Karolina Ekholm: Macroprudential policy and clear communication
contribute to financial stability
Speech by Ms Karolina Ekholm, Deputy Governor of the Sveriges Riksbank, to the Swedish
Banker's Association, Stockholm, 30 March 2012.
* * *
The views expressed in this speech are my own and are not necessarily shared by the other members of the
Executive Board of the Riksbank. I would like to thank Mr Johan Molin and Mr Per Sonnerby for all their help with
writing this speech.
A new policy area has attracted a lot of attention recently - an area that has come to be
called macroprudential policy. Macroprudential policy entails focusing on the financial system
as a whole instead of on the health of an individual institution, as is the case in traditional
supervision. In my view, such a broad approach is an important, and perhaps even a
necessary, complement to traditional supervision. However, we must of course be realistic
about what macroprudential policy can actually achieve, particularly as monetary policy and
fiscal policy are also important to the stability of the financial system.
Today I will speak about how I believe macroprudential policy can be used as an element of
the work to prevent financial crises. This also gives me the opportunity to mention that we
have recently taken a step towards a broader approach to promoting financial stability. We
have namely set up a council for cooperation on macroprudential policy together with
Finansinspektionen. I will tell you how we expect this council to work and I will also touch
upon the need to develop communication concerning financial stability. However, already at
the outset I would like to emphasise that this macroprudential council should be seen as a
temporary solution while awaiting a more permanent framework for macroprudential policy in
Sweden. In the longer term, we need to clarify where responsibility for macroprudential policy
should lie. It is also important that there are clear and well-defined tools for macroprudential
policy.
The financial crisis in the United States became a debt crisis in Europe
What began as a financial crisis in the United States in 2007-2008 has now become a debt
crisis in Europe. However, the current problems in a number of euro countries are basically
due to the fact that they pursued policies that were not in line with economic development.
The introduction of the euro meant that the euro countries lost the possibility to conduct their
own monetary policies. All of the responsibility for stabilising an economy when it was
exposed to asymmetric shocks fell instead to fiscal policy. But fiscal policy has not been used
to the full in this way in several euro countries. In countries such as Greece and Ireland,
growth and inflationary pressures have been much higher than the average for the euro area.
These countries should have conducted a much tighter fiscal policy in order to counteract
this. But, unfortunately, they did not. The budget rules at the national level were too weak to
enforce an effective fiscal policy. And the EU rules that are intended to promote sound public
finances, the so-called Maastricht criteria, simply did not work.1
What appeared to be the emergence of an acute crisis at the end of last year has been
averted, partly by measures taken by the European Central Bank. This has provided a
necessary breathing space, but it has not solved the fundamental, underlying problems.
Growth prospects have weakened, partly as a result of the consolidation measures that the
crisis has forced governments to take. Unfortunately, there are no good alternatives to such
measures. If the countries that have the weakest public finances refrain from implementing
them the interest rates on their sovereign debts will rise and there will thus be a risk of the
crisis spreading to other countries.
We have also seen some signs of credit tightening in parts of the euro area.2 One of the
factors contributing to this may be the European Banking Authority's recommendation to
introduce a capital adequacy requirement of at least 9 per cent for European banks no later
than June this year.3 However, as in the case of the impact of consolidation measures on
growth prospects, one could argue that the alternative to requiring a higher level of capital
adequacy would be even worse. Without such requirements for banks with a low degree of
capitalisation, there is a risk that the crisis will spread to other banks through poorer access
to market funding. Although we ourselves do not belong to the euro area, we are still highly
affected by developments there. Sweden is a small, export-dependent country and our most
important export markets are in Europe. It is therefore of crucial importance to the Swedish
economy that the euro crisis is managed in an orderly way.
Can crises be avoided with different fiscal and monetary policies?
As the European drama has unfolded, many observers have asked how we can prevent
similar crises from occurring in the future. When, like me, you come from a central bank, it is
natural to ask whether a different monetary policy had been able to prevent the crisis. Some
analysts have identified the low interest rates that prevailed in many countries, and above all
in the United States, for some years before the crisis as an important cause of unsustainable
increases in indebtedness and property prices.
Before the crisis, the most common view among central bankers was that monetary policy
should only react to sharp increases in indebtedness and asset prices if these could be
expected to lead to overheating in the economy as a whole and thus to a too high rate of
inflation. Otherwise, the central bank should wait-and-see before adjusting monetary policy,
but be prepared to quickly cut the policy rate if a burst asset-price bubble initiates a dramatic
fall in demand in the economy.
However, this view has been called into question recently. Many observers, including myself
in one of my first speeches as a member of the Executive Board, have asked themselves
whether monetary policy shouldn't also be used to counteract the development of bubbles.4
Would it have been possible, for example, to prevent this financial crisis if monetary policy
had been tighter in the United States in the years leading up to 2007, when the problems on
the US financial market began? As can be seen in Figure 1, the actual real policy rate was
relatively low in this period. However, it is doubtful whether a higher policy rate would have
been able to bring growth in property prices and credit to a more moderate pace in the
United States without driving the economy into a recession at the same time.5
Figure 1
Policy rates minus actual inflation (CPI change), 1998-,
per cent
Sources: Central banks and statistics agencies in the respective countries
Countries such as Ireland and Spain have also seen a bubble-like development of their
housing markets: first a situation with gradually rising prices over a long period of time which
was then followed by a rapid fall. Would it have been possible to avoid this if the ECB had
conducted a tighter monetary policy and what would this tighter policy have cost in terms of
unemployment and possible deflation in countries such as Germany, where the economy
was developing quite differently?6
I have no clear answers to these questions. But even though it is possible that an
expansionary monetary policy contributed to the development of housing-price bubbles in
some countries, it is still the case that other factors were the prime causes of the global
financial crisis. The Federal Reserve began raising the interest rate already in 2004. Over the
course of two years it increased by more than four percentage points, at the same time as
loans continued to grow. In the United States, deficiencies in the regulation of the mortgage
market and a housing policy that promoted homeownership among low-income earners were
more prominent contributing factors.
A study based on Swedish data has indicated that low real interest rates in combination with
increasing incomes have been important factors behind the increases in prices for housing in
Sweden.7 As both real interest rates and incomes are affected by monetary policy it should
be possible to say that movements in housing prices have been indirectly affected by
monetary policy. However, the same study points out that if monetary policy had been used
to stem housing-price increases, then this would have been extremely costly in terms of
lower growth and lower employment.8
So, although we cannot entirely discount the role of monetary policy as a tool for averting
financial crises, it is not reasonable to assume that monetary policy can do this on its own:9
at least not without risking serious side effects in the economy as a whole. The repo rate
affects the entire economy and cannot be directed at specific markets alone. It can thus have
a negative impact on sectors that are not overheated. Increasing the repo rate in order to
mitigate household credit growth and increases in housing prices also makes it more
expensive for firms to fund new investments. In situations in which investment is low and
unemployment is high this is something one wants to avoid. In such situations it would be
inappropriate to use the repo rate as a means of pursuing macroprudential policy. My view is
that it is only justifiable to use the repo rate in this way in cases where there is reason to
believe that the central bank is the only body that can take measures to counteract what
appears to be an unbalanced development.
So what about fiscal policy? Can't fiscal policy be used to counteract an unbalanced
development? Yes, under certain circumstances. As I mentioned earlier, stricter budget
discipline would probably have counteracted overheating in some European countries, but it
could not of course have averted the financial crisis, which was largely "imported". On the
other hand, a tighter hold on the reins during the good years preceding the crisis would have
increased resilience and provided more room for manoeuvre to manage the crisis when it did
occur. It would then have been possible to manage the crisis within a couple of years and we
wouldn't still have to be dealing with it today.
My conclusion is that well-balanced monetary and fiscal policies offer the best possible
chances of preventing financial crises, but essentially other measures are needed. We need
tools that are specially designed for working with the stability of the financial system.
Macroprudential policy - a new policy area
Traditionally, financial supervision has had a rather one-sided focus on the health of
individual financial institutions. In practice this has also been the case in Sweden, although
formally Finansinspektionen has the task of working for a stable and efficient financial system
alongside its consumer-protection tasks.
However, the fact that individual parts of the financial system appear to be healthy does not
mean that they are immune to contagion from other parts of the system. The institutions have
exposures to one another and it is sometimes unclear who is exposed to what risks. When
an individual institution experiences problems, this may then have serious repercussions for
the financial system and, ultimately, the real economy. However, traditional supervision has
not sufficiently taken into account the risk of financial problems becoming contagious.
Monitoring those risks is also a rather different process to monitoring the risks in an individual
institution.
Traditional regulation and supervision have also found it hard to handle the tendency to
rollercoaster behaviour of the financial sectors. In good times, there is almost always a
tendency to expand lending and to ignore the risks this entails. However, when the downturn
comes, the same players tend to run for the exits at the same time, which serves only to
make the downturn worse. A vicious circle arises when a credit crunch leads to lower
production and lower employment, which in turn feed back into in the financial sector by
making loan losses even higher. This type of feedback effect between the financial system
and the macro economy is not the province of traditional financial supervision either.
This is where the concept of macroprudential policy comes in. Quite simply, financial
supervision must be complemented by a much broader approach. This broader approach is
usually referred to as macroprudential policy.
At the European level, the efforts to develop a framework for macroprudential policy have
European Systemic Risk Board
resulted in the formation of the (ESRB). This body, in which
the Riksbank is represented, will be responsible for overall macroprudential policy for the
financial system in the EU.
The ESRB's tasks include identifying and ranking systemic risks. When such systemic risks
are discovered and are deemed to be significant, the ESRB should issue warnings and,
when appropriate, recommend that corrective measures should be taken. When necessary,
the ESRB will make these warnings and recommendations public. A so-called comply or
explain mechanism is linked to these recommendations. This means that the recipient of a
recommendation is expected to comply with it or otherwise explain why it will not do so.
The ESRB thus has no direct regulatory tools. In order for this to work, there must therefore
also be effective frameworks for macroprudential policy at the national level. It is at the
national level that the ESRB's warnings and recommendations must be met. It is also at the
national level that the actual macroprudential policy decisions must be made. Each country
thus needs an institutional framework for this. There is also a need for concrete tools that the
national authorities can use for the exercise of macroprudential policy.
What tools are needed and how do they work?
But what tools are we talking about? Work is now underway in various international forums to
develop a toolbox for macroprudential policy. So far, however, relatively few specialised
macroprudential-policy tools have emerged. The tool that is probably attracting most
attention at the moment consists of the countercyclical capital buffers that have been
adopted within the framework of the Basel III Accord. The aims of these buffers are to make
the banks more resilient and to dampen the cycles in credit growth and asset prices. The
idea is that the authorities should force the banks to hold extra capital in good times, when
lending is beginning to increase too quickly, in order to be able to reduce capital
requirements later when times are not so good. This will make it more expensive for the
banks to build up risks in good times at the same time as buffers are created that the banks
can use in bad times when the risks materialise. However, this thus means that there must
be a national authority that can decide when the countercyclical buffers should be turned on
and off.
The tools that can be characterised as "specialised" macroprudential-policy tools also include
capital requirement surcharges for systemically-important financial institutions. Apart from
this, most of the tools that can be considered for macroprudential policy are those that in one
way or another are already included in financial supervision's toolbox. These include, for
example, the so-called mortgage cap, although this is usually justified in terms of consumer
protection. However, as development in this area progresses it is probable that the number
of specialised macroprudential-policy tools will increase.10
But do we really need any new tools in this area? Isn't it enough that the supervisory
authority can introduce a mortgage cap for consumer protection reasons and that the central
bank can raise the interest rate to stabilise inflation and resource utilisation when credit
growth is high? No, I don't think so. Referring to consumer protection seems to be an overly
narrow approach in the face of a rapid growth in lending to households and rising housing
prices. On the other hand, the impact of the interest rate is too wide-ranging to be effective
and risks doing more harm than good.
A tool such as the countercyclical capital buffers may seem to be so wide-ranging that it
should be able to work in approximately the same way as the interest rate. Both tools affect
the price of credit in the economy. When the banks are forced to hold more capital their
funding costs increase, as they do when the interest rate is raised, and the price of credit
also increases. However, there are important differences between the impact of the interest
rate and the impact of countercyclical capital buffers. As different types of asset on the
banks' balance sheets have different risk weights, not all types of lending are affected in the
same way when the authorities increase or reduce the buffers. It is easier for the banks to
increase the buffers by reducing lending that is relatively risky rather than reducing other
lending. An interest-rate increase, on the other hand, makes all lending more expensive. The
countercyclical capital buffers thus have a more direct impact on that part of lending that is
associated with high risk, which is just that part that is important to financial stability.
As opposed to the interest rate, countercyclical capital buffers do not have an obvious impact
on the exchange rate. All else being equal, a repo-rate increase is expected to lead to a
strengthening of the exchange rate as the expected return on financial assets denominated
in kronor increases. Raising the capital buffers, on the other hand, could therefore possibly
be used to dampen a domestic expansion of credit without undermining the competitiveness
of the export industry.
Obviously there is a great interest from the banks to find out how countercyclical capital
buffers could be applied in Sweden, However, at this point in time it is too early to tell. For
instance, I shall soon explain that we do not have a permanent macroprudential framework in
place yet.
Responsibility for macroprudential policy in Sweden?
So who should be responsible for the macroprudential-policy tools? In Sweden, as in many
other countries, there has long been a lack of a clear mandate and a clear division of labour
and responsibility for this type of supervision. Initiatives have therefore been taken in several
parts of the world recently to fundamentally reorganise financial supervision. In the United
Kingdom, for example, the main responsibility for macroprudential policy has been given to
the Bank of England.
In Sweden, both Finansinspektionen and the Riksbank have tasks relating to the stability of
the financial system. Both authorities also have a role to play in the prevention of financial
crises.
Finansinspektionen has the task of exercising supervision over financial companies, in
particular those that are of the greatest significance to the stability of the system, and of
working for orderly financial markets by supervising securities trading on stock exchanges
and other marketplaces.
The Riksbank has the task of promoting a safe and efficient payment system, which in
practice means that the Riksbank has a broad responsibility for financial stability. The
Riksbank oversees the development of the financial system as a whole, with a focus on
institutions, markets and infrastructure of importance to financial stability, and presents its
views on risks in, and the efficiency of, the financial system.
Finansinspektionen and the Riksbank thus have partly overlapping tasks, but have different
ways and means of performing these tasks and base their analyses and assessments on
slightly different perspectives.
A council for cooperation on macroprudential policy
How Sweden should best organise macroprudential policy for the financial system is one of
Financial Crisis
the - very difficult - questions currently being addressed by the Commission.
While awaiting the report of the Commission and a future parliamentary decision on a
longterm solution for a macroprudential policy framework we will have to try to make the most of
the existing arrangements. It makes sense that a small country like Sweden should utilise the
expertise and know-how that already exist at the Riksbank and Finansinspektionen. In
January 2012, these two organisations set up a joint council for cooperation on
macroprudential policy.
The idea behind this council is that the authorities should consult and
exchange information concerning their assessments of risks to the financial system as a
whole, and discuss appropriate measures to prevent these risks. Another task will be to
discuss the development of tools and methods in the area of macroprudential policy.
The first meeting of the council was held on 24 February and the aim is that the council
should meet at least twice a year. The minutes of the meeting are available on the websites
of the Riksbank and Finansinspektionen. The intention is to publish the minutes of all the
meetings.
Great need for clear communication
The publication of these minutes is an expression of the ambition to be open and
transparent - an ambition that has become something of a trademark of the exercise of
public authority in Sweden. Openness and transparency facilitate democratic control and
evaluation. This is an area very close to my heart, so I would like to say a little more about it
before I go on to present my view of how macroprudential policy can be developed further.
The Riksbank is often ranked as one of the most open central banks in the world. At the
Riksbank it is now self-evident that we should strive be open and accessible. The only
exception is when limits are imposed by the regulations and legislation on secrecy.
In the field of monetary policy, the Riksbank was one of the first central banks to publish
attributed minutes of its monetary policy meetings. We were also one of the first to publish
our own path for the policy rate - the repo-rate path.
How we communicate is not only of importance to monetary policy, but also to the work with
financial stability. In this field, the Riksbank has strictly speaking no tools with which to affect
the behaviour of financial agents other than to communicate its warnings and
recommendations. This of course demands a high degree of credibility. The Riksbank broke
new ground when the first stability report was published in the autumn of 1997. Other central
banks were also somewhat surprised when we published the results of stress tests for
individual major Swedish banks for the first time.
It is our belief that openness and transparency are important components of the effort to
prevent financial crises. Many crises, not least the most recent one, have been preceded by
a lack of transparency in the financial system. During the latest crisis, the lack of
transparency made it almost impossible to know which participants were exposed to the
most serious risks. This impenetrable uncertainty was one of the main factors that
contributed to the paralysis of the world's financial markets in the autumn of 2008. It is often
uncertainty about the true state of things that in itself makes people nervous and that
sometimes leads to bank runs and panic selling, which in turn can lead to devastating chain
reactions in the financial system. Of course, the need to increase transparency primarily falls
on the participants in the financial system. But the Riksbank can also contribute by being
open about its assessments and analyses of the state of the financial system, for example by
publishing stress tests.
How open the Riksbank should be about its assessments, its preparedness and its own
measures is determined by how this can be expected to affect confidence. In a crisis
situation, we may of course be forced to carefully consider what can or cannot be said.
However, the fundamental rule is that it is better to be open and clear than to be
uncommunicative and ambiguous. A "negative" but reliable announcement can therefore be
better for confidence than a "positive" but uncertain announcement. Openness about the
problems that underlie a crisis may therefore be the key to regaining confidence. This is a
lesson we learned from the Swedish banking crisis of the early 1990s11 - and a lesson that
proved useful during the crisis of 2008-09.12
How we communicate is, however, something that we need to work on and develop
constantly. At present, we are trying to improve our communication concerning our
assessments of the risks in the financial system. Not least, we want to be even clearer about
how we want the banks and other financial agents to respond to these assessments. We are
therefore currently developing ways and means of presenting our recommendations to the
participants in the financial sector. From this it follows that we also need to review ways and
means of following up the recommendations we have made.
The recently-formed macroprudential council also means that we will be able to coordinate
our communication with that of Finansinspektionen to a greater extent than before.
Macroprudential policy needs clear mandates and effective tools
The cooperation between the Riksbank and Finansinspektionen will probably lend greater
weight to the communication of risks and countermeasures, which is good. But the new
macroprudential council does not make any decisions on its own. The council will not alter
the independence, responsibility and decision-making powers of the Riksbank and
Finansinspektionen. Consultating and "communicating" risks are all very well, but in the long
term we probably need something more than an advanced forum for discussion.
This is why I believe that the macroprudential council is only a temporary solution. To
become really effective, macroprudential policy needs to acquire the distinct status of an
independent policy area with its own tools for promoting stability in the financial system as a
whole. There are a number of factors that I believe are particularly important in order to
create an effective institutional framework.
1. The power to make decisions. This presupposes a clear mandate and effective
and clearly defined tools. However, as macroprudential policy is a policy area that is
still under development, the legislation also needs to clarify how new tools can be
added to the toolbox in the future.
2. The body that is given responsibility for macroprudential policy
Independence.
should be free from external pressure, both from the political sphere and from the
financial sector. I believe that this is particularly important, as macroprudential policy
will entail making many unpopular decisions.
3. Accountability. If a body for macroprudential policy is given a high degree of
independence, it must also be made accountable for the actions it has taken - or
failed to take. This means that both the mandates and the tools must be clearly
defined. For example, the mandate could include demands that the body must take
action, or publicly explain why it refrains from taking action, when certain
predetermined levels for key variables are passed. Accountability would also be
facilitated by demands for far-reaching transparency and reporting, for example to
the Riksdag.
Macroprudential policy is only a complement
I have now expressed my heartfelt support for the need to make it possible to conduct
effective macroprudential policy in Sweden. However, I would like to conclude by referring
back to what I said initially about having realistic expectations of what macroprudential policy
can achieve. We can ask ourselves, for example, if we would have avoided the stress on the
financial markets that we have seen recently if an effective macroprudential policy had been
conducted in the euro area. No, we probably wouldn't have, because the problems
essentially relate to the fact that monetary policy and fiscal policy have not been appropriate
given the economic development in a number of euro countries. Macroprudential policy
cannot take the place of well-designed monetary and fiscal policies. But it can act as a
wellneeded complement, as well-designed monetary and fiscal policies provide no guarantees
against being hit by financial crises.
Thank you!
References
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