrictions when price tools have an insufficient effect on systemic risk (example references: Switzerland FSSA, 2014; Sweden Staff Report, 2014). ### Enforcement, targeting, and trade-offs - More targeted measures are typically more efficient at promoting financial stability but: - May require more information. - Can be more difficult to enforce. - Example: measures to contain credit risks from lending in FX should ideally target unhedged borrowers only; loan-by-loan hedging data is often unavailable, creating enforcement challenges. - Differentiated LTV and DSTI ratios (e.g., distinguishing first-time buyers and investors, or by region as in Korea) may be more efficient but harder to enforce; regional differentiation can face legal constraints (as in Canada). ### Adjustment costs for financial institutions and phase-in - Tools imposing minimum ratios on intermediaries may create adjustment costs that can be mitigated through phase-in or step-wise tightening. - BCBS recommends giving a notice period of up to 12 months to provide banks time to meet a CCB requirement. - Examples: - Korea announced a ceiling on the LTD ratio in December 2009, which banks were expected to meet by the end of 2013 (subsequently brought forward to June 2012). - New Zealand: minimum core funding ratio initially set at 65 percent of total loans and advances in 2010, raised in two steps in 2011 and 2013 to reach 75 percent. ### Measures targeting flows of new lending or funding - Measures that affect the flow of new lending or new funding should take immediate effect to avoid frontloading (e.g., increase in risk-weights on new loans, change in maximum LTV for new borrowers, marginal reserve requirement). - If pre-announced too long in advance, frontloading can occur as borrowers and banks act before the measure takes effect. - A measure targeting flows can generally be tightened more sharply since banks do not need to adjust existing balance sheets; however, caution is warranted due to uncertainty in transmission strength and potential side effects on output. ### Assessing potential costs to output growth - Balance sheet tools (e.g., increased capital and provisioning requirements) increase resilience but often have only weak effects on loan rates and credit volume (IMF, 2013d; BIS, 2010), implying generally weak effects on output. - Effects can be larger when: - Aggressive tightening forces intermediaries to cut lending. - Tightening occurs during financial stress when finding equity or stable funding is difficult. - Recommendation: phase in balance sheet tools (capital buffers, liquidity requirements) gradually and well ahead of financial stress. - Tools addressing flow of new credit (e.g., LTV, DSTI) are expected to have greater impact on output; variation in LTV has meaningful effects on consumption and investment (IMF, 2013d). - Such measures should be tightened gradually, especially when the economy is weak and monetary policy is constrained (e.g., currency unions or the zero lower bound). - Some costs may need to be borne when risks are elevated and tightening is started late. ### Cautious approach and real-time assessment - Uncertainty on the strength of transmission warrants a cautious and gradual tightening approach, iterating between tightening and real-time assessment of effects. - Continued monitoring of triggering indicators and repeated stress testing can assess whether measures have improved resilience (Wong and others, 2014). - Example approaches: U.S. approach to capital buffers; April 2014 GFSR Chapter 1. ### Cross-border and spillover considerations - Tools applied at the level of international banking groups can generate cross-border output costs. - Some tools have effects confined to domestic economy (e.g., CCB, LTV, DSTI). - Other tools (liquidity tools, capital surcharges) apply to all assets of international banking groups and can cause unintended deleveraging across borders. - Unintended cross-border effects are more likely if tightening is ill-timed or occurs during financial stress. - Staff should advise bringing in and tightening such tools in good times with sufficient phase-in to avoid local and cross-border deleveraging. - Regional coordination mechanisms can help assess and mitigate spillovers. ### Guidance consistent with spillover analysis principles - Staff should discuss the full range of spillovers from policies with authorities when those policies may significantly impact global stability. - While members are not obligated to change policies that promote their own stability, staff should recommend alternative policies that achieve objectives at reduced costs to other countries. ### C. When Should Macroprudential Tools be Relaxed? #### Objective and general stance on relaxation - Macroprudential policy aims to prevent disruption to credit provision that can seriously harm the real economy. - Where buffers have been built up, some may be relaxed to support credit provision when systemic risks materialize. - A softening of aggregate demand alone is not sufficient to justify relaxation; macroprudential policy should not be used to manage business cycles (IMF, 2013a). - Financial cycles are generally longer than business cycles; financial imbalances can grow during cyclical downturns (Drehmann and others, 2012). Empirically, through more than half of recessions in their sample, real credit growth stays positive (Drehmann and others, 2010). #### When to consider relaxation - Consider relaxation if: - Systemic risk dissipates. - Systemic risk materializes and financial conditions tighten in a way that threatens to drag down real activity (to arrest adverse feedback loops). - Relaxation is aimed at avoiding credit crunches that depress economic activity and further deteriorate intermediary balance sheets. #### Trade-offs and timing of relaxation - Relaxation during stress involves trade-offs: easing constraints may support credit but must maintain confidence and resilience against future shocks. - Timing must balance costs of relaxing too early (fuels financial imbalances, reduces resilience) versus too late (binding constraints leading to sharper procyclical slowdown). - Prompt release of macroprudential buffers is argued for when signs of incipient systemic financial stress appear (Drehmann and others, 2010; BCBS, 2010; ESRB, 2014). ### Indicators that can guide relaxation decisions - Indicators for loosening differ from those for activation/tightening. Stock variables (e.g., credit-gap) are useful for detecting build-up; market-based indicators and flow variables (e.g., credit growth, default rates) better capture turning points and imminent materialization of systemic risk. - Useful indicators differ across instruments (Table 2 summaries): - Capital tools - High frequency indicators of balance sheet stress (e.g., increases in bank CDS spreads). - Increases in lending rates/spreads. - Slowing credit growth. - Increasing default rates and NPLs/arrears. - Indications of worsening credit supply from lending surveys. - Household tools (residential property: LTV, DSTI) - Decreasing house prices. - Decreasing real estate transactions. - Increasing spreads on household loans. - Decreasing prices of mortgage backed securities. - Slowing net household loan growth (change in stock). - Slowing growth of new household loans (flow). - Increasing household NPLs/arrears. - Note: a fall in house prices alone is not sufficient to justify relaxation; look for additional evidence (sharp slowdown in mortgage credit and transactions, increases in mortgage spreads, defaults/foreclosures, falling prices for real estate–backed securities). - Corporate tools - High frequency indicators (e.g., corporate CDS spreads, bond yields). - Increases in lending rates/spreads. - Decreasing corporate loan growth. - Increasing corporate default rates/NPLs/arrears. - Indication of worsening credit supply from lending surveys. - Liquidity tools - Increasing spread between interbank rate and policy/swap rate. - Increasing wholesale funding costs. - Increased recourse to central bank liquidity windows. - Swap rate of local currency against FX and FX implied volatility. - Reversal of gross capital inflows. - Decision to relax needs considerable judgment, drawing on market intelligence, supervisory assessments and stress tests (ESRB, 2014); early-warning signs may give false alarms and uncertainty will be high. ### Taking account of trade-offs in relaxation and creating policy space - Relaxation needs to ensure system resilience to future shocks; adequate buffers must be built in good times and relaxation should not fall below levels considered safe in downturns. - Staff recommendations: - Encourage a sufficient range of variation of CCBs (beyond the commonly used benchmark of 2.5 percent of risk-weighted assets) and dynamic provisions to create policy space for relaxation (example: Finland Staff Report 2014). - Encourage authorities to define maximum LTV and DSTI ratios considered safe in downturns (perhaps around 85 percent and 45 percent, respectively) to provide space for tightening during risk build-up and relaxation in stress (Detailed Guidance: Household sector tools). - Encourage liquidity ratios to be calibrated more tightly to address systemic liquidity risk, creating policy space for relaxation while respecting prudential minima in downturns; relevant for net stable funding ratio, where Basel calibration will need to account for country-specific circumstances and may often need to be tighter than the Basel minimum (Gobat and others, 2014). *Source: IMF staff guidance note excerpt.* ### 45. Tools can be relaxed more readily where the effect on resilience is small. For instance, ### 45. Tools can be relaxed more readily where the effect on resilience is small. For instance, ### Relaxation of macroprudential tools — principles and effects - Relaxations that are confined to new exposures have less effect on banks’ resilience (BoE, 2014). - Relaxation of caps on LTV and DSTI ratios affects only new loans and refinancing, thereby preserving resilience for existing exposures. - Relaxation of stamp duties can support the housing market and should be considered before relaxing LTV/DSTI, since a relaxation does not reduce the resilience of borrowers or banks (Hong Kong SAR Staff Report, 2014). - Tools addressing structural risks or FX risks in the household and corporate sector will rarely need to be relaxed. ### What influences the effectiveness of a relaxation? - The effect on credit depends on circumstances and on how binding the tool is as a constraint. - Capital tools: - Constraints more likely to be binding in bad times, when earnings are subdued and finding new equity is difficult (IMF, 2013d). - Market discipline may impose a tighter constraint when buffers are not regarded as sufficient, reducing the effect on credit of a relaxation. - LTV and DSTI tools: - Effects on mortgage credit depend on the share of existing borrowers constrained by falling house prices and on new demand unlocked by relaxing DSTI and LTV. - Depend also on banks’ response to changes in caps. - Liquidity tools: - In the presence of liquidity stress, liquidity tools are likely to become binding; their relaxation should help sustain credit and avoid fire-sales. - Relaxation can accommodate investors’ preference to shorten funding maturity in stressed conditions and need not entail loss of confidence. - Empirical literature (IMF, 2013d; Jiménez and others, 2012; Igan and Kang, 2011) is not inconsistent with largely symmetric effects on credit of relaxations and tightenings, but data on relaxation episodes is still relatively scant and results are not conclusive. ### Sequencing and policy mix - Sequence policy response to the source of incipient financial stress: - If corporate or household solvency weakens without liquidity stress → prioritize relaxation of broad-based capital or housing-related tools rather than liquidity tools. - If liquidity stresses emerge before domestic solvency weakens → prioritize relaxation of liquidity tools. - If liquidity stresses arise from a global shock to investor confidence → consider relaxing liquidity tools while increasing capital buffers or tightening other macroprudential measures to restore investor confidence. - Relaxation of liquidity tools may need to be complemented by other actions: - Provision of emergency liquidity assistance by the central bank. - Monetary policy accommodation, including easing collateral requirements and provision of emergency liquidity. - Steps to maintain confidence, such as stress testing of individual banks to demonstrate system resilience (IMF, 2013a). ### Communication of macroprudential policy - Staff should advise authorities to communicate openly on macroprudential policy to improve transmission when measures are taken or relaxed (IMF, 2013a; Giese and others, 2013). - Benefits of an ex ante policy strategy: - Elaborates objectives, decision-making process, and expected transmission of tools. - Fosters public awareness and acceptance (Domanski and Ng, 2011). - Counters biases in favor of inaction and improves accountability (Goodhart, 2011). - Prepares markets for relaxation of buffers and can reduce adverse confidence effects. - Benefits of periodic risk assessments and ex post assessments: - Periodic risk assessments should be comprehensive and include recent indicator readings. - Ex post analysis of effectiveness creates a measure of success, builds credibility, and can support further measures if objectives are unmet. - Such assessments may form part of a (semi-annual) Financial Stability Report or a periodic macroprudential authority report. - Benefits of publishing a record of meetings: - Establishes transparency on issues discussed and clarity on votes cast (IMF, 2013a). - Helps establish a narrative to prepare markets and the public and can signal commitment to using macroprudential policy. - Identifying votes increases likelihood that dissenters must explain themselves during crises. ### Limits to transparency - Staff should generally not call for publication of detailed minutes because: - Early release of deliberations can lead to frontloading of credit activity (e.g., for LTV). - Risk of adverse market reactions during stress and the need to avoid releasing institution-specific information. - Potential for public or political backlash from revealing deliberation details. - Advice should weigh drawbacks of open communication and ways to address them (see footnote 14). ### Leakages of macroprudential tools: assessment and strategies - Leakages: migration of financial activity outside scope or enforcement of tools, undermining policy objectives. - Domestic leakages: activity moves to domestic providers outside initial scope (e.g., bank-affiliated leasing companies in Croatia). - Cross-border leakages: activity moves to foreign providers (branches, subsidiaries, or direct foreign entities). - Staff and authorities should: - Assess leakages ex ante and monitor them ex post. - Monitor nonbank activity for domestic leakages and cross-border credit flows for cross-border leakages. - Consider preemptive measures to avoid rapid leakages and advise on remedies when detected. ### Strategies to contain leakages - Expand scope of application to domestic nonbanks, connected entities, and foreign providers where feasible, recognizing legal and operational challenges. - Containment by tool type: - Broad-based and corporate sector tools: - Domestic leakages through connected nonbank entities can be addressed by consolidation requirements. - Cross-border leakages are acute for corporate credit that can be sourced abroad; strategies include reciprocity arrangements, greater host-control, CFMs, and fiscal policy. - Household sector tools (LTV and DSTI): - Main challenge is domestic leakage; apply borrower eligibility criteria to all products and enforce across regulated institutions. - May require cooperation across supervisory agencies or expansion of licensing for unregulated entities. - Address arbitrage between government-provided insurance/securitization and private label securitization by harmonizing eligibility standards (example: Canada mandated private mortgage insurers follow government rules in 2008). - Direct cross-border leakages less likely for household loans due to disadvantages foreign banks face in local retail credit appraisal and collateral. - Liquidity tools: - (Section begins but content beyond provided excerpt; see source for continuation.) ### Box 2 — Strategies to Address Cross-Border Leakages (summary) - Reciprocity: - Core of Basel III CCB: when activated in one country, reciprocity requires other countries’ supervisors to apply the same buffer on their banks’ exposures into the host country as long as the buffer does not exceed 2.5 percent of risk-weighted assets (above which reciprocity is voluntary). - Internationally active banks face the CCB as a weighted average of CCBs in countries where they have exposures. - No international agreement mandates reciprocity for increases in sectoral risk weights for corporate exposures; staff should encourage bilateral/regional agreements, especially in highly integrated regions. - Greater host control: - Encourage or require local affiliates to be subsidiaries rather than branches so they can be subject to local capital and macroprudential regulation (examples: Brazil, Mexico, New Zealand). - Legal constraints in some jurisdictions (e.g., EU) can prevent conversion of branches to subsidiaries. - Host-control can impose costs on parents (capital and liquidity ring-fencing); staff should consider spillovers and recommend lower-cost alternatives where available. - Capital flow management measures (CFMs) and fiscal policy: - CFMs may help limit inflow-driven credit growth from international nonbank investors, provided they do not substitute for warranted macroeconomic adjustment or regulatory measures. - Alternatives include increased taxation of corporate profits, measures correcting tax bias in favor of corporate debt, or tax penalties on FX borrowing. *Staff Guidance Note on Macroprudential Policy — excerpted content* ### 60. Where liquidity tools are applied to the domestic banking system, maturity ### _110614 - 60. Where liquidity tools are applied to the domestic banking system, maturity ### Liquidity tools and migration of maturity transformation - Where liquidity tools are applied to the domestic banking system, maturity transformation can migrate to domestic nonbanks. - If sizable maturity transformation occurs in parts of the system that remain connected to the banking system (as with Asset Backed Commercial Paper conduits ahead of the crisis), such activity can be consolidated on the balance sheet of the core system and thereby be subject to the scope of the liquidity tools. - Liquidity tools can be extended to nonbank providers of maturity transformation directly, even if this requires cooperation of separate supervisory agencies (see further Detailed Guidance: Liquidity tools). - Example given: U.S. Money Market Mutual Funds where liquidity requirements have been tightened since the crisis. - International principle: regulatory authorities can apply liquidity requirements to both foreign subsidiaries and branches (Basel Concordat), reducing cross-border leakage of liquidity tools. - In principle, central banks can apply reserve requirements to nonbank financial companies (as in Turkey and Serbia), as well as foreign branches, reducing cross-border leakages. ### Country characteristics shaping macroprudential policy advice (overview) - Staff advice on macroprudential policy must fully account for country circumstances. - Time-dimension advice should reflect a wide range of factors, including: - (i) the availability of data and strength of supervisory capacity, - (ii) the level of debt to GDP and pace of growth of credit, - (iii) the country’s economic structure, such as its degree of diversification, - (iv) the degree of capital account openness and financial integration. - Structural-dimension needs are determined by the size, structure and complexity of the financial system. - The distinction between low income, emerging and advanced economies is, in general, less useful as a starting point for staff advice. - Further considerations for low income countries are set out in a dedicated note. ### Constraints from data and supervisory capacity (paras 62–63) - Lack of data and supervisory capacity can constrain macroprudential policy: - Both assessment of systemic vulnerabilities and deployment of macroprudential tools can be hampered by lack of data and supervisory capacity. - This applies to low income countries and to emerging and advanced economies where data availability and supervisory capacity has not kept up with financial development and cross-border integration. - Staff will often need to emphasize improvements in these areas as a precondition for effective use of macroprudential policies. - Example: Effective enforcement of tools applied to borrowers, such as LTV and DSTI, relies on establishment of a credit register to compute these ratios at the borrower level. - Where detailed information is missing or the supervisory environment is weak, greater emphasis may be needed on permanent capital buffers to increase banking system resilience. - Analysis of the ratio of credit to GDP should be a starting point irrespective of financial development: - Rapid growth in credit relative to economic activity can signal need for action even when financial depth started low. - Literature finds systemic crises are usually preceded by rapid growth in credit relative to GDP; the “credit to GDP gap” is the best single early-warning indicator of crises, signaling crises five to three years in advance. - The credit gap accounts for differences in trend growth in credit to GDP and accommodates financial deepening. - The credit gap’s signaling properties hold for emerging market economies as well (ESRB, 2014; Drehmann and Tsatsaronis, 2014). - The credit gap should be used as part of a broader assessment because of potential for Type I and Type II errors. - Computation of the credit gap requires quarterly series of both credit aggregates and GDP of at least ten years; where unavailable, assessment should start with other credit measures such as annual growth in the ratio of credit to GDP. ### Country-specific factors in evaluating systemic risk from credit/GDP increases (para 64) - Factors that support healthy financial deepening: - Improvements in the legal framework (e.g., reforms enabling greater mobilization of collateral). - Improvements in lenders’ information on borrowers (e.g., establishment of a credit register). - Improvements in payment and market infrastructures supporting interbank markets. - Factors pointing to increased systemic risk: - Rapid credit growth fuelled by financial and capital account liberalization, associated with increased competition, deterioration of lending standards and increased use of wholesale funding strengthens case for macroprudential action. ### When credit growth has slowed (para 65) - Even where credit growth has slowed, macroprudential action may be needed: - A prolonged credit boom resulting in a high level of private sector indebtedness, possibly with asset price overvaluation, can justify macroprudential action even if credit growth has slowed. - High household or corporate indebtedness can amplify vulnerability to income, interest rate and asset price shocks and justify imposition of capital buffers even where credit growth has slowed and the credit gap has closed. - Other tools targeting borrower resilience that might induce gradual deleveraging (e.g., LTVs, LTIs, DSTIs) should be considered. ### Economic structure and macroprudential approach (para 66) - Where financial and business cycles move in lockstep and are driven by volatile external factors, emphasis should be on establishing high resilience of the financial system. - Particularly relevant for countries with low economic diversification or resource-rich countries with cycles driven by volatile commodity prices (IMF SDN/14/1). - This calls for a more rules-based macroprudential approach that works through automatic stabilizers (e.g., dynamic provisioning regimes, conservatively calibrated LTV and DSTI ratios), with calibration guided by judgment. - Complementary permanent capital buffers beyond international minima may be warranted and would be relaxed only in the event of a large external shock. - Creation of macroprudential policy buffers should be accompanied by fiscal buffers to allow their use in large adverse shocks (IMF SDN/14/1). ### Capital account liberalization and financial integration (paras 67–68) - Capital account liberalization increases need for macroprudential policy: - Full capital account liberalization is not an appropriate goal for all countries at all times (IMF, 2012a). - Liberalization should proceed gradually and sequentially starting with foreign direct investment and resident outflows. - Liberalization of portfolio and banking inflows needs careful management, including strong macroprudential policy to address potential build-up of financial stability risks. - Potential build-up of systemic risks from increases in short-term wholesale funding of the banking system and increased FX exposures will need management using liquidity and FX-related macroprudential tools. - Capital account liberalization can increase exposure to global financial conditions and reduce monetary policy autonomy; may require measures countering increases in financial stability risks from low interest rates in major currencies. - Financial integration increases scope for cross-border leakages of macroprudential policy: - Macroprudential tools (such as the CCB and sectoral capital tools) can increase domestic resilience but may shift credit across borders. - In highly financially integrated countries/regions, strategies to address leakages are required (e.g., reciprocity arrangements for macroprudential tools at regional level; closer regulatory control for host authorities over foreign branches). - These approaches aim to level the playing field between foreign and domestic credit providers and should be combined with mechanisms to monitor risks and cross-border impacts at the regional level. - Examples: The ESRB and the Nordic-Baltic Macroprudential Forum. ### Structural-dimension considerations (paras 69–70) - Large and interconnected financial systems warrant greater need for structural measures: - Where financial system assets are large as a percentage of GDP, inter-linkages or asset concentration can render institutions “too important to fail” or “too big to save.” - Staff should consider capital surcharges on domestic systemically important institutions in line with Basel Guidance, and other measures to contain likelihood and impact of failure (see Detailed Guidance: Structural tools). - Cross-border operations, funding market involvement, credit market concentration, or derivatives market activity increase potential for systemic cross-border spillovers. - Greater emphasis on assessing inter-linkages and measures to contain knock-on defaults is warranted where the domestic system is complex and characterized by cross-exposures between banks and nonbank institutions. - Highly concentrated systems may require structural measures even if interconnectedness is low: - In mainly bank-based systems with shallow interbank markets, concentration can make most or all banks systemically important. - Macroprudential measures have a role in containing risk of failure in such banks, supplementing enhanced supervision. ### Interaction with other policy settings (paras 71–76) - Staff advice should account for prevailing monetary conditions and other policy settings (fiscal, structural, financial sector) and advise on the policy mix best suited to achieve financial and macroeconomic stability. - Care is needed to ensure macroprudential policy does not substitute for needed macroeconomic policy adjustment. How advice should take account of monetary policy settings (paras 72–75) - Macroprudential measures may be needed to contain adverse financial stability effects of the monetary policy stance (IMF, 2013a): - Accommodative monetary policy in weak economy with subdued inflation can build financial stability risks through feedback between asset prices and leverage and increased prevalence of variable rate contracts. - Where such developments occur in real estate markets, tighten LTV and/or LTI ratios and apply (stressed) DSTI ratios (IMF, 2013d; Detailed Guidance: Household sector tools). - To counter prevalence of interest-only mortgages and overstretched borrower balance sheets, staff can advise introducing maximum amortization periods (examples: Canada, the Netherlands, Hong Kong SAR, Singapore). - Small open and emerging economies: - Differentials between domestic and foreign policy rates can increase FX and liquidity risks, leading to FX-denominated borrowing and short-term FX borrowing by the financial system. - FX-induced credit risks tools include higher risk weights, tighter LTV and DSTI ratios for FX loans, and caps on share of FX loans in total new loans. - Liquidity risk tools include measures that penalize and lengthen average maturity of FX wholesale funding, such as differentiated reserve requirements and liquidity buffers applied by currency, core funding ratios and levies on FX wholesale funding (see Detailed Guidance: Liquidity tools). - Currency unions and pegs: - Currency unions (e.g., European Monetary Union) pose challenges since center-chosen policy rates can produce differing effective stances across members; macroprudential policies are needed at national level and must be coordinated across union members. - For currency pegs and currency boards with open capital accounts, in absence of exchange rate flexibility strong countercyclical fiscal policy is needed together with macroprudential policy to address credit booms and asset bubbles (IMF SDN/14/1). How other policies can reduce burden on macroprudential policy (para 76) - Given imperfections of macroprudential policy (leakages, uncertain effect sizes), staff should explore other policy changes to avoid overburdening macroprudential policy: - Where monetary policy stance is inappropriately loose, tighter monetary policy can reduce burden on macroprudential policy. - If monetary policy is appropriately set, macroprudential policies should be first line of defense for financial stability side effects. - Staff may explore fiscal stance adjustments to improve overall policy mix (e.g., greater fiscal support can reduce need for prolonged low policy rates). - Real external imbalances should be addressed by appropriate fiscal and structural policies; macroprudential policy can complement but not substitute for these macroeconomic adjustments. - Correcting tax biases favoring debt financing (e.g., mortgage interest relief, light taxation of imputed rent, corporate tax preference for debt over equity) can help reduce systemic risk and the burden on macroprudential policy (IMF, 2013b). - Adverse feedback between sovereign and financial sector solvency requires strong ex ante fiscal and resolution frameworks; macroprudential policy is ill-equipped to prevent such feedback loops once they set in. - Systemic liquidity risks in nonbank financial markets may require policy responses beyond macroprudential tools: - Macroprudential intervention can be extended to nonbank intermediaries/activities (money market mutual funds, collective investment schemes, securities lending) to reduce run and fire sale externalities (experience limited to date; see Detailed Guidance: Liquidity tools). - In developing and emerging markets there is scope to develop local markets to increase resilience, e.g., improving ability of long-term institutional investors to absorb sudden capital flow changes. - Need to assess ability of government or central bank to provide liquidity in times of stress (see Detailed Guidance: Liquidity tools). *STAFF GUIDANCE NOTE ON MACROPRUDENTIAL POLICY — INTERNATIONAL MONETARY FUND* ### 77. A strong institutional framework is essential to ensure that macroprudential policy can ### A strong institutional framework is essential to ensure that macroprudential policy can work effectively ### Importance of a strong institutional framework - A strong institutional framework is essential to: - Assure willingness to act and counter biases for inaction or insufficiently timely action that can arise from difficulties in quantifying the benefits of macroprudential action, lobbying by the financial industry, and political pressures. - Foster the ability to act in the face of evolving systemic threats by assuring access to information, effective surveillance capacity, and assigning an appropriate range and reach of macroprudential instruments to the macroprudential authority. - Promote effective cooperation in risk assessments and mitigation while preserving the autonomy of separate policy functions (IMF, 2013a; IMF SDN/11/18; IMF, 2013c). - Where an institutional framework is lacking or deficient, it can pose material risks for both domestic and global stability; bilateral surveillance should cover such risks and staff should develop recommendations to strengthen frameworks where needed. ### A. How can the framework assure “willingness to act?” - Assign the macroprudential mandate to a body or committee to avoid collective action problems, ensure responsibility, and increase accountability. - The central bank is desirable to play an important role because it: - Harnesses central bank expertise in systemic risk identification. - Fosters coordination between macroprudential and monetary policy while preserving monetary policy independence. - Helps shield macroprudential policymaking from political interference (IMF, 2011a; IMF SDN/11/18; IMF, 2013a). - Three increasing-prevalence institutional models for macroprudential policymaking: - Model 1: Mandate assigned to the central bank, with its Board or Governor making macroprudential decisions (examples: Czech Republic, Ireland, New Zealand, Singapore). Where supervisory/regulatory agencies are outside the central bank, complement with coordination mechanisms (e.g., coordination committee chaired by central bank; explicit powers for central bank to make recommendations to other regulatory bodies as in Norway and Switzerland). - Model 2: Mandate assigned to a dedicated committee within the central bank structure (examples: U.K., Malaysia). Benefits include dedicated objectives/decision-making structures separating monetary and macroprudential mandates and inclusion of separate supervisory agencies and external experts in the committee. - Model 3: Mandate assigned to a committee outside the central bank, with central bank participation (examples: Australia, France, U.S.). This can accommodate a stronger role for the Ministry of Finance (MoF), useful when legislative changes or fiscal cooperation are needed to expand tools or regulatory perimeter. - Risks and mitigating features regarding MoF involvement: - A dominant role of the MoF risks delaying action and compromising independence of agencies (IMF SDN/11/18; IMF, 2013a). - Mitigants: central bank chairmanship (as in Australia), a strong central bank voice (as in Mexico), or a veto for the central bank (as in Germany); ensure a strong role for central bank independent analysis (as in Germany). - Well-defined objectives and accountability: - A clear objective in law fosters willingness to act and reduces risk of inaction or abuse of macroprudential policy. - Objectives can articulate responsibilities in time and structural dimensions, e.g., to (i) maintain overall resilience of the system; (ii) contain risks from unsustainable increases in credit and leverage; and (iii) contain structural risks from inter-linkages within the financial system. - Secondary objectives (e.g., ensuring financial system supports long-run economic growth, protecting depositors) can be specified but the primary objective needs clear priority. - Communication tools in an accountability framework help the public assess actions and foster commitment and public accountability. - Institutional support measures: - Establish dedicated financial stability units or departments to analyze systemic risks, develop and monitor core indicators, and prepare policy proposals—preferably within the central bank. - Working-level subcommittees to the main macroprudential committee can prepare policy responses. - If the treasury plays an important role, an independent office within the treasury can support its work (example: U.S. Office for Financial Research). ### B. What powers are needed to assure “ability to act?” - Powers are required to obtain information, fill data gaps, influence regulatory calibration, designate systemically important institutions, and expand the regulatory perimeter (information powers; calibration powers; designation powers) (IMF, 2011a). - Strength and types of powers: - Hard (direct) powers: give the policymaker direct control, avoid implementation delays, useful for tools that control rapid build-up of risks in the time dimension (example: U.K.), and for designation of systemically important institutions (example: U.S.). Direct powers provide a credible ‘stick’ and can serve as a back-up (example: U.S. Office for Financial Research’s back-up power to collect information directly). - Semi-hard powers: enable formal recommendations to other agencies coupled with a ‘comply or explain’ mechanism. Advantages include breadth of influence across regulatory actions; ‘comply or explain’ increases compliance, transparency, and public accountability and can strengthen the hand of separate supervisory agencies when facing industry or political pressure. - Soft powers: enable expression of opinions or recommendations not subject to ‘comply or explain’. Useful to extend influence beyond prudential tools and the existing regulatory perimeter—appropriate when addressing the legislature to initiate new tools or legal changes, or when mitigation requires cooperation beyond regulatory authorities (e.g., fiscal authorities and tax-code changes fueling debt build-up). - Combination of powers: effectiveness often benefits from combining hard, semi-hard, and soft powers; soft powers alone are unlikely to suffice (IMF, 2013a). ### C. How can the framework foster cooperation in risk assessment and mitigation? - Key mechanisms to ensure cooperation: - Resolve legal impediments to sharing supervisory data. - Involve relevant supervisory and regulatory agencies in decision-making bodies to reconcile perspectives and create ownership of decisions. - Include financial stability objectives in mandates of separate regulators to reduce conflicts and increase compliance with recommendations (example: U.K. securities regulator) (IMF SDN/11/18; IMF, 2013c). - Overlapping membership between monetary and macroprudential decision-making bodies and provision of common analysis to both committees can foster coordination without eroding monetary policy independence (example: U.K.). - Crisis management and coordination: - Policy coordination in crisis times requires dedicated arrangements distinct from the macroprudential policy framework (IMF SDN/11/18). - Crisis management may require actions beyond prudential tools, including monetary easing, emergency liquidity assistance by the central bank, effective resolution of failing banks by resolution or deposit insurance agencies, execution of contingency plans, and potential public guarantees and capital support by fiscal authorities. - Dedicated crisis-management arrangements should coordinate macroprudential and crisis management functions, and can allow the treasury to assume a greater role when the central bank is central to macroprudential policy (IMF, 2013a). - Practical coordination: overlapping membership so key supervisory and regulatory agencies and the chair of the macroprudential body participate in crisis management arrangements. *Source: STAFF GUIDANCE NOTE ON MACROPRUDENTIAL POLICY (excerpts).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2014/_110614.pdf_