Transcript Macro-prudential - Banque de France

The macroprudential approach to regulation
and supervision: What? Why? How?
by
Claudio Borio*
Bank for International Settlements, Basel
Banque de France and Toulouse School of Economics
Conference on “The Future of Financial Regulation”
Paris, 28 January 2009
* Claudio Borio, Head of Research and Policy Analysis at the BIS. The views expressed are those of the
author and not necessarily those of the BIS.
Motivation, objective and structure
 Term “macroprudential” (MaP) has become popular in
policy circles yet remains unclear
• how does it differ from “microprudential” (MiP)?
• what is its relationship to procyclicality?
 Understanding this is important for the future of the
financial regulatory and supervisory (FR&S) frameworks
 Thesis: need to strengthen MaP orientation of FR&S
frameworks
 Structure of remarks:
• what?
• why?
• how?
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I – What?
 Intentionally stylised distinction between MaP and MiP
• two souls coexist in current FR&S
 Two distinguishing features of MaP
• focus on the financial system (FS) as a whole rather
than individual institutions
• Objective: contain likelihood and cost of financial
system distress to limit costs for the real economy
• treat aggregate risk as endogenous w.r.t. collective
behaviour of economic agents
• sharp contrast to what individual financial
institutions do
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Table 1*
The macro- and microprudential perspectives compared
Proximate objective
Ultimate objective
Characterisation of risk
Correlations and
common exposures
across institutions
Calibration of
prudential controls
Macroprudential
limit financial system-wide
distress
avoid output (GDP) costs
linked to financial instability
Seen as dependent on
collective behaviour
(“endogenous”)
Microprudential
limit distress of individual
institutions
consumer (investor/depositor)
protection
Seen as independent of
individual agents’ behaviour
(“exogenous”)
important
irrelevant
in terms of system-wide risk;
top-down
in terms of risks of individual
institutions; bottom-up
* As defined, the two perspectives are intentionally stylised. They are intended to highlight two
orientations that inevitably coexist in current prudential frameworks.
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II – Why? Three reasons
 Costs i.t.o. real economy is what matters most for welfare
 Cannot assess the soundness of individual institutions on a
stand-alone basis
• common exposures across institutions to the same risk
factors are key
• direct and indirect (via interlinkages)
 Endogenous risk is crucial to financial instability
• procyclicality of the FS
• self-reinforcing mechanisms within FS and between FS
and the real economy that can exacerbate booms/busts
• most prominent in downward phase
• most insidious in expansion phase
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II – Why? Recent experience reinforces need
 Reinforced by what is new….
• need system-wide perspective to understand threat arising
from “dissemination” of risk outside banks
 And what is not new
• crisis as turn in an outsized credit cycle
• overextension in balance sheets in good times masked
by veneer of strong economy
• build-up of “financial imbalances” (FIs) that at some
point unwind
• evidence
• unusually low volatility and risk premia (G II.2)
• unusually rapid growth in credit and asset prices (G 3)
• BIS leading indicators help in real time (G A.1)
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II – Why? The key mechanisms



Limitations in measuring risk (and values)
• expectations are not “correct/unbiased”
• bouts of optimism/pessimism; hard to tell cycle/trend
• measures of risk are highly procyclical
• spike when risk “materialises” but may be quite low as
risk/vulnerabilities build up
• thermometers rather than barometers of financial distress
Limitations in incentives
• how imperfect information/conflicts of interest are addressed in
financial contracts
• eg. direct link valuations-lending capacity via collateral
• ie. wedge between individually rational and socially desirable actions
(private/public interest)
• “coordination failures”, “prisoner’s dilemma”, herding
• eg. lending booms, self-defeating retrenchment
Importance of short horizons
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III – How? Two dimensions of a MaP approach
 Cross-sectional dimension of aggregate risk
• distribution of risk in FS at a point in time
• systematic vs idiosyncratic risk
 Time dimension of aggregate risk
• evolution of system-wide risk over time
• procyclicality
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III – How? Cross-sectional dimension
 Principle: calibration to  weight on exposures to risks that
are common across institutions rather than specific to
them (systematic vs idiosyncratic risk)
• at present no distinction: calibrate w.r.t. overall risk of
an institution
 How to implement? Tighter standards if:
• many institutions have a common exposure
• the impact of an institution’s failure on the system is
greater
• various ways this could be done
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III – How? Time dimension
 Principle: build-up buffers in good times so as to run them
in a controlled way and within limits in bad times, as
strains threaten to emerge
• to cushion the blow to the system, need to allow
buffers to be run down
• otherwise not act as buffers!
• regulatory minima from shock absorbers
become shock amplifiers
• build-up of buffers  dragging anchor  can restrain
risk-taking
 How to implement?
• five general points
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III – How? Point 1: holistic approach
 Holistic approach is needed
• degree of procyclicality depends on a broad range of
policies
• monetary policy; fiscal policy
• accounting
• deposit insurance and resolution procedures
• capital is just one prudential tool
• eg liquidity, underwriting, margining standards,
including LTVs
• eg, trend to FVA is increasing procyclicality
• either adjust accounting, or adjust more elsewhere
• eg, prudential filters
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III – How? Point 2: build on Basel II
 Building on Basel II is important
• superior to Basel I
• hard-wiring of credit culture
• better at cross-sectional dimension of risk
• reduce implementation costs

How? Simple and transparent adjustments to  cyclical
sensitivity of regulatory capital/have countercyclical elements
(MaP “overlays”)
• Pillar 1 or Pillar 2
• within each, several possibilities
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III – How? Point 3: rules better than discretion
 Rely as far as possible on rules rather than discretion…
•  margin of error
• measuring aggregate risk in real time with sufficient lead
and confidence to take remedial action is very hard
• rules act as pre-commitment devices
•  pressure on supervisors not to take action during boom
even if see risks building up
• fear of going against view of markets
 …But do not rule it out!
• fool-proof rules may be hard to design
• can be better tailored to features of FIs
• need to discipline discretion (transparency and accountability)
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III – How? Point 4: strengthen institutional set-up
 Need to strengthen institutional setting for implementation
• align objectives-instruments-know how
 How?
• strengthen cooperation between central banks and
supervisory authorities
• strengthen accountability
• clarity of mandate, independence, transparency
• monetary policy as a model?
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III – How? Point 5: scope of regulation
 Need to find a way of dealing effectively with the
unregulated sector
•
major challenge
• is indirect approach enough?
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Conclusion
 There is now a widespread recognition in the policy
community of the need to strengthen the MaP orientation
of FR&S frameworks
• so far focus largely on procyclicality (time dimension)
• expect greater attention to cross-sectional dimension in
future
 Task now is to examine concretely various policy options
(desirability and feasibility)
• BIS actively involved in this process
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