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Why are central banks delegated macroprudential responsibilities?

Domenico Lombardi

(Centre for International Governance Innovation)

Manuela Moschella

(Centre for International Governance Innovation and University of Turin)

Abstract After the global financial crisis, it is now widely recognized that in addition to established microprudential policies, the stability of the financial sector requires the adoption of macroprudential policies. A number of countries have reviewed their institutional frameworks for financial stability in order to support the development of macroprudential regulatory (MPR) policy. One of the key features of the new institutional set ups has been the delegation of MPR responsibilities to central banks. Why did policy makers delegate MPR responsibilities to central banks in the aftermath of the global financial crisis? What factors account for the choice between concentrated and dispersed governance arrangements? Based on the comparison of the MPR institutional design created in the UK, the EU, and the US, the paper challenges conventional rationalist explanations according to which delegation basically reflects policy makers’ demand for expertise and policy credibility. Policy-makers’ attempt to deflect accountability for the adoption of politically unrewarding decisions and for potential failures in preventing systemic crises also played a key role. The paper also found that that pattern of delegation built on, rather than disrupted, pre-crisis institutional regulatory arrangements. Keywords: central banks; financial stability; macroprudential regulation; Federal Reserve; Bank of England; European Central Bank.

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1. Introduction

Among the lessons drawn from the global financial crisis, few are as less disputed than the

recognition that the microprudential regulatory approach that had dominated before 2008 is not up

to the task of ensuring financial stability. Macroprudential regulation and supervision (MPR) is now

increasingly called for to complement the regulation of idiosyncratic risks (Baker, 2012). The

macroprudential approach is meant to limit systemic risk by monitoring and regulating the

interconnectedness and the buildup of common exposures among institutions and market players,

and by assessing whether the aggregate effect of individual actions lead to excessive procyclicality

and systemic fragilities (on these issues Borio, Furfine and Lowe, 2001; White, 2006).

In recognition of the importance of macroprudential policies for stabilizing the financial

cycle several macroprudential authorities have been created both in advanced and emerging market

economies over the last few years.1 For example, in the advanced economies, macroprudential

oversight bodies have been created in in the United Kingdom (i.e. FPC), in the European Union (i.e.

the European Systemic Risk Board) and the United States (i.e. the FSOC). Interestingly, central

banks play a key role in the development and implementation of MPR in all three cases – albeit, in

some cases, the central bank has complete authority over MPR (e.g. in the UK), whereas in the

other cases (e.g. in the EU and in the US) the central bank has been granted more extensive

responsibilities than other relevant regulatory authorities within committee-type governance

frameworks.2

1 This paper solely focuses on specific experiences in the advanced economies. For an overview of the main institutional changes in the group of emerging market countries see, for instance, (Nier et al., 2011, 6). 2 As will be discussed at greater length below, in the newly established MPR committees, central banks are often assigned key responsibility for the supervision of systematically important financial institutions. Furthermore, they often serve as the chairmanship of the committee or provide the bulk of the analytical input to monitor systemic risk.

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Why did policy makers delegate MPR responsibilities to central banks in the aftermath of

the global financial crisis? What factors account for the choice between concentrated and dispersed

governance arrangements?

Based on the comparison of the MPR institutional design created in the UK, the EU, and the

US, the paper challenges conventional rationalist explanations according to which delegation

basically reflects policy makers’ demand for policy credibility and information – a logic that has

largely been applied to explain the delegation of monetary authority to independent central banks

across countries (Grabel, 2000). Although adverse political economy problems and policy

complexities are certainly important factors to account for the delegation of MPR responsibilities,

similarly to what happens for monetary policy, there is no neat correspondence between the

intensity of the demand for policy credibility and information and the degree of discretion accorded

to central banks in the exercise of the new MPR responsibilities. In particular, politicians ultimately

retained significant control over systemic financial stability issues. The discretion granted to central

banks is thus more limited than the rational model of delegation would lead us to expect.

This paper argues that a full explanation of the delegation of MPR powers to central banks

requires taking into consideration policy makers’ desire to deflect accountability for policy

interventions whose public benefits are not easy to be discerned but whose failures are manifest.

The problem is that achieving systemic financial stability is not always self-evident to the public

especially in the absence of crisis. In contrast, the burst of a crisis attracts public attention. Given

the distribution of costs and benefits, it is plausible to hypothesize that delegation was used to

transfer the politically unrewarding activity of crisis prevention as well as the blame for potential

failures.

Turning to the second question that motivates this paper, we argue and illustrate that the

choice between concentrated and dispersed governance framework can largely be explained by pre-

crisis domestic regulatory characteristics. In particular, whether the central bank has been assigned

sole or shared MPR responsibilities depends on the country-specific institutional framework that

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allocates responsibilities for supervision and regulation, and on the specificities of the central bank

mandates. In short, the delegation of MPR powers is largely influence by pre-existing institutional

features.

Before proceeding, the scope of the paper should be made clear. First, the paper solely

focuses on the system-wide responsibilities delegated to central banks. This means that we do not

explicitly explore other, related delegation of responsibilities that pertain to the role of the central

bank as microprudential supervisor – such as the creation of the Single Supervisory Mechanism

(SSM) in the EU. Second, it is not a purpose of this paper to assess the efficacy and efficiency of

different institutional setups in search of the optimal governance framework and the optimal level

of involvement of the central bank in macroprudential oversight. Furthermore, our analysis does not

provide an empirical assessment of the consequences of MPR responsibilities for central bank

independence (on these issues see, for instance, Ingves, 2011). Indeed, as will be discussed at

greater length below, there are serious concerns about whether the central bank could safeguard its

hard-won monetary policy independence if it also assumes the role of the macroprudential

supervisor because of the interconnections between the two policies (on the post-crisis debate

regarding the role of monetary authorities in financial stability see Moschella, 2014).3 More

narrowly, our analysis is meant to shed light on the factors that have led to the delegation of MPR

powers to central banks in the first place, leaving the assessment of the resulting implications that

derive from such acts of delegation to future analysis.

The paper is organized as follows. In the next section, we introduce the concept of

macroprudential regulation and review the potential role for central banks. In doing so, we critically

discuss two alternative explanations that may help account for the delegation of MPR powers to

central banks in the aftermath of the global financial crisis. We then suggest how existing

3 For instance, the objectives of monetary and financial stability policy may occasionally diverge as is the case when monetary policy requires low interest rates and macroprudential policies would need to tighten to limit the potential negative consequences for financial stability. This is a problem similar to the one that bedevils central banks when they take on microprudential responsibilities: when the banking system is under stress, the central bank may be hesitant to impose the appropriate degree of tightening because of the potential negative implications for the solvency of the banks it supervises (Goodhart and Schoenmaker, 1995).

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explanations need to take into account policy makers’ need to deflect accountability in order to

account for the delegation of MPR powers to central banks. We also draw attention to pre-crisis

institutional setup in order to account for the type of delegation across countries. Section 3, 4 and 5

illustrate our arguments based on the examination of the delegation of MPR powers to the central

bank in the UK, the EU and the US. The last section concludes by reflecting on the findings and

speculating about their implications for future research.

2. Macroprudential regulation and the role of central banks

In general terms, macroprudential policy has been defined as the monitoring of systemic risks in

financial markets and implementation of prudential tools to limit these risks. Systemic risk refer to

‘a risk of disruptions to financial services that is caused by an impairment of all or parts of the

financial system, and can cause serious negative consequences for the real economy’ (IMF, 2011).

This definition implies that much of macroprudential policy is implemented via regulatory

interventions, using instruments that are often deployed for microprudential purposes (Ingves, 2011,

8). Although there is broad agreement that macroprudential policies must complement existing

supervisory and regulatory policies to help mitigate systemic risks, the appropriate toolkit and the

delegation of authorities necessary for conducting such policies remains a lively debate. The MPR

policy toolkit often includes countercyclical capital buffers and provisions to increase resilience to

shocks, sectoral tools to contain a build-up of risks in particular sectors (i.e. sectoral capital

requirement, limits on LTV and DTI ratios), and liquidity tools to contain funding risks.4 There still

remains debate as to whether other instruments such as capital controls, interest rates, or tax policies

should be included in the toolkit.

4 MPR instruments are also commonly distinguished according to whether they are price-based instruments (such as the setting of capital and liquidity ratios or by taxing certain financial transactions) or quantity-based measures (such as setting loan-to-value (LTV) or debt-to- income (DTI) limits for mortgages, or margining requirements for secured financing transactions).

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The second aspect of the MPR policy framework subject to heated debate is who should

monitor systemic risk, design and implement MPR policy. Country reviews of post-crisis regulatory

changes suggest that at least two governance frameworks for the conduct of macroprudential policy

have emerged (IMF, 2013a, 15-16). The first delegates the responsibility for macroprudential

policies to an existing public authority, often the central bank. It may also include the assignment of

MPR responsibility to a separate decision-making body within the central bank whose sole

objective is to promote financial stability.

The second governance framework shares macroprudential responsibilities among different

agencies usually delegated to a newly established committee. ‘In some cases, the macroprudential

committee will have decision-making powers that are binding on its constituent agencies and/or on

market participants. In other cases, the committee may perform a coordinating function and not

have decision-making powers.’ (IMF, 2013a, 15-16). While the institutional specificities of these

dispersed decision making systems vary across countries, central banks are generally assigned key

responsibilities. Indeed, central banks often serve as chair of the committee (as in Australia) or

provide the bulk of the analytical input for monitoring systemic risk (as in the EU). Furthermore,

they are often granted a stronger voice than other participants (as in Mexico), have veto power over

policy decisions (as in Germany), or are tasked with distinct supervisory responsibilities (as in the

US) (IMF, 2013b, 30).

The delegation of MPR powers to the central bank is often justified using a similar set of

arguments that have been used to explain why monetary policy should be delegated to an

independent central bank. Similarly to monetary policy, macroprudential regulation is a policy

subject to adverse political economy problems and characterized by an elevated degree of technical

complexity (for a discussion of these problems Ingves, 2011). In light of these features, there are

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credibility and informational gains to be attained by delegating MPR policy to the central bank, just

as there are benefits to delegate monetary policy in this way.5

To start with, similarly to what happens in the realm of monetary policy where politicians

may be tempted to oppose the adoption of disinflationary policies because this choice risks denting

popular support especially in ‘good’ times, politicians are also likely to oppose countercyclical

macroprudential policies for the same reasons, especially during a financial boom (Goodhart, 2008).

Policymakers may also hesitate in applying macro-prudential remedies because of pressure from

interest groups such as lobbyists for the financial services industry which is hurt the most from

tighter prudential standards (White, 2006). The independence of MPR authorities is thus very

important because short-term electoral interests could bias the implementation of MPR tools away

from longer-term societal interests.

From this perspective, no agency is better placed to resist such political and social pressures

than the central bank because of its track record in delivering relatively stable prices as an

independent institution. Furthermore, since credibility cannot be created at a stroke of a pen but

takes a long time to be established, setting up a brand-new independent agency to run macro-

prudential policy, with no experience or track record, does not represent an appealing option

(Viñals, 2010). Finally, central banks are subject to the ‘right’ incentives to make MPR work. These

incentives derive from the synergies between MPR and the liquidity and lender-of-last-resort

(LOLR) policies that central banks normally perform (c.f. IMF, 2013b, 9; Nier et al., 2011). Since

there are moral hazard and reputational costs for the central bank that mishandle its liquidity and

financial assistance function, the central bank has an incentive to develop an interest in an effective

5 Of course, the arguments in favor of delegation to the central bank are not without challenge especially because of the potential incompatibility that may arises between monetary policy and domestic financial supervision (Goodhart and Schoenmaker, 1995). However, it is interesting to note that even those who are skeptical about the involvement of central banks in financial stability policy recognize that there are gains to be attained from the delegation of MPR powers in the preventative stage. For instance, ‘Ideally, the central bank should have access to macroprudential levers for containing the build-up of imbalances and so preventing the risk of a potential financial disturbance. In this regard, the global development of institutions involving central banks with the power to implement macroprudential measures is promising, although it may take decades to assess the effectiveness of such measures in practice.’ (Orphanides, 2013, 16)

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regulation of the financial sector as a whole to limit spill-over effects for individual institutions

(Nier et al., 2011, 12).

Next to addressing adverse political economy problems and the opportunities for corruption

that bedevil MPR policy, the complexity of macroprudential policy is a further reason that justifies

its delegation to an ‘expert’ central banks. A systemic approach to financial stability entails

understanding the linkages and externalities among several market segments and sectors where

unexpected events can generate costly and rapid explosions (Baker, 2013)(also Haldane writings to

be added). This activity requires access to data from a wide range of sources as well as knowledge

of the calibration and effectiveness of different policy tools (Claessens and Kodres, 2014, 16).

Central banks are usually well-positioned for having access to the relevant information because of

their knowledge of financial markets derived from the management of liquidity.6 Furthermore,

central banks are already involved with some type of financial stability assessment.

In short, the delegation of MPR responsibilities to the central bank can be explained in light

of the credibility and technical problems that characterize macroprudential policy. Central banks, so

the argument goes, are more likely to deliver system-wide stability than policy-makers and other

regulatory agencies because of their independence and expertise as attested by their strong

performance in maintaining price stability.

Although the comparison with monetary policy is certainly a powerful explanation to

account for the delegation of MPR responsibilities, the actual modalities of delegation do not fit

perfectly with the theoretical expectations that underpin the conventional logic of delegation just

described. These expectations hold that, to be credible, MPR policy must be insulated from the

vagaries of the political process – otherwise, it will generate inferior outcomes or be manipulated at

the detriment of systemic stability. Furthermore, rational models of delegation suggest the existence

of a trade-off between the demand for information and policy credibility on the one hand and the

6 Some central banks have also developed specific strategies to take financial stability considerations into account when formulating monetary policy. This is, for instance, the case of the ECB whose monetary policy strategy entails the ‘pillar’ of monetary analysis, which explicitly takes into account the medium-term implications of booming asset prices and credit markets for price stability.

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extent of delegation on the other hand (Epstein and O'Halloran, 1994; Epstein and O'Halloran,

1996; Epstein and O'Halloran, 1999; Huber and Shipan, 2000; Moschella, 2013). In particular, the

higher the complexity of an issue and principals’ demand for credible commitment, as is the case in

MPR policy as discussed above, the greater the discretion allocated to the agent.

However, as illustrated below, these expectations are not fully supported by the empirical

record thus far. In particular, the analysis of the institutional designs of the new MPR authorities

reveals that the insulation from political pressures is far from being assured but policy makers

retained significant control over the conduct of MPR policy. Furthermore, the central bank’s

discretion has been kept in check and in some cases even streamlined.

In what follows, we thus suggest expanding the conventional model of delegation by

bringing in other factors that shape the logics of delegation. Specifically, we suggest testing the

proposition that delegation was not solely motivated by policy makers’ demand for credibility and

information but also reflects an attempt to deflect accountability. Since politicians ultimately

retained significant control over financial stability issues, it is plausible to hypothesize that

delegation was used to transfer the costs and the blame associated with the activity of preventing

crises. The problem is that achieving systemic financial stability is not always self-evident to the

public whereas instability is manifest. To start with, financial stability in general and systemic

stability in particular cannot be numerically approximated in terms of a generally agreed index as is

the case for price stability (Ingves, 2011, 28). This means that no clear benchmark exists to assess

performance and attribute credit for positive results. Furthermore, the merits of the MPR regulator

are unlikely to be recognized when no crises erupt because the public cannot see that a crisis has

been effectively averted. To the contrary, when a financial bubble bursts, policy failures become

immediately apparent.

Furthermore, we suggest two propositions that can help account for the variation in the

governance arrangements that have been created in the countries under investigation. The first

proposition is that the central bank is likely to be designated as the sole MPR authority in domestic

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contexts where the central bank already performs relevant regulatory and supervisory powers. In

contrast, where supervisory powers are dispersed across several agencies, the delegation of MPR

powers to the central bank will most likely take place within the framework of a committee-type

governance arrangement. Shared forms of delegation are also likely to be found in those domestic

contexts where the Ministry of Finance (MoF) traditionally plays a strong role in financial stability.7

The second theoretical proposition is that central banks are likely to be delegated shared

MPR responsibilities when their mandate clearly prioritizes one objective – for example price

stability – over all else. In order to safeguard the central bank’s primary mandate, MPR functions

will be dispersed across several authorities. In other words, shared responsibilities decrease the

probability that a dual mandate – for example, maintaining price and financial stability - will

destroy the hard won credibility earned in monetary policy.

In short, our expectation is that country-specific institutional arrangements shaped the

choice between concentrated and dispersed governance arrangements.8 In other words, we expect

to find a pattern of delegation that builds on, rather than disrupts, pre-crisis institutional regulatory

arrangements. In the following sections these propositions will be subject to empirical scrutiny. In

particular, we examine the delegation of MPR powers to the Fed, the BoE and the ECB.

3. The BoE and the FPC

[the empirical sections are not complete as yet…sorry!]

1) Introduction of what the FPC is and what its functions are

2) Focus on the role of the BoE within the FPC

3) Explanation of why the BoE has been assigned special MPR responsibilities

7 Participation of the MoF can be useful when changes in legislation are needed to expand the macroprudential toolkit or the regulatory perimeter. However, a dominant role of the MoF risks delaying macroprudential action and can compromise the independence of participating agencies, including the central bank and separate supervisory agencies (Nier et al, 2011). 8 On the importance to country-specific institutional arrangements and legal constraints see also (IMF, 2013b, 30).

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4) Explanation of why the delegation took the form of a concentrated regulatory system (as

opposed to ‘dispersed’ among several authorities)

1) The 2012 Financial Services Act (FSA) re-organized both the micro and macroprudential

regulatory framework in the UK. Specifically, it created a new MPR policy decision-making body

within the Bank of England (i.e. the FPC), and returned microprudential supervision to the central

bank, via an operationally independent subsidiary.9 It also amended the BoE’s financial stability

objective to reflect its primary role to ‘protect and enhance’ financial stability. 10 In effect, the new

framework has placed the Bank of England at the core of financial sector supervision.

2) The FPC consists of the Governor and Deputy Governors of the BoE, the Chief executive of the

FCA (not part of the BoE), a member appointed by the Governor of the BoE, after consultation with

the Chancellor of the Exchequer, four members appointed by the Chancellor of the Exchequer, and

a non-voting representative of the Treasury. The composition of the committee ensures overlap with

related decision-making bodies, including the MPC and the PRA board. This overlap is to ensure

that policy coordination is a central feature of the monetary policy-regulatory arrangement (Tucker

2013). The FPC’s objective is to contribute to achieving the Bank’s Financial Stability Objective,

and subject to that, supporting the economic policy of Her Majesty’s Government, including its

objectives to growth and employment. This mirrors the MPC’s objective concerning price stability

with the same secondary function of supporting the Government’s economic policy. The FPCs

responsibilities include ‘the identification of, monitoring of, and taking action to remove or reduce,

system risks with a view to protecting and enhancing the resilience of the UK financial system’

9 The FSA responsibilities for micro prudential supervision of banks and insurers have been transferred to a new independent subsidiary (within the BoE), the PRA. 10 The financial stability objective was originally established by the Banking Act of 2009 stating that, ‘an objective of the bank shall be to contribute to protecting and enhancing the stability of the financial systems of the United Kingdom’. This was amended by the Financial Service Act 2012 to read ‘an objective of the bank shall be to protect and enhance the stability of the financial systems of the United Kingdom’.

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(Bank of England Act 1998, Section 9C). Most of the analytical support for the FPC is provided

internally within the bank.

The FPC has been granted two powers to address systemic risks: recommendations and

directions. First, the FPC can make recommendations to microprudential regulators, the FCA or the

PRA, on a ‘comply or explain’ basis. It may also make recommendations to the BoE concerning its

liquidity operations and, after consulting with the Treasury, it can make recommendations to the

Treasury concerning macroprudential measures and other relevant regulatory activities. Its

recommendations to the BoE and the Treasury are not, however, on a ‘comply or explain’ basis.

The FPC’s second power is to give direction to the microprudential regulators concerning the

implementation of macroprudential measures. These directions require action as soon as reasonably

practical, but the FPC cannot enforce the specific means or specific period by which they are

implemented.

The independence of the FPC, the authorities that address the BoE’s financial stability

objective, is not as strong as the independence of the MPC, the authorities that address the BoE’s

monetary policy objective, and the Treasury retains significant oversight over the FCP. For instance,

unlike for monetary policy, the Treasury may at any time by notice in writing to the FPC make

recommendations concerning the matters that the Committee should regard as relevant to the

Bank’s Financial Stability Objective, the responsibility of the Committee in relation to that

objective, the responsibility of the Committee in relation to support the economic policies of the

Government, and matters to which the Committee should have regard in exercising its functions.

The FPC must respond to all recommendations on a ‘comply or explain’ basis. Second, unlike the

instrument independence granted to the BoE with respect to monetary policy, the Treasury

prescribes which macroprudential tools the FPC may use to pursue its objective.

3) What explains the renewed delegation of financial stability powers to the BoE?

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Although the Treasury has empowered the BoE with MPR powers, it has retained significant

oversight over these policies. This gives the impression that the government can influence MPR

policy and be held accountable for the tough decisions that it entails. Ultimately, however, it is the

central bank that will be held accountable for the tough decision involved in MPR policy as well as

the failure of MPR policy when the next crisis occurs. For instance, the central bank is responsible

for implementing MPR policies during a financial cycle boom, when times are good. And although

the Treasury could intervene in MPR policy, the credibility, technical authority, and independence

of central bank activity makes it unlike to interfere in the central bank’s decisions. The central bank

will also likely be held accountable for the failure of MPR policy to prevent the next crisis. This is

partly a reflection of the fact that the public already believes that central banks should have done

more to prevent the global financial crisis before they had MPR powers (citation, this point was also

discussed to earlier in the paper). But it will also be held accountable for this failure because the

central bank is the institution that provides the analysis of systemic risks. In other words, if the

central bank fails to adequately identify systemic risks, it will be the central bank that will be at

fault; not the government who accepted the central bank’s technical expertise with little hesitation.

In sum, despite the important oversight function of the Treasury, it is ultimately the BoE that will be

held accountable for MPR policy.

Furthermore, on top of regular hearings by the Treasury Select Committee and occasional

Hearings by the House of Lords, the new institutional design involves wide and deep reporting and

disclosure requirements. In particular, the FPC is mandated to make public its meeting records,

within six weeks, summarizing the FPC deliberations and internal balance of arguments [what

about market sensitive information? to be checked] and to update the Chancellor on developments

in prudential regulation and financial stability twice per year. The FPC is also required to laid

before Parliament two times per year its Financial Stability Reports containing assessments of

potential and actual risks to financial stability, and actions taken by the FPC. The Treasury will also

determine the requirements for public consultation with affected parties - for example, on how the

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FPC expects to implement regulatory measures (Ingves, 2011, 17-18). Finally, the new governance

arrangements ‘preserve the decision making authority of the Chancellor when it comes to putting

taxpayer money at risk’ (Ingves, 2011, 17) ßto be checked

4) Why is the BoE the ‘sole’ MPR supervisor?

After the crisis, there was widespread dissatisfaction with the FSA and its failure to

effectively secure the stability of the financial system. The new regulatory framework was

established to address the dissatisfaction with and failures of the previous framework. …..

4. The ECB and the ESRB

1) Introduction of what the ESRB is and what its functions are

2) Focus on the role of the ECB within the ESRB

3) Explanation of why the ECB has been assigned special responsibilities within the ESRB

4) Explanation of why the delegation took the form of a dispersed regulatory system (as

opposed to ‘concentrated’ in one authority) (e.g. impact of previous institutional setup +

clear hierarchy in the ECB’s mandated objectives)

1) In the EU, the ESRB is responsible for the macroprudential oversight of the financial system in

order to contribute to the prevention and mitigation of systemic risks to stability that may arise from

developments in the financial sector as well as in the real economy. In contrast to the FPC, the

ESRB has no formal directive power but it has the power to issue recommendations and risk

warnings to member states, National Competent Authorities (NCAs) and European Supervisory

Authorities (ESAs). Each recipient must address these recommendations on a comply-or-explain

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basis. However, unlike for the FSOC in the US, comply-or-explain obligations are not

automatically made public. Instead, the decision to make a MPR recommendation public requires

two-third majority support by the General Board, the decision-making committee of the ESRB. If

the ESRB determines that an emergency situation requires macroprudential action, the General

Board may issue a confidential warning to the European Council who has the power to require the

ESAs to implement macroprudential regulations.

2) On the role of the ECB in the ESRB

The ECB and the NCBs have significant influence over the decision-making process of the

ESRB, and provide the bulk of the analytical support. The General Board includes the President and

the Vice-President of the ECB and the Governors of the NCBs. In other words, central bankers hold

a majority of the seats (20 out of 28 voting members) on the decision-making committee. In

addition, the day-to-day business of the ESRB including analytical, statistical, administrative and

logistical support operates within the ECB. The ECB and the NCBs also have representatives on the

steering committee, which guides the decision-making process, and the Advisory Technical

Committee which provides advice and assistance on MPR issues. In general, the ECB provides the

bulk of analytical support to the ESRB, with the assistance of networks of technical and subject

matter experts drawn from agencies that form the European financial regulatory system. It should

also be noted that the President of the ECB, currently Mario Draghi and formerly Jean-Claude

Trichet, was appointed as the Chair of the ESRB for the first 5 years of its operations.11

Recent EU Banking legislation has further strengthened the ECB’s role in MPR policy.

Specifically, it has made the ECB the supervisor of systemically importance financial institutions

within the EU and responsible for effective and consistent functioning of the Single Supervisory

Mechanism (SSM) which includes close cooperation with the ESAs and the national competent

11 The appointment of the President of the ECB as the Chair of the ESRB was a functional appointment to ensure that it promptly began its operations with strong leadership. The process for appointing or electing the Chair of the ESRB has yet to be determined and is set to be examined by the European Parliament and the Council.

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authorities. Currently, EU legislation that enforces Basel III banking reforms ensures that the

national competent authorities and the ECB have the authority to implement countercyclical capital

buffers. If regulators wish to use any other MPR tools to address systemic risks, they must notify

the European Parliament, the Council, the Commission, the ESRB, and the EBA and receive

authorization by the Council on a proposal from the Commission.

The ECB also has the important task of overseeing the implementation of MPR policies.

Specifically, the NCAs must notify the ECB of its intentions to implement any MPR policies and

respond to any of the ECB’s concerns. Moreover, the ECB has the authority to tighten existing

MPR policies implemented by NCAs if it sees fit.

3) Explaining the delegation of MPR powers to the ECB within the ESRB

The central banks and regulatory bodies will most likely bear the burden for implementing

unfavorable regulations and be held culpable for failing to identify systemic risks and preventing

the next crisis. They provide the bulk of the analysis of systemic risks, have the technical authority

for addressing such risks, and are responsible for implementing MPR policy. The ECB, specifically,

will be held most accountable for unfavorable regulation or MPR failures because of its special

oversight function over the SSM and MPR policy throughout the EU.

4) Explaining why the MPR functions have been assigned to a committee rather than to the ECB

alone (explanation based on the pre-crisis fragmented regulatory and supervisory framework)

Prior to this new financial regulatory framework, MPR was decentralized and unorganized:

it was not appropriate for monitoring and addressing EU wide systemic risks. The ESRB and

established supervisory framework was designed to create a network of the relevant supervisors

including both union and national level authorities in order to enhance the flow of information and

ensure consistency in financial supervision. This network recognized that the NCA have the

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expertise, logistical systems, and credibility necessary for continuing their national functions. The

new financial supervision framework thus improved the integration of the EU financial system

while retaining policy decentralization.

Aside from the decentralized nature of EU policy-making, the more strict institutional

design of the ECB also helps explain why the central bank was not assigned sole authority over

MPR policy. There is a strong belief that the central bank should have strict independence and

formal accountability mechanisms in pursuit of its hierarchical goal of maintaining prices stability.

This institutional design reflects path independence from the post-WWI hyperinflation in Germany,

and the subsequent credibility of the strictly independence Bundesbank (Howarth and Loedel, 2003).

Indeed, even assigning the ECB a primary role within the SSM has been controversial out of fear

that it would threaten its independence in pursuing price stability. This is clear by the Bundesbank’s

remarks on separation of the ECBs monetary policy and supervisory functions, ‘the units that are

responsible for the two policy areas are to be separated by Chinese walls within the ECB. ECB staff

entrusted with supervisory tasks may not exercise any monetary policy functions and must be

organised in separate reporting lines and chains of command’ (Bundesbank July 2013 Monthly

Report).

5. The Fed and the FSOC

1) Introduction of what the FSOC is and what its functions are

2) Focus on the role of the Fed within the FSOC

3) Explanation of why the Fed has been assigned special responsibilities within the FSOC

5) Explanation of why the delegation took the form of a dispersed regulatory system (as

opposed to ‘concentrated’ in one authority + no clear hierarchy in the Fed’s mandated

objectives)

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1) Following the adoption of the Dodd-Frank Act (DFA) in July 2010, the US authorities

established the FSOC. The FSOC was created to address the systemic risk oversight gap in the

regulatory framework. It is a federal entity vested with clear responsibility for maintaining financial

stability and is directly accountable to the US Congress. The FSOC has three statutory missions: to

identify risks to the financial stability of the US; to promote market discipline; and to respond to

emerging threats to the stability of the US financial system. As for its powers, the FSOC may

generally recommend specific action by its member agencies. This means that, as for the UK’s FPC

and the EU’s ESRB, the microprudential regulators are responsible for implementing regulatory

measures.12 In contrast to the ESRB whose recommendations might not be public as explained

below, the FSOC’s recommendations are more potent because they are all made publicly.

Although the FSOC generally has no enforcement authority, there are areas in which such

authority has been provided. These include FSOC recommendations on payment, clearing and

settlement activities. The FSOC is also a crucial actor in determining the perimeter of financial

regulation. Indeed, it has the power to designate financial firms and providers of financial

infrastructure as systematically important institutions thus requiring heightened supervision and

regulatory standards. As will be clarified below, this is the area where the Fed intersects with the

FSOC (i.e. nonbank financial companies and financial market utilities that are designated as

systemically important are subject to more intense regulatory oversight and supervision by the Fed).

The FSOC consists of 10 voting and 5 non-voting members, and it includes all of the major

federal regulatory and supervisory agencies as well as representatives from state financial

authorities.13 The 10 voting members are the Secretary of the Treasury (Chair), Chair of the Federal

Reserve Board, Comptroller of the Currency (OCC), Director of the Consumer Financial Protection

12 The member agency must respond publicly to final recommendations made by the FSOC on a ‘comply or explain’ basis. 13 To support the activities of the FSOC and its member agencies, the Office of Financial Research (OFR) has been established with the task of collecting and improving the quality of financial data, developing tools to evaluate risks to the financial system, and performing applied and necessary long-term research. As will be discussed below, the OFR is housed within the Treasury Department.

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Bureau (CFPB), Chair of the US Securities and Exchange Commission (SEC), Chair of the Federal

Deposit Insurance Corporation (FDIC), Chair of the Commodity Futures Trading Commission

(CFTC), Director of the Federal Housing Finance Authority (FHFA), Chair of the National Credit

Union Association, and an independent member (with insurance expertise) appointed by the

President. The FSOC is chaired by the US Treasury Secretary and takes decision on a majority

voting basis. The Treasury vote is necessary though ß to be checked.

2) The legislation gives the Fed a special role in regulating, in coordination with the FSOC, large

bank holding companies and other large nonbank companies that are deemed to be systematically

important. In particular, Section 165 of the DFA assigns the Fed responsibility for overseeing large

interconnected bank holding companies and for developing enhanced prudential standards for them.

Under the DFA, the Federal Reserve is the microprudential supervisor for all systematically

important financial institutions (both banks and non-banks) with the power to heighten (or just

recommend?) prudential standards for macro prudential reasons. TO BE EXPANDED WITH A

LIST OF THE MPR POWERS ASSIGNED TO THE FED.

3) Why was the Fed assigned these important MPR responsibilities? This question is all the

most puzzling in light of the public and political opposition raised at the Fed in the wake of the

crisis (Congressional debate to be inserted here). As one former Fed official puts it, in the aftermath

of the crisis,

‘Public confidence in the Fed organization as a whole appeared to be shaken. …. The organization was perceived as remiss not only in failing to grasp the intense threat of the crisis early on but also in seeming to neglect many of the regulatory and rule-making areas that were, so it came to appear, involved with the growing credit problems. Questions were raised in the press and in the halls of Congress about the competence with which the Fed has dealt with, among others, emerging developments in the subprime mortgage market, the role played by off-balance sheet reporting and its implications for bank capital, and its responsibilities for certain consumer and mortgage credit protection functions’ (Axilrod, 2011, 172).

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This negative public reaction may help explain why the Fed’s authority has been

streamlined in a number of important respects in the wake of the crisis. As has been noted, ‘there is

a less prominent role for the central bank in the new US arrangements, by comparison with the new

arrangements in Europe’ (Ingves, 2011, 13). For instance, the designation of systemically important

financial institutions that warrant heightened supervision by the Fed requires a two-thirds majority

vote of FSOC members, including the affirmative vote of the Treasury Secretary. Furthermore, the

FSOC is chaired by the Secretary of the Treasury whereas the Chairman of the Fed Board of

Governors is just one of the ten voting members. In addition, the main analytical support for the

FSOC is the OFR which is housed in the Treasury – this is, for instance, different from the EU

governance arrangements where the ECB provides the bulk of the support to the ESRB.14

Furthermore, the Fed’s emergency powers have been revised and now require the Treasury assent to

be activated (to be checked and expanded).15 Since the start of the crisis Congress has further

limited the Fed powers, particularly regarding which assets the bank may purchase. According to

some commentators, this situation risks endangering the central bank’s crisis management ability

(Posen, 2013a).

Given the public and political backlash at the Fed, and the revisions aimed at circumscribing

the Fed’s room of maneuver in crisis management, why was the Fed delegated specific MPR

powers? à desire to deflect accountability here. In order to make this point, we should insert

insights from the negotiations on the creation of the FSOC and interviews with policy makers

involved. One document whose insights need to be included is the Blueprint issued by the Treasury

before the creation of the FSOC. The document can be used to detect policy makers’ motivation

behind delegation of MPR powers to the Fed.

14 Furthermore, beyond the MPR mandate, the Dodd-Frank law requires that the new Fed vice chairman for supervision appear twice a year before relevant congressional committees to report on the Fed board’s activities and plans for supervision and regulation of depository institutions and other financial firms supervised by the Board. 15 The Dodd-Frank Act allows emergency lending by the Federal Reserve under Section 13(3) but only with the agreement of the Treasury Secretary.

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Furthermore, the examination of the FSOC institutional design reveals that the discretion

granted to the Fed in the exercise of its systemic responsibilities is more limited than the policy

credibility and information expectations would lead us to expect. Indeed, there are serious

limitations to the Fed’s MPR functions. For instance, next to annual testimonies,16 certain Federal

Reserve actions in the area of financial regulation and supervision [what actions? to be found] must

be reported to Congress (Ingves, 2011, 18).

….

4) As for the type of delegation that has taken place in the US, the starting point is that the

FSOC is am example of a dispersed governance arrangement – i.e. the Fed has been assigned MPR

powers within an institutional framework that encompasses other regulatory agencies. This

governance arrangement should be explained in light of the pre-crisis repartition of supervisory

responsibilities in the US.

6. Conclusions

General observations:

The crisis has drawn increasing attention to central banks and their activities (Lombardi and

Moschella, 2014). However, explanations to account for variation across central banks’ new roles in

monetary and financial stability have not been fully explored, nor systematically tested in the

political science scholarship. This scholarly neglect is particularly puzzling as compared to the

important contributions made to the study of other policy areas in the aftermath of the crisis, from

bank bailouts (Grossman and Woll, 2014; Moschella, 2011), to fiscal policy (Armingeon, 2012;

16 The Fed, as well as the other FSOC members, are required to attest personally that they believe that the FSOC, the Government and the private sector are taking ‘all reasonable steps to ensure financial stability and prevent systemic risk’. [insert the relevant provision]

22

Vail, 2012) and financial regulation (Brummer and Loko, 2014; Kastner, 2014; Pagliari and Young,

2013) among others.

Summary of the arguments:

- delegation of MPR powers to the central bank as an attempt to deflect accountability for the

distributional implications of MPR and for the potential failure in preventing a systemic

crisis. In short, policy-makers have an incentive to delegate MPR responsibilities because

the exercise of such a policy can trigger adverse societal reaction while it rarely generates

public praise. The result has been that, in contrast to what happened in the realm of

monetary policy, policy makers delegated MPR responsibilities to the central bank but, at

the same time, they did not release full control over the policy;

- domestic arrangements for monetary and supervisory policy played a strong role in shaping

the type of delegation that has occurred and, specifically, the modalities of central banks’

involvement – i.e. concentrated versus dispersed responsibilities.

Implications of our findings:

- In a certain sense, the pattern of delegation reveals a renewed primacy of politics over

expertise – e.g. politicians maintained control (rather than delegated) over contentious

policy. This is particularly interesting as a comparison with what happened with monetary

policy and the wave of CBI

Final considerations:

- A broader question that we do not directly address in this paper is whether central banks

should target credit growth and asset prices as much as they do with inflation in order to

ensure financial stability à in other words, should central banks be given an explicit

mandate for financial stability, such as targeting the growth of credit and asset prices?

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- Another broader implication/discussion theme for the conclusion is about the interaction

between monetary policy and financial stability policy. ‘As more responsibilities are

allocated to the central bank, the incentives for political capture and misuse by governments

increase. Overburdening monetary policy may eventually diminish and compromise the

independence and credibility of a central bank, thereby reducing its effectiveness in

maintaining price stability and contributing to crisis management.’ (Orphanides, 2013)

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