Macroprudential policy: From Emperor Tiberius to BoE’s Financial Policy Committee

Sir John Cunliffe has a nice speech on the topic.

These days most central bankers are trying to pick some incident from history to justify their interventions:

Historians still argue about the exact causes of the financial crash of AD 33 that rocked the Roman Empire.  The commentators of the day did not unfortunately have, let alone record, the vast amounts of data that we have become used to today.  But in a world still painfully extricating itself from the crash of 2008, the key features look eerily familiar, as a number of modern day commentators have observed.  An extension of credit across the empire, a sudden deleveraging, debtors failing and bank closures in a number of Roman provinces, the total drying up of liquidity in the financial system and widespread panic.
 
The remedies look familiar too.  The Emperor Tiberius was not able to rely on a modern independent central bank with the ability to print money to staunch the crisis.  But notwithstanding that immense shortcoming, Tiberius took effective action, injecting into the system a huge amount of liquidity stored in coin in his treasury, setting interest rates at zero for a three year period – an early example of forward guidance – and doubling loan to value requirements for property loans.  He also executed those he thought most responsible: though some might advocate that today, I think in that respect at least we have moved on from AD 33.
 
Systemic financial crises, as this episode shows, are not new.  The invention of credit and the development of banking and financial systems have been key to the improvement of human living standards throughout history.  But they bring with them the boom and bust extremes of the credit cycle, driven by greed and fear, and the risk of systemic crises which can badly damage the real economy.
 
As financial systems have developed and spread, public authorities, from Tiberius’ administration to the Financial Policy Committee (FPC) of the modern Bank of England today, have had to adapt both to deal with financial crises when they occur and to try to prevent them occurring in the first place.  It has often been an unequal struggle. 
 
I want today to review a little of that history from the Bank of England’s perspective.  I will draw out the development of what – following the great financial crisis of 2008-9 – has become known as “macroprudential” policy.  Put simply, this is the regulation and supervision of the financial system as a whole rather than just the ‘micro’ regulation and supervision of the firms and the markets that go to make up the system. 
This incident from history actually suggests just the opposite. The emperor did not need a modern central bank to slush liquidity in the system. They did it themselves! There is a reason why all this mega engineering by central banks is nothing but fiscal policy under a different name. Only governments have been that adventurous and are allowed to be so. Not central banks which are expected to be conservative.
He speaks about the new animal FPC:
I want to highlight some of the steps the FPC has taken in this area.
First, using macroprudential policy to address changing risks depends upon a clear assessment of risks and of the action necessary to address them.  The institutional incentives will inevitably tend to drive macroprudential authorities to the identification of all possible – and if we are not careful, some impossible – risks.  Failure to spot a risk is worse than spotting one too many.  The outcome of this dynamic, however, can too easily be a lack of clarity and focus: an assessment that identifies everything but actually identifies nothing.
With this in mind, the FPC has changed the structure and content of its bi-annual Financial Stability Report (FSR).  The FSR aims to set out publicly the FPC’s view on risks, its assessment of the resilience of the system and to explain its policy.  In its new form, the FSR will focus on no more than a handful of risks, the ones the Committee judges are the most important and the most prominent. 2 And it will then set out what, given the level of resilience in the system, the Committee thinks should be done about those risks.  The intention is that such a shorter, more focused report will create a discipline for the FPC’s thinking, help to communicate what the FPC is truly concerned about and make it easier for others to hold us to account.
Second, the Committee is developing the use of stress testing to assess macroprudential as well as microprudential risk.  Last year, the FPC, together with the PRA ran the first ever stress test of the UK banking sector as a whole.  The aim was to test not just the resilience of individual banks but what happened to the system if all of the major banks faced a severe but plausible stress scenario at the same time.  We are conducting a similar test this year.
The Committee intends to set out later this year how we want to develop macroprudential stress testing to help us respond to the ever changing level of risks in the financial system.  At present we are using stress testing to help us judge how resilient the banking system is to different severely adverse, but plausible, scenarios.  A development of this approach would be to use stress testing more countercyclically.  Rather than testing every year against a scenario of constant severity, the severity of the test, and the resilience banks need to pass it, would be greater in boom times when credit and risk is building up in the financial system and it has further to fall and then reduced in weaker periods when there is less risk in the system and the economy needs the banking system to maintain lending.
Third, macroprudential risk goes wider than the banking system.  Risks can arise in other parts of the financial system and in the real economy.  A year ago, the UK housing market was clearly developing significant momentum.  Prices were growing much faster than incomes.  Borrowers were increasingly driven to borrow a greater amount relative to their annual income.  The amount of such new mortgages at high loan to income (LTI) ratios – borrowers borrowing over 4 times their annual income – had exceeded its pre-crisis peak.
The risk the Committee saw was that if the number of high LTI mortgages continued to grow, there would be increasing numbers of highly indebted households very vulnerable to a change in economic circumstances.  This would increase both macroeconomic volatility and systemic risk.  The Committee came to the view that this was a macroprudential risk that needed to be insured against.  It recommended the introduction of limits on the proportion of new mortgages at high LTI ratios.
The momentum in the housing market cooled and the limits have not so far been reached.  It is impossible to say how much this was a result of the Committee’s action; a number of other important factors were also in play.  But it is an example of the FPC’s approach to adjusting policy to respond to changing risks.  And it is also an example of the Committee taking a broad view of financial stability that goes wider than direct risks to the banking system.
Just layers and layers of technocracy being added really. With BoE’s MPC failing badly, one wonders what FPC can bring to the table? All these members of such committees talk about free markets/free economy at mere drop of their hats  while being an .academician. On becoming a committee member/policymaker they suddenly think that they have the powers to manage/regulate the system..

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