Responsibility for the new policy area will be shared. National macroprudential authorities will be the first to act. The range of instruments includes higher buffer requirements for systemically important banks, stricter requirements for mortgages and a countercyclical capital buffer, which takes account of credit growth in setting capital requirements for banks. The ECB may use its ‘topping up’ power to tighten any measures imposed, insofar as they relate to the banking sector. While experience with macroprudential policy has so far been limited, quite a few countries have taken measures in this area. Expectations are that many others will follow suit.
Why is it important?
Financial imbalances, especially those in the banking sector, can have disastrous repercussions, as the financial crisis has made painfully clear. Moreover, the European sovereign debt crisis showed that diverging financial developments within a currency union can also lead to loss of welfare. Experiences like these highlight the importance of macroprudential policy, which seeks to counteract excessive financial developments, thereby reducing the likelihood and impact of financial crises. Such developments are not limited to excessive mortgage lending and commercial property financing, but also include the interdependencies between governments and banks, as they became manifest during the European sovereign debt crisis. In the euro area in particular, financial imbalances must be addressed at an early stage, given that the single monetary policy cannot target diverging national financial cycles.
How does it work?
In the wake of the crisis, macroprudential policy frameworks have been put in place for implementation across the globe. In Europe, all countries have designated national macroprudential authorities, which are in charge of safeguarding financial stability through macroprudential instruments. These instruments, such as higher capital buffers and stricter mortgage lending requirements, were recently applied in several countries (see Table 1). In the Netherlands, DNB raised capital buffers for Dutch systemically important banks, while the loan-to-value (LTV) ratio for mortgage loans is gradually being lowered to 100%. Other European countries, such as Belgium, Ireland, the United Kingdom and Sweden, took macroprudential measures in a bid to mitigate systemic risks arising from their housing markets and large, concentrated banking sectors. Likewise, measures have been taken outside Europe, including in Asia and the United States, to slow down cycles in credit growth and asset prices, and to bolster the banking sector.
Table 1: Recent macroprudential measures
|Belgium||Increased risk weights for mortgage loans|
|Increased capital requirements for high-risk trading activities|
|Hong Kong||LTV limit for mortgage loans|
|Transaction tax where homes are resold|
|Ireland||LTV and loan-to-income (LTI) limits for mortgage loans|
|Netherlands||Higher capital buffers for systemically important banks|
|LTV limit for mortgage loans|
|United Kingdom||Increased risk weights for commercial property|
|LTI limit for mortgage loans|
|United States||Higher leverage ratio for banks|
|South Korea||Taxes on foreign capital flows to banks|
|Sweden||Increased risk weights for mortgage loans|
|Higher capital buffers for systemically important banks|
|Countercyclical capital buffer|
|Switzerland||Higher capital buffers for systemically important banks|
|Countercyclical buffer for mortgage loans|
The table lists selected large and medium-sized countries.
For a more extensive overview please go to http://www.bis.org/publ/qtrpdf/r_qt1309i.htm (for housing markets) or https://www.ecb.europa.eu/pub/fsr/shared/pdf/sfafinancialstabilityreview201405en.pdf (for Europe)
A bias for action
Macroprudential policy is very much terra incognita - authorities will be treading on new terrain, without past experience as a reliable guide. To exchange views and benefit from them, DNB recently hosted a seminar for policymakers, examining officers and academics. Key insights from the seminar have been gathered in a DNB Occasional Study. It is clear that macroprudential policy may be particularly effective in Europe, given that financial systems are still organised along national lines and are dominated by banks. After all, macroprudential instruments primarily target the banking sector, which means they could dampen financial cycles in EU Member States along that path. A further insight gained is that real estate, notably the housing market, is fundamental to financial stability. To a large degree, therefore, macroprudential policy will need to address imbalances in the financing of the real estate sector.
In addition, macroprudential policy action is hampered by inaction bias. Macroprudential measures have tangible short-term costs – such as higher capital buffers for banks – but less visible long-term gains, such as the prevention of a financial crisis. The innate tendency is therefore to delay policy action. To counteract that tendency, macroprudential authorities could use risk indicators that identify an excessive build-up of risks and signal that action is warranted. If those indicators and alerts are publicly available, authorities will be able to account for their actions and can be held accountable, should they fail to take action.