Macro-Prudential Macro-Prudential Surveillance – Surveillance –

Shaping the FutureShaping the FutureCCBS/PFTAC WorkshopCCBS/PFTAC Workshop

Nuku’alofa, TongaNuku’alofa, Tonga10-13 August 201010-13 August 2010

When the music stops, in terms of When the music stops, in terms of liquidity, things will be complicated. liquidity, things will be complicated. But as long as the music is playing, But as long as the music is playing, you got to get up and dance. We’re you got to get up and dance. We’re still dancing.”still dancing.”Chuck Prince, former CEO of Citigroup,Chuck Prince, former CEO of Citigroup,

July 2007July 2007

OutlineOutline• What is Macro-Prudential Surveillance?What is Macro-Prudential Surveillance?• How is it different to Micro-Prudential How is it different to Micro-Prudential

Surveillance?Surveillance?• Two dimensions of RiskTwo dimensions of Risk• The Australian framework of surveillanceThe Australian framework of surveillance• Why the resilience of the Australian financial Why the resilience of the Australian financial

system?system?• Some principles for effective macro-prudential Some principles for effective macro-prudential

surveillancesurveillance• Discussion – implications for the Pacific Island Discussion – implications for the Pacific Island

Central BanksCentral Banks

““Macro-prudential supervision seeks Macro-prudential supervision seeks to ensure financial stability by to ensure financial stability by limiting disruptions to financial limiting disruptions to financial services caused by an impairment of services caused by an impairment of all or parts of the financial system and all or parts of the financial system and [and which have] the potential to have [and which have] the potential to have serious negative consequences for the serious negative consequences for the real economy.”real economy.”Source: Committee on the Global Financial System, May Source: Committee on the Global Financial System, May 20102010

Macro-prudential and Micro-prudential Macro-prudential and Micro-prudential Approaches ComparedApproaches Compared

Macro-prudentialMacro-prudential Micro-prudentialMicro-prudential

Immediate Immediate ObjectiveObjective

Avoid financial Avoid financial system-wide system-wide distressdistress

Limit distress of Limit distress of individual firmsindividual firms

Ultimate Ultimate ObjectiveObjective

Avoid output (GDP) Avoid output (GDP) lossloss

Depositor Depositor protectionprotection

Characterisation Characterisation of Riskof Risk

Endogenous: Endogenous: dependent on dependent on collective collective behaviourbehaviour

Exogenous: Exogenous: independent of independent of individual agents’ individual agents’ behaviourbehaviour

Correlations and Correlations and common common exposures across exposures across institutionsinstitutions

Seen as importantSeen as important Seen as irrelevantSeen as irrelevant

Calibration of Calibration of Prudential Prudential ControlsControls

Top-down: Top-down: specified in terms specified in terms of system-wide riskof system-wide risk

Bottom-up: Bottom-up: specified in terms specified in terms of individual firmsof individual firms

Source: BIS Working Paper No. 128, February 2003Source: BIS Working Paper No. 128, February 2003

Macro and Micro Macro and Micro Prudential SurveillancePrudential Surveillance

• The macro and micro approaches to The macro and micro approaches to prudential surveillance are prudential surveillance are complementary.complementary.

• A prudential supervisor that does A prudential supervisor that does not take systemic risks into account not take systemic risks into account is failing in its micro-prudential is failing in its micro-prudential mandate, as well as a macro-mandate, as well as a macro-prudential one.prudential one.

The Role of Macro-The Role of Macro-Prudential PolicyPrudential Policy

• Two dimensions of systemic risk:Two dimensions of systemic risk:• Cross sectional – risk arising from Cross sectional – risk arising from

linkages within the financial system.linkages within the financial system.• Time – risk arising from the Time – risk arising from the

business/financial cycle.business/financial cycle.

The Australian Framework The Australian Framework for Macro Prudential for Macro Prudential

SupervisionSupervision• Council of Financial Regulators – the Council of Financial Regulators – the

primary (and formal) co-ordinating primary (and formal) co-ordinating body for Australia’s main financial body for Australia’s main financial regulatory agencies – comprises the regulatory agencies – comprises the RBA (Chair), APRA, ASIC and RBA (Chair), APRA, ASIC and Australian Treasury.Australian Treasury.

• The Council contributes to the The Council contributes to the effectiveness of financial regulation by effectiveness of financial regulation by providing a high-level forum for co-providing a high-level forum for co-operation.operation.

The Australian Framework The Australian Framework for Macro Prudential for Macro Prudential Supervision (cont’d)Supervision (cont’d)

1.1. The Council of Financial Regulators:The Council of Financial Regulators:

2.2. shares information and views;shares information and views;

3.3. discusses regulatory reform or issues discusses regulatory reform or issues where responsibilities overlap; and where responsibilities overlap; and

4.4. co-ordinates responses to potential co-ordinates responses to potential threats to financial stability (if need threats to financial stability (if need be).be).

The Australian Framework The Australian Framework for Macro Prudential for Macro Prudential Supervision (cont’d)Supervision (cont’d)

““The Reserve Bank of Australia will be The Reserve Bank of Australia will be strengthened and its role focused on strengthened and its role focused on the objectives of monetary policy, the objectives of monetary policy, overall financial system stability and overall financial system stability and regulation of the payments system.”regulation of the payments system.”

Treasurer’s response to the Wallis Treasurer’s response to the Wallis Inquiry, 1997Inquiry, 1997

The Australian Framework The Australian Framework for Macro Prudential for Macro Prudential Supervision (cont’d)Supervision (cont’d)

Communication:Communication:• The RBA publishes a formal Financial The RBA publishes a formal Financial

Stability Review every six months (since Stability Review every six months (since 2004).2004).

• Macro-prudential indicators are shared Macro-prudential indicators are shared with APRA on an ad hoc basis and through with APRA on an ad hoc basis and through the regular Coordination Committee the regular Coordination Committee meetings between the RBA and APRA meetings between the RBA and APRA (Memorandum of Understanding, 1998).(Memorandum of Understanding, 1998).

The Australian Framework The Australian Framework for Macro-Prudential for Macro-Prudential

SupervisionSupervisionAPRA has a requirement to:APRA has a requirement to:

““balance the objectives of financial balance the objectives of financial safety and efficiency, competition, safety and efficiency, competition, contestability and competitive contestability and competitive neutrality and, in balancing these neutrality and, in balancing these objectives, is to promote financial objectives, is to promote financial system stability in Australia.”system stability in Australia.”

APRA Act, 1998, Section 8(2)APRA Act, 1998, Section 8(2)

Why the Resilience of the Why the Resilience of the Australian Financial Australian Financial

System?System?1.1. Australian banks had not accumulated Australian banks had not accumulated

large exposures to US mortgage-large exposures to US mortgage-backed securities – focused on backed securities – focused on domestic loan demand.domestic loan demand.

2.2. Household sector activity underpinned Household sector activity underpinned by tight labour market - strong growth by tight labour market - strong growth in real average earnings and rising in real average earnings and rising employment-to-population ratio.employment-to-population ratio.

3.3. Absence of housing supply over hangAbsence of housing supply over hang

Why the Resilience of the Why the Resilience of the Australian Financial Australian Financial

System? (cont’d)System? (cont’d)4.4. Lending standards did not ease as much as Lending standards did not ease as much as

in the United States, with APRA raising in the United States, with APRA raising capital requirements on certain mortgage capital requirements on certain mortgage products.products.

5.5. Australian households cannot deduct Australian households cannot deduct interest on owner-occupied mortgage, interest on owner-occupied mortgage, reducing the incentive to keep mortgage reducing the incentive to keep mortgage balances high.balances high.

6.6. Loan-to-valuation ratios lower in Australia Loan-to-valuation ratios lower in Australia than United States with less people facing than United States with less people facing negative equity.negative equity.

Some Principles for Some Principles for EffectiveEffective

Macro-prudential OversightMacro-prudential OversightDesirable Institutional arrangements:Desirable Institutional arrangements:1.1. The need for an agency with an explicit The need for an agency with an explicit

mandate to monitor and analyse systemic risk mandate to monitor and analyse systemic risk in the financial system.in the financial system.

2.2. The need for financial regulators to share The need for financial regulators to share information and co-operate to identify and information and co-operate to identify and respond to systemic vulnerabilities.respond to systemic vulnerabilities.

3.3. The systemic risk regulator, either The systemic risk regulator, either independently or through a formal body (the independently or through a formal body (the Council of Financial Regulators in Australia), Council of Financial Regulators in Australia), should have a mandate to call for institutional should have a mandate to call for institutional changes needed to forestall the build-up of changes needed to forestall the build-up of systemic vulnerabilities.systemic vulnerabilities.

Some Principles for Some Principles for EffectiveEffective

Macro-prudential Oversight Macro-prudential Oversight (cont’d)(cont’d)Conduct of macro-prudential oversight and Conduct of macro-prudential oversight and

analysisanalysis4.4. The systemic risk regulator should regularly The systemic risk regulator should regularly

conduct and publish analysis about systemic conduct and publish analysis about systemic risks and vulnerabilities, (the Financial risks and vulnerabilities, (the Financial Stability Review in Australia).Stability Review in Australia).

5.5. The supervisory frameworks of all prudential The supervisory frameworks of all prudential and market integrity regulators should and market integrity regulators should accommodate systemic concerns.accommodate systemic concerns.

6.6. Supervisory responses should be informed Supervisory responses should be informed by, but not mechanically driven, by by, but not mechanically driven, by macroeconomic variables.macroeconomic variables.

Implications for the Implications for the Pacific Pacific

For Discussion:For Discussion:• Is there a need for Pacific Island central banks Is there a need for Pacific Island central banks

to enhance their macro-prudential surveillance, to enhance their macro-prudential surveillance, given low level of integration with global given low level of integration with global financial system and low level of connectedness financial system and low level of connectedness domestically?domestically?

• What form should surveillance take, given What form should surveillance take, given limited resources and dominance of foreign-limited resources and dominance of foreign-owned banks?owned banks?

• A macro-prudential surveillance approach A macro-prudential surveillance approach requires regulators to monitor developments in requires regulators to monitor developments in the global banking system as well as national the global banking system as well as national systems. How well are Pacific islands central systems. How well are Pacific islands central banks placed to carry out this function?banks placed to carry out this function?