INTERNATIONAL MONETARY FUND Macroprudential Policy: An Organizing Framework1 Prepared by the Monetary and Capital Markets Department In consultation with Research and other departments Approved by Jos Vials March 14, 2011 Contents Page Executive Summary .3 I. Introduction 5 II. Macroprudential Policy: Key Concepts 7 III. Systemic Risk Assessment and Monitoring .13 IV. Macroprudential Policy Toolkit .22 V. Institutional Set up and Policy Coordination 33 VI. Key Takeaways and Work Going Forward .45 References 55 Tables 1. Macroprudential Instruments .23 2. Models of Macroprudential Policy 52 3. An Assessment of the Models54 Figures 1. Financial Stability Framework and Macroprudential Policy .9 2. Examples of Aggregate Risk Measures .20 3. Potentially Useful and Actually Used Instruments 29 4. Rules or Discretion? A Continuum 32 1 Prepared by a team led by Jan Brockmeijer, Marina Moretti, and Jacek Osinski, comprising Nicolas Blancher, Jeanne Gobat, Nadege Jassaud, Cheng Hoon Lim, Elena Loukoianova, Srobona Mitra, Erlend Nier, and Xiaoyong Wu. 2 Boxes 1. Key Aspects of Macroprudential Policymaking 4 2. Basic Questions on Macroprudential Policy 6 3. How Business and Financial Cycles Matter for Macroprudential Policies .18 4. An Illustrative Example of Systemic Risk Monitoring (Systemic Risk Dashboard) .21 5. Adjusting Microprudential Tools to Account for Systemic Risk 24 6. Experience with Limits on Loan-to-Value for Residential Mortgages 26 7. The Institutional Set-up across CountriesSome Recent Examples 36 Appendices I. Financial Stability and Macroprudential Policy Survey: A Summary .48 II. Looking for a Model of Macroprudential Policy 51 3 EXECUTIVE SUMMARY Considerable efforts are underway to draw lessons from the recent crisis. One of these lessons is the need for an overarching policy framework to address the stability of the financial system as a wholea macroprudential policy framework. Macroprudential policy seeks to limit systemic, or system-wide, financial risk. Defining elements of macroprudential policy are its objective, its scope of analysis (the financial system as a whole and its interactions with the real economy), its set of powers and instruments, and their governance (prudential tools and those specifically assigned to macroprudential authorities). Macroprudential policy is a complement to microprudential policy and it interacts with other types of public policy that have an impact on systemic financial stability. Indeed, prudential regulation, as carried out in the past, also had some macroprudential aspects, and the recent crisis has reinforced this focus; hence, a clear separation between “micro” and “macro” prudential, if useful conceptually, is difficult to delineate in practice. Moreover, no matter how different policy mandates are structured, financial stability tends to be a common responsibility, reflecting the far reaching consequences of financial crises. This calls for coordination across policies, to ensure that systemic risk is comprehensively addressed. Equally important, macroprudential policy is no substitute for sound policies more broadly, including, in particular, strong prudential regulation and supervision, and sound macroeconomic policies. Operational independence in other policy areas, including monetary and microprudential policy, should not be undermined in the name of macroprudential policy. Finally, given the global nature of the financial system, the multilateral aspects of macroprudential policy will need to be fully consideredan important aspect that is only touched upon in this paper. To be effective, institutional arrangements for macroprudential policy need to ensure a policymakers ability and willingness to actincluding clear mandates; control over macroprudential instruments that are commensurate with those mandates; arrangements that safeguard operational independence; and provisions to ensure accountability, supported by transparency and clear communication of decisions and decision-making processes. This paper draws a number of key takeaways from the work conducted to date within and outside the Fund. Given the partial state of our knowledge, it is too early at this stage to cast these as a set of principles of good practices that could support internationally consistent implementation of macroprudential policies. However, the preliminary views offered on key aspects of macroprudential policymaking, as summarized in Box 1, could form the basis for ensuring broad consistency in Fund advice on macroprudential policies, given growing demands in this area; and could, in due course, be an input towards an internationally agreed set of macroprudential principles. Much further work will be needed in the coming years to achieve this goal. 4 Box 1. Key Aspects of Macroprudential Policymaking General 1. The prime objective of macroprudential policy is to limit build-up of system-wide (systemic) financial risk. 2. Public policies should comprehe