manuel sanchez : understanding macroprudential instruments and their impact remarks by mr manuel sanchez, deputy governor of the bank of mexico, at the seminar “ financial stability : designing and implementing macroprudential policy ”, organized by central banking publications, windsor, united kingdom, 21 april 2015. * * * it is a pleasure to be with you in this prestigious forum devoted to the discussion of central banking issues. i would like to thank the organizers for their invitation to share my thoughts with you on one of today ’ s most stimulating topics in economics, the design and use of macroprudential instruments. i will start by discussing what is involved in defining and measuring macroprudential policies. then, i will briefly review the empirical evidence on the effectiveness of their implementation and pinpoint some possible unintended consequences and long - term risks. i will end by touching on mexico ’ s experience with prudential financial measures. as always, my remarks are entirely my own and do not necessarily reflect the views of the bank of mexico or its governing board. the measurement challenge macroprudential policies are at the forefront of current economic discussions. they encompass tools aimed at containing systemic risk and pursuing financial stability. in general, systemic risk refers to the possibility that the financial system experiences significant disruptions which may impair the functioning of the economy. the scope is the system as a whole, as opposed to microprudential tools which are directed at fortifying individual financial institutions. macroprudential instruments can be classified according to various criteria. a useful set is that presented by international financial organizations on the basis of what these mechanisms are meant to tackle. specifically, they can seek to curb excessive credit expansion, such as through time - varying capital requirements ; offset amplification of systemic risk, as in the case of limits on maturity mismatches ; and counteract structural vulnerabilities and spillovers of stress, such as with additional loss absorbency related to systemic importance. 1 an objective evaluation of effectiveness is essential for coherently implementing economic policies. in the case of macroprudential measures, this exercise should provide an assessment of how well the goals are being achieved, as well as an identification of possible unintended consequences and long - term risks. here the analyst faces several challenges, among which, three stand out. the first is conceptual, involving the absence of widely accepted, precise, and quantifiable definitions of systemic risk and financial stability. the obvious implication is that

was not acceptable. apart from the benefits of a multilateral netting scheme, we also needed a real time settlement system, for its superior characteristics in terms of risk control and simplicity, and because it would be very useful for our liquidity provision mechanisms. in order to perform simultaneously multilateral netting and settlement in near real time, banco de mexico developed and proposed a methodology based on mathematical models and operations research techniques. bis central bankers ’ speeches specifically, we created a linear programming model that linked a network flow problem for money with many network flow problems for securities. in other words, we proposed a model were money and securities constitute a flow through a network of participants. the solution we were looking for could be obtained by maximizing these flows quickly and applying the results immediately to the participants ’ balances. since there are specialized algorithms that solve linear programming problems very fast, we had, in principle, a method to choose a set of transactions with maximum value that could be settled with the available resources. this methodology, however, would, in some cases, settle transactions only partially – for example, instead of settling the 1, 000 cetes that were intended in a transaction, only 990 would be settled – a practice unheard at the time. we broke the mold when we realized that it was feasible to offer participants a simple choice : to operate on the basis of an efficient multilateral netting scheme that would partially settle some operations, or to operate on a gross basis. the intermediaries went for the most efficient solution. and so, thanks to the use of operations research techniques, a new methodology to settle securities in the mexican market was born. with this solution in hand, banco de mexico felt indeval had the capability to develop a system that would : 1. settle under a delivery versus payment scheme. that is, having an unbreakable link between the settlement of a securities transfer and the corresponding payment. 2. settle operations frequently. participants would be able to know, almost in real time, which transactions were settled. 3. make efficient use of the liquidity available for settlement, both in terms of securities and money. we knew from the models developed by banco de mexico that it was possible to implement a system with such characteristics and, more importantly, that this would yield a first class securities settlement system. after intensive analysis, testing and calibration, and with the valuable assistance of the instituto tecnologico autonomo de mexico ( itam ), indeval