Discussion of session on Macroprudential Regulation

1
Discussion of session on Macroprudential
Regulation

• by
• Claudio BorioHead of Research and Policy
  Analysis
• Bank for International Settlements, Basel
• Prepared for the Joint Conference of the
  Inter-American Development Bank and the Reserve
  Bank of Atlantas Americas Center
• Toward Better Banking in Latin America
• Washington DC, 30 September 2005

• The views expressed are those of the author and
  not necessarily those of the BIS

2
Structure of remarks

• From Microprudential (MiP) to Macroprudential
  (MaP)
• BIS research perspective
• Specific comments on thought-provoking papers

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What is meant by Macroprudential?

• Broader (least interesting)
• synonymous with systemic risk
• Narrower (more interesting) 4 features (Borio
  2003)
• costs of financial instability i.t.o. real
  economy
• system-wide shocks rather than idiosyncratic
  shocks plus contagion
• endogenous risk
• dynamic interaction financial system-real economy

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What is MaP in the papers?

• JR
• aggregate shock
• calibration of instruments w.r.t. individual
  exposures to the shock
• AK
• procyclicality of regulation and capital flows
• CG
• dynamic GE modelling of real-financial
  interactions
• regulation and procyclicality

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Why the focus on MaP now?

• Asian financial crisis
• Basel II

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Research at the BIS

• Focus on MaP and procyclicality since late 1990s
• Highlight 3 points
• it is the financial sector that is potentially
  excessively procyclical
• do not over-emphasize regulation!
• cause? risk perceptions gap and incentives
  gap
• empirical evidence supports this
• real-time indicators of joint excessive
  credit-asset price expansion have good predictive
  content for banking crises (3-5 years ahead)
  (Borio Lowe 2002, 2004)
• these indicators add explanatory power to
  Merton-type default predictors (Tarashev 2005)

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JR what does he argue?

• Lack of independence of supervisors as main cause
  of banking crises
• - failure to pre-commit not to bail out (LoLR)
  arises from political pressures
• Arrangements should have 2 features
• prudential instruments and LoLR calibrated w.r.t.
  exposures to macro-shock
• no LoLR for institutions whose exposures are
  excessive
• capital requirements (KRs) increase with the
  exposures
• strict independence of supervisors with full
  control over LoLR

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JR what I liked?

• Shift from MiP to MaP
• calibration of instruments w.r.t. systematic risk
• Call for greater autonomy for supervisors
• great merit of JR

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JR some reservations/questions (1)

• Failure to pre-commit as primary source of
  banking crises?
• banking crises preceded safety nets and (some)
  were exacerbated by ex post inaction
• more fundamental causes? (eg, the two gaps)
• Too much emphasis on illiquidity rather than
  insolvency?
• illiquidity as late-stage exacerbating factor
• predictive content of indicators of (masked)
  asset quality deterioration
• KRs would rise in downturns?

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JR some reservations/questions (2)

• Framework not MaP enough?
• in equilibrium, real economy costs are not
  dependent on joint failures
• no feedback on financial sector
• Overestimation of political pressures on failure
  to pre-commit?
• especially important in case of idiosyncratic
  shocks
• a new perspective on deposit insurance

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AK what does he argue?

• Fragility view of intermediation
• KRs etc have real costs
• link to procyclicality
• Excessive procyclicality of Basel II could be a
  problem
• - especially for high quality (largest) banks in
  a recession
• Shift towards Fair Value Accounting (FVA) could
  add to procyclicality
• - especially in conjunction with earnings
  management
• For EMEs, should strive to develop insurance
  markets
• - not seek to lengthen maturities, etc

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AK what did I like?

• Procyclicality of Basel II
• an issue but we do not know the impact of the
  overall package
• could even be less procyclical than current one!
• Stress on implications of accounting reform
• badly underestimated
• call for forward looking provisioning (Borio
  Lowe 2001)
• Stress on need for structural reform in EMEs

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AK some reservations/questions (1)

• Link asset quality procyclicality unambiguous?
• What roles for accounting and prudential
  supervision? Need for reconciliation (Borio
  Tsatsaronis 2004)
• accounting to provide best approximation to
  unbiased valuations and performance, including
  risk information
• prudential supervision instil the desired degree
  of prudence in behaviour
• need for close cooperation in developing and
  implementing corresponding measurement/information
  system (valuation risk profiles and
  uncertainty surrounding both)

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AK some reservations/questions (2)

• Unwise to suggest that EMEs should not seek to
  lengthen maturities
• excessive short-term debt can arise from a
  number of less benign factors
• could have inhibited improvements in debt
  management in recent years (including FX)
• Overestimate benefits and practicality of
  insurance markets for EMEs?
• if risk factors truly independent of own
  behaviour, benefits may be smaller (see evidence
  on crises)
• if not independent, insurance harder and more
  costly

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CG what do they argue?

• Adjustment of KRs should be shock-dependent
• not necessarily countercyclical
• lowered (loan demand shock) but raised (credit
  crunch shock)

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CG what did I like?

• Dynamic interaction between real economy and
  financial sector in a GE model
• Countercyclical KRs described as standard view!

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CG some questions/reservations

• Is the introduction of KRs somewhat artificial?
• constraint reduces welfare
• Do prescriptions really differ that much from
  standard view?
• KRs are minima not binding in a credit crunch
• How realistic is the model?

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References

• Amato, J and C Furfine (2003) Are credit
  ratings procyclical?, BIS Working Papers, no
  129, February.
• Borio, C (2003) Towards a macroprudential
  framework for financial supervision and
  regulation?, CESifo Economic Studies, vol 49, no
  2/2003, Summer, pp 181-215, (also available as
  BIS Working Papers, no 128).
• Borio, C, C Furfine and P Lowe (2001)
  Procyclicality of the financial system and
  financial stability issues and policy options,
  in Marrying the macro- and micro-prudential
  dimensions of financial stability, BIS Papers, no
  1, March, pp 1-57.
• Borio, C and P Lowe (2001) To provision or not
  to provision, BIS Quarterly Review, June, pp
  36-48.
• Borio, C and P Lowe (2002) Assessing the risk
  of banking crises, BIS Quarterly Review,
  December, pp 43-54.
• Borio, C and P Lowe (2003) Securing sustainable
  price stability Should credit come back from the
  wilderness?, paper prepared for ECB Workshop on
  Asset prices and monetary policy in December
  2003, BIS Working Papers, no 157, July 2004.
• Borio, C and K Tsatsaronis (2004) Accounting
  and prudential regulation from uncomfortable
  bedfellows to perfect partners, paper prepared
  for the maiden issue of the Journal of Financial
  Stability, no 1, September.
• Crockett, A (2000) In search of anchors for
  financial and monetary stability, BIS Speeches,
  27 April.
• Crockett, A (2001) Marrying the micro- and
  macro-prudential dimensions of financial
  stability, BIS Speeches, 21 September.
• Lowe, P (2002) Credit risk measurement and
  procyclicality, BIS Working Papers, no 116,
  September.
• Segoviano, M A and P Lowe (2002) Internal
  ratings, the business cycle and capital
  requirements some evidence from an emerging
  market economy, paper presented at the Federal
  Reserve Bank of Boston Conference on The impact
  of economic slowdowns on financial institutions
  and their regulators, BIS Working Papers, no
  117, August.
• Tarashev, N (2005) An empirical evaluation of
  structural credit risk models, BIS Working
  Papers, no 179, July.