Micro and Macro Prudential
Perspectives 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
Micro and macro prudential
perspectives of Financial Stability
The relevance of Financial Stability in a context
of Macroeconomic Stability
Price Stability
Sound financial system
Well-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
perspectives 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:
Production
Employment
Income of households
Poverty
Inequality
Consolidation of proper values in society
Micro and macro prudential
perspectives of Financial Stability
The need for consistency among macroeconomic policies
Micro and Macroprudencial Regulation
Financial
Stability
Fiscal Policy
Monetary policy
Identifying relevant systemic risks and addressing externalities
Monetary and fiscal policies can help to mitigate costs of
aggregate weaknesses and individual failures
The ability to use monetary policy is limited in countries facing
short term currency appreciation pressures
Micro and macro prudential
perspectives of Financial Stability
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
Micro and macro prudential
perspectives of Financial Stability
Some lessons from the financial crisis:
What are we discussing?
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
Micro and macro prudential
perspectives of Financial Stability
Some lessons from the financial crisis:
What are we discussing?
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
Micro and macro prudential
perspectives of Financial Stability
Fundamental objectives of financial regulation
Adverse
Selection
Representing
uninformed agents
Moral
Hazard
Costly State
Verification
Mitigating systemic
risks / externalities
Financial Safety/Stability Net
Micro and macro prudential
perspectives of Financial Stability
Financial Safety Net
Preventive
tools
Corrective
tools
Prudential
Regulation
Lender of
Last Resort
Control and
Supervision
Resolution
Mechanisms
Micro and macro prudential
perspectives of Financial Stability
Financial Safety Net: Governance
Prudential
Monetary Policy
Regulator and
Lender of Last
Resort
Supervisor
Deposit Insurer
and Resolution
Agency
Explicit conflict of objectives and coordination
Micro and macro prudential
perspectives of Financial Stability
Financial Safety Net: Governance and Conflict of Objectives
The decision-making of some crucial issues
Intervening
financial institutions
Liquidating
financial institutions
Short term
financial assistance
Mergers and
acquisitions
Micro and macro prudential
perspectives of Financial Stability
Institutional Determinants of the Financial Safety Net Design
Separation/Unification of the
Financial Safety Net agencies
Make explicit the
conflict of objectives
Relative institutional
strenght
Expertise and
capacities
Reputation and
credibility
Micro and macro prudential
perspectives of Financial Stability
Degree of Centralization of Financial Regulation
The necessary consistency in supervision
and regulation across markets and agents
Financial
intermediaries and
non-intermediaries
Capital
markets
Pension fund
administrators
Insurance
markets
Micro and macro prudential
perspectives of Financial Stability
Degree of Centralization of Financial Regulation
More centralized
Lower
bureaucratic costs
Economies of scale
and scope
Conglomerates
logic
Lower regulatory
arbitrage
Less centralized
Efficiency due to
specialization
Lower power
concentration
Micro and macro prudential
perspectives of Financial Stability
Financial Stability Net: Governance
Prudential
Monetary Policy
Regulator and
Lender of Last
Resort
Supervisor
Deposit Insurer
and Resolution
Ministry of
Finance/
Agency
Treasury
Coordination and contribution for all agencies
to comply with their respective mandates
Micro and macro prudential
perspectives of Financial Stability
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
Representation of
uninformed agents
Micro-prudencial
Mitigating
systemic risks
Macro-prudencial
Micro and macro prudential
perspectives of Financial Stability
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
Micro and macro prudential
perspectives of Financial Stability
Implications of systemic risks on rules and institutions
Risk-based regulation
Systemic risks
Exposure to common
and correlated risks
Broad perimeter
Rules
Ownership/stockholding
of non-financial entities
Interconnectedness
(players and markets)
Regulatory treatment of
public entities
Financial and real
sector conglomerates/
cross border
Regulatory arbitrage
across entities with
different licenses
New kinds of risks as
markets develop
Corporate governance
Financial Safety Net
Institutions
Centralized Regulation
Financial Stability
Framework
Micro and Macro Prudential
Perspectives 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