02.10.2023
The role of macroprudential policy in the stabilisation of
macrofinancial fluctuations
Conference on Financial Stability/Banco de Portugal
Lisbon, Portugal
Pablo Hernández de Cos
Governor
Ladies and gentlemen, bom día.
Thank you very much for your kind introduction, Mario, and thank you for inviting me to this
conference. It is always a pleasure to come to Lisbon.
I would like to use this opportunity to consider the role of macroprudential policy in the
stabilisation of macro-financial fluctuations and ways to enhance this role.
Macroprudential policy objectives
The global financial crisis taught us some important lessons from a financial stability
perspective. Firstly, that individual financial institutions needed greater and higher quality
capital and liquidity buffers. Second, that an exclusively microprudential approach to capital
requirements cannot take into account how the actions of individual banks impact the
financial system as a whole, interacting with those of other banks and of the rest of the
players in the system, and influencing the probability of future crises.1
As a consequence, and focusing on the banking sector, the Basel Committee on Banking
Supervision (BCBS) undertook an ambitious overhaul of the prudential regulatory
framework, known as Basel III, which is now very close to being fully transposed into the
legislation of the main jurisdictions.
Together with a strengthening of microprudential requirements to boost individual bank
resilience, a significant aspect of this reform was the introduction of macroprudential policy,
with the specific goal of mitigating the accumulation of systemic risk in the financial system,
both over financial cycles (time dimension) and across financial market participants
(crosssectional dimension). The reasoning behind this goal is that the materialisation of systemic
risk can impair the financial system and disrupt the provision of financial services, with
serious negative effects for the real economy.2
Importantly, macroprudential policy is designed not only to improve the resilience of the
financial system against the materialisation of these two dimensions of systemic risk, but
also to lean against the root causes of systemic threats and vulnerabilities and their
accumulation over time.
Indeed, even if macroprudential policy does not fully eliminate systemic risk, empirical
evidence suggests that it can significantly reduce it. Moreover, limiting the aggregate risk
assumed during financial expansions reduces the severity of systemic risk materialisation.
And the accumulation of capital buffers to absorb losses during bust periods allows a
speedier recovery in the provision of financial services to the real economy.
Moreover, bearing in mind that, through a number of different channels, financial conditions
can be a major driver of the business cycle, the conduct of an active macroprudential policy
will also generally help to temper the growth of nominal and real activity in boom phases
and also their decline during downturns, which should moreover become less frequent.
Hence, macroprudential policy can be conducive to a less volatile growth path and less
hysteresis during crises.
In this regard, macroprudential policy can be seen as a complement to monetary and fiscal
policies with regard to their macroeconomic stability objective.
The role of macroprudential policies in stabilising the economy might be particularly relevant
in the European Monetary Union (EMU), where a common monetary policy is shared by
countries whose economic and financial cycles are still heterogeneous and where, in the
absence of a common permanent fiscal capacity, national fiscal policy is left alone to
counteract the negative consequences of idiosyncratic shocks or common shocks that
generate different heterogeneous effects across member countries.
Looking ahead, this potential stabilisation role of macroprudential policy could be
particularly relevant given the presence of high levels of structural public deficits and debt
in many countries, which has significantly reduced the space available for fiscal policy to
play its stabilisation role.
The outbreak of the COVID-19 pandemic, when fiscal, monetary and macroprudential
policies acted jointly to support the real economy, illustrates this stabilization role. However,
macroprudential policy was constrained by the fact that the accumulated macroprudential
buffers existing at its onset were small or non-existent in many jurisdictions,3 given the
precrisis context of very limited signs of any build-up of financial systemic risk.
A stronger role of macroprudential policy to effectively address adverse shocks that occur
independently of the financial cycle - as the COVID crisis - will require, therefore, increasing
the policy space generated by macroprudential buffers.
Capital buffers and buffer usability
In the case of the banking sector - that part of the financial system for which
macroprudential policy is most developed - capital buffer requirements and limits on lending
standards are the main macroprudential tools.
Let me focus on capital buffers. In Europe, for example, the combined buffer requirements
(CBR), which are placed on top of minimum capital requirements, comprise the capital
conservation buffer, the systemic risk buffer, buffers for global and other systemically
important institutions and the countercyclical capital buffer (CcyB). Importantly, some of
these buffers are releasable by authorities, in particular the CcyB.
This distinction between releasable a non-releasable buffers is key. When banks experience
losses, they can decide on their own to dip into the macroprudential buffers to absorb them.
This would not involve a breach of minimum capital requirements, but banks would still have
to face restrictions on their profit distributions via dividend and bonus pay-outs and share
buybacks. Or macroprudential authorities may decide to release the CcyB, which would
automatically increase banks' available voluntary buffers. In this second case, dipping into
the enlarged voluntary buffer would not involve profit distribution restrictions for banks.
The CCyB has the primary objective4 of ensuring that the banking sector as a whole has an
additional capital buffer, beyond microprudential requirements, which could be used to
absorb losses in a downturn that is preceded by a period of excessive credit growth
associated with the build-up of systemic risks. During business cycle downturns and
financial crises, banks would be allowed to use this additional capital headroom instead of
deleveraging. In this manner, the CCyB would help to sustain the supply of credit to the
economy in bad times. The initial regulatory focus for the CCyB is, therefore, the credit cycle
and bank resilience.
What makes the CCyB different from non-releasable macroprudential buffers is, therefore,
that it can be reduced (released) by the authorities (if necessary, all the way down to zero)
when risk materialises. For a given level of an institution's CET1 ratio, the release of all or
part of the CCyB requirement means that the management buffer of the bank automatically
increases.
What do we know about the effectiveness of this framework?
In contrast to microprudential policy, the effectiveness of macroprudential policy cannot be
analysed simply by assessing whether a certain increase in the level of capital allows a given
bank to absorb a systemic shock of a given intensity. This is certainly relevant, but the goal
of macroprudential policy is also to induce banks to absorb losses while continuing to
provide credit to the real economy in times of stress and therefore to smooth financial
cycles.
In this regard, the effectiveness of macroprudential buffers depends on their usability, which
can be defined precisely as the willingness of banks to dip into the buffers in order to
maintain the flow of credit to the real economy. If buffer usability is low, banks will have
greater incentives to deleverage in response to adverse macro-financial shocks.
The usability of voluntary buffers should not be taken for granted. Market pressure and
profitability considerations could provide incentives to banks to conserve these resources,
and deleverage instead.5 Uncertainty about the cost and time path for rebuilding these
buffers could also disincentivise their use.
The academic literature generally shows that higher capital ratios allow banks to satisfy loan
demand more easily, in particular in periods of stress. However, there is more limited
agreement on whether the relevant factor is the total level of capital or the voluntary buffer,
that is to say the gap between the actual level of capital and the capital requirements. This
issue is highly relevant to the design of the macroprudential framework.
If the only relevant factor for smoothing financial cycles is the absolute level of capital, then
macroprudential policy should concentrate its efforts on the accumulation of non-releasable
buffers, assuming that banks will make use of them if they incur losses.
In contrast, if the relevant factor is not only the absolute level of capital, but the distance
from capital requirements, then the availability of releasable macroprudential buffers could
play a key role in mitigating the impact of systemic shocks, as their release would
automatically increase voluntary buffers and thus contribute to a stable provision of credit
during periods of materialisation of losses.
The empirical evidence gathered in the euro area and the United States during the pandemic
shows the unwillingness of banks to dip into regulatory buffers and that the size of voluntary
buffers was the main factor determining the propensity of banks to keep lending to
nonfinancial corporations (NFCs).6 In particular, banks with low capital headroom lent less
7
during the pandemic than those banks with large voluntary buffers.
This is precisely the main reason behind the benefits of releasing buffers such as the CCyB
during systemic events. The empirical studies assessing the role of released buffers in
Europe during the pandemic show that they helped support the provision of credit to
9
companies and households.8
In particular, recent evidence from the United Kingdom shows that banks that benefitted
more from the release of the CCyB, because they had either a higher share of credit within
their risk-weighted assets or lower capital headroom, granted mortgages for higher amounts
with lower interest rates during COVID-19.
Research under way at the Banco de España seemingly corroborates these benefits, by
identifying, in particular, that banks increased lending in jurisdictions where the CCyB was
released in response to the pandemic, and that these positive effects were mainly significant
for the most capital constrained banks, which are precisely those banks found to cut lending
more in the absence of measures.10
For the particular case of the Spanish banking system, there is also evidence that voluntary
buffers, not absolute capital levels, were more relevant determinants of the willingness of
6
An argument often used against the effectiveness of releasable buffers is that banks will use them to increase the
distribution of dividends in downturns, rather than to continue lending. The empirical evidence shows that some banks
try to keep stable the remuneration that they offer for their shares. But even if this is the case, the release of capital
buffers will still lessen the incentives to reduce the size of their balance sheet, and by extension the supply of credit, to
achieve profit distribution targets.
7
José M. Berrospide, Arun Gupta, and Matthew P. Seay. (2021). "Un-used Bank Capital Buffers and Credit Supply
Shocks at SMEs during the Pandemic", Finance and Economics Discussion Series, Board of Governors of the Federal
Reserve System, 043; and Cyril Couaillier, Marco Lo Duca, Alessio Reghezza, and Costanza Rodriguez d'Acri. (2022).
"Caution: do not cross! Capital buffers and lending in COVID -19 times". ECB Working Paper, 2644.
8
Lucas Avezum, Vítor Oliveira, and Diogo Serra. (2021). "Assessment of the effectiveness of the macroprudential
measures implemented in the context of the COVID -19 pandemic", Working Paper, Banco de Portugal, 2021/07; Cyril
Couaillier, Alessio Reghezza, Costanza Rodriguez d'Acri and Alessandro Scopelliti. (2022). "How to release capital
requirements during a pandemic? Evidence from euro area banks ", ECB Working Paper, 2720; and Aakriti Mathur,
Matthew Naylor and Aniruddha Rajan. (2023). "Useful, usable, and used? Buffer usability during the COVID-19 crisis",
Working Paper, Bank of England, 1011.
9
This is in contrast to what happens with borrower-based measures. The available evidence from those countries that
have already made use of them, of which Portugal is one notable example, tends to indicate that their activation (that is,
the introduction of restrictions on banks' lending conditions) can dampen credit growth and business cycles robustly
and relatively quickly. They also generate resilience on the borrowers' side, as lending standards are safer. However,
deactivation during periods of financial stress would appear to have weaker effects, since funds are not released that
can be used by banks when a crisis breaks, and increased risk aversion under such a scenario causes banks to keep
credit standards tight despite relaxed regulatory requirements.
10
Mikel Bedayo and Jorge E. Galán. (2023). "Are capital buffers good for credit? Evidence from CCyB announcements
on bank lending pre- and post-COVID-19", Documentos de Trabajo - Banco de España, forthcoming.
banks to continue lending during the COVID-19 crisis. Specifically, for banks with smaller
voluntary buffers, it is possible to identify a significant negative (differential) variation in the
supply of loans to NFCs with which they had more recent, and hence weaker, banking
relationships.
Furthermore, when loans with COVID-19 public guarantees (which introduced a significant
positive credit supply shock) are excluded from the analysis, institutions with lower voluntary
buffers are found to have granted significantly less overall credit to NFCs during the
pandemic. This shows that the COVID-19 public guarantees compensated for the higher
11
propensity of banks with lower voluntary buffers to reduce their loan supply. Hence, this
finding adds up to the evidence that the interaction of fiscal policy and financial stability
proved fundamental in the pandemic, in a context in which there were no releasable capital
buffers, as was the case for Spain.
Increasing releasable macroprudential buffers
Two main conclusions can be drawn from the available evidence summarised above. First,
banks seem to be unwilling to dip into their unreleased buffers when losses materialise,
which means that buffers may not fulfil their role as shock absorbers. Second, releasable
buffers (the CCyB, mainly) seem to be used by banks when released. The main corollary of
this evidence should be that there might be a need to increase releasable buffers that can
be released during crises, in particular the CCyB.
In addition, as discussed in the first part of my address, there might be reasons to defend a
more flexible and active use of the CCyB.
Under the current framework, the activation of the CCyB is linked only to signals of systemic
credit imbalances. The experience during the outbreak of the COVID-19 pandemic, and, to
some extent, also from the Russian invasion of Ukraine and the subsequent high level of
geopolitical tensions, has shown, however, that a systemic crisis can and does arise for
reasons exogenous to the economic and financial systems. As these exogenous shocks are
unpredictable and may not be preceded by a financial boom that warrants the activation of
the CCyB, under the original framework we cannot guarantee that the CCyB will be at a
positive level when they arise.
Moreover, if we would like to use the CCyB as a complement to the traditional
macroeconomic stabilising policies, its activation would also be required even if signals of
credit imbalances are neutral, for example in the presence of a positive output gap.
This flexible and more active use would also mitigate the inaction bias, which is another
common concern in the area of macroprudential policies.
However, the practical implementation of higher releasable buffers poses several important
questions.
In particular, when evaluating the introduction of more releasable macroprudential capital
buffers, it is necessary to consider whether it can be neutral in terms of total capital levels,
both at inception and at different points of the financial cycle. In fact, higher capital ratios in
a steady state could have a dampening effect on credit provision and, therefore, on potential
GDP, so it is crucial to evaluate whether these costs are offset by the benefits in terms of
lower probabilities of financial crises and, should they arise, of them being shallower.
If the overall capital levels are to be preserved in periods of stress, total capital requirements
must increase during booms or even normal and intermediate times. This approach would
be capital neutral in periods of stress, but entail an overall capital increase in other periods,
and hence through the cycle. Otherwise, the greater release and use of capital buffers during
busts could leave banks, and indeed the whole financial system, more vulnerable to further
losses in periods of stress. The alternative, increasing releasable buffers while maintaining
current capital levels, would be capital neutral at inception, but it would plausibly entail lower
capital through the cycle.
This debate has given rise to the concept of a positive neutral CCyB in normal times, first
introduced by the Bank of England in 2016.12 This term refers to the introduction of a positive
CCyB requirement level even in the absence of financial imbalances. Since the outbreak of
the pandemic, the debate has naturally gained ground in many institutions. Indeed, the
Basel Committee published last year a newsletter clarifying that the Basel framework leaves
open the possibility of introducing a positive neutral CCyB.13 The ECB and the ESRB have
also reiterated their support for this approach.14 Indeed, many European countries have
gradually adopted this new CCyB calibration approach in recent years, including Croatia,
Cyprus, Estonia, Ireland, Lithuania, the Netherlands, Norway and Sweden.
Let me illustrate how a positive neutral CCyB can be set throughout the financial cycle. To
this end, I will take as a reference the analytical framework described by De Nederlandsche
Bank,15 where four different phases associated with the degree of systemic risk are
distinguished. First, the recovery phase, which is the one that follows a crisis, is a period of
recovery of deteriorated balance sheets, both in the financial system and among households
and businesses. In this phase, the CCyB is maintained at zero. Second, in the normality
phase, the balance sheet recovery is well under way and the CCyB is built up to reach the
neutral level. Third, in the phase of increased risk, when excessive developments in lending
or asset prices lead to higher systemic risk, the CCyB should be raised above the neutral
level. Finally, in the materialisation phase, risk materialises and the CCyB is fully or partly
released.
Obviously, not all these phases need to happen in the aforementioned stylised order. For
example, the phase of increased risk could be curbed as a consequence of the increase in
the CCyB above neutral levels or the use of other macroprudential tools. If that is the case,
the CCyB could be progressively released to the neutral level. Or, after reaching the neutral
level, the economy could enter a recession abruptly, before vulnerability signals accumulate,
thus entailing losses for the banking system. Depending on the circumstances, a total or
partial release of the buffer could be advisable to smooth the business cycle, thus helping
monetary and fiscal policy to close the output gap.
A decision on introducing a positive neutral CCyB should weigh up the different pros and
cons of such an approach.
Regarding the costs and benefits, the estimations of the elasticity of credit and GDP to
changes in capital requirements during recessions and expansions could be useful. In the
Spanish case, for example, the available evidence shows that an increase in an
expansionary period of 1 percentage point (pp) in the capital-to-risk-weighted assets ratio,
consistent with a tightening of credit requirements, would not have negative effects on total
credit to the corporate sector, while it would lead to a reduction of 0.5 pp in credit to
households and of 0.2 pp in GDP.16 By contrast, the same amount of capital being released
during a crisis would lead to an increase of up to 3.5 pp in credit to households and the
corporate sector and of 1.6 pp in GDP.17
This evidence supports the existence of an asymmetry between the costs of activating the
CCyB in normal times, even in the absence of significant systemic imbalances, and the
benefits of its release during downturns. The gradual activation of the buffer at an early
stage makes capital planning easier for banks when conditions are good, reducing potential
negative credit supply effects of the activation. It allows also to take into account uncertainty
in the identification of risks, which can result in a delay and a more rapid activation later in
the cycle.
But the analysis of the pros and cons is more complex. In this regard, a key problem for a
macroprudential policymaker is to decide whether we are in "normal times" at a particular
time. In this regard, authorities can employ a broad range of indicators, including the
creditto-GDP gap and other financial and macroeconomic metrics, such as the output gap.
Furthermore, it is also necessary to assess the appropriate neutral level of the CCyB in
normal times. This may depend on:
- The (cyclical and structural) characteristics of the domestic economy that
can affect the estimated intensity of systemic crises.
- The desired level of macroeconomic stabilisation capacity afforded to
national macroprudential policies in light of the available buffers in other
policy instruments.
- The (cyclical and structural) characteristics of the banking system, such
as the intensity of competition and sectoral composition of assets and
liabilities, which can affect the capacity to withstand potential shocks, under
both baseline and adverse scenarios.
- Other factors, such as the degree of domestic and cross-border
interconnectedness of the financial system and the overall economy, also
need to be considered. These factors have a significant impact on the
vulnerability of the economy to internal and external shocks.
Authorities that have moved to a positive neutral CCyB have used different approach to
calibrate the positive neutral rate, including analyses of historical losses, stress test models,
assessments of the impact of buffer releases during the pandemic and expert judgement18.
All these considerations, which may vary among jurisdictions and therefore could condition
the desirability of moving to a positive neutral CCyB, justify the position of the BCBS, which
supports and sees the benefits of the authorities' ability to set a positive cycle-neutral CCyB
rate voluntarily.
In particular, the Committee noted that circumstances indeed vary across jurisdictions,
including the macroeconomic conditions and the range of macroprudential tools available,
for example sectoral buffers, and their use to generate sufficient capital for banks to absorb
unpredictable shocks. As a result, not all authorities consider a positive cycle-neutral CCyB
rate to be appropriate in their jurisdictions.
In any case, it was considered important to stress that in the event authorities implement
such an approach, they should continue to comply with the existing Basel standards,
including the agreed calibration of the minimum requirements and other regulatory buffers.
Conclusions
Macroprudential policy emerged as a new policy domain only after the global financial crisis.
Ever since, we have witnessed and suffered fresh systemic crises and turmoil stemming
from exogenous shocks, such as the COVID-19 pandemic and the Russian invasion of
Ukraine, while macroprudential policy was designed to address events of systemic stress
that are fundamentally endogenous to the financial system. We have also found some
indications of a positive relationship between lending and the capital headroom of banks
(i.e. the surplus of a bank's capital above all minimum regulatory requirements and
regulatory buffers). As a result, there might be a case for increasing releasable buffers, in
particular the CCyB, and for defending a more flexible use of this tool considering its
potential for helping other policies in macroeconomic stabilisation.
In this regard, an increasing number of jurisdictions have chosen to implement positive
cycle-neutral CCyB rates. Under this approach, authorities aim for a positive CCyB rate
when risks are judged to be neither subdued nor elevated.
Authorities that have introduced positive cycle-neutral CCyB rates have found it helpful for
banks in their jurisdictions to have capital buffers in place that can be released in the event
of sudden shocks, including those unrelated to the credit cycle, such as the impact of the
COVID-19 pandemic. This approach can help address concerns that banks in some
jurisdictions may be reluctant to cross regulatory buffer thresholds in times of stress, but
may be more willing to use their capital to support lending when buffers are explicitly
released by authorities.
Looking ahead, rigorous analytical research will be essential to improve our understanding
of the recent experience with systemic events and refine macroprudential policy so that we
can enhance its effectiveness and thereby release monetary and fiscal policy space to
confront these challenges. I am glad to see that this conference is gathering some prominent
contributors to this important effort.