B&E | Macroprudential Policies in Developing Asia

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 in practice.

An Excerpt from Asian Development Bank's 

Global Outlook 2015 Report

Cover Art Attribute: A view of the iconic Fullerton Hotel and Cavenagh Bridge, as seen from the Anderson Bridge, with Singapore's Financial District in the background / Flickr CC

Before the global financial crisis, bank monitoring focused primarily on prudential risks to individual institutions and failed to consider that a buildup of macroeconomic risks and vulnerabilities could pose systemic risk by severely affecting a number of institutions simultaneously. The global financial crisis highlighted the need for national bank supervisory authorities to improve surveillance systems and better detect early on the buildup of macroeconomic risks that could threaten the financial system. This requires strong macroprudential policy that includes measures to prevent periods of instability or crisis, as well as a rich set of instruments to alleviate financial risks that stem from vulnerabilities building up in the broader financial system, be they related to credit, liquidity, or capital.

The Basel Committee on Banking Supervision is  increasingly guided by the need for a macroprudential  perspective on financial regulation. Although much progress  has been made on the regulatory front—especially with  Basel III tightening of the rules on the quantity and quality  of bank capital, requiring for example a countercyclical  capital buffer—regulations apply to only some financial  institutions. In contrast, macroprudential policy aims to limit  the buildup of risk in the entire financial system and enhance  its resilience following shocks. Efforts are mainly to identify  systemic threats to financial markets that could affect the  real economy, and so avoid another financial crisis.

Macroprudential policy measures fall into the following three broad categories (Lim et al. 2011):

• Credit controls, including caps on ratios of loan to value and of debt to income and on foreign currency lending, as well as ceilings on credit or credit growth;

• Liquidity regulations, which place limits on net open currency positions or currency mismatches and on maturity mismatches, while establishing reserve requirements; and

• Capital requirements, including countercyclical capital requirements, time-varying/dynamic provisioning, and restrictions on profit distribution.

Macroprudential tools such as minimum capital ratios and loan-to-value ratios have been used for some time. Compared with some other regions, Asia has long experience in implementing a variety of macroprudential measures to prevent or address asset price bubbles or other threats to financial stability. This experience is derived primarily from dealing with previous threats to financial stability, especially arising from volatile capital flows

Can macroprudential policies keep Asian financial systems stable?

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 in practice. This section presents the basic framework of an empirical analysis to gauge how effectively macroprudential policies control credit growth, leverage growth, and housing price appreciation.

Two significant findings emerge. Broadly, macroprudential policies can indeed promote financial stability in Asia. More specifically, different types of macroprudential policies are more effective against different types of macroeconomic risks. For example, the results suggest that credit-related macroprudential policy dampens credit growth in India, liquidity-related macroprudential policy reins in leverage growth in Indonesia, and credit-related macroprudential policy helps to control housing price escalation in the Republic of Korea.

Responses to selected macroprudential policies in selected economies

Click her for figure data

The general pattern across the region suggests that credit-related macroprudential policies can effectively dampen credit expansion and housing price inflation, while liquidity-related macroprudential policy tools moderate leverage growth and housing price escalation. The salient implication for Asian financial regulators is that, while they should explore the use of macroprudential policies, they should assess which exact policies are appropriate for the particular macroprudential risk they face.

Download : ADB's Global Outlook 2015 Report

Publication Details:

This article is a part of a chapter for Asian Development Outlook 2015

Creative Commons Attribution 3.0 IGO license (CC BY 3.0 IGO)

© 2015 Asian Development Bank

6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines

Tel +63 2 632 4444; Fax +63 2 636 2444

www.adb.org; openaccess.adb.org

ISBN 978-92-9254-895-7 (Print), 978-92-9254-896-4 (PDF)

ISSN 0117-0481

Publication Stock No. FLS157088-3