Part 1:
Institutional Models for Macroprudential
Policy – Strengths and Weaknesses.
Prepared for COMESA Monetary Institute
September 2015
Outline
• Introduction
• Institutional Models for Macroprudential Policy
• Criteria for the Assessment of Strengths and
Weaknesses
• Stylised Models for Macroprudential Policy
– Full Integration Model
– Partial Integration Models
– Separation Models
• Mechanisms to address weaknesses of models
• Conclusion
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Introduction
• As economies’ continue to recover from the most recent
financial crisis of 2007-2012, the issues of financial stability
and crisis management are ever more apparent.
• Policy makers realised a purely micro-based approach
to supervision and financial regulation is inadequate,
and system-wide risk must be more of a focus.
• There is a need for the prudential regulatory framework
for COMESA countries to be re-orientated to have a
system wide focus. This will be achieved through
developing skills on macroprudential policy tools to assist
COMESA member countries to confront this changing
reality of the global financial architecture.
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Introduction
• There is no consensus on best practices; there is
considerable variation across countries’ with
respect to the institutional set-up and
macroprudential policy implementation.
• Despite there being no clear consensus on best
practices, there are two necessities:
• There is a need to appoint a macroprudential authority that
takes the lead.
• Measures must be implemented to ensure coordination
between relevant organisations.
• Given a central banks’ universal mandate of price and
financial stability and thus its advantageous position, it must
play a prominent role in the implementation of
macroprudential policy.
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Institutional Models
• While institutional models differ in a vast number of
ways, Nier et al (2011) identify 5 key distinguishing
dimensions of real-life models:
• Degree of institutional integration of the central
bank and financial regulatory functions
• Ownership of macroprudential policy
• The role of the Treasury
• Institutional separation of policy decisions from
control over policy instruments.
• Existence of a separate body coordinating across
policies to address systemic risk.
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Strengths and Weaknesses
A desirable institutional model should be conducive to effective
mitigation of systemic risk, providing for:
• Effective identification, analysis and monitoring of systemic risk,
including through:
– Assuring access to relevant information; and
– Using existing resources and expertise.
• Timely and effective use of macroprudential policy tools by:
– Creating strong mandate and powers;
– Enhancing ability and willingness to act;
– Assuring appropriate accountability.
• Effective coordination in risk assessments and mitigation, so as
to reduce gaps and overlaps in risk identification and
mitigation, while preserving the autonomy of separate policy
functions.
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Stylised Models for Macroprudential Policy
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Full Integration - Model 1
Under Model 1 essentially all
financial regulatory and supervisory
functions rest with the central bank.
If the objective of the central bank
is to maintain financial stability then
the central bank becomes the
owner of macroprudential policy.
The Board of the central bank is
responsible for macroprudential
decision-making.
Czech Republic, Ireland and
Singapore have this set up.
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Full Integration - Model 1
Strengths:
• Management can provide incentives for proactive delivery
of information to the Board.
• Central banks already have vast experience analysing
systemic risk.
• Central banks already have practice communicating risks to
both the market and the general public. They can also
ensure that all officials speak with ‘one voice’.
• The central bank is both responsible and accountable for
macroprudential policy. This strengthens the incentives for
achieving its objectives.
• Failure to implement macroprudential policy successfully will
have an adverse effect on the objectives of a central bank –
price stability and the role of lender of last resort.
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Full Integration - Model 1
Weaknesses:
• Full integration hands a lot of power to the central bank,
which is already responsible for monetary policy.
• Mechanisms to challenge views within the central bank are
lacking.
• Failures in prudential policy could then affect the credibility of
the central bank as monetary policy maker.
• Addressing systemic risk requires coordination with the
government. The complete lack of involvement of the treasury
under this setup can therefore diminish Treasury cooperation if
they are excluded from discussions on policy action.
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Partial Integration – Models 2,3,4.
This setup involves close institutional integration between the
central bank and the prudential supervisor and regulator of
potentially systemic financial institutions, while the regulation of
activities or ‘conduct’ in retail and wholesale financial markets is
institutionally separate from the central bank. Countries following
this setup include the United Kingdom, Malaysia, and Romania.
The central bank retains access to relevant prudential data and
strong control over prudential tools that can be employed to
mitigate systemic risks.
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Partial Integration - Model 2
Given their similarities, Model 2 possesses
many of the same strengths and
weaknesses as Model 1.
However, under this arrangement a
dedicated macroprudential committee
is set up within the central bank that has
full responsibility for mitigating systemic
risks to the system as a whole.
Malaysia, Romania, Thailand and the UK
have this set up.
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Partial Integration - Model 2
Strengths
• The central bank retains access to relevant prudential data and expertise,
helping risk identification. Risk mitigation is also clearly assigned to one body –
the committee.
• Reputational risks are minimized. Failure to provide effective macroprudential
policy lies with those responsible for delivering it. The monetary decision maker
remains independent with their reputation unscathed.
• A dedicated macroprudential committee allows for treasury participation,
without undermining the independence of the monetary policy function.
Weaknesses
• The creation of a separate, dedicated macroprudential committee is at the
expense of reduced coordination with monetary policy, potentially leading to
a suboptimal policy mix.
• There may be inadequate coordination and support from the conduct and
securities regulator in identifying systemic risk.
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Partial Integration - Model 3
Under model 3, responsibility for
financial stability lies completely
with an independent policy-making
committee, but has participation
from the central bank.
The committee is chaired by the
treasury.
Brazil, France and the U.S have this
set up.
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Partial Integration - Model 3
Strengths
• A balanced committee can challenge views that could otherwise become
entrenched and unchallenged within one institution.
• The involvement of the treasury can lead to increased political support.
Weaknesses
• When a number of key players are involved in macroprudential policy it can
be difficult to establish clear accountability, and responsibility for prevention
of systemic crises is unclear.
• Inefficiencies in risk assessment may arise due to no one institution having all
the information needed to analyze the interlinked aspects of systemic risk.
• A strong treasury presence increases the risk that short-term political
considerations bear more weight than mitigation of systemic risk.
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Partial Integration - Model 4
This model is identical to Model 1, other
than the fact the authority overseeing the
retail and wholesale financial markets is
separate from the central bank.
Belgium, the Netherlands and Serbia have
this set up.
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Separation - Models 5-7
There is a much greater degree of
institutional separation between the central
bank and the supervisory agencies under
Models 5-7.
In addition to the securities regulators,
prudential supervision and regulation of
financial institutions are also institutionally
separate from the central bank.
As a result, the central bank is responsible for
oversight of the payments system and
control over the reserve requirement, but
has no direct power over macroprudential
tools such as liquidity requirements or loanto-value ratios.
Australia, Canada, Iceland and Switzerland
are examples of some of the countries who
have this set up in place.
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Separation – Models 5-7
The identification and mitigation of risk is a multi-agency effort
under this group of models. Decision making is distributed around
the various agencies, with each one responsible for the
macroprudential tools under its purview.
Strengths
• Each agency remains focused on their main objective: for the
central bank this is price stability; the banking supervisor is
focused on the soundness of financial institutions.
• There is clear accountability between macroprudential and
monetary policy.
• Institutional separation reduced the risk that one institution has
dominance, as each institution has the ability to develop
individual institutional culture.
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Separation – Models 5-7
Weaknesses
• With each institution focused on their particular objective, the opportunity to
bring together relevant expertise diminishes.
• Focus of each institution only on their objective can increase the risk of “gap”
– unaddressed or unidentified risks.
• Having multiple institutions dilutes the accountability for systemic risk – when
multiple agencies are cooperating for the desired policy outcome, no one
agency is fully responsible if the cooperation fails. This can lower the incentive
to cooperate in the reduction of systemic risk.
• Perspectives on risk may differ across the agencies which could lead to a
delay in taking action. There may be disagreement surrounding the source of
risk, or the best way to minimizing it.
• Separation may also lead to a suboptimal policy mix. For example, a central
bank is concerned with financial stability, but most of the tools to achieve the
objective are at the disposal of the prudential regulator.
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Addressing Weaknesses of Models
There is great variation in the strengths and weaknesses across
each model, but they do all possess some drawbacks. It is
possible to enhance the models by addressing each of the
weaknesses. Mechanisms include:
• Mechanisms to discipline independent use of powers.
 A mandate needs to be established in law, simultaneously opening and
constraining the discretionary use of powers.
 Accountability should be tied to the process, and not the outcomes of
macroprudential policy.
 Composition of the internal decision making committee can enhance the
effectiveness of internal checks and balances.
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Addressing Weaknesses of Models
•
Mechanisms to compensate for separation of decisions from control
over instruments.
– This can include vesting the macroprudential authority with binding
powers over specific and well-defined macroprudential instruments that
are carved out of the policy domain of a separate regulatory authority.
•
Mechanisms to address the risk of delayed action.
– Carefully designed voting systems subject to majority rule.
– Clear distinction between macroprudential policy and crisis management
to reduce unnecessary treasury involvement.
•
Mechanisms to address lack of cooperation in risk assessment and
mitigation.
– Establishment of a formal coordinating committee.
– Legislation changes affecting access to confidential data.
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Conclusion
• These 7 models have allowed us to capture the vast majority
of arrangements that are in place or are being developed
across countries.
• At the highest level, a desirable institutional model should be
conducive to effective mitigation of systemic risk.
• Institutional arrangements need to take account of local
conditions. There is no ‘one size fits all’.
• Despite there being no clear consensus on best practices,
there are two necessities:
 There is a need to appoint a macroprudential authority that takes the
lead.
 Measures must be implemented to ensure coordination between
relevant organisations.
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Thank You!