Framework for Macroprudential Analysis 

Context in source publication

Context 1

... any single individual or company or to any groups of individuals or companies. A recent set of macro-prudential regulations has also been implemented to manage and address the impact of capital inflow surges, especially since the second half of 2009 (Table 3). To reduce short-term volatility, Bank Indonesia (BI) introduced a one-month holding period for its certificate (SBI) purchased in both primary and secondary markets in June 2010. Prior to this, BI launched a concerted effort to shift the maturity structure from one-month to 3- and 6-month tenors and from weekly to monthly auction. Longer maturity SBIs ---SBI-9 months and SBI-12 months--- are being considered in late 2010 with the purported aim of lengthening the maturity profile of investors. In November 2009, authorities in Korea imposed a set of tighter regulations on currency trading, including new standards for foreign exchange liquidity risk management, restrictions on currency forward transactions of non-financial companies, and mandatory minimum holdings of safe foreign currency assets by domestic banks. This set of policies followed an earlier move to curb speculative foreign exchange transactions. In July 2010, the minimum amount of deposits for foreign currency margin trade was raised to 5 percent of transaction value from 2 percent, in an effort to clamp down on speculative foreign exchange trading by individual investors. A number of SEACEN economies, such as the Philippines and Thailand, have made it easier for domestic residents to invest abroad. Easy access to foreign investments has long been one prescribed measure to mitigate the impact of capital inflows on the domestic economy. Going forward, a number of issues remain to be resolved. Should these macroprudential policies be implemented on a transparent rule based approach? This is a familiar question and has long been debated for monetary and fiscal policies. For both fiscal and monetary policies, we have learned that the fixed rule and discretion approaches offer their own distinct advantages. It is likely that a combination of these approaches could maximize the effectiveness of macro-prudential regulations. The proponent of the rule- based system claims that this approach aligns the expectations of market and policy makers so that policy is transmitted quickly and effectively to the economy. However, if any lesson can be drawn from the recent global financial crisis, it is that financial institutions have been very adept at gaming rule-based systems and that there are enough incentives for risky financial activities outside the perimeter of supervision and regulation (Yellen (2010)). Furthermore, financial institutions and their activities will evolve in ways that may limit the ability of the rule-based system to address all emerging systemic threats. Hence, a certain degree of discretionary measures to a generally rule-based approach are potentially warranted here. Another consideration relates to the need for extensive international cooperation in designing and implementing these macro-prudential measures. A rising concern now is with rule arbitraging. If one economy were to go it alone with tough and comprehensive measures, it is likely that we would see financial institutions fleeing the economy to another with softer policy stances and hence, the importance of international commitment and cooperation to develop and implement coherent and comprehensive approaches. Lastly, to what extent should monetary policy be coordinated with macro-prudential regulation, especially with macro-prudential supervision? This issue remains a contentious one around the globe. Macro-prudential measures will undoubtedly have macroeconomic spillovers. Therefore, authorities must strive to ensure that monetary policies and macroprudential regulations, including supervisory ones, work in a coherent manner. Hence, should these monetary and macro-prudential regulations and supervisory policies be closely integrated and assigned to the central bank? We will return to these two pertinent issues in the latter part of the paper. From the many continued debated definitions of financial stability, it is obvious that financial stability is neither a state of equilibrium nor is it ever static. It may continue to evolve, moving along a continuum and is consistent with what is known as “a perpetual state of flux and transformation” (Schinasi (2004, p.8)). Given this situation, it is important for supervisors to assess and determine whether the financial system is potentially entering or is already in a range of instability. In the past, the main focus has largely been to strengthen and develop further key financial stability indicators. While these indicators are useful, there is one critical shortcoming. These indicators are static and only capture the present conditions of the financial institutions’ balance sheets. On the other hand, the basic idea of stress testing is based on the macro-financial linkages (Figure 9) where the state of the “financial system is inextricably intertwined with the performance of the economy and its resilience to shocks” (Trichet (2005)). Stress testing (ST) examines financial institutions’ balance sheet indicators corresponding to exceptional but plausible events in the near future. 11 As a forward looking instrument/tool, ST not only adopts the same set of financial stability indicators, but also focuses on the present/contemporaneous stage - the balance sheets of the financial institutions exposed to various possible financial and economic shocks, domestically and externally. The ST results would provide a range of financial indicators associated with those future different plausible shocks. In general, there are at least six ways to stress test a financial institution (BIS 2000). 12 These ...