Macroprudential Policy

Abstract

Macroprudential policy seeks to smooth out the broad sweeps of the credit cycle. In doing so, horizons far beyond monetary policymakers are considered. Some knowledge of bank balance sheets is required to understand the effects of macroprudential policy. The influences of regulation on capital and liquidity are explored in this chapter before addressing the role of targeted interventions into lending standards. Credit cycles will nonetheless inevitably turn down, and policymakers also have an array of tools available to moderate the shock.

Appendices

Main Messages

• Banks must hold liquid assets ready for sale in the event of a temporary funding shortage. They must also hold their own capital to cover potential losses on their assets.

• When capital or liquidity requirements change, the bank can adjust to meet the target by changing either the asset or liability side of its balance sheet . The policymakers intended response need not be the one delivered, with potential costs for the real economy during adjustment.

• Banks are required to hold some capital at all times to avoid failure and its socialised costs. Beyond that, there are buffers designed for use during stressed periods. The capital conservation buffer (CCoB, 2.5%), countercyclical capital buffer (CCyB) and supervisor-set buffers for individual institutions are the buffers regulators intend to be used.

• Capital requirements used to focus on weighted risk assets, but desire to avoid underappreciated risks crystallising led to the non-risk-weighted leverage ratio. This measure is a simple backstop for constraining systemic risk.

• Intent to resell loans or to build market share for economies of scale could cause lending standards to loosen in a way that is optimal for a bank, at least in the short term, but bad for society overall. Regulated limits on lending standards can potentially prevent excessively lax standards.

• Excessive concentration of risk can cause systemic problems, perhaps by banks having too much exposure to borrowers over-stretching their income or overly leveraging their purchase. The need to accept price markdowns when selling repossessed assets can feed on itself as price falls weaken the market, begetting more possessions and price falls.

• Policymakers mostly subscribe to the doctrine of Walter Bagehot, which prescribes liquidity in abundance for solvent institutions. Potential losses are constrained by lending for a fee against collateral. Support can be provided to individual organisations or on a systemic basis that might crowd out the private market activity and determine the price of what is left.

• Macroprudential policies might typically be thought to trim tail risks ahead of and in the aftermath of shocks, while monetary policy is used to manage the central demand outlook.

Further Reading

• Bank of England. 2015. The Bank of England’s approach to stress testing the UK banking system.

• Bank of England. 2015. The Bank of England’s Sterling Monetary Framework (the ‘Red Book’).

• European Commission. 2013. Capital Requirements Directive. Directive 2013/36/EU.

• Basel Committee on Banking Supervision. 2011. Basel III: A global regulatory framework for more resilient banks and banking systems. Bank for International Settlements.