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Micro and Macro P rudential Perspectives of Financial Stability

This article explores the importance of financial stability in a macroeconomic context, its impacts on production, employment, poverty, and inequality, and the need for consistency among macroeconomic policies. It also discusses lessons from the financial crisis, the need for both micro and macroprudential regulation, and the governance and conflict of objectives within the financial safety net.

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Micro and Macro P rudential Perspectives of Financial Stability

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  1. Micro and Macro PrudentialPerspectives of FinancialStability Mario Bergara Managing the Capital Account and Regulating the Financial Sector: A Developing Country Perspective UNDESA – IPD - IPEA, Rio de Janeiro, August 23, 2011

  2. Micro and macro prudential perspectives of Financial Stability • Therelevance of FinancialStability in a context • of MacroeconomicStability • Price Stability • Soundfinancialsystem • Well-functioningpaymentsystem • Theycontributetogeneratecredibility and longtermperspective, allowing a betterdecision-makingonsavings, credit and investments. A healthyfinancial sector channelsthosedecisions more efficiently. • A properFinancial Safety Net reduces thesystem’svulnerability. • Theycomplement social policies, byprotectingthepoor: lowerincomepopulation has lessabilitytofighttheeffects of highinflation and financial crisis.

  3. Micro and macro prudential perspectives of Financial Stability • The importance of economic and financial stability • No experiences showing economic and social development in contexts of macroeconomic and financial disorder. • The largest declines in production and the largest rises in poverty are linked to bank runs and macroeconomic crises. • Disconsidering price and financial stability is disconsidering their impacts on: • Production • Employment • Income of households • Poverty • Inequality • Consolidation of proper values in society

  4. Micro and macro prudential perspectives of Financial Stability The need for consistency among macroeconomic policies Micro and Macroprudencial Regulation Financial Stability Fiscal Policy Monetary policy • Identifying relevant systemic risks and addressing externalities • Monetary and fiscal policies can help to mitigate costs of aggregate weaknesses and individual failures • The ability to use monetary policy is limited in countries facing short term currency appreciation pressures

  5. Micro and macro prudential perspectives of Financial Stability Some lessons from the financial crisis: What are we discussing? • Current discussion influenced by the situation in developed countries • The lack of a macro-systemic approach was clear, but was the microprudential regulation working properly? • Failure of the regulatory approach and of the organizational design of financial regulation • The decentralized governance failed as well as the “light supervision” approach • The focus on the macroprudential issue will be fruitful only if it does not imply that the microprudential regulation was doing its job

  6. Micro and macro prudential perspectives of Financial Stability Some lessons from the financial crisis: What are we discussing? • A possible (dangerous) lesson from the crisis: “Everything was right except that the macroprudential approach was lacking” • Supervision was poor and the organization of the Financial Safety Net was inaccurate in some places and chaotic in others • From Financial Safety to Financial Stability: both micro and macro prudential perspectives are essential • Regulation should be determined by the assessment of risks, avoiding arbitrage incentives • Risks include those derived from externalities: micro and macro-systemic risks have to be taken into consideration

  7. Micro and macro prudential perspectives of Financial Stability Some lessons from the financial crisis: What are we discussing? • The discussion about the governance of macroprudential policies might be “smuggling” a more transparent debate about the failure of the decentralized regulatory approach and the need to move towards a more centralized fashion • This process might be determined by political economy considerations, but it is relevant to pose the right questions on the table • Governance implications could be wrong if we think that the only problem is to “add” the macro perspective • In order to revise that, we need to get back to the conceptual determinants of the optimal Financial Safety/Stability Net: conflict of objectives, incentive structures and organizational design

  8. Micro and macro prudential perspectives of Financial Stability Fundamental objectives of financial regulation Adverse Selection Moral Hazard Costly State Verification Representing uninformed agents Mitigating systemic risks / externalities Financial Safety/Stability Net

  9. Micro and macro prudential perspectives of Financial Stability Financial Safety Net Preventive tools Corrective tools Prudential Regulation Lender of Last Resort Control and Supervision Resolution Mechanisms

  10. Micro and macro prudential perspectives of Financial Stability Financial Safety Net: Governance Prudential Regulator and Supervisor Monetary Policy Lender of Last Resort Deposit Insurer and Resolution Agency Explicit conflict of objectives and coordination

  11. Micro and macro prudential perspectives of Financial Stability Financial Safety Net: Governance and Conflict of Objectives The decision-making of some crucial issues Intervening financial institutions Liquidating financial institutions Short term financial assistance Mergers and acquisitions

  12. Micro and macro prudential perspectives of Financial Stability Institutional Determinants of the Financial Safety Net Design Separation/Unification of the Financial Safety Net agencies Make explicit the conflict of objectives Relative institutional strenght Expertise and capacities Reputation and credibility

  13. Micro and macro prudential perspectives of Financial Stability Degree of Centralization of Financial Regulation The necessary consistency in supervision and regulation across markets and agents Financial intermediaries and non-intermediaries Capital markets Pension fund administrators Insurance markets

  14. Micro and macro prudential perspectives of Financial Stability Degree of Centralization of Financial Regulation More centralized Less centralized Lower bureaucratic costs Efficiency due to specialization Economies of scale and scope Conglomerates logic Lower power concentration Lower regulatory arbitrage

  15. Micro and macro prudential perspectives of Financial Stability Financial Stability Net: Governance Prudential Regulator and Supervisor Monetary Policy Lender of Last Resort Deposit Insurer and Resolution Agency Ministry of Finance/ Treasury Coordination and contribution for all agencies to comply with their respective mandates

  16. Micro and macro prudential perspectives of Financial Stability Financial regulation Perspectives Representation of uninformed agents Micro-prudencial Mitigating systemic risks Macro-prudencial The complementary roles of micro and macro perspectives • Both micro and macro perspectives have to be considered in order to set the optimal governance structure to the Financial Safety/Stability Net • The contribution of both approaches should be transversal to all the Financial Safety/Stability Net agencies

  17. Micro and macro prudential perspectives of Financial Stability The complementary roles of micro and macro perspectives • Sound risk management are needed not only of individual institutions but also of the financial system as a whole • Both approaches should help to make agents to internalize externalities in both static and dynamic dimensions of financial stability • All proposals (capital buffers, counter-cyclical provisioning, caps on Loan-to-Value ratios, liquidity requirements) require more understanding for implementation and impact evaluation • Rules vs. Discretion: equilibrium between flexibility and reputation • Corporate governance is also relevant: internal risk-management process and compensation schemes should be aligned with a reasonable risk-taking behavior

  18. Implications of systemic risks on rules and institutions Micro and macro prudential perspectives of Financial Stability Risk-based regulation Systemic risks Broad perimeter Exposure to common and correlated risks Rules Ownership/stockholding of non-financial entities Interconnectedness (players and markets) Regulatory treatment of public entities Financial and real sector conglomerates/ cross border Corporate governance Financial Safety Net Regulatory arbitrage across entities with different licenses Centralized Regulation Institutions Financial Stability Framework New kinds of risks as markets develop

  19. Micro and Macro PrudentialPerspectives of FinancialStability Mario Bergara Managing the Capital Account and Regulating the Financial Sector: A Developing Country Perspective UNDESA – IPD - IPEA, Rio de Janeiro, August 23, 2011

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