The monetary stability condition has focused on position after the global crisis as a condition for monetary stability for large economic health and good life. Policymakers around the world known that concentrated on price stability and on the macroprudential regulation of individual job and markets was not enough. A technic macroprudential policy was requested to ensure the capacity to get back quickly from toughness, and stability of the financial system.
The beginning of the term “macroprudential” can be traced back to the late 70s. One of the key alarms at this period in the financial monitoring circles was the fast growth of loans to developed counties and its probable negative effect on financial stability. In 1979, the term “macroprudential” was announced at a meeting of the Cooke Committee (Basel Committee on Banking Supervision) to report the question of international bank loaning. Shortly after the conference, the term “macroprudential” was introduced in a document prepared by the Bank of England (see Maes, 2009). The objective of this paper is to investigate the Prevention of systemic risk; macroprudential policies in UK area.
2. Theoretical background
2.1 macroprudential policy
The Financial Stability Board (2011) claim that macroprudential policy is presented to reduce systemic risk. Borio (2003), argues that the close objective of the macroprudential policy is to limit the risk of events of system-wide financial misery and its goal is to limit output costs (GDP loss) in the event of such actions. Securities regulators are also concerned about systemic risk, there are 3 growing key concerns should be forward through macroprudential policies:
(i) Allen and Wood (2006) write down the term “financial stability” (considering price stability as an independent objective) was initially used in 1994 by the Bank of England. an additional way to define financial stability through three elements: Capital Allocation, a continuous method to measure financial risk, the capability to assimilate financial and real economic impact (Schinasi, 2005)
(ii) Systemic risk as one of the principal element in evaluating financial stability is a new idea in the central banks and policy-makers group. nevertheless, Bartholomew and Whalen (1995) describe systemic risk as “the probability of a brusque generally unexpected crash of confidence in a significant part of the banking or financial system with a potentially wide real economic effect.
(iii) The Bank for International Settlements (2009) defines procyclicality as the event that over time the dynamics of the financial system and of the real economy add to each other, growing the amplitude of economic expansion and contraction that occurs repeatedly and not ensuring stability in both the financial sector and the real economy
The central banks play a key role sight macroprudential system about how the transmission instrument of monetary policy functions is an essential element in assessing the monetary rule’s ability to cope with the financial effect that menace the stability of the financial system. This is an act for a category in the index. Nevertheless, the central banks recognized and debate on how the realization of macroprudential against policy interest rate changes affects the monetary policy transmission system. (Bank of England, 2015).
Fig. 1. Macroprudential dealings over time. Note: The experimental covers 1,047 macroprudential policy activities applied in 64 countries (29 advanced and 35 developing market economies). The database has been completed by means of info in Kuttner and Shim (2016) and Lim et al. (2013). Sources: IMF, BIS.
The country authorities state that they are picking simple, effective and easy-to-implement instruments with minimal market distortions. They evaluate it needful that the pick of macroprudential instruments is coherent with other public policy objectives (fiscal, monetary, and Prudential). They also estimate that it significant to pick macroprudential instruments which decrease regulatory arbitrage, especially in advanced economies with big nonbank financial sectors and intricate and exceedingly interconnected financial sectors.
2.2 Macroprudential Tools
Macroprudential policy tools as a new set we need and which it will help the authorities more directly to influence the supply of credit. In the literature on monetary policy, there is a precise agreement on the role of different instruments. The policy rate is seen as the primary instrument, with general communication which plays a relevant role. (Blinder et al., 2008).
defining macroprudential tools as instruments either
specifically tailored to mitigating systemic risk, or not originally developed with systemic risk in mind
but modified to become part of the macroprudential toolkit, provided that they fulfill two conditions.
Firstly, they should target explicitly and specifically systemic risk. Secondly, the chosen institutional
framework is underpinned by the necessary governance arrangements to ensure that there is no slippage
in their use.
according to IMF (2011a), macroprudential tools defining as instruments either specifically designed to mitigate systemic risk, or not initially developed with systemic risk in wit but altered to be a part of the macroprudential toolkit, on condition that they fulfill two provisos. in the first place, they ought to vise clearly and specifically systemic risk. in the second place, the picked institutional cadre is supported by the needful governance dispositive to assure that there is no slippage in their utilization.
the macroprudential toolkit for emerging market economies could also encompass measures to limit system-wide currency mismatches, which objective at stemming from the domestic financial consequences of capital inflows. Examples are limits on open foreign exchange positions and strained on the type of foreign currency assets. (Turner, 2009).
The IMF study identified different instruments that have been very often applied to attain macroprudential objectives. There are three types of measures:
Ø Credit-linked, i.e., maximum on the loan-to-value (LTV) ratio, maximum on the debt-to-income (DTI) ratio, maximum on foreign currency loaning and max on credit or credit growth.
Ø Liquidity-linked, i.e., the boundary on net open currency positions/currency mismatch (NOP), the boundary of maturity mismatch and reserve design requirements.
Ø Capital-linked, i.e., time-varying capital requirements/countercyclical, time-varying/dynamic provisioning, and limitation on profit distribution.
In general, there is a clearly defined policy objective when the instruments put in the application. precisely, the instruments have been used to attenuate four great types of systemic risk:
· Risks made by heavy credit growth and credit-driven asset price inflation.
· Risks appearing from extreme leverage and the consequent deleveraging.
· General liquidity risk
· Risks linked to huge and volatile capital flows, adding foreign currency lending. IMF (2011b).
The condition required countercyclical capital requirement is a growing function of the amount of credit lent by financial institutions. For the experiment of UK banks, there have been studies which examined the level to which make changes in bank-specific capital requirements affected current capital ratios. The study finds a considerable effect, and both reach an end that capital requirements were constraining on capital ratio choices. UK capital regulation 1998-2007; it established that least capital requirements seem to have been constraining on bank capital decisions continuously for the experiment of UK banks from 1998 to 2007. (Alfon, Argimón, and Bascuñana-Ambrós 2005)
Deputy Governor of Financial Stability at the Bank of England, Paul Tucker, has very often spoken about the potency issue of the “dilution” of cyclical macroprudential policies, and how this marks the need for international coordination:
“Co-operation will be especially important in the deployment of “cyclical” instruments. If one country tightens capital or liquidity requirements on exposures to its domestic economy, the effect will be diluted if lenders elsewhere are completely free to step into the gap. Basel and the EU are addressing how to handle that where the instrument is the Basel 3 Countercyclical Buffer. But we need to explore whether other potential instruments should be subject to similar rules of the game. This is not like a monetary policy with a floating exchange rate.” (Tucker 2011, pp12)
another several instrument and example for the Macroprudential instrument could be found in Table 1. Another precious macroprudential instrument to attenuate the procyclicality of the financial sector is dynamic provisioning. GDP has a negative relationship with Banks provisioning. sometimes Banks tend to underestimate the risk during good times and afford few provisions and suffer losses huge than they expected in times of economic slowdown. as a result, the cyclical behavior of provisioning increases the gravity of economic slowdown for the banks. With dynamic provisioning banks would keep aside more provisions when their income is high. (Pain, 2003).
There is an active discussion about the ef?cacy of macroprudential tools and the suit role for monetary policy in making safe ?nancial stability. Central banks are now meet with the challenges of a new mission, one that may demand them to use uncommon and disputed macroprudential tools together with interest rate policy.
3. Implementation of macroprudential policies in the UK
3.1 The UK Financial Policy Committee
According to Tucker (2011), in the UK, the Financial Policy Committee (FPC) is a committee with eleven people. Five of them are select from the executive of the Bank. Financial service Authority (FSA) is members during the interim period. The Financial Policy Committee has two comprehensive functions: “paving” and “shadowing”. This means FPC will give direction for the statutory reborn of the Committee by advising the government on the instruments and powers FPC could be given by Parliament. And, secondly, FPC will be far as possible behind the scene the role of the statutory FPC, which fundamentally means advising the FSA on where and how it should use its regulatory tools for system-wide ends.
3.2 The Objective and instrument use by FPC
The UK government has suggested that the FPC’s main responsibility should be the main responsibility of FPC should be removed or reduce systemic risks with an assessment of protecting and reinforcing the resilience of the UK financial system. System risk is well-defined to hold both fault lines in the framework of the financial system.
The UK government plan does not imply that the FPC is held accountable for developing the credit cycle, but rather to ensure stability by sustaining the resilience of the system. For example; if boom credit and the FPC increase banks capital requirements. That may help to slow the boom, and it would be supportive if it did so. But if the boom continued with higher capital ratios the banking system ought to be more resilient when the bubble erupts. but if those measures stop banks going bankruptcy then slow-down in the credit cycle, and in the business cycle would be less critical because the flow of credit services could be sustained.
The UK government has suggested that the FPC be topic to a restriction that it ought not to act to conserve stability at the cost of significantly the capacity of the financial sector to supply to medium-to-long term economic growth. In the implementation, this means that if a situation presents or incipient threat to stability then FPC must try to find a solution and avoids damage in long-term growth. (Tucker Paul, 2011)
For example, the macroprudential authority would have secure banks capital requirements against exposures to property and to shadow banking. The macroprudential authority provides powers to do things then it would have asked if the system was good enough resilient from the market itself, that risk was undervalued.
Another example, for implementation of an instrument of macroprudential policy in the UK; the capital requirement; according to the data funds by S. Aiyar, Charles W., T. W, 2014) the sample contains 104 regulated banks with 48 UK-owned banks and 56 foreign companies, and 173 unregulated foreign branches working in the UK. Bank fusions are dealt with by forming an unreal merged data series for the complete period. The variables comprised in this research is listed and defined in Table 2 reports summary statistic.
As Table 2 and Figure 1 shows, the variation in capital ratio requirements is large. The mean capital requirement ratio is 10.8, the standard deviation is 2.26, the minimum value is 8%, and the maximum value is 23%. Figure 2 displays the distribution of changes in capital requirements, which are divided according to the change in the size of the capital requirements that are imposed on the banks.
The FPC fills that gap by identifying, monitoring and, crucially, acting to remove or reduce systemic risks to the resilience of the financial system. This paper has defined the objectives of the FPC and see the obstacle of implementation of the macroprudential capital requirement in each bank works in the UK.
Banks that were subject to UK capital regulation display large and statistically significant responses in their loan-supply behavior to changes in regulatory capital requirements. The loan supply behavior of banks that were not subject to UK capital requirements foreign bank branches operating in the UK responded to increases in UK capital requirements by increasing their loan supply, even as regulated banks contracted to lend.