The role of macroprudential policies is both to prevent the build-up of risks on the financial sector and the diffusion of systemic risk. On the one hand, the cross-section dimension of MPP, by addressing the vulnerabilities of financial institutions, aims at preventing the materialisation of systemic risk and spillovers to the economy when a crisis occurs. On the other hand, the temporal dimension of MPP aims at supervising the evolution of risks within the system, prevent the formation of financial bubbles and address troubles related to the procyclicality of the financial system. 

 

 

Cross-sectional dimension

 

 

Banks balance sheets

 

In order to improve the stability of the banking sector, and the resilience of the financial system to potential crisis, Basel III agreements have implement further capital requirement ratios:

 

• Market-specific counter-cyclical buffer: these buffers are implemented in over-heating sectors, markets of countries. The capital requirements grow up to additional 2,5% of RWA in the ascendant phases of the cycle, and are released in case of crisis. It is a way to smooth credit-supply.

• Dynamic provisions: provisions are the amount of capital you need to cover potential losses. They vary according to the assessed default risk of the counterparty. Increasing these provisions in the ascendant phase of the financial cycle is supposed to increase the cost in capital of risk-taking, and smooth credit-supply as well.

• Basel II fixed ratio: these requirements are adding to previous Basel II capital (common equity CET1 + common stock Tier 1) requirement ratio of 8% of Risk-Weighted Assets. This is a fixed ratio, aiming only at improving the resilience of banking institutions.

• Liquidity coverage ratio: is the quantity of high-quality assets that bank must hold at any given time. This amount has to be equal to 30 days of expected net cash outflows in case of financial stress.

 

 

Lending conditions

 

Another way to smooth credit-supply is to tighten credit conditions in phase of potential over-heating. The Loan-to-Value ratio indicates the percentage of the value of an asset that can be borrowed. For example, for a housing loan, if the LTV ratio is 70%, it means that I can only borrow 70% of the value of the house, and that I have to come with 30% of contribution. Tightening the credit supply through this ratio has proven to be quite effective in Hong-Kong during the 1997 crisis. 

 

 

Temporal dimension

 

To achieve cross-sectional stability, macroprudential authorities implemented systemic buffers. There have also been several reforms of market structures in Europe.

 

A system buffer up to 2,5% of RWAs can be imposed to banks assessed as “systemic”. This is an application of the polluter pays principle, systemic banks are responsible of their contribution to the systemic risk.

 

Market structures. The EMIR regulation imposes the obligation of central compensation to all OTC derivatives. The compensation chambers make sure that risk management exigences are met and they smooth the relations between market operators. EMIR is also a way to harmonize OTC derivatives markets in Europe with the implementation of common norms for capital requirements, organization, rules of conduct. Basel III agreements implement a new ponderation system that favors derivatives that are contracted through a compensation chamber in the risk weighting.

 

We can also evoke the several banking separation laws that have passed in european countries over the last few years. The European commission encourage reforms in Europe following the UK’s Vickers rule. France and Germany both voted separation laws in 2013 but they won’t be applicable before 2019.

 

 

Going further :

 

- Macroprodential spillovers, VoxEu, Piotr Danisewicz, Dennis Reinhardt, Rhiannon Sowerbutts, 5 March 2015

- Macroprudentialism, a new Vox ebook, VoxEu, Dirk Schoenmaker

- Europe’s proposed capital markets union: Disruption will drive investment and innovation, Jon Danielsson, VoxEu, Eva Micheler, Katja Neugebauer, Andreas Uthemann, Jean-Pierre Zigrand 23 February 2015

- Macroprudential supervision in banking union, VoxEu, Dirk Schoenmaker 09 December 2012

- Banques hybrides et réglementation des banques de l’ombre, Terra Nova, Laurence Scialom et Yamina Tadjeddine, 17/11/2014

- Qu'est-ce que la politique macroprudentielle ?, BSI Economics, Thibaut Duprey, 18 février 2014