What it means
Microprudential supervision checks that each bank has enough capital and good controls. Macroprudential analysis asks a bigger question: even if every bank looks sound by itself, could the system as a whole be fragile?
The 2008 financial crisis showed that firms behaving sensibly one by one can still create a dangerous whole. Analysts follow indicators of build-up and exposure.
These include the ratio of credit to the size of the economy, house price growth compared with incomes, bank leverage, the share of loans that have gone bad and how interconnected firms are. They also run stress tests that ask how the system would cope with a deep recession or a sudden jump in interest rates.
The results guide policy. If risks are building, authorities can raise capital requirements, set limits on how much borrowers can borrow relative to their income or the value of the home, or require banks to hold more liquid assets.
These tools aim to slow dangerous growth and make the system more resilient before a shock arrives. Businesses and investors should care because these decisions affect borrowing costs and credit availability.
A rule that restricts lending against property, for example, can cool a housing market and change the plans of developers and lenders alike. Companies planning large borrowing may find terms tightening when regulators judge that credit is growing too fast.
There are challenges. Risks are hard to measure, warning signs can be misread, and acting early can be unpopular because it restricts growth during good times.
The analysis is therefore as much about judgement as about statistics. International organisations also review financial systems this way and publish assessments, which can influence the confidence of investors in a country.
A clean report can lower a country's borrowing costs, while a critical one can raise them.
In practice
Real-world examples.
Example
A central bank notes that mortgage lending is growing at twice the pace of incomes. It introduces a rule limiting loans to a maximum multiple of borrowers' income, which cools lending without changing interest rates.
Example
A regulator runs a stress test in which house prices fall 30% and unemployment doubles. The results show three banks would fall short of required capital, so the regulator asks them to retain profits instead of paying dividends.
Example
A credit analyst at an investment bank reads the stability report of the national regulator. The report warns of growing commercial property lending, which she takes into account when valuing the shares of the local lenders.
Formula
Calculation
Credit-to-GDP ratio = Total credit to the private sector / GDP x 100%, and Credit gap = Actual ratio - Long-term trend ratio
Suppose a country has private sector credit of $1,800 billion and gross domestic product (GDP, the total value of goods and services produced in a year) of $2,000 billion. The ratio is 1,800 / 2,000 = 0.90, or 90%. If the long-term trend is 75%, the credit gap is 90% - 75% = 15 percentage points. A gap this large would prompt regulators to consider extra capital requirements for banks.Case study
Seen in the real world.
Westmarch is an illustrative, fictional country whose banks had grown quickly on the back of a property boom. The financial stability committee reported that credit had reached 110% of GDP, 25 percentage points above trend, and that a large share of new loans were at very high ratios to property values.
The committee raised the capital banks must hold against mortgage lending and capped loans at 85% of a property's value. Lending growth slowed and house prices flattened. When a global shock hit two years later, the fictional banks had more capital and borrowers had more equity, so losses were smaller than in neighbouring countries.
Critics said the measures had slowed the economy during the boom, and the illustrative committee accepted that the benefit shows up only when a crisis is avoided or softened.
Watch out
Common mistakes.
- Assuming a system is safe because each bank is individually healthy, when risks can be shared and interlinked.
- Treating a single indicator, such as the credit-to-GDP gap, as a precise warning signal.
- Confusing macroprudential policy with monetary policy, when the first targets financial stability and the second targets inflation and employment.
Questions
People also ask.
What is the difference between macroprudential and microprudential supervision?
Microprudential supervision looks at the safety of individual institutions, while macroprudential supervision looks at the stability of the whole financial system.
What tools do regulators use?
Common tools include countercyclical capital buffers, limits on loan size relative to income or property value, and liquidity requirements.
Why does it matter to a business?
These measures affect how easy and expensive it is to borrow, so they can change investment plans and property values.
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