1. MACRO-PRUDENTIAL
POLICY: BANKS RISK &
CAPITAL CONTROLS
Adrian Blundell-Wignall
Special Advisor on Financial Markets to the OECD
Secretary General.
2. Macro-prudential over time
2
• The Cross Committee 1986: the sense is innovation and
off-balance sheet issues in big banks can cause macro
problems.
• Crocket 2000—(1) pro-cyclicality of the financial cycle
and the need for countercyclical buffers; (2) connected
institutions that have systemic consequences when they
have similar exposure. A calibration of tools is required,
as we succeed conceptualising the tasks of micro and
macro-prudential.
• FSB 2011: macro-prudential is: “the uses of prudential
tools to limit systemic or system-wide financial risk”.
• This is where the problems start.
3. 4 Requirements of macro-prudential
3
• Identify imbalance before they become a problem.
• Select the appropriate prudential tool, or tools;
• Decide how to calibrate (data and modeling) and time
the intervention;
• Coordinate all the responsible regulators and supervisors
to bring it about, including achieving political support
for the actions—and since the tools may vary from one
situation to the next, a macro-prudential regulator will
need to be involved in the coordination at both the
domestic and international levels.
4. Identify Imbalances Before they Become a
Problem
4
• Failure to predict the Mexico crisis.
• Failure to predict the Asia crisis.
• The IMF in April 2007 Financial Stability Report:
“The weakness has been contained to certain portions of the
subprime market…….and is not expected to pose a serious
systemic threat. Stress tests…..show that even under
scenarios of nation wide house price declines that are
historically unprecedented, most investors with exposure to
subprime mortgages through securitised structures will not
face losses.”
--IMF Global Financial Stability Map shows credit crisis the least likely
of all events.
• These were massive crises and no global institution came even close.
I am very pessimistic about this. Rules based approaches are going
to be better.
5. Tools For Balance Sheets
5
For influencing financial institution balance sheets, where solvency and
liquidity risks might be the source of systemic stability concerns, the policy
tools include inter alia:
• Counter-cyclical capital buffers;
• Time varying systemic surcharges;
• Systemic capital surcharges;
• Systemic liquidity surcharges and supporting measures such as caps on
loan-to-deposit ratios, the liquidity coverage ratio (LCR) the net stable
funding ratio (NSFR);
• Capital surcharges on OTC derivatives not cleared centrally;
• A capital surcharge for global systemically important financial institutions
(GSIFI’s);
• Varying the capital plans of individual banks after stress testing exercises;
and
• Dynamic provisioning.
6. Tools for Borrowers & Lenders,
International Spillovers, & Network Risk
6
Where non-bank borrowers and financial institution lenders are judged to be taking
excessive risks the available tools include:
• Variations in require Loan/valuation ratios (linked to the house price cycle);
• Imposing caps on the ratio of debt service to disposable income ratios;
• Setting rules to avoid currency mismatches for borrowers and lenders;
• Ceilings on credit growth; and
• Rules on the reference interest rates for mortgage lending.
Where international interconnectedness issues are judged to be a source of instability in
the domestic economy due to spillovers—such as the current low rates in the West
and quantitative easing policies, the tools include:
• Cross-border supervision; and
• Controls on international capital flows (with an emerging market economy --EME --
focus).
Where counterparty risk and complex network effects are a source of systemic concern
the favoured tools seem to be:
• Though the cycle variation of haircuts and margins;
• Limits on interbank exposures;
• Variations in Basel risk weights, such as the CVA charge; and
• Transactions taxes.
7. Calibration is a Problem: DTD Model—
What Factors Matter for Bank Default Risk
7
9. Complexity: DTD Study Implications
9
• The three monetary policy variables are most highly correlated with the per cent change in
the national house price indexes. This is consistent with leaning-into-the-wind monetary
policy taking into account the key housing asset price cycle.
• The change in the Tier 1 ratio appears to be negatively related to the house price index
variable, (higher Tier 1 is associated with a weaker asset price cycle) which suggests it is a
contender.
• However, the change in the Tier 1 ratio is also highly significantly correlated with the GMV
of derivatives in a perverse way. That is, a tightening up of the T1 ratio is associated with
the increased use of derivatives in off-balance sheet products, CVA desk arbitrage, and
other forms of regulatory arbitrage. The GMV of derivatives variable has one of the biggest
independent negative influences on the DTD.
• All three business model influences on the DTD, (the GMV of derivatives, wholesale
funding, and trading securities) are correlated with each other, and to leverage, but they
aren’t correlated with monetary policy, and they are perversely correlated to the Tier 1 ratio.
This block of influences on the DTD must be treated separately from macro-prudential
considerations.
• While countercyclical rules may be effective in the traditional bank segment of the market,
those same policies will interact with the GSIFI bank group, where destabilising factors can
come into play.
• The OECD has long recommended separating off securities businesses that engage in
activities such as prime broking, market making, underwriting and origination. This would
pave the way for more effective macro-prudential policy for core deposit banking.
10. Governance
10
• In regard to the fourth requirement for successful macro-prudential
policy, governance, it is likely that coordination issues will be
problematic.
• The supervisors for banks and all of the shadow banks are different
in most jurisdictions, and include central banks, prudential
regulators, consumer protection agencies, federal level regulators,
state level regulators and international regulatory bodies.
• The responsibility for any one of the above list of tools varies widely
from one jurisdiction to the next, and there are overlaps of
responsibilities within and between countries.
• Data for surveillance have holes, especially in the shadow bank
sector.
11. Capital Controls
11
Many EME’s also use capital controls to manage the capital account
when they perceive they are in disequilibrium, and count it as a macro-
prudential tool. Measures to support a macro policy of managing the
exchange rate include, inter alia:
• Ceilings on foreign exchange forward positions.
• Guidance from authorities on the extent of foreign currency
borrowing and swap activities.
• Restrictions on bank loans in foreign currency.
• Limiting foreign exchange transactions to those supporting
underlying trade and investment activities.
• Imposing minimum holding periods on domestic government
securities.
• Variation in taxes on cross-border flows.
12. International Reserves Re-investment in
Treasuries
12
0
1000
2000
3000
4000
5000
6000
$bn
Öther
Carrib.
Brazil
Korea
UK
OPEC
SEA
Japan
China
Fed Balance Sheet
US Fed Hld Tsy
13. Impact on US 10 Year—Carry Trade
Catalyst
13
-4
-3
-2
-1
0
1
2
1998M12
1999M12
2000M12
2001M12
2002M12
2003M12
2004M12
2005M12
2006M12
2007M12
2008M12
2009M12
2010M12
2011M12
2012M12
Contribution (%) to
US 10Y Sov Bond
Yield
Contribution of CPI_MOM
Contribution of LIBOR_3M
Contribution of TS_FHDL_GDP
14. Carry Trade Returns: US vs Emerging
14
50
70
90
110
130
150
170
190
Jan-07
Jun-07
Nov-07
Apr-08
Sep-08
Feb-09
Jul-09
Dec-09
May-10
Oct-10
Mar-11
Aug-11
Jan-12
Jun-12
Nov-12
Apr-13
Sep-13
Feb-14
Jul-14
Dec-14
Index
US Tsy Tot Ret 1-3y
US Tsy Tot Ret 10y+
Merrill Tot Ret EM Credit
15. Saving Investment Correlation,
EME/OECD, Rolling Window
15
Source: OECD.
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
1982 Q1-
86 Q4
1984 Q1-
88 Q4
1986 Q1-
90 Q4
1988 Q1-
92 Q4
1990 Q1-
94 Q4
1992 Q1-
96 Q4
1994 Q1-
98 Q4
1996 Q1-
00 Q4
1998 Q1-
02 Q4
2000 Q1-
04 Q4
2002 Q1-
06 Q4
2004 Q1-
08 Q4
2006 Q1-
10 Q4
Emergers OECD All
If EME investment and saving correlation is represented by: 𝐼𝑒 = 𝑎 + 0.7𝑆𝑒 + 𝜀 𝑒
and OECD by: 𝐼 𝑜 = 𝑏 + 𝜀 𝑜, as implicit in the correlations shown here, then 𝑆 𝑜 =
𝑎 + 𝑏 + 𝜀 𝑒 + 𝜀 𝑜 − 0.3𝑆𝑒.
A significantly large EME world would become destabilising if the correlations did
not begin to change.
19. Capital Controls OECD Study
19
• The OECD duplicated the IMF Ostry study and finds it is not robust. An OECD panel
regression study for the effects of IMF capital controls data on GDP growth shows
interesting results. Capital controls are not an appropriate macro-prudential tool for
EME’s or any other country.
• The apparent effectiveness of this tool at times may stem from the fact that these
countries prefer to target the exchange rate versus the US dollar. During inflow
periods economic growth is strong. Capital controls have a positive effect on GDP,
because they help the targeting of the exchange rate, and reduce domestic monetary
creation that follows from foreign exchange market intervention. Growth is not
damaged as company cash flow is more plentiful, and some domestic monetary
creation is difficult to avoid.
• However, when risk aversion rises, economic growth slows down and capital outflows
begin to dominate, the evidence suggests that the presence of capital controls is very
damaging. Domestic money creation reverses, there is no upward pressure on the
exchange rate anyway, and company cash flows begin to suffer. It is at this time that
capital inflows are needed, in both FDI and through the banking system. Countries
with the highest capital controls become the least desirable destinations for foreign
investors. Growth suffers as a consequence.
• Such policies risk countries not getting the right fiscal and monetary policy balance,
and the requisite need for exchange rate flexibility. They also cause EME’s to delay
the need for structural reforms, which includes the financial sector.