The Financial Stability Institute (FSI) of BIS published a paper that reviews the debate on central bank involvement with financial oversight in the light of recent developments and the evolution of policy frameworks worldwide. The focus is on the interplay between objectives and instruments across different policy domains. The paper covers the evolution of institutional arrangements since the great financial crisis, discusses the case for assigning a financial stability role to central banks, and analyzes links between the micro- and the macro-prudential functions. The paper concludes that, based on the experience with COVID-19 policy response, there seems to be a clear case for assigning the financial stability mandate to central banks and an even stronger one for including both macro- and micro-prudential responsibilities in that mandate.
The oversight of financial sector involves a number of policy functions aimed to ensure adequate market functioning and the stability and integrity of the financial system. These functions include the monitoring of the solvency and conduct of business of different types of financial institutions. The design of institutional arrangements for financial sector oversight requires these different functions to be assigned to specific agencies. Decisions need be made on how policy objectives should be assigned between different authorities. Traditionally, this question has revolved around identifying conflicts and complementarities between their various remits. Equally important, however, is the question of whether specific policy instruments can be neatly assigned to specific objectives. When a specific policy instrument can significantly influence more than one objective, the case for assigning each of those objectives to a different agency weakens.
The COVID-19 crisis has shown how different policy instruments could be activated in parallel by different agencies with the aim of stabilizing the economy and the financial system. It also showed the difficulty of making clear distinctions between actions aiming at addressing deflationary risks (and economic instability more generally) and those targeting the availability of credit to the real economy. Moreover, the measures taken reveal that the latter objective cannot be achieved by purely macroeconomic or macro-prudential measures, without adjusting the micro-prudential policy stance. The impact of various policy instruments on differing social objectives constitutes a challenge for the adequate functioning of institutional arrangements based on allocating monetary, macro-prudential, and micro-prudential responsibilities to different agencies. During a crisis, agencies may naturally agree on the need to adopt extraordinary measures. On the other hand, the challenges of a coordinated policy response may become more severe as authorities decide on the pace of normalization based on their own remit but using instruments that may also affect the other objectives of the other agencies.
This paper shows that there is a reasonably sound argument for assigning a financial stability function to central banks. It highlights that, based on the experience with COVID-19 policy response, there would seem to be a clear case for assigning the financial stability mandate to central banks and an even stronger one for including both macro and micro-prudential responsibilities in that mandate. The paper also puts forward the view that the financial stability function should encompass both macro-prudential and micro-prudential responsibilities. These two tasks should ideally be combined within a single policy framework comprising the instruments that would allow an authority to address all the different dimensions (entity-by-entity, systemic) of the financial stability objective. Although this lies outside the scope of this paper, political economy considerations could, of course, be equally important for an adequate institutional design. The accumulation of responsibilities by independent authorities, such as central banks, raises issues of democratic legitimacy and accountability. These need to be satisfactorily managed if the chosen formula is to be socially acceptable and, hence, sustainable.
Keywords: International, Banking, COVID-19, Macro-Prudential Policy, Micro-Prudential Policy, Financial Stability, FSI
Leading economist; commercial real estate; performance forecasting, econometric infrastructure; data modeling; credit risk modeling; portfolio assessment; custom commercial real estate analysis; thought leader.
Previous ArticleBundesbank Releases XBRL Taxonomy 2.10 for Reporting
PRA published the policy statement PS8/21, which contains the final supervisory statement SS3/21 on the PRA approach to supervision of the new and growing non-systemic banks in UK.
EBA published a report that sets out the final draft regulatory technical standards specifying the conditions according to which consolidation shall be carried out in line with Article 18 of the Capital Requirements Regulation (CRR).
EBA updated the list of other systemically important institutions (O-SIIs) in EU.
BCBS published two reports that discuss transmission channels of climate-related risks to the banking system and the measurement methodologies of climate-related financial risks.
UK Authorities (FCA and PRA) welcomed the findings of FSB peer review on the implementation of financial sector remuneration reforms in the UK.
PRA and FCA jointly issued a letter that highlights risks associated with the increasing volumes of deposits that are placed with banks and building societies via deposit aggregators and how to mitigate these risks.
MFSA announced that amendments to the Banking Act, Subsidiary Legislation, and Banking Rules will be issued in the coming months, to transpose the Capital Requirements Directive (CRD5) into the national regulatory framework.
EC finalized the Delegated Regulation 2021/598 that supplements the Capital Requirements Regulation (CRR or 575/2013) and lays out the regulatory technical standards for assigning risk-weights to specialized lending exposures.
OSFI launched a consultation to explore ways to enhance the OSFI assurance over capital, leverage, and liquidity returns for banks and insurers, given the increasing complexity arising from the evolving regulatory reporting framework due to IFRS 17 (Insurance Contracts) standard and Basel III reforms.
ECB published results of the benchmarking analysis of the recovery plan cycle for 2019.