Macroprudential Policy: What Instruments and How to Use Them? Lessons from Country Experiences Xiaoyong Wu Monetary and Capital Markets Department
Outline of the Paper I. Country experiences with macroprudential instruments II. Effectiveness of macroprudential instruments II. Effectiveness of macroprudential instruments III. Lessons and Policy Messages IV. Next Steps: Remaining Gaps
I. Country Experiences with Macroprudential Instruments
What Instruments are Used? • 10 of the most frequently used instruments are examined (mostly prudential) • Those capable of addressing systemic risk are • Those capable of addressing systemic risk are considered macroprudential � Procyclicality (time dimension) � Interconnectedness (cross-sectional dimension)
Instruments and Risks Credit-related: • – caps on the loan-to-value (LTV) ratio; Risks generated by strong • – caps on the debt-to-income (DTI) ratio; credit growth and asset – caps on foreign currency lending; price inflation. – ceilings on credit or credit growth. Liquidity-related: Liquidity-related: • • Systemic liquidity risk. Systemic liquidity risk. • • – limits on net open currency positions/currency mismatch (NOP); • Risks arising from excessive – limits on maturity mismatch; leverage and the – reserve requirements. consequent de-leveraging. • Capital-related: – countercyclical/time-varying capital requirements; • Risks related to large and – time-varying/dynamic provisioning; volatile capital flows. – restrictions on profit distribution. 5
Objectives of Macroprudential Instruments credit growth/ asset price inflation 100 80 60 40 20 20 capital flows/ currency 0 excessive leverage fluctuation systemic liquidity risk Caps on LTV Limits on maturity mismatch Limit on net open currency positions/currency mismatch Restrictions on profit distribution Source: IMF Financial Stability and Macroprudential Policy Survey, 2010
What Affects the Choice of Instruments? Economic Size of Financial Sector Development Stage Size of Capital Inflow Exchange Rate Regime 7
% of Countries in Each Group Using Each Type of Instruments Credit-related Liquidity-related Capital-related Advanced 43 19 10 Economic Development Emerging 68 93 68 Stage Stage Market Market Flexible 48 55 40 Exchange Rate Managed/ 100 89 56 Fixed Large 48 36 20 Size of Financial Sector Small 67 88 67 Small 58 54 29 Size of Capital Inflow Large 56 68 56
How are the Instruments Used? Single 36 Multiple 64 Broad-based 55 Targeted 45 Fixed Fixed 45 45 Time-varying 55 Rule 8 Discretion 92 Coordination 59 No coordination 41 0 20 40 60 80 100 (percent)
II. Effectiveness of MacroPrudential Instruments
Effectiveness of the Instruments Limiting interconnectedness Dampening procyclicality in exposures of credit growth? of credit growth? to wholesale funding? to wholesale funding? of leverage? of leverage? to foreign funding? to foreign funding? Three Approaches 1 2 3 case study simple panel correlation regression 11
1. Case Study Small but diverse group of countries: � China � Colombia � Colombia Instruments seem to Instruments seem to � Korea have achieved, to various � New Zealand degrees, their intended � Spain objectives. � USA � Some Eastern European countries 12
2. Simple Approach Change in Credit Growth After the Introduction of Instruments (average across countries) (y/y change) LTV DTI (y/y change) 1.0% 1.0% 0.5% 0.5% 0.0% t-2 t-1 t t+1 t+2 t+3 t+4 -0.5% 0.0% t-2 t-1 t t+1 t+2 t+3 t+4 -1.0% -0.5% -1.5% -2.0% -1.0% -2.5% -3.0% Quarterly -1.5% Quarterly Reserve Requirements Dynamic Provisioning (y/y change) (y/y change) 7.0% 1.0% 6.0% 0.5% 5.0% 4.0% 0.0% t-2 t-1 t t+1 t+2 t+3 t+4 3.0% -0.5% 2.0% 1.0% -1.0% 0.0% t-2 t-1 t t+1 t+2 t+3 t+4 -1.5% -1.0% -2.0% -2.0% Quarterly Quarterly
2. Simple Approach (cont’d) Credit Growth vs. GDP Growth With and Without Caps on Loan-To-Value Ratios With and Without Caps on Debt-to-Income Ratios 5% 5% No Caps on DTI (blue) No Caps on LTV (blue) 4% 4% Caps on DTI (red) Caps on LTV (red) 3% 3% rowth (Percent Quarterly) wth (Percent Quarterly) 2% 2% 1% 1% 0% 0% -10% -5% 0% 5% 10% -10% -5% 0% 5% 10% -1% GDP Growth (Percent Quarterly) -1% GDP Growth (Percent Quarterly) Credit Grow Credit Gro -2% -2% -3% -3% -4% -4% -5% With and Without Reserve Requirement -5% With and Without Dynamic Provisioning 5% 5% No Reserve Requirements (blue) No Dynamic 4% Provisioning (blue) 4% Reserve Requirements (red) Dynamic 3% 3% Provisioning (red) Credit Growth (Percent Quarterly) Credit Growth (Percent Quarterly) 2% 2% 1% 1% 0% 0% -10% -5% 0% 5% 10% -10% -5% 0% 5% 10% -1% GDP Growth (Percent Quarterly) -1% GDP Growth (Percent Quarterly) -2% -2% -3% -3% -4% -4% -5% -5%
3. Panel Regression Statistically Significant ( ✔ ✔ ) or Not ( ✘ ✔ ✔ ✘ ✘ ) ✘ Reductions in: Procyclicality of Interconnectedness Foreign Wholesale Credit Leverage funding funding ✔ ✘ Caps on LTV ✔ ✔ Caps on DTI ✔ ✔ ✔ ✔ Limits on Credit Growth Limits on Credit Growth ✔ ✘ Limits on NOP ✘ ✔ Limits on Maturity Mismatch ✔ ✔ Reserve Requirements ✔ ✔ Time-varying/Dynamic Provisioning ✘ ✔ Countercyclical/Time-varying Capital Requirements 15
3. Panel Regression: Caveats • Regression coefficients are: – Averages of country performances – Not an indication of equal effectiveness in all countries – Not an indication of equal effectiveness in all countries – Affected by small sample size (limited number of observations) • Country-specific circumstances are important for effectiveness
III. Lessons and Policy Messages
Lessons and Policy Messages • Many instruments are found to be effective. • Effectiveness does not seem to depend on: – stage of economic development; – exchange rate regime. • As with regulation in general, there are costs involved. – May lower growth unnecessarily. – May generate unintended distortions. – Benefits should be weighed against costs. 18
Using Instruments: Do’s and Don’ts Single vs. Multiple : • use single when risk is well-defined from a single source; • use single when risk is well-defined from a single source; • use multiple to tackle a risk from various angles but do not • use multiple to tackle a risk from various angles but do not overdo. overdo. overdo. overdo. Targeted vs. Broad-based : • use targeted to minimize cost or distortion; • use targeted to minimize cost or distortion; • use broad-based to limit the scope of circumvention. • use broad-based to limit the scope of circumvention. 19
Using Instruments: Do’s and Don’ts (cont’d) Fixed vs. Time-varying : • Use fixed to provide a minimum buffer with a low cost • Use fixed to provide a minimum buffer with a low cost • Make adjustments with changing circumstances - on sound and • Make adjustments with changing circumstances - on sound and transparent principles transparent principles transparent principles transparent principles Rules vs. Discretion : • Use rules when risk of inaction is high or risk management • Use rules when risk of inaction is high or risk management capacity is weak capacity is weak • Use discretion when structural changes occur but with constraint • Use discretion when structural changes occur but with constraint 20
Next Steps • Deeper analysis of interconnectedness (cross-section dimension). – Data availability is a constraining factor • Deeper understanding of design and calibration of instruments. • Estimates of cost of implementation : distortions, unintended consequences. • Relationship between macroprudential and microprudential regulation. 21
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