Asia and Pacific Department
© 2013 International Monetary Fund
Joint Bank-Fund Library
Macroprudential frameworks in Asia/edited by Rodolfo Maino, Steven A. Barnett. — Washington, DC : International Monetary Fund, c2013.
p. ; cm.
Includes bibliographical references.
1. Financial institutions — Risk management – Asia.
2. Banks and banking — Risk management – Asia. 3. Banks and banking, Central – Asia. 4. Financial crises – Asia — Prevention.
5. Economic stabilization – Asia. I. Maino, Rodolfo, 1961–.
II. Barnett, Steven (Steven Alan). III. International Monetary Fund.
ISBN: 978-1-47551-719-4 (paper)
ISBN: 978-1-47555-007-8 (ePub)
ISBN: 978-1-47556-589-8 (Mobipocket)
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Disclaimer: The views in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its members.
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Tae Soo Kang
Both Asian and advanced economies have learned from the 1997 Asian crisis and the 2008–09 global crisis the importance of financial stability and the need to prevent financial imbalances by active use of macroprudential policy measures. Most countries have now entrusted their central banks with either sole or shared responsibility for pursuing financial stability in addition to their traditional mandate of monetary stability.
A central bank can pursue and maintain financial stability by preventing financial imbalances from building up; by reducing systemic risk arising from interlinkages, from common exposures, and from procyclicality of the financial system; and by discouraging risk-taking behavior of financial institutions that may have systemic implications. This may sound straightforward, but it is not.
First, how does one define, identify, and measure financial instability?
Unlike price stability, which can be clearly defined as the extent of price increases, measured and monitored using the inflation rate as an index, it is difficult to do so for financial instability. Financial indicators, indices, or even some early-warning data are mostly about individual risk or individual institution risk and may not be able to flag financial instability issues that are systemic in nature and have multiple dimensions.
Second, how can we integrate the information or data into a formal model for vigorous analysis of imbalances or instability or the analysis and implementation of monetary policy, given the limited knowledge we have about the linkages between the real economy and the financial sector? How do we decide what tools to use and what the quantitative impacts of the selected tools are?
Institutional constraints are another major challenge in mitigating systemic risk, especially if the responsibilities for micro- and macroprudential supervision do not reside in the same agency, and coordination between responsible agencies is not well established. How does one ensure effective and efficient coordination mechanisms for close consultation, coordination, and sharing of information of the micro- and macroprudential supervisors so that the interests of all agencies are well aligned and so that the necessary prudential measures can be implemented?
From an emerging market’s point of view, there are some recommendations for the enhancement of financial stability:
Regularly monitor the threat of financial imbalances because they can lead to financial instability if left unchecked. The Bank of Thailand regularly monitors seven areas that are vulnerable to the buildup of financial imbalances, such as the housing and property market, the capital market, and the extent of indebtedness of various sectors.
Use macroprudential measures, which are powerful tools and have been widely used in emerging markets, to preempt the buildup of systemic risk. The most commonly employed macroprudential tools are the loan-to-value ratio, the debt-to-income ratio, and ceilings on credit or credit growth to address threats from excessive credit expansion in the system; limits on maturity mismatches; caps on foreign currency lending; and levies on noncore funding to address the key amplification mechanisms of systemic risk.
Capacity building in analytical skill and technical expertise for early detection of systemic risk is an urgent need. Staff members with the skill sets and competency for risk identification usually work in different departments in a central bank, such as examination, supervision, and economic policy. At the Bank of Thailand, we pool these staff members to form a working group, which meets regularly to assess the risk of potential financial instability building up. Although it is difficult to integrate the information or data into a formal model for rigorous analysis of imbalances, the dialogue and views form an important basis for policy formulation. No doubt, significant technical challenges remain and building up our knowledge base and technical expertise is necessary to better understand the complexity of maintaining financial stability.
Capital flows are posing a significant challenge for emerging markets. Although there are other policies to deal with capital flows, they are not always effective and may pose conflicts at times. Clearly, using monetary policy to cut interest rates to reduce interest rate differentials is not an option now because of the relatively robust economies in most emerging market, and some may even face the threat of inflation and imbalances. Inflows can lead to financial excesses and disruption can be even bigger when there is a reversal of the flows. It is important that emerging markets take steps, including macroprudential measures, to further strengthen their resilience and ensure that imbalances do not develop as a consequence of the inflows.
Appropriate monetary policy is a necessary condition for financial stability. It is now well accepted that monetary policy that keeps interest rates low for too long can sow the seeds of instability. If financial imbalances are building up because of accommodative monetary policy, changing the course of the monetary policy is the right approach. Macroprudential measures must not be used to substitute for the necessary adjustments to monetary policy to achieve financial stability.
There must be legal clarity in the mandates of micro- and macroprudential supervisors and clear procedures for coordination and information exchange between them, if they are not the same agency. In fact, even if both mandates belong to the same authority, which occurs when a central bank also has a bank supervision function, clarity is also very useful for ensuring effective implementation of policy measures for both mandates without concerns of conflicts of interest.
Outside interference and threats to central bank independence from having financial stability as a mandate can arise. Financial stability tools usually affect only certain economic sectors if financial imbalances are judged to be building up. Hence, central banks could face immense lobbying against and resistance to such measures. Therefore, proper legal provisions and governance structures need to be in place. At the Bank of Thailand, independence is carefully preserved:
First, monetary stability is the responsibility of the Monetary Policy Committee, whereas policy formulation and micro- and macroprudential supervision of the financial sector are under the Financial Institution Policy Committee (FIPC). Both committees are headed by the governor of the central bank. Two deputy governors also sit on each committee. For the sake of supervisory coordination, the heads of the Securities and Exchange Commission and Office of Insurance Commission also sit on the FIPC. The remaining members are outsiders, and outnumber internal members.
Second, the mandates of each committee are clearly spelled out in the law. Hence, the independence of each committee is legally guaranteed. Since the governor and deputy governors are in the minority, pressuring them would be futile interference. Because each outside member is proposed, based on his or her integrity, among other things, by the governor for selection by the board and is accountable by law for his or her decisions, the risk of external members being successfully interfered with is deemed minimal. So far, this governance structure has worked well.
What is most important in maintaining financial stability is the will to take away the punch bowl when the party gets interesting with monetary policy or macroprudential policy, which are unpopular measures. Without this will, any simple excuse can lead to delayed action or no action. Clear legal mandates and the governance structure discussed above make it somewhat easier for the relevant authorities to make tough decisions. In addition, during normal times, the macroprudential supervisor and the central bank need to have frequent communication with bankers and the general public to build acceptance that the boom-and-bust cycle is detrimental to economic well-being, and it would be in the best interests of all for the authorities to take unpopular measures when needed. It may sound highly idealistic and naive to hope for such acceptance, but with the memories of the global crisis still fresh, now is the best time for this strategy. The fact that most Asian economies have been able to safeguard financial stability with unpopular macroprudential measures may well suggest that they were able to get support from the masses who still remember the pain of the 1997 crisis. This is the case with Thailand, where there have been campaigns for prudent risk management on the part of households and the business sector, including banks and other corporations. Risk awareness and the willingness to trade short-term gains for long-term sustainability are much higher today.
The last important message is to remember that the market only behaves according to the incentives in place. For example, monetary policy that is perceived by the public to remain accommodative for a prolonged period irrespective of economic developments provides fertile ground for financial speculation. Similarly, a policy that leads the public to believe that any asset-price burst will subsequently be supported by accommodative policy can fuel speculation. This is the issue of moral hazard, which policymakers must be very mindful of. Central bankers need to think about these long-term implications even in their pursuit of monetary stability. It is, of course, technically difficult to extend significantly the horizon of monetary policy, with our limited ability to see into the future. But without such awareness, the implementation of monetary policy may have significant adverse impacts in the long run.
Former Governor of the Bank of Thailand
In the aftermath of the 2008–09 global economic and financial crisis, important questions arose about the optimal design of financial stability institutions and how to implement macroprudential policies in a credible way throughout the cycle. Although the crisis left Asia relatively unscathed, Asian countries were already leading the way regarding the best ways to deploy macroprudential policies.
Many Asian countries timely recognized that a single tool is unlikely to be sufficient to address the various sources of systemic risk. In their work on implementation issues, macroprudential authorities in the region tailored specific macroprudential instruments to particular vulnerabilities, including tools such as countercyclical capital buffers, variations in sector risk weights, dynamic provisioning, loan-to-value ratios, targeted restrictions on foreign currency lending, and liquidity requirements. Recognizing the importance of individual systemically important financial institutions (SIFI) and the systemic risk they convey, several jurisdictions in Asia even considered applying higher capital requirements on SIFIs to mitigate the risks of their potential failure.
Although we are still at an early stage of implementation, many lessons can be derived from practice. Three crucial factors seem to be at the root of any successful policy implementation on the macroprudential front:
building a sound institutional framework by effectively identifying risks, providing incentives to take action in a timely manner to confront the arising risks, and facilitating the coordination of policies that affect systemic risk;
designing an analytical framework to monitor and assess systemic risk; and
establishing a system of international cooperation based on the recognized interconnectedness of financial crises.
Two main themes across the many countries covered in the book should be underlined:
Macroprudential policy should focus on risks arising primarily within the financial system, or risks amplified by the financial system.
Macroprudential policy is not intended to address financial stability risks associated with macroeconomic imbalances and shocks, or inappropriate macroeconomic or structural policies—for which the first line of defense should be adjustments in macroeconomic policies.
Moreover, critically important questions still include the following:
Do particular frameworks for financial stability institutions carry certain advantages in managing systemic risk and adjusting macroprudential policies, especially in such a volatile global environment?
How should macroprudential policies be coordinated with monetary and fiscal policies? How do countries ensure that macroprudential policies work in concert with credible frameworks for monetary and fiscal policy?
Which macroprudential instruments tend to be the most effective in containing systemic risk? Do countries have useful metrics for measuring systemic risk and for assessing the effectiveness of macroprudential tools?
Are rules-based macroprudential policies more effective than those applied with discretion? When are single instruments more effective and when should a country rely on multiple instruments?
Answers to these questions are yet to be found. In the meantime, this book advances an excellent array of experiences from 13 countries in Asia and from some other latitudes as well—including Latin America and Israel—on these complex issues. We hope you will find this book insightful and a source of motivation to undertake further research on macroprudential tools and the institutional frameworks that can ensure their effective and timely deployment.
The authors would like to thank the discussants at the Monetary Policy Workshop on Strengthening Macroprudential Frameworks—organized by the IMF Regional Office for Asia and Pacific with financing provided by the government of Japan—for their valuable contributions and, fundamentally, for ensuring a stimulating intellectual environment. During the workshop, held in Tokyo March 22–23, 2012, insightful papers were presented, which eventually made their way into this book.
The editors are particularly grateful to the management team of the IMF Regional Office for Asia and Pacific, in particular Ms. Naomi Miyagi and Ms. Midoriko Yamaguchi, and its Director, Mr. Shogo Ishii, who promoted the original idea for this workshop and later provided encouragement and guidance to publish this book. We also wish to thank Ms. Tarisa Watanagase, former governor at the Bank of Thailand, for her support and opening remarks at the workshop. Special thanks and recognition are also due to the government of Japan for its generous financial support for this workshop.
All the views expressed in this book are those of the respective authors and should not be interpreted as those of the International Monetary Fund.
Bank for International Settlements
Bangko Sentral ng Pilipinas (Central Bank of the Philippines)
China Banking Regulatory Commission
Central Bank of Sri Lanka
consumer price index
debt to income
Financial Stability Board
Financial System Stability Committee
gross domestic product
Hong Kong Monetary Authority
Bank of Indonesia
investment fluctuation reserve
International Monetary Fund
loan to value
National Bank of Cambodia
nonbanking financial companies
People’s Bank of China
Special Administrative Region
systemically important bank
systemically important financial institution