Macro-prudential Policies - Coursework Example

Macro-prudential Policies To be certainly practical, financial policies and regulations should always be forward-looking. Moreover, formulated to accommodate the challenges of managing the pace of disruptive innovation both registered and potential (Gai, & Haldane, 2011, p.415). Such kinds of changes are by their complexion not mainstream, and might never become so. Thus, they can be driven from top to down as well centralized policy innovations or by bottom-up and decentralized trade changes (Gai, & Haldane, 2011, p.415). Therefore, in this section this paper is going to discuss five drivers that are so crucial to the effective operations of the financial system. The first driver is Disintermediation of capital and payments. It involves a combination of new business models and technology that is facing out the indigenous intermediaries in the financial transactions. For instance, by the use of peer to peer lending platforms, borrowers can link directly with servers (Acharya, and Yorulmaze,2008, p.2012). Similarly, there are new forms of making payments that include digitized currencies such as Bitcoin that could be a challenge to the banking or financial system. Secondly, a new form of credit creation as well is a driver that affects the financial system. Money is established by banks when they extend lending periods. The state pledged bank deposits; however, other forms of IOUs are given out by non-banking institutions with no state backing could still be accepted as money (Gai, & Haldane, 2011, p.415). It is not a new process since digital technology provides new possibilities for the diverse credit creation that can be directly associated with social and environmental positive impacts. A long-term environmental and social impact forms a group of another driver. A series of related events straight from resource limitations and climatic variations in unmanageable debt levels has significant implications for a long-term economic pattern. Consequently, the factors are so crucial in the long-term savings, particularly, in available pension schemes as well in the insurance industry (Gai, & Haldane, 2011, p.416). The third driver is Technological innovation. The use of information technology in communication as well in the commerce sector. This has contributed to the revolution in a manner that the financial transactions are processed and leads to the provision of totally new services as well as business models. To this effect, there are two different connected and overlapping technological systems.This have led to the increase in volume and variety of big data as well regular network connection (Acharya, and Yorulmaze ,2008, p.2017). Hence, these probably need some components of financial systems. The aspects are significant since they help in adjusting the latter in order to sustain the relevance and profitability in the future financial system. Besides, Innovations in economics and monetary policy is one o the key drivers that affect the financial system. The financial calamity has led to an analysis of earlier theories and policy instruments that are found in the sectors of macroeconomics and finance. Consequently, the theories help manage monetary policies and regulations of the financial system. This driver examines six evolutions in the macroeconomic and financial policy sectors that have ability to contribute to the creation of an efficient and inclusive financial system (Acharya and Yorulmazer, 2008,p.215). One common attribute of these drivers is putting more market power in the hands of consumers. For example, they allow the customer to select directly companies and projects to invest in. This constitutes an intriguing question; will the joint decisions of empowered consumers lead to wealthy and more inclusive outcomes than the mutual decisions of the present financial market system? If this will clear the doubt by bringing up the greener and better financial system, then people could be in the perfect position to prevent being redundant. Otherwise, however, people are required to consider what drivers can facilitate more sustainable impacts within the present and future financial system. . , financial system drivers can be categorized into two. Namely, those that coordinate and link global actions that are required and, on the other hand, those that varies with a regional tactical approach that are desired. Given the skepticism facing the world economy and the buildup of the challenge of evolution to a green and inclusive economic system, experimentation with different set of policy approaches would promote innovation and speed up the rate of economic development. (b) macro-prudent instruments. There is an increase in international agreements on the need to create and observe regulatory framework that facilitate firm emphasis on mitigating risks about the entire financial system. Certainly, there are various potentials micro prudent instruments that are being used by the financial system. Following this, the financial risks instruments are classified into three categories. They include: those instruments that influence the status balance sheet of a given financial institution. Secondly, there are those instruments that have effects on the terms and conditions of commercial loans and some of the financial transactions. Finally, there those instruments that affect the market structures. To start with, Balance sheet tools consists of maximum leverage ratios, time-varying, countercyclical capital and liquidity buffers. These tools affect the aggregate levels of force as well the maturity mismatch of the financial system. Consequently, variable risk weights have a role in aiming at emerging risks indefinite exposure classes. At particular levels in the cycle, sometimes it is significance to adopt various risks to the emerging new lending relative to the stock (International Monetary Fund, 2011). The applications of these tools are capable of influencing the credit terms indirectly of a given financial institution. I).Countercyclical capital buffers, this is a group instrument that is aimed at creating the resilience in the upswing and can also assist in moderating the financial institutions. When establishing credit expansion and excess leverage to a financial institution. The capital buffer are found to be negatively affecting resilience as they can lead to the increase of capital requirements of across the entire banking system(International Monetary Fund,2011). To this effect, banks would advance towards the prudent lending hence this will reduce leverage. Systematically, when this pattern is reversed the FPC can allow free buffer, and this makes the banks experience temporary loss as it maintains the lending course provided that shock incidents have passed. Following the boom, the banking system becomes more resilient, and the supply of credit is maintained with the help of the countercyclical buffer. The primary feature of these practical instruments was agreed at the Basel. It the provision that allows the handling the international leakages, which acts as a substitute towards the credit so long as branches of the foreign are being run domestically or across the border. This is very effective in countries like the United Kingdom where the offshoot of the foreign banks accounts for a greater share of domestic of the non-house credits (International Monetary Fund,2011). Therefore, in relation to this, dangers encountered due to leakages are corrected through mutual recognition of countercyclical buffers of a nation. For instance, it revealed that FPC resolutions would be automatically applicable to the United Kingdom’s subjection to the foreign banks. By the same amount, the subjected domestic banks will take the minimum buffer decided upon by the overseas regulation. This reciprocity instrument is only applicable to the buffers up to two point five percent. ii) Sectoral capital requirements (variable risk weights) The instrument can be bought into action through capital add, it is marked as a proportion of banks’ subjections to the sectors that are taken to be risky. Otherwise, risks can be changed directly. Many developed firms use the internal rating associated with the model for establishing risk capital costs. These models strongly relay on the organizations’ personal major criteria such as the possibility of default and loss provided (International Monetary Fund, 2011). A cumulative scalar for the sector being investigated is applicable to the model output. However, the efficiency and the effectiveness of these particular instruments are not always absolute. The capital requirements for a given sector accumulate capital in banks which are believed to have the exposure of the industry revealed as the exact risks resulting from a systematic perspective. Hence, the operation of this particular model is the best for the resilience of significant risks in the identified institution. However, the instrument is less powerful if losses are experienced in almost every part of the system. Thus, it is a challenge to predict spillover effects. The sectoral approach could give a vivid description and incentives to prohibit taking a risk in the sector before they become intensive. These kinds of measures can result in expected side effects of transferring risks into the different area that are not affected. In this kind of situations, the first use of sectoral capital necessity can be followed where need be, by increasing general capital requirements (Merrouche, 2010, p.160). . ii) Maximum leverage ratios The key determinants of the size of capital requirements could be the riskiness of banks’ assets. The original Basel Accord started the implementation of this approach by bringing coarse risk categorization for bank assets. Basel took significant different technique, with the aim of minimizing the regulatory arbitrage (Merrouche,2010,p.120).It enables this by changing the gradations of asset danger and working to fine-tune the amount of capital needed to the assets riskiness held by the bank. The present financial crisis has increased fundamental concerns about the technique. From the macro-prudential perception, simple leverage restraints which the assets weight possess, certain notable desirability over the weighing risk methodology, especially in the terms of being powerful to mismanagements (Merrouche,2010,p.120). iv) Time-varying provisioning practices Averagely, banks have made very little provisions in safer periods, and they have shared larger losses in downturns than expected. This has magnified the effect of the recession on their return and capital. Operating towards the expected loss can make the accounting framework can control the problem by keeping separate capital against the predicted loss in a bit early in the financial cycle. The banking system can increase its provisions above the ones that are needed by the accounting standards. As a result, supplements to the cyclical capital buffer against the predicted loss acts as the mitigation of the problems. Thus, time varying is needed instead of the risks being subtracted from the banks’ losses and profits. The profit and losses can create a convincing balance sheet reserve is removed from the regulatory capital and is made very clear and understandable to market participants. This process reduces the banks potential to pay to repay dividends. Similarly, it can adversely influence bank’s long-term potential to acquire capital (Merrouche,2010,p.160). v) Restrictions on distributions Another element to implement this model is through restricted share of profit given to the ordinary shareholders. It is done through share buy- backs in paying dividends. The idea behind this instrument originates from the ability to a collective action problem. Less stable banks experience much pressure to match the payout capacity of their stronger counterparts in a bid to avoid showing their weaker side to the prospective investors (Nier, 2011, p.150).). Certainly, there is greater evidence of such kind of behaviors with less stronger banks struggling to cover for dividends despite their worsening positions. Hence, this technique affects the most influential and weaker banks. More still it can affect the banks long-term capital acquisition. vi) Time-varying liquidity buffers Micro prudential liquidity standards prevail under development that could delay the detailed paradigm of macro-prudential instruments. However, there is a greater range of possible tools. These tools could entail the application of varied buffer over the Basel Liquidity Coverage Ratio. This requires institutions to hold stocks of more exceptional quality liquid assets enough to cover their total cash outflows in a 30-day stress period (Rockett, 2000). Practically, this could be established either through an additional scalar applied to the limited requirement or as a change in the time of stress period. Tools that influence terms and conditions on new lending I Loan to value and credit to income restrictions A standard method to implement these restrictions is through an outright cap, restricting financial institutions from the period extension of mortgage credit beyond the cap. Some product forms that is, buy-to-let and second-charge, are, however, not Currently controlled by the Financial Services Authority. So if LTV caps are to be imposed in the UK. It is affecting change in legislation will be needed to ensure that caps can be applied towards the mortgages secured on all the residential properties in the country(Rockett, 2000). The approach is probably less prone to international leakages in comparison to prudential rules since it applicable to all chains of foreign banks in relation domestic banks. ii) Margining requirements on secured financing and derivative transactions Minimum margin requirements can be arbitraged in maximizing the use of unsecured finances to offset any greater margin that may be a requirement to secure investment, leaving total intra-financial sector unchanged. Under present regulations although capital requirements on the lending bank would be many, as a result of that a switch. It is uncertain that the borrowing bank can experience any addition to capital requirements (Rockett, 2000). Credit risk limits, borrowing terms and collateral can also be reduced in response to interventions.Any additional instrument could be designed critically to reduce leakages across borders, as well as market segments. Currently, there is no internationally consensus framework for coming up with either static or time-constant minimum margins. This could be a major area of a continuing work of Committee on Payment and Settlement Systems. Market structure tools Market structure tools consist of obligations designed to conduct financial transaction on organized trading platforms. More still it helps to clear trades via central counterparties. Requirements for targeted disclosure can be applied to improve resilience by limiting uncertainty on some particular exposures or interconnections. Intra-financial system risk weights variations could as well play an important role in reducing excessive subjection building up among the financial institutions. c) Macroprudential Policies Macro-prudential policies are systemized to identify and attenuate risks to systemic stability. Hence, as a result, the policies lower the cost to the economy from the interference of the financial services that controls the functions of financial markets. Such services include insurance payment and settlement as well provision of credit. The policies devised include the following: Variation in segmented risk weights: it is designed to be less active than flexible capital buffers. This policy requires institutions to put more money to cater for new loans in sectors that build up more risks. For instance, Turkey recently expanded requirements for new borrowing by the households to remove the high credit increase in this segment (Nier, 2011, p.150).). Dynamic provisions: These policies command the banks to put aside capital to cover loan losses experience within safer periods when credit losses are still comparatively low. Paying in good time ensures that bank’s balance sheets are prepared to reflect losses that are experienced during downturns. A dynamic regime was embraced in Spain by the year 2000 and most recently in Chile, Peru, Colombia, and Uruguay (Nier, 2011, p.150). Loan-to-value ratios: increasing Maximum loan to the value ratios are applied to mitigate systemic risk during a boom-bust increase in real estate markets. Through reducing the loan amount below the value of the product, loan-to-value ratios assist in reducing household’s leverage (Merrouche,2010,p.205). They can as well put a restriction on the increase in domestic prices and minimize the chance of subsurface households being forced to default on loans when the housing cycle reverse.(IMF, 2011b). Debt always forces them to income ratios aims to lower the portion of household income spent used to service the debt. Estimation of the expected foreign currency lending rates: If lenders acquire loans in alien currency, their potential to pay back can be greatly influenced. If the value of the foreign currency increases in any case they have done not protect themselves against such kind of changes. The danger of an increase in foreign currency value intensifies credit risks for granted because repayment becomes costly for borrowers. Macro-prudential criteria to reduce these risks consist of portfolio limits on foreign currency borrowing and other earmarked restrictions, such as asking for more capital and restricted debt-to-income ratios and loan-to-value for foreign currency loans. Many countries recently adopted the approach in eastern and central Europe (Rockett, 2000, p.21). Liquidity requirements: when finance is easy to acquire, an expansion in required buffers of liquid assets. Those that can converted to cash be easily and quickly, give cash reserves and can be drawn if funding dries up. Such a period’s varying expansion in finance requirements can as well mitigate credit increase fueled by short-term and unstable wholesale funding and reducing risk reliance on such funding. Korea and New Zealand recently adopted such measures(Merrouche,2010,p.205). Measuring systemic risk: this policy shows How to create an analytical design that is appropriate for identifying systemic dangers at a very early stage. The policy that promotes the macro-prudential authority to take appropriate and timely actions is a primary issue as well. Many trials have been developinged towardaas a particular measure of overall systemic risk that could initiate the adoption of macro-prudential instruments. However, as appealing as such a statistic would be, it could be softly communicated and used as yardstick for measuring the effectiveness of policy actions. Finding one has proved to impossible so far (Merrouche,2010,p.205). Instead, policymakers have gone toward engaging a set of indicators. This method appreciates the fact that systemic risk has many directions dimension. More items of information also assist policymakers in identify the tool or combination of instruments that would be most useful in combating potential problems. For instance, to capture aggregate risk, the macro-prudential authority has to monitor entire liquidity, credit and market risks including any concentrations of the risks in a certain segment (Merrouche,2010,p.205). The sector could be housing or consumer credit. It should then examine those risks to help him come up with policy tool that is most appropriate to address the problems. The international dimension: since national financial systems are globally interconnected, and financial services are carried across country borders. Macro-prudential policies must be linked and matched among courtiers (Rockett, 2000, p.20). International coordination is very fundamental since credit booms and asset can be managed by credit as long as it is from abroad. Even the best macro-prudential policies are not able to control all financial crises. As a result, it calls for a stronger lender of last resort that can be manipulated at varies changing situations. , the central bank is the body convenient to rescue help the failing financial organizations. Finally, policymakers are required to be mindful of the macro-prudential policy, like any other public policy, is not of costless and entails trade-offs between the consistency and efficiency of financial systems. For instance, when directing financial institutions to have higher levels of capital and liquidity, policymakers could promote the stability of the system. However, they also employ measures that make credit more expensive and hence may reduce economic developments. Balancing between costs and benefits often calls for difficult judgment. Gai, P, Haldane, A and Kapadia, S, 2011).Complexity, concentration, and contagion, Journal of Monetary Economics.ages 453–70 Rockett, A. 2000, Stability, remarks before the Eleventh International Conference of Banking Supervisors, September 20–21 (Basel) Merrouche, O. and Erlend W., 2010, Causes of world Financial Crisis. Evidence on the Drivers of Financial Imbalances 1999–2007.Washington: International Monetary Fund Nier, Erlend W., 2011, Macroprudential Policies Taxonomy and Challenges, National Institute Economic Review, PG 216. Jacek Os, Luis I. and Madrid, P., 2011, Institutional Models for Macroprudential Policy.Washington: International Monetary Fund International Monetary Fund (IMF), 2011, Macroprudential Policy: An Organizing Framework, IMF Policy Paper (Washington). Acharya, V and Yorulmazer, T,2008, Information Contagion and bank herding, Journal of Money, Credit, and Banking. Pages 215-31. Read More