Its acronym is MAP, but it's clear from the recent conference, Next Steps for Macroprudential Policy, sponsored by Columbia University's School of International and Public Affairs and by the IESE Business School: There is no clear roadmap when it comes to implementing macroprudential policy. "Here we are eight years after the global financial crisis, and my own sense is that we are far from having established the full rule framework," said Jordi Canals, dean at IESE.
The recent wave of MAP began as an answer to the 2008 global financial crisis as central banks searched for remedies to avoid or at least cushion the blow from the next crisis. The aim is to reduce systemic risk for the financial system as a whole. The tools aren't new, but implementation on such a wide scale is, especially in developed markets. The International Monetary Fund found 46 countries have wielded a combination of macroprudential tools in the last seven years.
Debate continues as to what is–and what is not–macroprudential policy. In large part it is a mindset that puts an emphasis on risk containment of borrowers and lenders and gives central banks and regulatory bodies more oversight of how the financial system functions. Emerging markets have often taken a macroprudential approach to both regulatory and capital policies, for example by restricting the amount or type of capital that can leave or enter the country.
Going After Lenders and Borrowers
In developed markets, macropru generally involves two broad sets of tools. Financial institution-based MAP largely consists of regulations meant to strengthen the banking sector. Although the list is quite long, the most recognizable tools are bank capital and banking liquidity requirements, particularly those which mandate that large banks hold a higher ratio of capital on their balance sheets to cover losses. Some macropru tools include higher requirements for particular types of risky lending such as mortgages, or when asset prices are booming and so are more vulnerable to a crash. "Macropru asks if banks have the ability to pay for their own funerals," said one conference participant. A huge concern is that credit and market liquidity could dry up as banks forego lending and abandon market making functions in order to shore up their capital ratios. What's more, lending is already moving from regulated banks to the less supervised shadow banking sector.
Borrower-based MAP restricts the amount of debt that consumers or businesses can take on, and has largely been applied to the real estate sector. Most rules have upped the size of downpayments, or restricted the debt-to-income ratios of would-be homeowners. "The problem with this approach: It's politically costly," said a participant who noted that governments routinely provide loopholes, such as exempting first-time borrowers from large down payments.
Governments, regulators, academics, and banks remain "in the early days of understanding the consequences of the financial regulatory adjustments that have been introduced," pointed out an economist who follows the effectiveness of MAP so far. Participants seemed to agree that stress testing and higher capital requirements in the US have made the financial sector safer. In other countries, experience with MAP tools suggests that they work best in conjunction with traditional regulatory and even fiscal policies. On the other end of the scale, most felt Brazil used MAP excessively, with one speaker attributing at least part of the blame of that country's "worst recession since the 19th century" to attempts to substitute MAP for sound fiscal and monetary policies.
The day-long conference was abuzz with controversy and questions, many of which are fodder for future research at SIPA and elsewhere. Conference proceedings will be published in coming months on this website, including short policy papers by speakers and a conference summary that will provide key takeaways from the event.
Among the key policy questions:
- Should MAP be proactive in identifying and containing potential spillovers in the financial system, or should policies be reactive, assuring that unintended consequences of asset crashes are restricted to one organization or sector?
- Does the current scattershot, country-by-country approach best address specific complexities, or should the financial system adopt a more global framework?
- Are European banks, in particular, at risk when additional macropru policies pressure already weak balance sheets?
- Is MAP contributing to a rise of shadow banking that could result in increased systemic risk outside the regulatory perimeter?
- Could a consolidation of counterparties signal a major defect in the capital markets?
- How should Central Banks manage joint responsibilities of setting interest rates and a more active role in managing financial stability risk through MAP?
Perhaps the most crucial question of the conference concerned what boom/bust cycle is looming on the horizon. What are the macroprudential tools that could create a buffer against the next economic crisis? Or are we perhaps setting the stage for something worse than the great recession by using policy tools we don't fully understand?