understanding financial stability & macro- prudential policy workshops/fourth... ·...
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Understanding Financial Stability & Macro-prudential Policy
Dr. Ayman F. AlfiFinancial Stability Division, SAMADeputyship of Research and International Affairs
Dec. 21, 2014
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Outline
• What is Financial Stability (FS)?
• Why Financial Stability
• What is Macro-prudential Policy – Definition & Objectives
• Systemic Risk: Sources & Dimensions
• Macro-prudential Toolkit
• Macro-prudential Policy Interaction with Other Economic Policies
• Example for Systemic Risk Assessment – Saudi Arabia
• Macro-prudential Issues and Challenges
The Economic Circular Flow – Role of financial Systems
3
4
What is Financial Stability (FS)?
• Ability to withstand shocks (resilience) – e.g., macro and micro shocks
• Ability of the financial system to process transactions without interruption or intervention
• Market participants have confidence in the financial system
• Stable capital market in the sense that prices are based on fundamentals
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FS Definitions by Other Central Banks
Central Bank Definition
AustraliaA stable financial system is one in which financial intermediaries, markets and market infrastructure facilitate the smooth flow of funds between savers and investors and by doing so, helps promote growth in economic activity
South AfricaThe absence of the macroeconomic costs of disturbances in the system of
financial exchange between households, businesses and financial‐service firms
ECB
A condition in which the financial system—comprising of financial intermediaries, markets and market infrastructures—is capable of withstanding shocks and the unraveling of financial imbalances, thereby mitigating the likelihood of disruptions in the financial intermediation process which are severe enough to significantly impair the allocation of savings to profitable investment opportunities
Japan“Financial system stability” refers to a state in which the financial system functions properly, and participants, such as
firms and individuals, have confidence in the system”
Why Financial Stability?
• Significant developments in the financial world (deregulation, innovation, globalization)
• Frequent Financial Disruptions
Currency crisis in Mexico (1994)
Asian financial crisis (1997)
LTCM collapse (1998)
Argentina crisis (2000)
The GFC (2007 --)
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Common symptoms of Crises
1. Exchange rate miss-valuation
2. Current account deficits (BoP crises)
3. Rising Debt (consumer, corporate, Government)
4. Low/Falling reserves
5. Mismatch on balance sheets (currency, maturity)
6. Erosion of policy credibility/Poor regulation (Confidence issues)
7. Sensitivity to external shocks
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Why Financial Stability?
Crises revealed/re-emphasized that:
• Financial Crisis cause too much damage and output losses, contagious, and too costly to resolve
• Price stability is not enough
• Real and financial sectors inter-dependence
• Government-financial sector relationship
• Healthy financial system ensures smooth policy transmission mechanism• Financial markets host fiscal and monetary transmission channels
Should consider Financial Stability as an explicit economic policy objective and develop a policy to achieve it
Macro-prudential Policy
What is MP Policy
Policy aimed at maintaining financial stability
The use of primarily prudential (regulatory) tools to limit systemic risk (IMF, 2011)
Systemic risk is “the risk of disruptions to the provision of 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 , 2009)
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Origins & Evolution
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June,
1979
• BIS meeting on International lending
• “… microeconomic problems began to merge into macroeconomic problems at the point where micro-prudential problems became what could be called macro-prudential ones”
Oct, 1979
• BoE background note: “This macro-prudential approach considers problems that bear upon the market as a whole as distinct from an individual bank, and which may not be obvious at the micro-prudential level”
1986
• First public appearance when published in a BIS report on Recent innovations in international banking which defined it as a policy that promotes “the safety and soundness of the broad financial system and payments mechanism
1992
• BIS report on Recent developments in international bank relations
1998-2000
• Triggered by the Asian crisis, IMF report Toward a framework for a sound financial system stated that “… macro-prudential analysis […] focuses on developments in important asset markets, other financial intermediaries, and macroeconomic developments and potential imbalances.
• BIS GM (Andrew Crockett) speech in the international conference of banking supervisors comparing Micro Vs. Macro – prudential policies.
Macro-prudential Policy Objectives
• Three main objectives:
1. Increase resilience of the financial system to aggregate systemic shocks
2. Contain the build-up of systemic vulnerabilities over time – time dimension
3. Control the build-up of vulnerabilities within the financial system that arises through inter-linkages - structural (cross-sectional) dimension
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Sources of Systemic Risk
Systemic Risk
Global -Domestic
Inter-linkages
Government-Bank
Feedback Loop
With-in system
(sectoral) Inter-linkages
Macro -Financial
Inter-linkages
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Systemic Risk Dimensions
Time Dimension
Pro-cyclicality: excessive risk taking during booms
Two Key elements:Credit (leveraging)
Liquidity (maturity mismatch)
Cross-Sectional (Structural) Dimension
Distribution of risk in the financial system at a given point of time
Key elements:
Size
Interconnectedness
Substitutability
Concentration 13
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MP Toolkit
Time Dimension Tools
Capital Requirements
(CAR, CCB, Counter-
cyclical buffers)
Dynamic Provisioning
Time-varying risk weights
Reserve Requirement
Liquidity Requirements
(LCR, NSFR)
Loan-To-Deposit (LTD)
ratio
Leverage ratios
Ceilings on credit/credit
growth
Cross-Sectional Tools
Systemic Capital
Surcharges
Debt-To-Income (DTI)
ratio
Systemic Liquidity
Surcharges
Limits on margin lending
Limits on foreign
exposure/ lending
Loan-To-Value (LTV) ratios
Macro-prudential Policy Interactions
Macro Vs. Micro Prudential Policies
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• Despite the differences, they should work together
– Micro-prudential is a necessary, but not sufficient condition for financial stability
• But where to draw the line between “micro” and “macro” prudential policies
– Some instruments are used for both policies
Top-Down Macro-prudential Policy
Financial Stability
Bottom-Up Micro-prudential Policy
Macro Vs. Micro Prudential PoliciesThe Macro- & Micro-prudential Perspectives
ComparedMacro-prudential Micro-prudential
Objective Stability/limit distress of the financial system as a whole (system-wide)
Stability/limit distress of individual institutions (Idiosyncratic)
Concern Financial instability (avoid crises)
Consumer Protection (investors/depositors)
Characterization of Risk Endogenous (system-wide Correlations)
Exogenous (independent of individual agents’ behavior)
Fallacy of composition: the state of the whole is NOT the sum of the state of seemingly independent parts
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Macro-prudential Vs. Monetary
• Is there a trade off between the two policies’ objective (Monetary Vs. Financial Stability)
– Complements or Substitutes?
• Monetary policy as a blunt tool; Can MP policy help?
• Could MP policy prevent the GFC? A case on MP & Monetary policies coordination
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A Conflict May Arise …
19
OR
Or May NOT !!!
20
AND
Macro-prudential Vs. Fiscal Policy
• Prudent fiscal Policy low systemic risk less burden on MP policy
• Tax structure
– Current structure encourages leveraging
– Can assist MP by targeting risky sectors21
Prudent Fiscal Policy
• Debt sustainability
• Budget Surpluses
Lower systemic risk
• No sovereign-bank feedback loop
• Low volatility in bond markets
Stable Financial systems
• Less need for frequent MP interventions
• Sustainable growth rates
Macro-prudential Vs. Other Policies
• Competition Landscape:
• Cross-border MP policies– Regulatory Arbitrage
– Need for International Cooperation
• Crisis Management Policies– Deposit Insurance Schemes (DIS)
– Resolution frameworks
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competition Risk TakingSystemic
RiskFinancial Instability
The complete interaction landscape
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Source: The Basel III Accord
Macro-prudential policy and Systemic Risk Assessment – Saudi Arabia
SAMA’s Macro-prudential Toolkit
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Instrument Regulatory Requirement
Capital Adequacy Ratio Basel requirement of a Minimum of 10.5%
Provisioning General: 1% of total loansSpecific: Minimum of 100% of NPLs
Leverage Ratio Deposits/(capital + Reserves) ≤ 15 times
Reserve Requirement 7% for Demand Deposits4% for Time Deposits
Loan-To-Value (LTV) Mortgage loans ≤ 70% of home value
Debt Service – To – Income (DTI) Monthly repayments ≤ 33% of Income
Loan-to-deposit (LTD) ratio 85%
Liquidity:• SLR• LCR (Basel III)• NSFR (Basel III)
Liquid Assets/deposits ≥ 20%100 % by 2019 (already fulfilled)100 % by 2019 (already fulfilled)
Counterparty Exposure Individual Exposure/total capital ≤ 25%
Foreign Exposure Approval Needed
Systemic Risk Assessment: Fiscal Sustainability
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1.537 1.6692.040
2.4622.721 2.793
0.0
0.5
1.0
1.5
2.0
2.5
3.0
2009 2010 2011 2012 2013 2014(Sep)
(Tri
llio
n R
ls)
SAMA's Reserve Assets
-86.629
87.731
291.092
374.093
180.347
-5.4
4.4
11.613.6
6.4
-10
-5
0
5
10
15
-200
-100
0
100
200
300
400
2009 2010 2011 2012 2013
Budget Surpluses
Fiscal Balance Fiscal Balance-to-GDP Ratio
14
8.5
5.43.6
2.7
0
5
10
15
0
50
100
150
200
250
2009 2010 2011 2012 2013
(BIL
LIO
N R
LS)
Public Debt
Public Debt Debt-to-GDP Ratio
• Source: SAMA
Source: SAMA
Source: SAMA
Source: SAMA
Systemic Risk Assessment: Global Interconnectedness
27
-150-140-130-120-110-100
-90-80-70
2012,Q1
2012,Q2
2012,Q3
2012,Q4
2013,Q1
2013,Q2
2013,Q3
2013,Q4
2014,Q1
(Bill
ion
Rls
)
Net Capital Flow mean
4.9
12.7
23.7 22.4
18.0
0
5
10
15
20
25
0
100
200
300
400
500
600
700
2009 2010 2011 2012 2013
(%)
(BIL
LIO
N R
LS)
Current Account Surplus Current Account Surplus Relative to GDP
4.2
3.83.7
2.9
3.5
2009 2010 2011 2012 2013
Inflation
Source: SAMA
Source: SAMA
Source: SAMA
Source: SAMA
-1.000
0.000
1.000
2.000
3.000
4.000
5.0002
00
9 Q
12
00
9 Q
22
00
9 Q
32
00
9 Q
42
01
0 Q
12
01
0 Q
22
01
0 Q
32
01
0 Q
42
01
1 Q
12
01
1 Q
22
01
1 Q
32
01
1 Q
42
01
2 Q
12
01
2 Q
22
01
2 Q
32
01
2 Q
42
01
3 Q
12
01
3 Q
22
01
3 Q
32
01
3 Q
4
Return on Assets
Saudi Arabia U.S. Swaziland China UK
Systemic Risk Assessment: The System from With-in
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175.7
138.9133.7120.6117.7
104.3
68.459.154.4 53 51 50.147.841.236.6
0
50
100
150
200
Banks Credit (Private Sector) to GDP, 2012
11.914.414.414.714.715.415.716.116.416.416.917.017.918.0
21.2
0
5
10
15
20
25
Au
stra
lia
Can
ada
USA
Mal
aysi
a
Jap
an
Om
an
Turk
ey
Ch
ina
Sin
gap
ore UK
Swit
zerl
and
Bra
zil
Sau
di A
rab
ia
Ku
wai
t
UA
ECapital Adequacy Ratio (CAR), 2013
Source: IMF
Source: World Bank
Source: World Bank
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Claims on Private Sector
59.3Cash10.6
Foreign Assets11.1
Claims on Government & semi Government
5.0 SAMA Bills9.5
Other Assets4.5
Distribution of Bank Assets (%), 2013
38.546.2
39.5 34.4 36.6 40.1
86.378.1 71.9 70.4 73.8 76.5
2008 2009 2010 2011 2012 2013
Bank Credit to GDP Ratio
Credit-to-GDP Ratio Credit-to-Non-Oil GDP Ratio
Source: SAMA
Source: SAMA
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7.6 7.36.0
3.8 3.73.1 2.6 2.6 2.5 2.3 2.0 1.5 1.3 0.9 0.8 0.6 0.5
Global NPL ratios, 2013
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
NPL Ratio
Source: SAMA
Source: World Bank
So … where is the risk?
1. Oil Market Volatility
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0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
0.00
20.00
40.00
60.00
80.00
100.00
120.00
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
Oil price Vs. NPLsoil prices NPL
0.00%
5.00%
10.00%
15.00%
20.00%
25.00%
0.00
20.00
40.00
60.00
80.00
100.00
120.00
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
Oil Pric Vs. Credit Growth
Oil price credit growth
Source: SAMA
Source: SAMA
2. The capital market
Excessive risk taking due to record low interest rates
Too much leveraging in the equity market
A chance for Asset Price Bubble
Sectoral Correlation
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-0.3-0.2-0.100.10.20.3
00.5
11.5
22.5
3
No
v-05
Mar
-06
Jul-
06
No
v-06
Mar
-07
Jul-
07
No
v-07
Mar
-08
Jul-
08
No
v-08
Mar
-09
Jul-
09
No
v-09
Mar
-10
Jul-
10
No
v-10
Mar
-11
Jul-
11
No
v-11
Mar
-12
Jul-
12
No
v-12
Mar
-13
Jul-
13
No
v-13
Mar
-14
Jul-
14
No
v-14
Equity Vs. Real Estate
real estate growth Tasi growth
Source: SAMA
Issues & Challenges
Designing a Practical MP policy (1)
• Selecting the appropriate tools– Many or few instruments?
– Sector or Institution specific (or both)
– Price or Quantity based tools (or both)
• Addressing country-specific factors– What sectors are most important:
• Housing market is more important in advanced economies LTV is more effective
• Capital flow is more important in emerging economies
– What macro variables are relevant for financial stability
• Addressing pro-cyclicality– The use of counter-cyclical tools
– Use of dynamic, time-varying MP regulation
– Understanding economic Vs. financial cycles34
Designing a Practical MP Policy (2)
• Closing regulatory gaps– Limiting the size of shadow banking
– Boundary issues (avoid conflicting with some institutions’ objectives such as SCIs)
• Closing data gaps:– Good collaboration between institutions and regulators
– Clear definitions of terms and ratios
• Good MP institutional/governance framework– Clarity in regulatory scope, roles, and responsibilities
– Understanding of policy interactions
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Challenges
1. Stability or Efficiency:- MP measures may restrict growth and developments (or may not !!!)
- Are we over-reacting to the GFC? Is it really the time for more regulation?
2. MP Governance- Who is in charge of MP
- How can ensure coordination between different regulatory authorities
3. Calibration & Modeling difficulties- Hard to quantify the impact of MP policy as crises are rare events
- Data gaps – a need for granular, high frequency, and market based
data
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References
• Bank for International Settlements (1986): Recent innovations in international banking, report prepared by a study group established by the central banks of the G10, Basel, April (Cross Report)
• --- (1992): Recent developments in international interbank relations, report prepared by a working group established by the central banks of the G10 countries, Basel, October (Promisel Report)
• Crockett, A (2000): “Marrying the micro- and macroprudential dimensions of financial stability”, BIS speeches, 21 September.
• Haldane, A (2013): “Macroprudential Policies – When and how to use them”, IMF conference, 16-17 April.
• International Monetary Fund, 2011a, “Macroprudential Policy: An Organizing Framework” (Washington: International Monetary Fund).
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