Sabine Lautenschläger: Current developments in macroprudential
oversight
Speech by Ms Sabine Lautenschläger, Deputy President of the Deutsche Bundesbank, at
the 14th Handelsblatt Annual Conference "Update on Banking Regulation", Mainz,
6 November 2013.
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1. Introduction
Dear Mr Afhüppe,
dear Professor Schulte-Mattler,
ladies and gentlemen
The flyer advertising this event invited us to "keep our finger on the pulse of developments in
banking regulation". In my opinion, the heartbeat of regulation cannot be overheard; it beats
fast, almost a staccato - if you consider the wave of regulations over the past five years and
the changes in the approach to supervision. Today, I would like to discuss one of the three
major changes that face banks and supervisors - and will possibly get your pulse going in
the future.
What changes am I referring to? The first major change are the completely revised rules for
banks, known as "Basel III". The second change is the banking union. Both subjects have
already been discussed at length and in great detail. I therefore propose to talk about major
change number 3 today, "macroprudential oversight". It is my impression that banks and
market participants have, to date, paid too little attention to the ways in which this new type
of supervision could affect them. However, the potential impact of the instruments available
for this task should not be underestimated; on the whole, they are directed at banks, they
may affect a category of banks or a national banking industry, and may impact all of the
business or just individual business areas. This raises elementary questions such as that of a
level playing field.
2. Macroprudential oversight: definition and background
What is macroprudential oversight anyway? Before the financial crisis, financial supervision
dealt mainly with individual market players or individual institutions. Put simply, the motto
was: if all is well at the individual institutions, all will be well with the system. Attention
centred on the micro level; the macro level was not monitored and evaluated systematically,
at least not at the national level. Macroprudential oversight is intended to do just that: its aim
is to identify and assess, in a timely manner, developments that could jeopardise the
financial system. We - the Bundesbank - define financial stability as the ability of the
financial system to fulfil its key economic functions at all times - in particular, to efficiently
allocate financial resources and risks, and provide an efficient financial infrastructure.
However, the objective of macroprudential oversight is not just to analyse and identify risks to
financial stability: it should also warn those responsible and recommend measures that will
contain any risks to the proper functioning of the financial market or - better still - nip them in
the bud.
The financial crisis has clearly demonstrated why macroprudential oversight is important. It
showed that tensions and imbalances in individual areas of the market or at individual market
players may jeopardise the system as a whole. For instance, we saw that developments that
appeared harmless in relation to just one institution caused considerable systemic risk when
a larger number of institutions were affected. However, the crisis also demonstrated that we
need suitable international agreements to identify vulnerabilities in the financial system early
and combat them effectively. This is particularly important in a world in which the
globalisation of the financial markets and technical progress in data processing mean that
markets and market participants are increasingly interconnected.
A key lesson from the crisis is therefore: a macroprudential perspective must be added to
microprudential oversight.
3. Objectives of macroprudential oversight
However, the difficulties start with the question of what concrete goal macroprudential
oversight should have. As I said earlier, the main intention behind macroprudential oversight
is to reduce dangers threatening the financial system as a whole. As I see it, macroprudential
oversight can take two directions: macroprudential activities may focus on increasing the
resilience of individual systemically important market players. Alternatively, the goal may be
to reduce procyclicality.
The aim of raising market players' resilience is virtually self-explanatory. In the event of a
crisis, players have more room for manoeuvre if they are more stable. They become
distressed less quickly and must, for instance, resort to fire sales less quickly; nor do they
need to curtail lending as much.
But what is procyclicality and why is it worth monitoring? Procyclicality in the financial system
is the result of self-reinforcing feedback effects between the financial system and the real
economy. Financial markets may amplify the real economic cycle and thus lead to economic
overheating or an overall recession. Such developments are, moreover, frequently
accompanied by destabilising effects for the financial system. Think, for instance, of a
pervasive real estate crisis or a credit bubble. It is therefore absolutely vital not to lose sight
of the financial system's often procyclical behaviour.
In a nutshell: the objective may be to prevent a bubble emerging or to prepare market
players for the bubble bursting. Now, you might interject that this distinction between two
objectives is somewhat artificial. After all, some measures address both goals. That may be
true. Nonetheless, when deciding on a measure, it is important to consider not only where
the danger is coming from and what concrete measure would be suitable to combat it.
Macroprudential supervisors must also be interested in the size of the potential damage if
they do not take the measure. Because that determines how much the measure can interfere
with third parties' rights - and that doesn't only mean banks' rights.
However, not only the objectives of macroprudential supervision must be clear, but also what
dangers or risks macroprudential supervisors should be monitoring. May these only be
domestic dangers or should they also include risks that emerge outside of the supervisor's
own territory but may have far-reaching consequences - such as the US subprime crisis?
Must harmful incentive structures arising from legislation, say tax legislation, be monitored
alongside the infrastructure critical for the smooth functioning of the markets? The wider the
circle of dangers to be monitored is drawn, the more important is international coordination,
amongst other things. The wider the circle of dangers to be monitored is drawn, the more
important are measures that target not only banks. And we have a long way to go in both
areas, in international coordination and on the macroprudential toolkit for non-banks.
4. Measures of macroprudential oversight
The question that springs to mind is: what do we do after identifying a danger? What sort of
measures are at our disposal? Some measures target individual players, others affect
cyclicality. I would like to give you a few examples.
An almost trivial, but still important way to prepare market players for a crisis are measures
focusing on capital levels. If they are sufficiently large, capital buffers strengthen the financial
sector's resilience to systemic events and reduce contagion risk. Sufficiently capitalised
financial institutions have more leeway in a crisis before they have to reduce risk assets or
curtail lending. As a result, they are less cyclical in their actions.
Banks are even less cyclical in their actions if the capital buffer is additionally anticyclical.
Such buffers "breathe" with the economic cycle. They are established in "good" times, ie
times in which there is a risk of a credit bubble emerging. They consequently have a
dampening effect on lending and ensure that banks have reserves in "bad" times. Measures
aimed only at individual business areas are also conceivable. For instance, capital backing
for real estate loans could be raised in order to dampen lending.
If capital requirements breathe with the cycle, they act in two ways: they strengthen the
individual market player and they dampen cyclical fluctuations.
The appropriate use of macroprudential measures is anything but easy, however. And this is
where it really gets difficult. The measure must not only be suitable, it must also be the
mildest possible. The choice of instrument must be suitable and the timing must be right -
the measure must not be deployed too soon. The dosage must also be correct; and there
must be transparent triggers, for both when to deploy them and when to phase them out.
Some thought must therefore also be given to how long they should be in place. With
anticyclical instruments, in particular, the phase-out period, ie when the dampening effect
stops, can be just as important as the phase-in period, ie the dampening itself.
However, another area is also vital to macro policy: the macroprudential toolkit still needs
some work - at both the national and the international level, as the only measures currently
available are those laid down in the CRR and the CRD IV; and those deal exclusively with
credit institutions. We lack instruments at the European level that target the behaviour of
insurers or other market players.
I will leave it at that, and now turn to the key players in macroprudential oversight.
5. Responsibilities for macroprudential oversight
As critical developments on financial markets know no national borders, macroprudential
oversight and, in particular, any measures resolved, have to be harmonised internationally.
Comprehensive and close cooperation between various national and international forums is
necessary for measures to have any kind of effect and for the playing field to be as level as
possible. Early warning systems that lack a mechanism to exchange information across
borders or are not harmonised are pointless. "State of play" reports from countries facing
critical developments can provide important information about potential vulnerabilities in
other countries.
However, in the macroprudential area too, it is not just a question of bilateral cooperation
between the individual national institutions. Strategies and tools have to be developed to
enable a structured exchange of information to take place and to harmonise courses of
action. European and global forums are thus required.
Which forums exist already? The Financial Stability Forum (FSF) was founded back in 1999.
In 2009, this forum was expanded to include all of the G20 countries and has been
re-established as the Financial Stability Board (FSB). The FSB is one forum active in
international macroprudential oversight. It deals with endogenous risks in the financial sector,
ie vulnerabilities that either originate in the financial system itself or are amplified there. For
instance, this could be shadow banking activities to generate liquidity in the financial system.
The European Systemic Risk Board (ESRB) began its macroprudential oversight duties in
2011. Its membership includes the European Central Bank together with the national central
banks, the European Commission, representatives of ESRB committees as well as the three
European financial supervisory authorities, namely the EBA, ESMA and EIOPA. The ESRB
was primarily conceived as an advisory body. It can issue warnings and recommendations.
The "comply or explain principle" applies to ESRB recommendations. If institutions do not
follow recommendations issued, they have to state their reasons why.
The ESRB has an additional mandate, namely to ensure that countries do not take
macroprudential measures at the expense of other countries. National macroprudential
forums therefore first have to check with the ESRB before proposing measures that have a
cross-border effect.
The macroprudential forum in Germany is the Financial Stability Committee (Ausschuss für
Finanzstabilität or AFS). The AFS was set up this year. It provides an institutional framework
for the cooperation between BaFin, the Federal Ministry of Finance and the Bundesbank,
which are the institutions that previously shared information informally about the
macroeconomic situation in Germany and the rest of the world. Within the AFS, the
Bundesbank is responsible for macroprudential oversight. The Bundesbank can propose that
the AFS issue warnings and recommendations. If the AFS believes that certain
developments pose considerable risks to financial stability at a national level, it can make a
public statement to that effect - and, most importantly, it can do this when signs of the risk
are emerging, meaning it does not have to wait until the risk has fully materialised. It can also
recommend that macroprudential measures be implemented. Then, we - the Bundesbank -
monitor and evaluate the implementation.
But why do we need our own national infrastructure when we already have the ESRB?
Despite the financial sector having a strong international focus, the nation-state is still of key
importance. Risks to financial stability are heavily affected by national factors such as the
structure of the financial market, bank customers' economic situation, financing requirements
in the real economy or the national legal and fiscal system. It is thus essential that
macroprudential oversight gives adequate consideration to national factors. It is for this
reason that Germany, too, needs its own infrastructure. The major challenge here will be to
strike the right balance between the need to address cross-border risks whilst at the same
time ensuring that national factors are not short-changed.
The European Central Bank (ECB) is also to be involved in macroprudential oversight. The
Single Supervisory Mechanism (SSM) is currently being set up. The ECB will be given both
microprudential and macroprudential powers which it can exercise over institutions in the
SSM member countries.
While national authorities will retain their powers to deploy macroprudential instruments at
national level, they will have to inform the ECB of these measures in advance - and the ECB
will have the power to make them stricter. Of course, there is no guarantee that the national
supervisory authorities will share the SSM supervisory bodies' conclusions and
recommendations - or the other way around for that matter. I therefore believe that we will
see intensive discussions and a need for coordination between the two levels.
6. Conclusion
This year we have officially begun our macroprudential oversight of the German financial
system. We have thus learnt a key lesson from the financial crisis, even if much still remains
to be done before the mandate is fully implemented. I hope my talk has helped to keep your
finger on the pulse of developments.
There is no doubt that many a major challenge still awaits those involved in macroprudential
oversight. I expect the implementation of macroprudential measures will require a high
degree of coordination, especially if European or international forums do not fully share the
conclusions and recommendations of national authorities.
Whatever challenges remain, I am certain that, through the institutional framework which we
have established, for instance, by setting up the ASF and our growing expertise in
macroprudential oversight and policy, we have laid a solid foundation for ensuring financial
stability in the future.
However, we must not forget that macroprudential oversight is only one aspect of
safeguarding financial stability.
Thank you for your attention.