Javier Guzmán Calafell: Challenges for macroprudential policy and the
Mexican case
Remarks by Mr Javier Guzmán Calafell, Deputy Governor of the Bank of Mexico, at the
panel on "Macroprudential policies for securing financial stability in a volatile external liquidity
environment", Fifth Summit Meeting of Central Banks on Inflation Targeting, Santiago de
Chile, 15-16 November 2013.
* * *
The views expressed in this document are strictly personal and do not necessarily coincide with those of Banco
de México.
I wish to start by thanking governor Vergara for his kind invitation to participate in this
interesting conference. I will focus my remarks on some of the challenges faced by
macroprudential policies at this stage, and on the Mexican experience with these
instruments, and more generally with policies aimed at preserving financial stability.
1. Challenges for macroprudential policy
Financial stability has been at the center of policy makers' attention during the last five years.
This is explained not only by the nature of the global financial crisis itself, but also by the side
effects of the measures that have been put in place to overcome it.
Indeed, the unconventional monetary policies that were set in motion to face the crisis have
allowed us to prevent a collapse of the world financial system and have rendered other
beneficial effects. Nevertheless, they have also given rise to a number of financial stability
risks for the world economy, deriving to a large extent from the potential consequences of a
prolonged period of extremely low interest rates in the advanced countries, and subsequently
from the return to more normal monetary policies and interest rates in these nations.
Initially, one of the main concerns in emerging markets were related to the strong capital
inflows to their economies fostered by these policies. More recently, with the expectation that
the Federal Reserve of the United States may begin to reduce its monetary stimulus, anxiety
has shifted to the implications of an increase in long-term interest rates in that country for
emerging economies' exchange rates, domestic financial markets, and access to external
financing. In any event, it is clear that the need to look for adequate instruments to preserve
financial stability has become imperative after the crisis.
One of the important lessons of the crisis is that price stability is a necessary but not a
sufficient condition for maintaining financial stability. Given the limitations that monetary
policy faces in this respect, there is overall agreement that it is indispensable to complement
available instruments with others which are more direct, and with a systemic perspective on
the financial system. Thus, macroprudential policy has gained growing importance at a global
level.
In very general terms, this policy has been identified with the use of prudential tools to
confront financial weaknesses of a systemic nature. Although no consensus exists with
respect to the precise meaning of the term macroprudential, a definition frequently used
considers the key elements of macroprudential policy to be: its objective of containing
systemic risk, its focus on the financial system as a whole, and the use of prudential tools
(and non-prudential tools as long as they are focused on systemic risk).1
The benefits of seeking financial stability through an approach that places greater emphasis
on the use of macroprudential tools are clear. However, until recently, the supporting
analytical work underpinning macroprudential policy was very limited. Over the last few
years, with the importance given to the subject as a result of the crisis, research on the
subject has grown rapidly.2
Recent literature has identified multiple challenges for the design and implementation of
macroprudential policy. Among them, I would like to emphasize the following:
First, it is necessary to have adequate measures of systemic risk. This concept has various
dimensions: 1) the time dimension, i.e., the amplification of risk over time through
interactions between the financial system and the real economy, or through pro-cyclical
factors of microprudential regulation; and 2) the transversal dimension, a result of common
risk exposures undertaken by financial institutions, or the contagion of problems in one of
them to the rest of the sector.3
In this context, part of the research has focused on the measurement of systemic risk on the
basis of estimates based on bank balances and other market indicators, early warning
indicators, vector autoregressive (VAR) models, and stress tests, among others.4 At the
same time, another line of research has focused on those institutions with systemic
importance due to their size or interconnectivity.5
Despite these efforts, currently there are no reliable and generally accepted measures of
systemic risk. The absence of precise and complete indicators to evaluate risk is not
exclusive to the macroprudential arena. However, for the aforementioned reasons, the
problem is particularly acute in this case. In other words, the margin for error is high.
Second, the theoretical foundation for macroprudential policy is at an incipient stage and still
far from being able to provide the bases required to design integrated policy frameworks in
this area. I am referring specifically to the need for a better understanding of the relationship
of the financial system with the macro-economy, and to the importance of devising models
that capture this relationship adequately.
Until recently, most macroeconomic and monetary models did not explicitly consider the
financial system. Various research efforts after the crisis have been oriented toward filling
this gap. Thus, for example, financial frictions have been incorporated in DSGE models, the
role of bank capital has been studied in monetary policy transmission mechanisms,
macroeconomic factors have been incorporated in detailed models of financial intermediation
cycles, and the theoretical and empirical aspects of the so-called risk channel of monetary
policy have been analyzed (i.e., the mechanisms through which monetary policy decisions
can affect the perception of or tolerance to risk).
However, generally accepted theoretical models for the implementation of macroprudential
policy do not exist. Therefore, the evaluation of the possible role of these instruments in the
containment of systemic risk, as well as the possible costs involved, is much more complex.
Thus, the basis for a deep evaluation of the effectiveness of macroprudential policy is still
weak.6
Furthermore, in addition to the areas pointed out in the preceding paragraphs, there are
numerous other factors on which greater analytical work is required. These include the
interactions between distinct macroprudential policies, better indicators for the
implementation of these policies, the definition of the right moment to activate or discontinue
the corresponding instruments, mechanisms for preventing evasion risks, and appropriate
communication policies, among others.
Third, there are interactions between macroprudential policy and other policies that should
be carefully taken into account and which, to date, have not been sufficiently analyzed. This
is in virtue of the fact that the use of one of these instruments can enter into conflict with, or
amplify the effects of, other policy instruments. The most obvious interaction is with monetary
policy.
In general, it is to be expected that monetary and macroprudential policies work in a
complementary way toward the achievement of their objectives, and thus mutually
strengthen one another.7 However, the possibility of conflict exists. Thus, for example,
evidence shows that loose monetary policy can fuel risk taking and excessive leverage,
accentuating financial system fragility. On the other hand, the introduction of
macroprudendial measures can affect domestic demand in a direction different from that
sought by monetary policy.
Thus, mechanisms are needed which permit adequate coordination between monetary and
macroprudential policies. In this context, there is growing acceptance of the idea that
monetary policy should preserve as its primary objective the control over inflation, and
macroprudential policy should adopt a role of greater importance in the alleviation of
procyclical and transversal risks in the financial system.8 On the other hand, it is important to
emphasize that macroprudential policy also interacts with other policies (among them, fiscal,
microprudential, crisis management and resolution, and competition policies) and that the
corresponding implications should be taken into account.9
Fourth, empirical evidence on the effectiveness of macroprudential tools is scarce. This is
understandable, given the fact that recognition of the important role that macroprudential
policy can play in financial stability surfaced only recently, and given the great variety of
measures that have been called macroprudential, which makes it hard to compile,
homogenize and evaluate the information. Furthermore, the simultaneity with which different
macroprudential policies are in some cases applied makes it difficult to isolate the specific
effect of a given policy.
The importance of evaluating concrete results is clear, since the effectiveness of
macroprudential policies is not assured, in addition to the fact that these tools can have costs
or generate distortions. For example, loan-value relationships limit credit risk, but under
certain circumstances they can reduce the efficiency of the market in allocating resources, by
introducing incentives in favor of, or to the detriment of, a certain sector. In a similar way,
dynamic provisioning can overreact to information or premature trends and become a heavy
burden for financial institutions.
Despite the difficulties faced, there have been important efforts aimed at identifying the
conditions under which macroprudential policies are likely to be effective in mitigating
systemic risk.10 Most post-crisis studies in this regard have focused on the costs and benefits
of these tools from a long-term perspective.11 More recently, a conceptual framework has
been developed to analyze, in addition to the expected costs and benefits, the unintended
consequences of the application of these measures.12 Logically, this is work in progress, and
it is still necessary to refine the models as well as the empirical evidence used.
Fifth, it is indispensable to establish adequate institutional arrangements for the design and
implementation of macroprudential policies. In general, such institutional arrangements
should be effective, in the sense that they enable the corresponding authorities to take
preventive action, in a timely and coordinated fashion. Nonetheless, I would like to
emphasize that there is no one recipe that works in all cases. In reality, the selection of an
adequate arrangement depends on the specific characteristics of each country, including its
legal and political context.
Given the above, more than the details of the institutional arrangement, I would emphasize
some of the principles which, from my point of view, are essential for the adequate
functioning of these kinds of arrangements.
a) The agencies responsible for macroprudential policy should be given an adequate
mandate for complying with this responsibility.
b) The authorities with this duty should have the information and analytical capability
needed to quickly identify when systemic risks surface, and the required tools to
face them.
c) The decision-making process should be transparent and isolated from political or
interest groups pressures.
d) Adequate accountability mechanisms should exist, including among others strict
requirements for the supply of information to the public.
It is widely accepted that central banks should play a very important role in these efforts,
given their deep analytical and operational experience in macroeconomic and financial
subjects, the tight relationship between monetary and macroprudential policies, and the
responsibility these institutions have as lenders of last resort.13 In addition, the empirical
evidence shows that there is a negative relationship between the response time of
macroprudential policy to developments challenging financial stability, and the involvement of
the central bank in institutional arrangements for these policies.14
As can be seen, despite the considerable increase in research on macroprudential policy, an
enormous effort is still needed to develop adequate foundations for the design and
implementation of these policies. Overcoming these challenges is very important given the
10
See, for instance: Lim et al., "Macroprudential Policy: What Instruments and How to Use Them?",
IMF Working Paper 11/238. October 2011.
11
See, for example, the Basel Committee on Banking Supervision, "An Assessment of the Long Term Economic
Impact of Stronger Capital and Liquidity Requirements," 2010.
12
See Nicolas Arregui et al., "Evaluating the Net Benefits of Macroprudential Policy: A Cookbook", IMF Working
Paper WP/13/167, July 2013.
13
See Committee on the Global Financial System, "Operationalizing the Selection and Application of
Macroprudential Instruments," CGFS Papers, No. 48, Bank for International Settlements, December 2012; and
Erlend W. Nier et al., "Institutional Models for Macroprudential Policy," IMF Staff Discussion Note,
November 1, 2011.
14
See Cheng Hoon Lim et al., "The Macroprudential Framework: Policy Responsiveness and Institutional
Arrangements." IMF Working Paper, WP/13/166, July 2013.
current circumstances, since what is under consideration is not only the possibility of a more
generalized use of macroprudential policy, but also assigning it a role of much greater
importance in the attainment of financial stability both at the domestic and global levels.
Mexico ́s recent experience with macroprudential policies and financial stability might help to
add some clarity to the issues that surround the use of these instruments.
2. The Mexican case
As in many other countries, the bankruptcy of Lehman Brothers and its repercussions at a
global level represented a big challenge for financial stability in Mexico. Suffice to say that
GDP fell by 4.7 percent in 2009; the exchange rate depreciated more than 50 percent from
early August 2008 to early March 2009; long-term government interest rates spiked (at the
moment of greatest pressure rising almost 400 basis points) and remained high with respect
to the monetary policy target; rates on corporate bonds rose almost 240 basis points above
the reference rate, and country risk as measured by the EMBI increased by more than 600
basis points.
Despite the magnitude of these shocks, and the fact that the crisis gave rise to substantial
losses for various financial entities in advanced economies that are parent banks of Mexican
banks, the financial system showed great resilience, mainly as a result of a combination of
macroeconomic, microprudential and macroprudential policies.
To start with, the implementation of prudent monetary and fiscal policies, combined with a
flexible exchange-rate regime and high levels of international reserves, strengthened the
nation's economic fundamentals considerably.
These efforts were complemented with a number of microprudential policies undertaken in
the aftermath of the 1995 crisis to improve the legal framework and the regulatory and
financial supervisory processes. This allowed Mexico to have an efficient and modern
payments system, with profitable and well-capitalized financial intermediaries, and deep
financial markets. It is worth to point out in this respect that in August 2008, a few days
before Lehman ́s bankruptcy, the Mexican banking system had a capitalization ratio of
15 percent, a non-performing loan ratio of 3 percent, and a loan-loss reserve ratio of
156 percent.
Furthermore, Mexican legislation requires financial institutions offering services in Mexico to
operate through subsidiaries, so that even if foreign entities have a participation in them, they
are separate legal entities and have their own capital. In addition to lowering the risks of
direct contagion between the parent bank and the entity established in Mexico, all banks in
the country are required by law to the same rules and supervisory processes regardless of
the nationality or other characteristics of shareholders. This is particularly important in
Mexico, since a little more than 70 percent of assets in the banking systems are owned by
foreign institutions.
The above was reinforced by modest Mexican banks direct exposure to assets linked to the
U.S. mortgage market and to the euro zone, and by the fact that retail deposits in the
domestic market are the main source of financing for Mexican banks. This allowed the
financial system to respond more flexibly to liquidity problems in international markets.
Macroprudential policies implemented before and in response to the crisis contributed to
maintaining a solid financial system in this difficult period. I would highlight in particular six
measures in this connection:
a. Regulations for banks' foreign-currency operations (structural and short-term
liquidity and exchange rate risk positions), which allow banks not to be exposed to a
structural imbalance due to funding long-term foreign-currency assets with
shortterm liabilities, insufficient liquid assets to face short-term obligations, and an
imbalance between assets and liabilities in the face of significant foreign-exchange
moves. Together, these rules limited structural currency gaps and kept abrupt
foreign exchange movements in 2008-09 from having an effect on the banking
system through this channel.
b. The establishment of a cap on exposure to related counterparties. In 2011, the rules
on capital were changed with the aim of requiring banks to limit exposure to
25 percent of capital. The key aim of these measures was to prevent possible
contagion of problems from related counterparties, including difficulties in foreign
parent banks passed to subsidiaries, which is of great importance to Mexico given
the proportion of assets held by foreign banks.
c. In October 2012, Banco de México established the requirement to seek
authorization from the central bank to make transfers of assets and implement other
operations among banks operating in Mexico and related counterparties, when in
one year these operations exceed 25 percent of Tier-1 capital. The objective is to
ensure that these operations are carried out under market conditions.
d. Caps on interbank exposures, including among other instruments net positions in
derivatives and repurchase agreements. The financing cap among banks is
equivalent to one time the Tier-1 capital of the lending institution. This rule has
reduced the risk of interbank contagion.
e. Higher limits on value at risk (VaR) for pension fund portfolios at times of high
volatility. When a pension fund reaches its risk limit according to the VaR, it is
required to unwind positions to reduce risk. During 2009-2010, taking into account
the magnitude of the financial crisis, the size of these funds ́ positions, and the effect
that a massive sale of assets would have had at a time of great turmoil, funds were
allowed to surpass the VaR limits. This prevented a precipitous re-composition of
portfolios which would have triggered a vicious circle.
f. The constitution of loan provisions as a function of expected rather than actual
losses, for revolving consumer loans starting in 2009 and for mortgage portfolios,
non-revolving consumer loans, and loans to federal and municipal entities since
2011.15
In addition, the corresponding methodologies for commercial portfolios were
published in June 2013. This allows the constitution of loan provisions in a gradual
way and not at the moment losses materialize.
Despite the resilience shown by the Mexican financial system to the effects of the global
crisis, the crisis highlighted the need to continuously evaluate possible sources of risk that
could affect the functioning of the financial system as a whole, as well as the real sector. In
this context, other macroprudential measures, among them counter-cyclical capital
requirements and regulatory requirements for systemically important financial institutions, are
under consideration. At the same time, the crisis demonstrated the importance of
establishing mechanisms for coordination among different authorities with the aim of
preventing or facing this type of crises.
Thus, in mid-2009 the authorities decided to create the Financial System Stability Council
(CESF). This is an entity of evaluation, analysis, and coordination among financial
authorities, oriented toward identifying risks to financial stability and proposing preventive
policies or, should those risks materialize, minimize their impact. The Council is not a
decision-making body, but rather a forum for cooperation and recommendation of courses of
action, in which each participating authority is committed to promoting, in the context of its
faculties and subject to the laws that govern it, the implementation of the recommendations
formulated in accordance with the applicable laws.
The Council is comprised of the Finance Ministry, the Central Bank, the National Banking
and Securities Commission (CNBV), the Insurance and Surety National Commission
(CNSF), the National Commission for Retirement Savings (CONSAR), and the Bank Savings
Protection Institute (IPAB).
The Council complies with, or is oriented toward complying with, the four principles I
mentioned that are essential for these kinds of arrangements to work: the CESF has a clear
mandate for performing its duties in this area, specified in the statutes of each of the
institutions that comprise it and in its own statutes; the CESF works in a transparent way and
with complete respect for the responsibilities and, if applicable, autonomy of the institutions
involved; and the CESF operates on the basis of a mechanism of accountability, based
mainly on periodic reports to the general public. Finally, the composition of the Council has
served as a basis for underpinning the availability of information and the analytical foundation
for evaluating the risks that could affect the financial system as a whole, as well as the
instruments needed for facing them, although much remains to be done in this respect.
Given the importance of this entity, the Executive has requested Congress to approve its
incorporation into law.
4. Conclusion
One of the main lessons from the global economic crisis is that financial stability requires a
new policy approach in which two features are particularly noteworthy: 1. macroprudential
policy is likely to adopt a more important role than before; and 2. the achievement of financial
stability requires simultaneous and coordinated efforts at the macroeconomic,
microprudential and macroprudential levels.
Although macroprudential policy is not a new concept, the issue at this stage is radically
different from the experience of previous years, both in reach and relevance. In particular,
the focus today is on the potential for a generalized use of these instruments at a global level
and for a greater responsibility in the achievement of financial stability. The problem is that
despite an explosion of research in this area, we still find ourselves with many gaps from
theoretical and empirical standpoints.
A number of measures need to be implemented at the domestic and international levels if
these challenges are to be overcome. This comprises research, more and better statistics,
building the appropriate analytical capacity, and adjusting national institutional frameworks as
needed, among other measures. Furthermore, in view of the implications of financial
globalization for contagion and regulatory arbitrage, cooperation from the international
community is of the essence.
It is also important to emphasize that expectations on the role of macroprudential policies in
financial stability must be kept within realistic boundaries. While it is true that these
instruments may have many possible advantages, we should not lose sight of the limitations
that we still face. With more experience, additional empirical evidence and a better analytical
foundation, we will be in a better position to evaluate their real potential.