Do macroprudential policies leak?

Blogging was absent as I was away on a mini-break. To resume now…

Shekhar Aiyar, Charles W Calomiris and Tomasz Wieladek write this interesting paper on the topic.

Say a central bank/prudential regulator imposes some macroprudential policies like raising capital ratios. leverage ratios etc. Do these measures help? As these measures are basically imposed on the regulated banking system one should expect lending to decline. What if the other non-regulated entities (shadow banking system) undo the measures by increasing lending…

In UK, fin reg applies to domestic banks and subsidiaries of foreign banks. However, finreg does not apply to branches of foreign banks.  So the authors study a capital rule imposed on domestic banks and assess the impact of the new capital rule:

We consider the consequences for bank credit supply of macroprudential capital regulation, using a unique UK ‘natural experiment’ (the practice of setting bank-specific, time-varying capital requirements) to gauge the potential effectiveness
of macroprudential changes in bank capital requirements. We employ data on individual banks operating in the United Kingdom from 1998 to 2007.

For macroprudential policy to be effective in controlling the aggregate amount of lending in an economy, three necessary conditions need to be satisfied: (1) it should be relatively costly to raise equity capital, (2) regulatory capital requirements  should bind on banks, and (3) macroprudential ‘leakages’— substitutes for regulated banks’ lending—should not fully offset the loan-supply effects of variation in capital requirements. The UK evidence suggests that all three conditions were satisfied in the
United Kingdom.

Banks that were subject to UK capital regulation display large and statistically significant responses in their loan-supply behaviour to changes in regulatory capital requirements. The loan-supply behaviour of banks that were not subject to UK capital requirements – foreign bank branches operating in the United Kingdom – responded to increases in UK capital requirements by increasing their loan supply, even as regulated banks contracted lending.

Although this ‘leakage’ was found to be material it only partially offset the initial impulse from the regulatory change. This suggests that, on balance, changes in capital requirements can have a significant impact on aggregate lending by UK-resident banks. The results also reinforce the need for macroprudential regulators to co-ordinate changes in capital requirements to prevent regulatory arbitrage by banks.

Really interesting study…Macropru norms are likely to be more effective in more bank based fin systems. In countries like UK, US etc where you have a bigger market based fin system macro-pru norms will have their challenges.



One Response to “Do macroprudential policies leak?”

  1. ¿Fugas disociar políticas? | ECONOMIA Says:

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