Marrying the Macro- and Micro-Prudential Dimensions of Financial Stability

Abstract

In addition to misperceptions of risk, complementary explanations of excessive procyclicality point to actions that, when taken in isolation, may appear reasonable, if not compelling, but that collectively add up to undesirable social outcomes. In other words, risk may be correctly perceived, but the response to it may not, in the aggregate, be appropriate. This outcome may result from a failure to internalise the consequences of the actions of others, the impossibility of coordinating responses or simply the fact that the costs would be borne by other groups in society.Certain types of response may be reasonable when seen from the perspective of individual agents regardless of what the others do. 24 For instance, in a downturn, it may be compelling for an individual bank to tighten lending terms. 25 Others, faced with the similar situation, would have the incentive to do 19 One version of this notion, known as "rational beliefs", has recently been formalised by Kurz (1997) and, who also derives implications for the behaviour of financial markets generally and asset prices in particular. 20 In statistical terms, the problems of limited power that plague tests of the validity of estimates of the tails of probability distributions for market risk (Kupiec (1995)) are therefore compounded in the case of credit risk (eg Saunders (1999)). The problems are particularly acute in the case of estimates of parameters such as correlations of default (McCallister and Mingo (1996)). 21 See the original treatment by Herring (1984) and. See also Herring (1999) for a discussion of disaster myopia in the context of recent techniques for the measurement and management of credit risk. 22 These are known, respectively, as "availability heuristic" and "threshold heuristic". On the former, see Tversky and Kahneman (1982); on the latter, see Simon (1978) and Slovic et al (1977). Kunreuther et al (1978) contains experimental evidence in favour of these hypotheses. See also Herring (1999). 23 The theory was developed by Festinger (1957).24 This is known as the "prisoner's dilemma" or more correctly, in the case of many agents, the "tragedy of the commons".25 This is almost certainly the case if others do not tighten. It also makes sense if others do tighten, since the action of any individual bank, taken in isolation, would not be such as to lead to a sufficient deterioration in the economic environment to make the bank worse off. The exception might be highly concentrated banking systems.39 Above all, experience suggests that overextension in the financial system, in the form of rapid credit expansion and unusually sharp increases in asset, especially property, 40 prices during the economy's 35 To avoid confusion, in what follows the movement in a financial indicator is said to be "procyclical" if it tends to amplify business cycle fluctuations. According to this definition, for instance, provisions behave procyclically if they fall in economic upswings and rise in downswings.36 Formal econometric evidence on credit/asset price...

Review Paper on Composite Leading Index Creation for Forecasting the Bangladeshi Financial Sector

“…The major difficulty in implementing regulations with a view to fostering financial stability lies in the fact that there is both a micro and a macroeconomic dimension. Crockett (2000) stressed this aspect of financial stability, which focuses as much on the objectives to be reached as the perception of the economic mechanisms concerned. The macroeconomic objective is to reduce probability with regard to crises occurrance and to limit the corresponding costs, including those arising from moral hazard prompted by certain prudential measures (such as limiting systemic risk).…”

“…In microeconomic terms, the prudential objective is to limit the probabilities of individual financial institutions or banks in terms of failure by limiting "idiosyncratic risk". According to Crockett (2000), this would be tantamount to giving an equal weight to each institution, whereas the macro-prudential perspective would focus on overall performance and the correlations between institutions. He suggested that prudential regulation should be calibrated to take account of the systemic significance of institutions, stressing that the failure of an individual institution is not a problem in itself.…”

Interbank Network Characteristics, Monetary Policy ‘News’ and Sensitivity of Bank Stock Returns

“…Daily stock market data of listed European banks from EEA (European Economic Area) are collected from the Bloomberg database and to retrieve annual bank-specific factors, we use the BankScope database. We omit savings, mutual and cooperative banks due to their specificities in terms of interbank relationships (Boss & Elsinger, 2004;BIS, 2001;Worms, 2001). Our final sample only includes listed commercial, investment, and real estate banks.…”

Bank credit risk and macro-prudential policies: Role of counter-cyclical capital buffer

“…In particular, policy makers and regulators introduced stronger regulation aimed at stabilising credit markets, reducing systemic vulnerabilities and high volatility, and ensuring the resilience of the financial sector to weather future crises (IMF, 2020). Against this background, macroprudential measures gained a front line relevance in the policy arena given their: (i) aim of ensuring the stability of the financial system and strong credit availability across financial markets (Hanson et al, 2011;Osinski et al, 2013); (ii) goal to reduce the macroeconomic costs resulting from financial distress, while considering risk as endogenous to the behaviour of the financial system (Crockett, 2000;Borio, 2003); and (iii) supplementary nature vis-a-vis micro-prudential regulation in identifying, monitoring and addressing ''systemic risks'' (BIS, 2016).…”