The 2007-08 financial crisis led to myriad regulations and strategies for preventing a repeat of such a collapse – including macroprudential policies, which seek to strengthen the resilience of the financial system as a whole.
Many questions remain as to how these interact with monetary policy and microprudential policies at individual banks, whether tools (such as stress tests) have been designed and used adequately, and what their long-term consequences (both intended and unintended) will be.
To address these complex questions, IESE and Columbia University’s School of International and Public Affairs (SIPA) jointly gathered a distinguished group of banking executives, regulators and academics from around the world at Columbia’s Italian Academy in New York this month.
Under the heading, “Next Steps for Macroprudential Policies,” the event followed on the heels of the IESE-hosted conference, “Challenges for the Future of Banking,” which was celebrated in London last year (read news article).
Among the speakers were Nellie Liang, director of the Office of Financial Stability, Policy and Research with the Federal Reserve Board, Paco Ybarra, global head of markets at Citigroup and Mervyn King, governor of the Bank of England.
IESE Professors Jose Manual Campa and Juan José Toribio participated in panels.
In his opening remarks, IESE Dean Jordi Canals, said: “This is a fascinating time, where pressing issues like macroprudential policies will be organized for the next few decades.”
“It’s a privilege to do this with SIPA this year. Building a solid banking system is a challenge for us all.”
To promote free interchange of ideas, the event was held under the Chatham House Rules.
Buffers Against Cyclical Busts
It was agreed that though macroprudential policies are increasingly used, especially in emerging markets, a full framework for these policies, which can be “fuzzy” and hard to define, is still far from being established.
The industry’s ambition to identify and design macroprudential tools currently exceeds its understanding of how they work.
One speaker shared a data point indicating that the policies are “buffers against cyclical busts,” but are seldom sufficient to stop them, as it is difficult to sustain the tools and “lean against the wind.”
In weighing systemic risks, regulators and policy makers must decide if it is better to use “proactive” tools to prevent shocks to the market, or “reactive” ones that act as absorbers.
Several of the banking executives in attendance agreed that macroprudential policies have made their institutions safer and better poised to withstand system-wide upheavals. Minimum standards for capital requirements have left banks with more assets and cash, and policies in place to “pay for their own funerals,” without interruption of service to companies or financial injections from the government. It is now both “difficult and safe” for big banks to die.
The “sticky issue” of governance was repeatedly raised. With macroprudential policies being focused exclusively on banking, as opposed to other sectors, there is a lack of international governance, and no systemic approach to analyze results.
Stress Tests Under the Microscope
Stress tests, which run scenarios to see whether banks can withstand adverse conditions are the most widely-used macroprudential tools. In the U.S., some are mandated by law under the Dodd-Frank Act. One aim of the tests is to prevent bubbles, particularly in the housing market, a frequent actor in economic upsets.
Speakers debated whether stress tests are technically accurate and helpful. The so-called “fetishization of bank balances,” leaving out other factors in revenue risk, was called into question; while the risks built into stress test models were themselves seen to be “at risk of changing.”
Concerns included the “Kafkaesque” nature of the more qualitative stress tests, a secretive process seen as insufficiently insulated from politics; and a fear that firms will “back-engineer” their processes to pass tests, while ignoring other risks.
Suggestions included employing a “multiple ratio approach including leverage ratio” when building models – using market indicators of risk, and publicly disclosing data from regulators.
While regulators can’t be expected to be “completely prescient about the next crisis,” it was decided, they nonetheless have an important role in identifying the early signs of one.
For global banks, geographical diversification is a key goal, meaning they are subjected to stress tests from individual countries, which may not assess their overall strength around the world.
Still, one executive claimed that, given the implementation costs of the stress tests, he strives to make them useful for his own management purposes.
Prudent or Risky?
While some speakers praised the “stability” generated by macroprudential policies, they shared serious concerns about other consequences resulting from their deployment.
There was consensus that regulations discourage diversification, encourage the “homogenization of balance sheets,” and decrease trader confidence – all of which were deemed risky outcomes.
Some spoke of how regulations create distortions in the market and “herd” behavior. As for capital requirements, finding the right balance was a theme of discussion, as banks must operate under some risk in order to serve their purpose.
One speaker went as far as to say that regulatory changes have severely challenged the business model of banks, and that pushing them too far could make them disappear; in turn destroying the ability of financial markets to work well.
The rise of “shadow” banks was discussed as another consequence of regulations, with many speakers predicting that the regulatory pendulum will soon swing away from the big banks and toward these other financial intermediaries.
More scrutiny of macroprudential policies is needed, attendees agreed, along with a more “forest versus trees” analysis of the financial system as a whole.
A total of four panel discussions was celebrated over the course of the day with a closing keynote from Governor of the Bank of England and Chairman of its Monetary Policy Committee to 2013, Mervyn King.
Attendees included Dong He, deputy director of monetary and capital markets at the IMF; Rafael Salinas, chief risk officer with BBVA; Matt King, global head of credit strategy, Citigroup; Stijn Claessens, senior advisor at the Federal Reserve Board; Ryozo Himino, vice commissioner for international affairs, Japan FSA; Sandie E. O’Connor, chief regulatory officer at JP Morgan Chase; Claudio Raddatz, director of financial policy division, Central Bank of Chile; Jean-Pierre Danthine, former vice chair Swiss National Bank; Paulo Vieira de Cunha, ICE Canyon LLC.
From Columbia, professors Guillermo Calvo, Takatoshi Ito and Charles Calomiris moderated panels.