micro and macro prudential perspectives of financial stability mario bergara managing the capital...

Micro and Macro Prudential Micro and Macro Prudential Perspectives of Financial StabilityPerspectives of Financial Stability

Mario Bergara

Managing the Capital Account and Regulating the Financial Sector: A Developing Country Perspective

UNDESA – IPD - IPEA, Rio de Janeiro, August 23, 2011

The relevance of Financial Stability in a contextof Macroeconomic Stability

Price StabilityPrice StabilitySound financial systemSound financial systemWell-functioning payment systemWell-functioning payment system

They contribute to generate credibility and long term perspective, allowing a better decision-making on savings, credit and investments. A healthy financial sector channels those decisions more efficiently.

A proper Financial Safety Net reduces the system’s vulnerability.

They complement social policies, by protecting the poor: lower income population has less ability to fight the effects of high inflation and financial crisis.

Micro and macro prudential Micro and macro prudential perspectives of Financial Stabilityperspectives of Financial Stability

The importance of economic and financial stability

No experiences showing economic and social development in contexts of macroeconomic and financial disorder.

The largest declines in production and the largest rises in poverty are linked to bank runs and macroeconomic crises.

Disconsidering price and financial stability is disconsidering their impacts on:

ProductionEmploymentIncome of householdsPovertyInequalityConsolidation of proper values in society


The need for consistency among macroeconomic policies

FinancialStability

Micro and Macroprudencial Regulation

Monetary policyFiscal Policy

Identifying relevant systemic risks and addressing externalitiesMonetary and fiscal policies can help to mitigate costs of aggregate weaknesses and individual failuresThe ability to use monetary policy is limited in countries facing short term currency appreciation pressures


Some lessons from the financial crisis:What are we discussing?

Current discussion influenced by the situation in developed countries

The lack of a macro-systemic approach was clear, but was the microprudential regulation working properly?

Failure of the regulatory approach and of the organizational design of financial regulation

The decentralized governance failed as well as the “light supervision” approach

The focus on the macroprudential issue will be fruitful only if it does not imply that the microprudential regulation was doing its job



A possible (dangerous) lesson from the crisis: “Everything was right except that the macroprudential approach was lacking”

Supervision was poor and the organization of the Financial Safety Net was inaccurate in some places and chaotic in others

From Financial Safety to Financial Stability: both micro and macro prudential perspectives are essential

Regulation should be determined by the assessment of risks, avoiding arbitrage incentives

Risks include those derived from externalities: micro and macro-systemic risks have to be taken into consideration



The discussion about the governance of macroprudential policies might be “smuggling” a more transparent debate about the failure of the decentralized regulatory approach and the need to move towards a more centralized fashion

This process might be determined by political economy considerations, but it is relevant to pose the right questions on the table

Governance implications could be wrong if we think that the only problem is to “add” the macro perspective

In order to revise that, we need to get back to the conceptual determinants of the optimal Financial Safety/Stability Net: conflict of objectives, incentive structures and organizational design


Fundamental objectives of financial regulation

Financial Safety/Stability Net

AdverseSelection

Representinguninformed agents

Mitigating systemicrisks / externalities

MoralHazard

Costly StateVerification


Preventivetools

Correctivetools

Lender ofLast Resort

ResolutionMechanisms

Control andSupervision

PrudentialRegulation

Financial Safety Net


Monetary Policy

Lender of Last Resort

Prudential

Regulator and

Supervisor

Deposit Insurer

and Resolution

Agency

Explicit conflict of objectives and coordination

Financial Safety Net: Governance


The decision-making of some crucial issues

Liquidatingfinancial institutions

Mergers andacquisitions

Short termfinancial assistance

Interveningfinancial institutions

Financial Safety Net: Governance and Conflict of Objectives


Separation/Unification of theFinancial Safety Net agencies

Relative institutionalstrenght

Reputation andcredibility

Expertise andcapacities

Make explicit theconflict of objectives

Institutional Determinants of the Financial Safety Net Design


The necessary consistency in supervisionand regulation across markets and agents

Capitalmarkets

Insurancemarkets

Pension fundadministrators

Financialintermediaries andnon-intermediaries

Degree of Centralization of Financial Regulation


More centralized

Efficiency due tospecialization

Lower powerconcentration

Economies of scaleand scope

Lowerbureaucratic costs

Less centralized

Conglomerateslogic

Degree of Centralization of Financial Regulation


Lower regulatoryarbitrage

Monetary Policy

Lender of Last Resort

Prudential

Regulator and

Supervisor

Deposit Insurer

and Resolution

Agency

Coordination and contribution for all agenciesto comply with their respective mandates

Financial Stability Net: Governance


Ministry of Finance/

Treasury

The complementary roles of micro and macro perspectives

Both micro and macro perspectives have to be considered in order to set the optimal governance structure to the Financial Safety/Stability Net

The contribution of both approaches should be transversal to all the Financial Safety/Stability Net agencies


Financial regulation Perspectives

Micro-prudencial

Macro-prudencialMitigating

systemic risks

Representation ofuninformed agents

The complementary roles of micro and macro perspectives

Sound risk management are needed not only of individual institutions but also of the financial system as a whole

Both approaches should help to make agents to internalize externalities in both static and dynamic dimensions of financial stability

All proposals (capital buffers, counter-cyclical provisioning, caps on Loan-to-Value ratios, liquidity requirements) require more understanding for implementation and impact evaluation

Rules vs. Discretion: equilibrium between flexibility and reputation

Corporate governance is also relevant: internal risk-management process and compensation schemes should be aligned with a reasonable risk-taking behavior


Implications of systemic risks on rules and institutions

Systemic risks

Rules

Institutions

Risk-based regulation

Broad perimeter

Financial Safety Net

Financial Stability Framework

Centralized Regulation

Ownership/stockholding of non-financial entities

Corporate governance

Regulatory treatment of public entities

Exposure to common and correlated risks

Interconnectedness (players and markets)

Financial and real sector conglomerates/

cross border

New kinds of risks as markets develop

Regulatory arbitrage across entities with different licenses


Mario Bergara

Managing the Capital Account and Regulating the Financial Sector: A Developing Country Perspective

UNDESA – IPD - IPEA, Rio de Janeiro, August 23, 2011

Micro and Macro Prudential Micro and Macro Prudential Perspectives of Financial StabilityPerspectives of Financial Stability

micro and macro prudential perspectives of financial stability mario bergara managing the capital...

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contexts of macroeconomic

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