Macroprudential policies keeping Asia stable - Minsoo Lee
Op-Ed / Opinion | 21 August 2015
Before the 2008 global financial crisis, bank monitoring focused primarily on risks to individual institutions, or what are generally referred to as prudential risks. Regulators thus failed to consider that a buildup of macroeconomic risks and vulnerabilities could pose systemic risk to the financial sector.
The global credit crisis showed the inadequacy of purely prudential surveillance systems and the need for bank supervisors to better detect the buildup of macroeconomic risks before they can threaten the financial system.
What has become known as macroprudential policy includes measures to prevent periods of instability or crisis as well as a rich set of instruments to alleviate financial risks. These include policies and regulations that manage credit, liquidity and capital risks that can build up in the broader financial system.
In theory, macroprudential measures can safeguard the stability of the banking system and the broader financial system by mitigating risks that affect the entire financial system and, therefore, the economy. The question is, as always, whether they actually work.
Several Asian countries have proven that implementing macroprudential measures can effectively prevent or address threats to financial stability, such as asset price bubbles. Since the 1997-1998 Asian financial crisis, banking supervisors and regulators have used an arsenal of macroprudential measures to cope with potentially volatile, large-scale capital inflows.
Examples from four countries in the region show that one size does not fit all and that macroprudential policies need to be tailor-made to address different domestic circumstances.
South Korea systematically enacted several macroprudential policy instruments before the global financial crisis. As early as 1997, authorities there adopted several types of liquidity ratio requirements to offset potential weaknesses in domestic banking and foreign currency fluctuations.
However, by the time the credit crisis came along, new imbalances had emerged among domestic banks as well as in foreign exchange transactions, associated in part with a housing boom. To meet the growing demand for foreign exchange derivative transactions, banks had begun to rely on short-term foreign borrowings.
The South Korean authorities responded by further tightening macroprudential policies in 2006, when home prices peaked. Credit-tightening requirements such as caps on loan-to-value and debt-to-income ratios had an almost instantaneous impact, dampening appetite for credit and reining in house price inflation.
Singapore, too, has employed macroprudential policies to address asset bubbles. Despite a highly developed financial system that is well-regulated and supervised by the Monetary Authority of Singapore, risks to financial stability emerged in recent years as galloping real estate prices surpassed their 2008 peak. Property loans, and thus household debt, continued to rapidly grow, with a corresponding rise in the exposure of local banks to the property sector.
This stoked regulatory concern that property price rises could rekindle inflation expectations and threaten financial stability. In response, the authorities enacted a range of measures to ensure macroprudential stability. These included tightening a limit on the ratio of mortgage payments to income, capping the loan-to-value ratio, imposing an additional buyer's stamp duty and increasing minimum cash down payments.
The measures have been broadly successful. Home price inflation and measures of housing affordability have stabilized.
In Indonesia, policymakers have faced some of the region's most complex challenges in managing strong domestic demand in an uncertain global economic and financial environment. The key question has been how to balance price stability for sustainable growth with maintaining external and financial system stability in the face of highly volatile capital flows, exchange rates and global commodity prices.
Indonesian authorities understood that monetary policy alone would not be enough and that a mix of macroprudential policy and other macroeconomic measures was needed.
In Indonesia's case, credit-related tightening measures like those implemented in South Korea and Singapore were not effective. However, liquidity-tightening measures such as reserve requirements, the imposition of a minimum holding period for short-term government debt and limits on net open positions in foreign currencies had a significant impact on credit expansion and leverage growth.
India's financial system is dominated by banks, and aggregate bank credit growth has been an important indicator in the conduct of monetary and macroprudential policies. The Reserve Bank of India's capital-related macroprudential policies have focused on both banks and other financial entities.
During the upswing of 2004 to 2008, the authorities implemented countercyclical policies by increasing the weighting for riskier classes of loans and revising other rules on provisioning against loan losses. Those capital-related policies targeting credit expansion had the desired effect of moderating the credit boom, in particular.
Recent history shows that macroprudential policies can be valuable tools for Asian financial regulators. Different policies have proved effective for different types of macroeconomic risks.
The implication for regulators is that they should assess which policies would be appropriate for the particular risks they face in their financial systems. They should continue to respond proactively to new systemic risks. Moreover, they should enhance their surveillance and analytical frameworks for assessing the likelihood and subsequent impact of emerging systemic risks.
Minsoo Lee is a senior economist in the economic research and regional cooperation department of the Asian Development Bank and is the co-author of the working paper, "Effectiveness of Macroprudential Policies in Developing Asia: An Empirical Analysis."