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24-25 SEPTEMBER
TIANJIN
2014
International Conference of Banking Supervisors
Venue: The Renaissance Tianjin Lakeview Hotel, Tianjin, China
The Post-Basel III Agenda
September 2014
Workshop 2
The interaction between macro- and microprudential policy
and supervision
Chair: Kerstin af Jochnick, First Deputy Governor, Sveriges Riksbank
As the primary objective of banking regulators and supervisors, the safety and soundness of banks sets
an important foundation for overall financial stability. However, ensuring the health of individual
components of the financial system is not sufficient to guarantee overall financial stability. In particular, it
is important to recognise the importance of systemic risk, and how individual banks’ actions can spread
distress through direct linkages and common exposures. This macroprudential view of the overall
financial system complements and reinforces microprudential regulation and supervision, fostering an
environment where individual firms and the overall financial system are more resilient to shocks. Taken
together, the financial crisis has underscored the need for a coherent risk assessment and policy
framework, with appropriate domestic and cross-border arrangements for cooperation and the
necessary powers and tools to secure durable financial stability and growth.
However, there are important preconditions for a successful use of micro- and macroprudential
tools and ensuring that the two frameworks act to reinforce rather than conflict with each other. First,
authorities must further develop tools for identifying vulnerabilities and assessing risk. Second, there is a
need to understand the important interactions not only between micro- and macroprudential policies,
but also with monetary and fiscal frameworks. Third, these interactions highlight the need for
appropriate cooperation and communication between policymakers and other stakeholders, both
domestic and cross-border.
1.
Understanding microprudential and macroprudential frameworks
As noted above, microprudential policies aim to ensure the safety and soundness of individual financial
institutions, by setting effective limits on risk-taking. Macroprudential tools aim to increase the resilience
of the overall system, but also to lean against the build-up of imbalances in the system. FSB, IMF and BIS
(2011) explain macroprudential policy as one that uses prudential tools to limit systemic or system-wide
financial risk. In this context, systemic risk is defined as the risk of disruption to financial services that is
caused by an impairment of all or parts of the financial system and that also has the potential to have
serious negative consequences for the real economy. Therefore, while it would be incorrect to say that
microprudential policies ignore interconnectedness, the focus on system-wide stability is an explicit
objective of macroprudential frameworks.
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As a result, the analytical scope of these two frameworks will necessarily differ, but are mutually
reinforcing. While microprudential frameworks tend to focus on individual firms or, in our case, banks,
macroprudential frameworks broaden the scope to the whole financial system, including non-bank
financial institutions, financial markets, and also governments and the real economy.
Table 1 below compares the different analytical frameworks for assessing financial stability.
Microprudential policies tend to focus on idiosyncratic risk, often driven by exogenous shocks. Systemic
risk, on the other hand, has both a time dimension and a cross-sectional dimension (Borio (2003)). The
time dimension emphasises the build-up of risk over time, including increases in concentration,
procyclical forces, and amplification mechanisms. The time dimension also incorporates second-round
effects into the analysis. The cross-sectional dimension, in contrast, describes systemic risk at a given
point in time, focusing on transmission channels such as direct linkages and common exposures.
Therefore, endogenous shocks become more central when risk is viewed through a systemic lens.
The macro- and microprudential perspectives compared
Proximate objective
Ultimate objective
Model of risk
Correlations and common
exposures across institutions
Calibration of prudential
controls
Examples of tools
Table 1
Macroprudential
Microprudential
Limit financial system-wide distress
Limit distress of individual institutions
Avoid output (GDP) costs
Consumer (investor/depositor)
protection
(In part) endogenous
Exogenous
Important
Irrelevant
In terms of system-wide distress; topdown
In terms of risks of individual
institutions; bottom-up
Countercyclical capital buffer, LCR drawdown, higher loss absorbency
requirement for systemically important
banks, recovery and resolution plans,
macro stress tests
Minimum capital requirements,
minimum liquidity requirements,
heightened supervision, bottom-up
stress tests
Sources: Borio (2003), BIS staff.
2.
Opportunities: learning from the crisis
While it has come to wider prominence in the wake of the crisis, the term “macroprudential” was used by
policymakers as early as 1979, at a Basel Committee meeting. 1 While it appears that authorities
understood the importance of both micro- and macroprudential aspects, the concept was not well
known in the public domain and a coherent framework to understand interactions between
microprudential and macroprudential policies had not yet been developed. However, many countries
have employed (what we now call) macroprudential tools to mitigate rising risks and fight crises in the
recent past (see, for example, IMF (2012)).
The global response to the financial crisis has incorporated the lessons learned and reinforced
the need to exploit the benefits of both micro- and macroprudential regulation and supervision. The
Basel III framework is still fundamentally a set of reforms to microprudential regulations and supervision.
However, taking the lessons learned from the crisis, the framework incorporates a number of
1
A later report to the G10 Governors stressed the importance of both micro- and macroprudential supervision of the
international banking system (Clement (2010)).
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macroprudential elements. For example, the countercyclical capital buffer and the ability to draw down
liquidity under the LCR both promote the building of resilience in normal times, but they also have
countercyclical properties. The large exposures framework helps manage risk concentrations and reduce
excessive interlinkages, which are both micro- and macroprudential by construction. Finally, the higher
loss absorbency requirement for systemically important banks (SIBs) forces the SIBs to internalise the
negative externalities they might otherwise impose on the financial system. Other policy measures
include the creation of recovery and resolution plans, as well as central counterparty clearing of
derivatives trades.
Complementing regulatory reforms and enhanced supervision, authorities have developed, and
some are using, macroprudential tools. As mentioned above, a number of jurisdictions are reviewing
their use and understanding of such tools. Some jurisdictions are also formally incorporating these tools,
and frameworks for activating them, into legal and other frameworks (see Annex 1 for an example from
the EU).
In order to implement these tools, jurisdictions have (or should have) also established or
enhanced institutional frameworks, both domestically and those which promote greater cross-border
cooperation. However, in most cases, cross-border initiatives still rely solely on non-legislative
“cooperation”. Many jurisdictions have established or strengthened macroprudential/systemic risk
councils that comprise banking supervisors, central banks, deposit insurers, finance ministries and other
relevant agencies.2 These domestic arrangements complement global forums, including the primary
international standard setters, such as the Basel Committee for Banking Supervision, and other
bilateral/multilateral forums, including supervisory colleges and crisis management groups.
3.
Challenges for the future: preconditions to optimise policy frameworks
Notwithstanding significant advances in the development of micro- and macroprudential frameworks in
both academic and policymaking circles, several important practical challenges must be mastered when
implementing these regimes.3 First, policymakers need to further develop analytical frameworks to
assess systemic in addition to idiosyncratic risks. Second, we need a better understanding of the
interactions between micro- and macroprudential policies, as well as their interactions with other
policies, such as monetary and fiscal policies. Third, institutional arrangements must be optimised to
exploit the complementarities between different policies and to ensure that policy tools are effectively
deployed.
3.1
Assessing vulnerabilities and risk
Our understanding of systemic risk, endogenous reaction functions and transmission channels is still
developing. Several analytical frameworks are used. At the most basic, these can include the assessments
of indicators of potential imbalances for individual firms, the overall financial system and the real
economy, such as balance sheet indicators, market-based indicators and macroeconomic variables.
However, these models are still in development and it is difficult to incorporate features that are
important for understanding systemic risk, eg contagion channels, amplification mechanisms, and there
2
Some examples include the US Financial System Oversight Committee, and the European Systemic Risk Board.
3
CGFS (2012) set forth some broad principles for the design and operation of macroprudential policy, including some
challenges discussed in this section.
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are also substantial challenges with operationalising these models for policy analyses, including issues
with the robustness of data sets (see Enria (2012)).
Most importantly, policymakers need to gain more experience in interpreting data, indicators
and models in order to develop and communicate policy decisions. In addition to the challenges noted
above, authorities must feel confident that the signals from analytical frameworks are sufficiently robust
for policy decisions to be based on them. This will develop over time as models develop and are
implemented. However, conflicting signals or a lack of confidence in the results of data-driven analyses
can result in hesitancy on the part of macroprudential authorities to take firm policy measures. This
could increase the dependence on other authorities and/or more “tried and true” policy frameworks,
exacerbating inaction bias by prudential authorities.
3.2
Understanding interactions between policy frameworks
As noted in Section 1, micro- and macroprudential policies can reinforce each other. While the
frameworks and tools may differ, macro- and microprudential policies share the same goal, which is to
reinforce the resiliency of banks and the banking system, including the latter’s interactions with other
parts of the financial system. This will enable banks to better absorb shocks and allow for continuous
operations, thus insulating the real economy from wealth destruction and large losses in economic
activity. Reinforcing positive interactions between the two viewpoints, as well as the agencies charged
with their execution, is important in securing these objectives.
However, there is some potential for conflict if micro- and macroprudential policies are not
coordinated. One source is what Crockett (2000) refers to as the “fallacy of composition”, when an action
that is optimal from an individual’s point of view is not in the common interest. For example, when faced
with a liquidity shock, a bank may act to reinforce its liquidity position. It may do so by selling securities
into the open market to generate cash or reducing contingent liquidity commitments to customers. Both
actions can lead to liquidity constraints on other agents in the financial system through common
exposures or interconnectedness. However, microprudential policies can also serve to reinforce systemwide resilience. As seen in Section 2, many of the microprudential reforms undertaken in the wake of the
crisis now incorporate macroprudential elements. In this way, overall financial stability can be fostered by
bolstering the resilience of individual banks, as calibrated to the negative externality they pose to the
system.
Importantly, there is a need to consider interactions between the financial system and the real
economy. This may be even truer when there is a need to coordinate across multiple objectives, such as
financial system stability, price stability and growth. One potential conflict is rooted in the observation
that business cycles and financial cycles are not always in synch; financial cycles tend to be longer and
have a higher amplitude than business cycles (see, for example, Drehmann et al (2012)). If this is the
case, actions taken by monetary policy or fiscal authorities to maintain price stability and encourage
growth may unintentionally exacerbate financial systems conditions that respond to these policies in
different ways. Authorities need to carefully consider the trade-offs associated with different tools to
achieve price stability and financial stability objectives, as well as their effectiveness under prevailing
macrofinancial conditions.4
In addition, there is a need to consider not only banking safety and soundness, but also stability
in other parts of the financial system. The macroprudential framework also needs to take into account
4
For further discussion, please see “Workshop 2: The interaction between extraordinary monetary policy and banking
regulation”, a note prepared for the ICBS workshop to be held on 25 September.
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the tendency for activities to migrate outside the formally regulated sector when they become the
subject of policy action to reinforce banking system stability (see, for example, Haldane (2014)).
Crystallisation of these risks could feed back into the banking system, due to interconnectedness (eg
through provision of liquidity facilities to non-banks) and common exposures (eg exposures to same
asset and/or funding markets).
3.3
Evolving optimal institutional arrangements
A coherent policy framework is needed to ensure that the positive interactions between micro- and
macroprudential frameworks are maximised. In order to do so, jurisdictions must develop appropriate
institutional frameworks or regulatory architecture. While these may differ across countries due to
national circumstances, some important features can be defined.
First, is it important that clear mandates are established for the relevant agencies, and that
these are well documented and provide some measure of accountability. These mandates would clearly
outline each agency’s primary responsibility with regards to the financial system (IMF (2013)). Crucially,
there should be some overarching coordinating structure to strengthen information-sharing and
cooperation in policy decision-making. Osinski et al (2013) note that this can take several forms,
including cross-representation in decision-making bodies or a committee structure, amongst others.
Clear mandates and a commitment to coordination not only foster efficient cooperation between
authorities and avoid regulatory arbitrage, but also serve to ground the expectations of financial system
participants and avoid misleading or mixed signals. In turn, this increases the credibility of policymakers
and will help ensure that policy decisions have the anticipated result.
Second, this commitment to coordination should not be limited to domestic authorities, but
should also apply to relevant foreign stakeholders, as external conditions and potential spillovers should
be factored into decision-making. Authorities should make extensive use of standing international
forums, such as the Basel Committee, supervisory colleges and crisis management groups to exchange
relevant information, identify and discuss emerging risks and to coordinate policy responses as
necessary. This will help build trust between authorities, which is crucial to avoiding unintentional
negative spillovers, implementating policies effectively, and achieving desired outcomes, particularly in
time-sensitive situations.
Finally, authorities must be transparent in their analytical frameworks and policy decisionmaking processes. It is important that vulnerability and risk assessments be linked to policy actions and,
potentially, the communication of desired outcomes. Many authorities already use speeches and
sometimes regular publications (eg financial stability reports) to warn of emerging risks. But it is possible
that these vehicles can make a more meaningful contribution to explaining the authorities’ perception of
risk and signalling their intentions to intervene. However, given the significant uncertainties regarding
policy interactions and effects, macroprudential authorities may want to rely on discretion rather than
rules. Regardless, building a strong narrative that explains the analytical frameworks used by authorities
to ground policy decisions will help build support for policy making, particularly in view of the difficulties
inherent in communicating the benefits of curbing the build-up of risk (Domanski and Ng (2011)).
Needless to say, market education regarding the respective roles of micro- and macroprudential
authorities will have to continue, particularly in the light of differing setups across jurisdictions.
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References
Borio, C (2003): “Towards a macroprudential framework for financial supervision and regulation?”, BIS
Working Paper, no 123, February.
Clement, P (2010): “The term “macroprudential”: origins and evolution”, BIS Quarterly Review, March.
Committee on the Global Financial System (2012): “Operationalising the selection and application of
macroprudential instruments”, CGFS Papers, no 48, December.
Crockett, A (2000): “Marrying the micro- and macroprudential dimensions of financial stability”,
remarks before the 11th International Conference of Banking Supervisors, Basel, 20–21 September.
Domanski D and T Ng (2011): “Getting effective macroprudential policy on the road: eight propositions”,
in “Macroprudential regulation and policy: Proceedings of a joint conference organised by the BIS and
the Bank of Korea in Seoul on 17–18 January 2011”, BIS Papers, no 60.
Drehmann, M, C Borio, and K Tsatsaronis (2012): “Characterising the financial cycle: don’t lose sight of
the medium term!”, BIS Working Papers, no 380, June.
Enria, A (2012): “Micro-data for micro- and macro-prudential purposes”, prepared for the Sixth ECB
Statistics Conference, April.
European Systemic Risk Board (2014): “Flagship Report on macro-prudential policy in the banking
sector”, March.
Financial Stability Board, IMF and BIS (2011): “Macroprudential policy tools and frameworks”, progress
report to the G20, October.
Haldane, A (2014): “Halfway up the stairs”, Central Banking Journal, vol 25, no 1, August.
International Monetary Fund (2013): “Key aspects of macroprudential policy”, June.
International Monetary Fund (2012): “The interaction of monetary and macroprudential policies –
Background paper”, December.
Osinski, J, K Seal and L Hoogduin (2013): “Macroprudential and microprudential policies: toward
cohabitation”, IMF Staff Discussion Note, no 13-05, June.
Questions for discussion
Q1. How do we judge the appropriate mix of macroprudential and microprudential policies to ensure
they complement each other within a coherent framework? How should macro- and
microprudential policies interact with other policy areas (eg monetary policy, fiscal policy)?
Q2. How do jurisdictions take into account international macrofinancial developments for domestic
policymaking? How should/do jurisdictions take into account the spillover effects of their own policy
decisions on other jurisdictions?
Q3. How can governance arrangements be structured to ensure an appropriate policy mix and avoid
inaction bias (ie a reliance on other policymakers for a solution)?
Q4. How do we create incentives and mechanisms for stronger cross-border cooperation?
Q5. Given the importance of transparency and communication, what is the appropriate balance between
rules and discretion in microprudential and macroprudential frameworks?
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Use of macroprudential tools in the EU’s Capital Requirements Directive and Regulation
Annex 1
Instruments under the CRD
Instruments under the CRR
Other
Countercyclical
capital buffer
(CCB)
Systemically
important
institution (SII)
buffer
Systemic risk
buffer (SRB)
Liquidity
requirements
under Pillar 2
Other
macroprudential
requirements
under Pillar 2
Higher requirements
for capital/
liquidity/large
exposures/risk weights
Higher real estate
risk weights and
stricter lending
criteria
Higher minimum
exposureweighted average
LGDs
Including
LTV/LTI/DSTI and
LTD limits and a
leverage ratio
CRD 130, 135-140
CRD 131
CRD 133 and 134
CRD 105
CRD 103
CRR 458
CRR 124
CRR 164
National legal
framework
Mandatory buffer:
(1) Mandatory
surcharge for
global systemically
important banks
(G-SII) applicable
from 2016. A
surcharge between
1% and 3.5% of
RWAs, depending
on the degree of
an institution’s
systemic
importance.
Optional buffer on
all or a subset of
institutions.
(2) Optional
surcharge for
other SIFIs (O-SIIs)
applicable from
2016. A surcharge
of up to 2% of
RWAs.
An SRB above 3%
requires
authorisation by
the European
Commission after
the EBA and ESRB
have provided
opinions.
Member States
have to decide on
a buffer rate
informed by a
buffer guide
based on the
credit-to-GDP
gap. Other
relevant variables
also have to be
considered.
Member States
can decide to
apply the CCB
from 2014 and
must apply it from
2016. Mandatory
reciprocity up to a
buffer rate of 2.5%
applies from 2019.
(3) Combination of
rules between GSII and O-SII
buffers and the
SRB to ensure a
floor/cap on all
three buffers at
the consolidated
and subsidiary
level.
Until 2015 the
competent or
designated
authority can set a
buffer between 1%
and 3% subject to
notification to the
European
Commission, EBA
and ESRB.
From 2015, the
same
authorisation is
required for an
SRB of above 3%
on exposures in
other Member
States and of
above 5% on local
and third-country
exposures.
Option:
Optional:
Optional:
Optional:
Optional:
Optional:
Competent
authorities may
impose specific
requirements to
address systemic
liquidity risks.
Competent
authorities have
the power to
impose additional
requirements on
institutions with
similar risk profiles
in a similar manner
if – inter alia – they
pose similar risks
to the financial
system.
National authorities
may apply stricter
rules for a number of
selected measures
subject to an EU
procedure. It has to be
established that the
measure is necessary,
effective and
proportionate, and
that other specified
measures cannot
adequately address
the systemic risk.
These measures are
subject to a
notification and nonobjection process, with
the Council having the
final decision on
whether to block a
measure if objections
are raised.
Competent
authorities can set
higher risk weights
up to 150% based
on financial
stability
considerations,
taking into
account loss
experience and
forward-looking
market
developments.
Competent
authorities can set
higher minimum
exposureweighted average
LGDs (no upper
limit) based on
financial stability
considerations,
taking into
account loss
experience and
forward-looking
market
developments.
Member States
can assign
macroprudential
instruments that
are not covered by
the scope of EU
legislation. This
includes
instruments, such
as LTV/LTI/DSTI
limits (eg to
dampen a boom
in real estate
mortgage lending
or to curb
excessive lending
for consumption),
liquidity
instruments, such
as LTD limits, and
a leverage ratio.
These instruments
are based on
national law.
These include
administrative
penalties,
including
prudential
charges that
relate to the
disparity
between the
actual liquidity
position and any
liquidity and
stable funding
requirements.
These
requirements
include own funds
and additional
disclosures.
Source: European Systemic Risk Board (2014).
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Applies only to
retail exposures.