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International Monetary Fund. Monetary and Capital Markets Department
Published Date:
December 2013
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Assessing Macroprudential Policies in a Financial Stability Framework

The global financial crisis revealed imbalances and vulnerabilities that had built up across the financial system during the preceding boom, including opaque interconnections among financial firms and the procyclical buildup of high debt and excessive leverage. These systemwide financial vulnerabilities, or systemic risks, were beyond the control of traditional “microprudential” financial regulation and supervision measures, which focus on individual institutions. They also arose during a period of relative economic and price stability.

Some time before the crisis, policymakers began to recognize the danger of systemic imbalances, particularly the buildup of credit booms, and discussed various “macroprudential,” or systemwide, approaches for containing them. The crisis forcefully illustrated that systemic risks could develop across institutions as well as cyclically and refocused the attention of policymakers and international institutions on the issue. Since the crisis, regulatory reforms have created new macroprudential structures and tools to identify and mitigate such systemic risks and thereby better protect the broader economy.

Systemic Risk

Systemic risk refers to the chance that large parts of the financial system may cease functioning and thereby disrupt the real economy (IMF, 2013b). Such disruption can arise from three basic threats to financial institutions: (1) excessive common exposures to risky asset holdings that can weaken the ability of the system to provide services when risks materialize (a systemic amplification of shocks); (2) credit booms fueled by procyclical linkages of asset prices and credit (the overexposure of all institutions to shocks); and (3) linkages within the financial system, arising from cross-exposures between institutions, that render certain intermediaries “too interconnected to fail” (a vulnerability to linkages).

Under any of those conditions, a major shock to the financial sector may trigger a cascade of problems across intermediaries—as exemplified by the bursting of the house price bubble in the United States in the run-up to the global financial crisis. If the affected financial institutions react by engaging in a fire sale of assets and pulling back on lending the result is a brake on activity in the real economy (IMF/BIS/FSB, 2009). Recovery from recessions caused by such financial crises takes a relatively long time because of the legacy of high debt levels and a weakened credit system.

In the event that financial institutions become vulnerable to linkages (the third threat), the failure of a single institution could generate systemic contagion through any of several channels, including the direct exposure of other institutions to the failed institution; a loss in the value of commonly held assets; a loss of funding, payment, hedging, or other services formerly provided by the institution; and a general spike in funding costs (runs), especially if there is uncertainty about the extent of risk or the level of exposure within the financial system (Nier, 2011).

The Origins of Macroprudential Policy

Systemic risk is mitigated through the use of macroprudential tools and policies. These are distinguished from macroeconomic policy, which encompasses the economy-wide levers of fiscal and monetary policy. And they are distinguished from microprudential oversight: although both micro- and macroprudential policies seek to constrain excessive risk taking by financial intermediaries, microprudential regulation promotes the stability and soundness of individual firms in order to protect investors, most notably insured depositors, and prevent losses to the taxpayer-backed deposit insurance agency. The goal of macroprudential regulation is to maintain the stability and resilience of the overall financial system, and hence shield the broader economy, by mitigating systemic risk primarily by preventing a major disruption in the provision of financial services (IMF 2011).

The macroprudential concept emerged about 35 years ago, in the context of the first threat listed above—common exposure to risky asset holdings, specifically to developing country debt. Early uses of the term generally referred to the regulated banking system, but the scope of macroprudential policy today is much broader.

A history prepared for the Bank for International Settlements (BIS) traces the first use of the term to the unpublished minutes of a June 1979 meeting about the macroeconomic risks of the rapid increase then under way in international lending to developing economies (Clement, 2010, p. 60). According to these minutes, the meeting’s chairman, W.P. Cooke, of the Bank of England, said,

micro-economic problems … began to merge into macro-economic problems … at the point where micro-prudential problems became what could be called macro-prudential ones. The Committee had a justifiable concern with [the link between] macro-prudential problems and … macro-economic ones.30

The following year, the Lamfalussy Working Party report to the April 1980 meeting of the Group of 10 (G10) central bank governors urged “effective supervision of the international banking system, from both the micro-prudential and the macro-prudential points of view.”31

The term “macroprudential” was used in a public document in 1986, apparently for the first time, but not again until 1992. In each case, it appeared in reports from the Euro-currency Standing Committee (ECSC) of the G10 central banks, each report examining the risks to the financial system posed by financial innovations, including in derivatives markets and securitization. For the 1992 report, the G10 governors asked the ECSC to focus on “the role and interaction of banks in non-traditional markets, … the linkages among various segments of the interbank markets and among the players active in them, and to consider the macro-prudential concerns to which these aspects might give rise.” (Clement, 2010, p. 62)

Another relatively early public use came in a 1998 IMF report examining supervisory approaches to “institutions that have the potential to create systemic problems domestically or internationally” (IMF, 1998, pp. 3 and 13):

Effective bank supervision … is mainly achieved through … both micro- and macro-prudential [monitoring] … Macro-prudential analysis is based on market intelligence and macroeconomic information, and focuses on developments in important asset markets, other financial intermediaries, and macroeconomic developments and potential imbalances.32

An influential discussion of the concept came in a 2000 speech by BIS General Manager Andrew Crockett, who said that systemic financial risk arises from the aggregate actions of financial institutions (a phenomenon beyond the scope of microprudential regulation) and that the goal of macroprudential policy is to protect the macroeconomy by limiting those risks. Moreover, he declared, systemic risk has a “time dimension,” in which expansions and contractions in the financial system and the real economy are mutually reinforcing (a feature later termed procyclicality); and a “cross-sectional” (now also termed structural) dimension of risks across institutions (Crockett, 2000).

In the years between the Crockett speech and the global financial crisis, notes Clement (2010, p. 65), “the policy debate had focused largely on the time dimension” and on countercyclical capital standards. “Following the crisis, however, the cross-sectional dimension also came to the fore, mainly as a result of concerns over systemically significant institutions and the associated ‘too big to fail’ problem.”

The Scope of Macroprudential Policy

Macroprudential policy must address the systemic risks stemming from all three of the threats listed above: the potential for shocks to be amplified, the overexposure of financial institutions to shocks, and the system’s vulnerability to linkages (particularly, the existence of institutions that are too big or too interconnected to fail). As a result, macroprudential policy must address both aggregate imbalances and imbalances that occur in individual, systemically important financial institutions (SIFIs), including nonbank financial institutions. Limiting aggregate imbalances implies macroprudential oversight of all leveraged providers of credit, including nonbank institutions such as finance companies and money market mutual funds because, in the aggregate, they can pose amplification and overexposure risk (Nier, 2011). And the rise of market-based corporate finance, banks’ use of wholesale funding, and more globalized finance mean that SIFIs include not just large banks but firms such as payment and insurance service providers.33 This implies that a potentially diverse range of regulatory agencies must be involved in the creation and implementation of macroprudential policy, not only in advanced economies but also increasingly in emerging market economies that are deepening their financial sectors.

The Limits of Macroprudential Policy

IMF (2013b) notes in an overview that the “use of macroprudential policy tools is growing rapidly, and many countries are striving to build appropriate institutional underpinnings for such policies, [but] the macroprudential policy framework remains work in progress.” As for any type of public policy, if the purposes of macroprudential policy are not clear, the results will fall short. Current work is focused on carefully delineating the important tasks for macroprudential policy from those to be achieved through other stability frameworks.

Most broadly, macroprudential policy should not be used to achieve objectives that are not closely related to systemic vulnerabilities. It is no substitute for macroeconomic management, which is in the realm of fiscal and monetary policy (although their effects on systemic risk, both positive and negative, are being increasingly studied), nor is it a tool to allocate credit or alter market rigidities.

For example, macroprudential policy tools can mitigate the systemic vulnerabilities produced by unsustainable capital flows or excessive exchange rate exposures. But it is the task of a different set of tools, capital flow measures (CFMs), to directly affect the level or direction of flows, even though these should not substitute for warranted macroeconomic policy adjustments. Inevitably, however, the two realms overlap, and the deployment of CFMs is often seen as an exercise in macroprudential control (Blanchard, Dell’Ariccia, and Mauro, 2013).

Another example is the problem of a run-up in the prices of securities and other assets (including the exchange rate insofar as it is an asset price). “Since these prices are likely to be driven by a range of fundamental and speculative factors—including other policies—affecting them should not be seen as a primary aim of macroprudential policies,” according to IMF (2013b). The question to be addressed with macroprudential policy is the extent to which sustained price increases are likely to be accompanied at some point by an increase in the vulnerability of the financial system. Such vulnerability may take the form of an unusual rise in the credit-to-GDP ratio or heavy exposure to particular sectors. In those cases, macroprudential policy may increase the resilience of the financial system to a price shock.

Nonetheless, macroprudential policy in practice overlaps with both the traditional prudential oversight framework and the systemwide scope of monetary policy. A key aspect of designing a macroprudential capability is preserving the independence of all three frameworks while ensuring that they work in concert.

Macroprudential policy is a complement to microprudential policy and it interacts with other types of public policy that have an impact on systemic financial stability. Indeed, prudential regulation, as carried out in the past, also had some macroprudential aspects, and the recent crisis has reinforced this focus; hence, a clear separation between “micro” and “macro” prudential, if useful conceptually, is difficult to delineate in practice. … This calls for coordination across policies, to ensure that systemic risk is comprehensively addressed. (IMF, 2011, p. 3)

With regard to the coordination of macro- with microprudential policies, a June 2013 IMF paper (Osiński, Seal, and Hoogduin, 2013) recommends a clear separation of “mandates, functions, and toolkits” so as to limit the potential for conflict between the systemwide and institution-specific aspects of the two frameworks, respectively. This paper cautions, however, that as the credit cycle nears what will later be seen as its expansionary peak, macroprudential policy may call for restraint at the same time that restraint seems least necessary from the micro perspective.

However, “The differences between the two policies are at their most stark in the downswing when they can have diverging assessments of the extent to which buffers may be released to contain excessive deleveraging without endangering the stability of individual institutions, as well as the extent of consequences of a potential deleveraging induced by microprudential policy actions” (Osiński, Seal, and Hoogduin, 2013, p. 15). In all cases, it is fundamental that there be discussion among the relevant authorities based on common information and “participation to the extent possible in each other’s decision-making” in order to ensure a consistent and effective approach to stability management (p. 13).

Likewise, coordination with monetary policy is essential. In an ideal world, macroprudential policy would be able to eliminate excessive risk in the financial system, releasing monetary policy to focus on the stability of prices and output. However, even in this ideal scenario, macroprudential and monetary policy would affect each other (IMF, 2013a). In practice, the distinction is even less clear-cut. Monetary policy often must be used to achieve some aspects of financial stabilization. “Similarly, where monetary policy is constrained, as within currency unions and in many small open economies, there will be greater demands on macroprudential policies.”

Indicators and Tools

The IMF has been monitoring and analyzing the postcrisis development of systemic risk indicators, macroprudential tools, and institutional frameworks to aid policymakers in shaping them to best fit national circumstances and international challenges.34 No single indicator of systemic risk has been identified as decisive, and so macroprudential policy must rely on a range of indicators. The pace or extent of credit growth, for example, are insufficient on their own to indicate whether such credit growth poses a systemic risk. In an econometric study of potential macroprudential indicators and tools, Chapter 3 of the IMF’s September 2011 Global Financial Stability Report (GFSR) finds that both credit growth and the ratio of credit to GDP provide strong to moderately strong advance signals of an impending banking crisis. It recommends, however, that authorities augment their use of those indicators by seeking to detect increases in other key indicators (a recommendation echoed in IMF, 2013b, which includes among the complementary indicators asset prices, leverage, lending standards, debt service indicators, interest rate and currency risks, and external imbalances).

Measures of capital and liquidity strength, derived in part through stress tests of institutions, can also indicate cyclical problems. And new measurement techniques (network analysis and contingent claims analysis) can help identify a buildup of structural risks related to interconnectedness, although the authorities will need improved data to take full advantage of those techniques (IMF, 2013b).

Macroprudential tools, some of which have been in use in emerging market economies since before the global financial crisis,35 broadly encompass three sets of tools: (1) countercyclical capital buffers and provisions; (2) tools that target exposures to particular sectors, such as limits on loan-to-value and debt-to income ratios; and (3) liquidity tools, such as liquidity and reserve requirements, to contain funding risks from rapid increases in credit (IMF 2013b).

According to IMF 2013b, these three sets of tools can reinforce and complement each other in addressing the buildup of risks through time. Interlocking use of these tools can help overcome the shortcomings of any one single tool and enable policymakers to adjust the overall policy response to a range of risk profiles.

Lim and others (2011) find that several tools are effective in limiting a buildup of financial risk taking: caps on the loan-to-value and debt-to-income ratios, liquidity requirements, and dynamic (countercyclical) loan-loss provisioning. The effects of countercyclical capital buffers are less evident, possibly because there are fewer observations of them than for the other tools during the sample period (2000–10). The results on effectiveness are independent of the type of exchange rate regime in place (see also IMF, 2013b, for a comprehensive account of tools, calibration, and regulatory and data gaps).

The use of reserve requirements as a macroprudential tool in Latin America was addressed in an IMF working paper that notes their “flexibility, widespread use, and scope” (Tovar, Garcia-Escribano, and Martin, 2012). The paper finds that macroprudential use of reserve requirements over the 2003–11 period had a moderate but transitory effect on credit growth. It also finds that the use of monetary and macroprudential instruments in Latin America, including reserve requirements, appears to have been complementary in recent cases.

Capital flow measures, which include capital controls as well as micro- and macroprudential tools, are intended to stem capital inflows, which can in turn fuel credit growth and exchange appreciation. An IMF review (Habermeier, Kokenyne, and Baba, 2011) finds that “for reasons that are not yet fully understood, capital controls and related prudential measures achieve their stated objectives in some cases but not in others, and it is not possible to draw definitive conclusions. Close attention needs to be given to the choice and design of such measures.” The issue of design is addressed in Ostry and others (2011).

The revised international standard for the regulation of banking, known as Basel III and issued in December 2010 by the Basel Committee on Banking Supervision (BCBS, 2010), embodies significant macroprudential elements for the oversight of banks. Basel III recommendations include phased-in requirements for higher and cyclically adjustable capital buffers, a leverage ratio, first-ever standards for liquidity and stabilized funding of assets. The Basel Committee is also addressing risk management, particularly when banks trade on their own account, for which it is proposing higher capital requirements and stricter isolation from core banking. In addition, the Basel Committee has revised its Core Principles for Effective Banking Supervision (BCBS, 2012) to emphasize the need for a macroprudential perspective and for better resolution mechanisms. The IMF and World Bank use the Basel Committee core principles as part of the Financial Sector Assessment Program, which evaluates countries’ prudential oversight of banking.

Mitigating the problem of “too big to fail” includes proposals for capital surcharges on institutions, efforts to separate “core” banking from riskier activities, and work on devising more effective resolution mechanisms for intermediaries to minimize the need for taxpayer funds in dealing with insolvency.

Another class of tools consist of structural changes to payment, settlement, and clearing systems to prevent the buildup of hidden counterparty credit risks such as those that occurred before the global financial crisis with bilateral transactions in customized derivatives (IMF, 2013b). Centralized counterparties that settle standardized products would introduce transparency and greater market discipline. (They have an incentive to monitor the condition of their counterparties and insist on having positions marked to market.) But they also concentrate risk and so themselves must be subject to close regulatory oversight. The safety of their operations, and of course of the entire financial system, would also be enhanced by requirements for greater transparency on the part of financial institutions.

Institutional Frameworks

Implementation of the broader institutional scope of the macroprudential view requires new institutional arrangements. A key feature of any formal financial stability mechanism is “an authority with a clear mandate for macroprudential policy; and a formal mechanism of coordination or consultation across policies aimed at financial stability” (IMF, 2011, p. 12). A number of jurisdictions have passed major legislation since the crisis to create such arrangements. A central goal of the initiatives is to create an explicit macroprudential policy function that integrates macroprudential oversight and tools within existing prudential and monetary policy frameworks (IMF, 2011, p. 36; and Box 3.1 of the September 2011 GFSR).

The appropriate macroprudential framework depends on country circumstances. IMF (2013b) finds three models are being increasingly used in practice and that all three share these desirable characteristics: a designated body is responsible for macroprudential policy, and the central bank is a participant if not the leader. The models are described in the report as follows:

  • Model 1: The macroprudential mandate is assigned to the central bank, with macroprudential decisions ultimately made by its board (as in the Czech Republic).
  • Model 2: The macroprudential mandate is assigned to a dedicated committee within the central bank structure (as in Malaysia and the United Kingdom).
  • Model 3: The macroprudential mandate is assigned to a committee outside the central bank, with the central bank participating on the macroprudential committee (as in Australia, France, Germany, and the United States).

The European Union follows model 3, with the president of the European Central Bank serving as head of the European Systemic Risk Board, which coordinates macroprudential policy across all member countries.

Latin America, historically a region highly prone to banking crises, is also making strides in establishing dedicated macroprudential policy bodies. Many countries in the region have long used macroprudential tools to address credit and exchange rate surges, and many have gradually strengthened their prudential oversight of banking. But only a few—Chile, Mexico, and Uruguay—have implemented explicit multi-institutional arrangements for maintaining systemic financial stability. (The governing board of the central bank of Brazil has created a committee of the whole that is tasked with the responsibility for macroprudential stability.)

Jácome, Nier, and Imam (2012) examine current and potential stability structures in eight Latin American countries. In five, dubbed the “Pacific” group—Chile, Colombia, Costa Rica, Peru, and Mexico—oversight of banking institutions is located outside the central bank; and in three (the “Atlantic” group)—Argentina, Brazil, and Uruguay—such oversight is lodged within the central bank.36 The study suggests that the coordinating committees established in Chile and Mexico represent an appropriate path for other countries in the Pacific group to tie together the efforts of their disparate oversight agencies, but that any such committee needs power—those in Chile and Mexico can only make recommendations.

In the Atlantic group, where the central bank directs both monetary policy and prudential oversight, the authors find the main challenge is to assign clear macroprudential accountability to the oversight function. “It would … seem desirable to introduce the pursuit of financial stability as the main objective of the central bank’s actions in supervision and regulation” (p. 30).

International Coordination

The fact that finance is highly globalized means that macroprudential policy in each country must have a multilateral perspective and capacity. The buildup of imbalances in any single country must be addressed multilaterally lest a form of cross-border arbitrage take hold. If only a single country or a small group of countries adjust policy, lending can take place through a subsidiary institution in one country while being recorded on the books of the parent in another. Basel III already calls for international coordination in the adjustment of countercyclical capital buffers (so that, when the buffer “is activated in any given country, all countries are meant to apply the buffer to exposures into that country”), and such reciprocity arrangements must be expanded to other tools (IMF, 2013b). International coordination is also critical for resolving home-host issues with regard to financial institutions that have affiliates in multiple jurisdictions and to achieve effective resolution of internationally active institutions.

The ability of national authorities to take action that may be controversial in their home countries can be strengthened by broadened surveillance of national frameworks by international bodies such as the IMF, as well as by guidance from the Basel Committee on Banking Supervision and the Financial Stability Board (FSB). The IMF is well placed to facilitate further work on macroprudential policy and, “through its existing programs of surveillance, [Financial Sector Assessment Program reviews], and technical assistance, to help countries conduct an in-depth assessment of systemic risks, and to advise on preventive macroprudential action in the light of this assessment” (IMF, 2013b).

The FSB is an international committee of officials from monetary and financial supervisory agencies established by the Group of 20 (G20) to “coordinate at the international level the work of national financial authorities and international standard setting bodies” and to promote effective policies for the financial sector. Notably, its charter states that part of its mandate is to assess financial sector vulnerabilities and review actions needed to address them “within a macroprudential perspective.”37 Under a mandate from the G20, the FSB and IMF jointly conduct the Early Warning Exercise program to assess low-probability, high-impact risks to the global economy and the means to address them.


Blanchard, Dell’Ariccia, and Mauro (2013) conclude that the mutual relationship among monetary, fiscal, and macroprudential policies is still “vague” and in flux. Central banks could emerge as the center of both monetary and macroprudential policy, with the independence of the monetary authority providing political cover to the potentially more contentious application of macroprudential tools. However, if the macroprudential measures are perceived to somehow threaten the independence of the monetary authority, at the extreme, the result could be a suppression of the use of such macroprudential tools.38 In that case, with the need for financial stability management no less urgent, the monetary authority might find itself moving toward a flexible inflation rate policy to cover the roles that arguably would be better played by macroprudential and fiscal tools.

The IMF (2013b) offers three conclusions about the relationship of macroprudential and macroeconomic policies:

  • The policy framework should not overburden macroprudential policy. Macroprudential policy cannot cure all ills. For it to make a contribution to macroeconomic stability, its objectives must be defined clearly and in a manner that can form the basis of a strong accountability framework.
  • Macroprudential policy must be complemented by strong macroeconomic policies. Prudential policies alone are unlikely to be effective in containing systemic risk driven by real imbalances. Macroeconomic policies are needed too, including monetary, fiscal and structural policies.
  • Macroprudential policy should not be expected to prevent all future crises. Policymakers need to accept that crises will continue to occur and be prepared to manage these crises through appropriate policies.

The IMF also identifies some important areas for further work, including the development of better leading indicators to signal when systemic risk is building, more reliable criteria for deciding when to take action, and a better understanding of financial system behavior in the aftermath of shocks.

Finally, macroprudential policies involve trade-offs. And there can be unintended consequences of using countercyclical and sectoral policies, particularly when there are gaps in the available data. The use of such policies may raise the cost of financial intermediation and induce financial institutions to relocate or shift their organizational structure to exploit regulatory gaps. As a result, macroprudential authorities must consider such dynamic factors and the limits of the available data when they assess the potential costs and benefits of action. And once tools are deployed, the authorities must likewise monitor developments to assess the policies’ effectiveness and to look for unanticipated shifts in financial system behavior and structure. These challenges are among the reasons the IMF emphasizes that “A strong institutional framework is essential to ensure that macroprudential policy can work effectively” (IMF 2013b).

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