Macro-Prudential Policies to Mitigate Financial System Vulnerabilities

Abstract

Macro-prudential policies (MaPP), aimed at reducing systemic financial risk, have become part of the toolkit of policy makers in many emerging markets (EMs) and some advanced countries (ACs). We review the analytical foundations for such policies. We then use panel data regression to analyze changes in balance sheets of some 2800 banks in 48 countries over 2000-2010 to identify those MaPP most effective in reducing financial cycles. We find that debt-to-income caps, loan-to-value ratios, and limits on credit growth foreign currency lending are effective in reducing leverage, asset and non-core to core liabilities growth during boom times, while countercyclical buffers (such as reserve requirements, limits on profit distribution, and dynamic provisioning) help mitigate declines in bank leverage and asset growth in adverse times. We conclude that MaPP can be important elements of the policy toolkit aimed at overall systemic risk mitigation, especially for EMs exposed to international shocks, but need to be properly designed and calibrated. _________________________