'Macroprudential': A Real Cure or Just a Buzzword?
Federal Reserve Chair Janet Yellen on Wednesday argued against using monetary policy to mitigate potential financial stability risks, saying that recent regulatory reforms were a better alternative.
Federal Reserve Gov. Daniel Tarullo on Monday said a slew of new regulations imposed on the biggest U.S. financial institutions should influence how banks make risky bets.
Federal Reserve Board Gov. Daniel Tarullo said the agency wants to enforce its liquidity rules in such a way as to ensure that accumulated capital can be deployed in times of economic stress.
WASHINGTON These days it is never enough for regulators to worry about one colossal bank without worrying about the system as a whole.
But seven years after the crisis, "macroprudential" regulatory policy is still very much a work in progress. The goal is clear to limit contagion risk and policymakers have crafted rules with a sharp focus on systemic health. Yet there remains ample debate about whether the policy is succeeding, or regulators have merely repackaged rules that still fundamentally address discrete bank risk. Many say that the clearest macroprudential devices are still untested.
Macroprudential is "a buzzword that people throw around, but it's not that clear what it means, and how to operationalize it," said Anat Admati, a professor of economics at Stanford University. "It says, and we kind of know from the crisis, that you have to watch the system. The tools that they have are still essentially micro tools in the end."
Although the term is amorphous, it has a traceable history. Just as prudential regulation focuses on individual safety and soundness, macroprudential supervision takes a more holistic approach, aimed at preventing risks from spreading. In a 2010 paper, Bank for International Settlements historian Piet Clement traced the word's roots to the late 1970s, but the concept did not gain prominence until much later. In a 2000 speech, the late Andrew Crockett, then the general manager of BIS, called the development of macroprudential policy one of the "challenges of the 21st century."
Of course, interest in crafting rules to combat contagion threats exploded following the 2008 crisis. The goals of macroprudential policy are behind whole sections of the Dodd-Frank Act and the international Basel III accord. For example, while the Federal Reserve Board's stress tests technically assess capital adequacy bank by bank, a clear intent is to ensure that the system as a whole survives the next crisis.
"A macroprudential approach to supervision and regulation needs to play the primary role" in guiding the central bank's work, Fed Chair Janet Yellen said last July.
But observers say the strategy is still opaque. Regulations focused on the largest banks and their systemic footprints have a macroprudential effect by design. Yet in some cases, the Fed and other regulators have appeared to rely on microprudential rules to resolve macroprudential concerns. For example, heightened capital requirements are hailed as aiding market stability, but at their core address the strength of individual institutions.
Meanwhile, other tools seen as addressing systemic issues head on such as the Financial Stability Oversight Council's authority to deal with activities that threaten financial stability remain largely untried. The FSOC created by Dodd-Frank specifically to identify macroprudential risks has signaled its intent to take an activities-based approach to asset managers rather than focus on individually risky firms. But that process is still in the very early stages. The law also created a new regime for resolving failed behemoths in a manner that protects the system, but it has not yet been called into action.
"None of the macro tools, with the potential exception of the stress tests, have been well-enough implemented to provide an extra level of macro stress protection, and even then only with the big banks," said Karen Shaw Petrou, managing principal at Federal Financial Analytics. "So we don't know."
Another largely untested macroprudential tool in the U.S. is the use of countercyclical capital buffers established in the Basel accord for the largest and most complex institutions. Those buffers, when applied, would require banks to pay higher capital costs during boom cycles for investing in bubble-inducing assets. The idea is to limit the impact of any ensuing bust on the system. Yet the U.S. regulators have yet to deploy that authority.
Some say the effect of such buffers could work in terms of helping individual institutions navigate a rough transition. But it is still an open question whether they would have a market-wide benefit.
"The other aspect of work' is whether something like the countercyclical capital buffer could actually smooth out the credit cycle or smooth out asset prices, and there I think one can be a little more skeptical about" the chances of success, said Donald Kohn, a former Fed vice chairman who is now a fellow at the Brookings Institution.
To be fair, many of the policies aimed at the largest banks since the crisis inherently macroprudential or not have put those institutions in better position to weather the next storm, arguably making the system safer. U.S. regulators have implemented a tougher version than Basel's "leverage ratio", and recently finalized a rule known as the Liquidity Coverage Ratio requiring banks to hold enough high-quality liquid assets to cover cash outflows during a 30-day stressed period. Additional capital and liquidity rules dealing with global systemically important banks are expected shortly.
Had the higher Basel capital requirements "been in effect in 2006, certainly more of the banks would have survived the decline," Kohn said.
But there is still growing skepticism that a macroprudential approach can succeed in eliminating systemic risks.
"We can be assured of very few things, but there will be instability and crisis in the future. We have not solved any of these things," Kevin Warsh, a former Fed governor and now a lecturer at Stanford, said at a CME Group Global Financial Leadership conference in November. "I don't want us to put ourselves in a position here we are overpromising that we have somehow assured the world's stakeholders that we have the toolkit all set this time."
Kohn cited recent research by the International Monetary Fund, which found that macroprudential policies have had a positive impact in other nations but that its applications are still fairly limited.
"There is evidence that some types of macroprudential rules are effective, but for the most part these have been applied in less well developed economies with less globally integrated financial systems," he said. "The open question is how is this going to work in highly developed, globally integrated markets, like in the U.S. and the U.K. and the Eurozone, etc."
Wayne Abernathy, executive vice president of regulatory affairs at the American Bankers Association, said the popularity of macroprudential policy and simultaneous uncertainty of its objective has created a breeding ground for unintended consequences.
"Conceptually, who could argue with it?" Abernathy said. "In practice, I think it got a little crazy. I think they're trying to do too many things and trying to look at too many variable issues that I fear they've set themselves up for failure. They need to ask themselves, what do they want macroprudential regulation to accomplish? I don't know that they've asked themselves that question."
Yet others say a macroprudential policy in the U.S. can succeed as long as the goals are within reason.
"If macroprudential policy is working appropriately, there are waves in the water but theres no tsunami, no big peaks and troughs, there's no whitecaps on the ocean," said David Wright, a former Fed official and now a managing director at Deloitte. "There are the usual cyclical patterns, but they've been evened out by the approach to macroprudential supervision."
But regulators must also grapple with the challenges of crafting systemic policy in a world of changing risks, as well as the threat that rules imposed on the banks could actually make the system as a whole more dangerous.
Susan Krause Bell, managing director at Promontory Financial, said while the policies put in place since 2008 may avoid another credit-induced catastrophe, macroprudential rules should also focus on newer risks to the system, such as cyber threats.
"I do feel that we're not going to have a credit risk crisis next time around, but that does not necessarily mean we are safer because there are many other risks in the system," said Bell, a former official at the Office of the Comptroller of the Currency. "My sense is the supervisory community is very sensitive to what happened last time and I think it will be a while before the system gets overheated in the same way that it did."
Petrou said some macroprudential regulatory policy to date is indeed responsible for certain risks, namely the growth of shadow banking and the migration of risk away from regulated entities.
"The more you regulate big banks, the safer you make them, but does that make the system safer?" Petrou said. "That's the critical macroprudential question FSOC was supposed to ask, and I don't think it has."