Financial Stability and Macroprudential Policy PDF

Financial Stability and Macroprudential Policy Financial Stability The European Central Bank website defines financial stability as: … a condition in which the financial system—comprising of financial intermediaries, markets and market infrastructures—is capable of withstanding shocks, the...

Financial Stability and Macroprudential Policy Financial Stability The European Central Bank website defines financial stability as: … a condition in which the financial system—comprising of financial intermediaries, markets and market infrastructures—is capable of withstanding shocks, thereby reducing the likelihood of disruptions in the financial intermediation process which are severe enough to significantly impair the allocation of savings to profitable investment opportunities.  The ECB defines three conditions associated with financial stability: The financial system should be able to efficiently and smoothly transfer Financial resources from savers to investors. Financial risks should be assessed and Stability priced reasonably accurately and should also be relatively well managed. The financial system should be in such a condition that it can comfortably absorb financial and real economic surprises and shocks.  Threats to financial stability are considered to pose systemic risks. The Committee on the Global Financial System (CGFS 2010: 2) Financial defines systemic risk as “a risk of Stability disruption to financial services that is caused by an impairment of all or parts of the financial system and has the potential to have serious negative consequences for the real economy. Financial Stability A key lesson of the 2007–2009 global financial crisis (GFC) was the importance of containing systemic financial risk and the need for a “macroprudential” approach to surveillance and regulation that can identify system-wide risks and take appropriate actions to maintain financial stability. By virtue of their overview of the economy and the financial system and their responsibility for payments and settlement systems, there is a broad consensus that central banks should play a key role in monitoring and regulating financial stability.  The aim of macroprudential supervision and regulation is to reduce systemic risk and preserve systemic financial stability by identifying vulnerabilities in a country’s financial system and implementing policy actions to address those vulnerabilities in a timely manner to prevent a crisis. Macroprudential supervision takes a “top-down” approach Macroprudential that focuses on the economy-wide system in which financial market players operate, and helps assess Policy sources of risks and incentives. It requires the integration of detailed information on banks, nonbank financial firms, corporations, households, governments, and financial markets. Macroprudential Policy CGFS (2010: 2) notes more specifically that: “Preventative in its orientation, macroprudential policy is distinct from financial crisis management policy.” The key point is to increase the resilience of the financial system so that it can absorb losses from economic and other shocks while remaining viable. A second and related aim of macroprudential policy is to limit the buildup of systemic risk by leaning against the financial cycle and thereby dampen its volatility (CGFS 2010). As part of this, it should work to reduce the procyclicality of the financial system and the regulatory framework.  Time involves dealing with how aggregate risk in the financial system evolves over time. This is a response to the tendency toward procyclicality of the financial system as a result of positive feedbacks between the economy and Macroprudential financial system. Policy: Two Cross-sectional Dimensions involves dealing with how risk is allocated within the financial system as a result of common exposures and interlinkages in the financial system. The guiding principle for policy is to calibrate prudential tools with respect to the contribution of each institution to systemic risk, as well as to take steps to increase the transparency of such risks. ROLE OF A CENTRAL BANK IN FINANCIAL STABILITY A country’s central bank is well qualified to play a key role in monitoring and regulating financial stability. This reflects its routine work of monitoring the macroeconomic developments and financial system conditions and its responsibility for overseeing payments and settlement systems. HOW A CENTRAL BANK CAN HELP ACHIEVE FINANCIAL STABILITY A central bank has a number of policy tools that can affect financial stability. Monetary policy tools are ordinarily aimed at affecting the demand for and supply of money, primarily open market operations and reserve ratio requirements. The lender of last resort function of the central bank can simply be seen as an extreme version of open market operations. Macroprudential policy tools are aimed at reducing systemic financial risk, most typically by restraining bank credit growth. ARCHITECTURE FOR FINANCIAL STABILITY Four Clarity of objectives and mandates: what the stability regulator expects components: to achieve. Adequate resources: the political backing, legal support, and human and financial resources to enable the stability regulator to carry out its objectives and mandates effectively. Strong implementation powers: the instruments, tools, and techniques that the stability regulator uses to achieve its objectives. Effective structure and organization: the organizational structure of the stability regulator that is able to perform the delegated financial stability responsibilities in the most effective way. Possible Modes of a First, a fully consolidated stability regulator, combining all the functions of central banking, financial Financial Stability supervision and regulation, and treasury could be the ideal arrangement from the perspective of maintaining financial stability. The second option would be for a central bank to play the systemic stability regulator function by taking over macroprudential supervisory and regulatory powers. Regulator The third option would be to establish a coordinated systemic stability regulatory council, comprising the finance minister, the central bank governor and the head(s) of national financial supervisors.  Financial Stability Bangko Sentral ng Pilipinas This Photo by Unknown Author is licensed under CC BY- SA Understanding Financial Stability Executing Financial Stability in the Philippines Systemic Risk Management and Macroprudential Policy Systemic Risk Management The promotion of “Financial Stability” is a formal mandate that is uniquely ascribed to the Bangko Sentral ng Pilipinas (BSP). The objective is to enhance the resilience of the financial system, in its totality and in its components, from shocks. This is done by managing systemic risks that could affect the financial system so that finance continues to be a value proposition to consumers in normal times while remaining resilient when disruptions do arise.  Systemic Risk Systemic risk refers to the risk of a breakdown of an entire system rather than simply the failure of individual parts. In a financial context, it denotes the risk of a cascading failure in the financial sector, caused by linkages within the financial system, resulting in a severe economic downturn. This Photo by Unknown Author is licensed under CC BY-SA- Systemic Risk Management Effectively managing systemic risks is a shared undertaking across many different stakeholders. As such, the objective of Financial Stability warrants an institutional arrangement to ensure continuous focus while setting clear accountabilities. This Photo by Unknown Author is licensed under CC BY- SA Macroprudential Framework Macroprudential policy is the means for mitigating these systemic risks. Macroprudential policy does not take anything away from the scope and focus of other policy objectives. It adds a new policy consideration for financial authorities which was overlooked until the emergence of the GFC. This Photo by Unknown Author is licensed under CC BY- SA  Macroprudential Framework As a guide, the BSP and the Financial Stability Coordination Council (FSCC) have adopted the following definition of "Financial Stability." “Financial stability is the state when prospective systemic risks are mitigated so as to allow financial consumers, both individuals and corporate entities, to pursue viable economic goals while avoiding disruptions to the smooth functioning of the financial system that can negatively affect the rest of the economy." Macroprudential Framework Taking the perspective of Economics, Financial Stability is considered a “public good” and systemic risks are the antithesis to stability. As a public good, there is an element of the “Tragedy of the Commons” and, more importantly, externalities exist so that the costs to society of any vulnerability will be larger than the simple sum of the private costs borne by individual entities. Macroprudential Framework AN EASY GUIDE TO THE MACROPRUDENTIAL POLICY STRATEGY FRAMEWORK: THE CASE OF THE PHILIPPINES Systemic Risk Management Financial The Monetary Board approved the creation of the FSPC to oversee and Stability Policy decide on the financial stability initiatives of the BSP. Committee of The FSPC was officially convened on 26 the BSP February 2020 by the BSP Governor as its Chairman, counting on the other Monetary Board Members (MBMs) as FSPC members. The FSPC meets six times a year.  The FSCC is an inter-agency council where the principals from the BSP, the Department of Finance, the Securities and Exchange Commission, the Insurance Financial Commission, and the Philippine Deposit Insurance Corporation convene quarterly. Stability Coordinatio These meetings provide the venue to assess possible systemic risks and to decide appropriate n Council macroprudential policy interventions. The National Treasurer is likewise an active participant in the discussions of the FSCC and is a Special Member of the Executive Committee.