The Role of Central Banks in Financial i Stability Macro and microprudential policies Ernesto Sepúlveda Villarreal Financial Specialist ernesto_sepulveda@banxico.org.mx Kuala Lumpur, 14 Oct 2011
Outline Some lessons from the crisis CB mandate FS institutional framework Macroprudential instruments t & toolkit Monetary policy & FS CB & bank supervision Final remarks 2
Some lessons from the international financial crisis Financial authorities have to paid more attention to systemic-wide financial developments In particular, a stronger macroprudential component in financial policy is required A number of authorities should be engaged, sharing an objective of delivering financial stability Identifying and addressing systemic risk Monitoring and enhancing the resilience of the financial system 3
Bank of Mexico (Banxico) s mandate The Mexican Constitution establishes that the central bank of Mexico is autonomous in its operations and management (since 1993) Banxico s main function is to provide domestic currency to the Mexican economy Main priority is to ensure the stability of the domestic currency s purchasing power Its other functions are to promote both Sound development of the financial system Optimal functioning of the payment systems 4
Council for Stability of the Financial System (CESF) Financial Authority Council (9 members) Technical Committee (14 members) Secretariat of Finance and secretary (chair) undersecretary (chair) Public Credit (SHCP) undersecretary 3highranking high-ranking reps. National Banking and Securities Commission (CNBV) National Insurance and Surety Commission i (CNSF)) National Commission for the Pension System (Consar) Institute for the Protection of Banking Savings (IPAB) Mexican central bank (Banxico) president president president executive secretary governor 2 deputy governors 3 vice-presidents 1vice-president 1 vice-president 1 assistant secretary 1 deputy governor 3 general directors SHCP Secretaría de Hacienda y Crédito Público CNBV Comisión Nacional Bancaria y de Valores CNSF Comisión Nacional de Seguros y Fianzas Consar Comisión Nacional de Ahorro para el Retiro IPAB Instituto para la Protección del Ahorro Bancario Banxico Banco de México 5
Members of the CESF and their scope of competence Financial entity Price Stability Financial Stability Prevention Resolution Micro Macro Economic Growth Secretariat of Finance and Public Credit (SHCP) National Banking and Securities Commission (CNBV) National Insurance and Surety Commission (CNSF) National Commission for the Pension System (Consar) Institute for the Protection of Banking Savings (IPAB) Mexican central bank (Banxico) CESF SHCP Secretaría de Hacienda y Crédito Público CNBV Comisión Nacional Bancaria y de Valores CNSF Comisión Nacional de Seguros y Fianzas Consar Comisión Nacional de Ahorro para el Retiro IPAB Instituto para la Protección del Ahorro Bancario Banxico Banco de México
Decision making (governance) In the event of policy disagreements within the Council, a majority vote resolves the controversies The Secretariat of Finance and Public Credit is the lead institution in the Council Each financial authority is responsible for the implementation of the policies comprised within the scope of its legal mandate Different arrangements for prevention and crisis management 7
Instruments of macroprudential policy in Mexico Currently in used Under study Limits on maturity mismatch in Countercyclical/time varying capital foreign currency (1992,1997)* requirements (Basel III) Limits on interbank exposure (2001)* Limits on lending to related counterparties (1994, 2001, 2008)* Limits on investment for pension funds (2010)* International reserve accumulation (1996-2001, 2010) Caps on loan-to-value ratio Bank system instruments Financial markets instruments *This is also a microprudential instrument. 8
Bases to build up the ideal toolkit A potential tradeoff between prudential policy (macro and micro) and economic performance should be considered The ultimate purpose is to achieve financial stability (systemic risk and resilience) at the lowest cost in terms of economic performance Each macroprudential instrument in the toolkit should target specific objectives, either to contain systemic risk or to improve the resilience of the financial system The effectiveness, potential cost (including side effects or distortions) and limitations of the instruments should be critically assessed, both individually and jointly Those macroprudential instruments that minimizes potential conflicts with other policy instruments should be preferred 9
Example of an expected cost-benefit analysis of macroprudential instruments (individually) Instrument Expected benefit Potential cost or limitations Caps on loan-to-value ratio Dynamic provisioning Limits on net open currency position Easy to implement To reduce procyclicality of credit growth To limit capital losses To reduce procyclicality of credit To limit bank s foreign currency risk Could limit efficiency gains from screening & signaling mechanisms Could be circumvented by overstating the value of assets Could overlook macroeconomic conditions Could overlook other potential sources of currency risk Countercyclical To turn banks capital Without timely information could capital buffer (Basel III) sensitive to credit risk To reduce procyclicality of credit increase output volatility International To increase confidence Financial: Inverse carry trade reserve and resilience before accumulation capital reversals 10
160 International Reserve in Mexico 140 120 Billion dollars 100 80 B60 40 20 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 11
Monetary policy and FS Inflation targeting and asset prices bubbles Central banks should care about bubbles Interest rates are unlikely to be the right tools for the job Integrating bubbles into an inflation targeting framework would have substantial impact on measured inflation and hence on policy However, it requires adjusting the horizon over which h policy makers strive to meet their inflation objective Non-interest-rates alternatives? Yes! Macroprudential regulation and supervision This a reason why central banks should have special interest on financial stability 12
Bank supervision by the CB Macroprudential Limits on maturity mismatch in foreign currency A limit on structural mismatches A ratio of liquid assets to short-term net cash outflows Microprudential 31 rules for banks operations with derivatives Consumer protection ti (information, transparency, and interest rates and service fees regulation) 13
Organizational changes in Banxico Creation of the Directorate of Financial Stability To gather information and organize data in a way to see whether FI are complying with regulation To ensure that there is sufficient information to judge whether there are systemic vulnerabilities in the Mexican financial system To have evidence at hand to do the analysis for macro and micro issues To facilitate coordination with other authorities To have more resources devoted to analysis and also the ability to make policy recommendations 14
Final remarks 15
What have we learnt about central banks role in financial stability? What CBs shouldn t do Initiate or feed asset price bubbles What they should do Collaborate with other authorities to preserve FS and to manage financial crises Priority: Focus on financial crisis prevention (new) Crucial: In financial crises management To provide liquidity in financial markets (debt & FX) To act as lender of last resort 16
What should be the mandate of central banks in Financial Stability? The central banks mandate must give priority to the job that entirely depends on its powers: price stability However, it should also includes financial stability This is so, not only because financial instability can interfere with price stability, but also because both price and financial stability are preconditions to maximize sustained growth and durable employment 17
Three crucial matters Do not overlook fundamentals (fiscal sustainability) Pay attention to the institutional framework governance Have a flexible tailor-suited macroprudential toolkit 18
Thank you 19