vitor constancio : margins and haircuts as a macroprudential tool remarks by mr vitor constancio, vice - president of the european central bank, at the esrb conference on macroprudential margins and haircuts, frankfurt am main, 6 june 2016. * * * the footnotes can be found at the end of the speech. ladies and gentlemen, it is a pleasure to speak here today at the esrb conference on macroprudential margins and haircuts. in my view, macroprudential margins and haircuts have the potential to become tools for controlling the build - up of excessive leverage in the financial system. importantly, these tools would reach beyond the banking system and also address the build - up of leverage and liquidity risks in parts of the financial system, where we have seen rapid growth in recent years. before i elaborate further on the specific need for macroprudential margins and haircuts, possible tools and how to implement them, allow me to set a more general stage for the important discussions we will be having and briefly touch upon a key lesson from the history of financial crises. in recent years, convincing evidence has been provided showing that excessive leverage, credit booms and subsequent de - leveraging episodes were at the heart of recurrent episodes of financial instability since the late 19th century. [ 1 ] let me single out two major crises where the build - up of leverage and the subsequent de - leveraging played a key role. first, the stock market bubble of 1927 – 1929 and the subsequent “ great crash ” of 1929 were accompanied by an extraordinary growth followed by contraction of leveraged trading in stock markets, amplified by margin calls. [ 2 ] the ensuing great depression brought real, severe economic consequences. while there is still debate on its ultimate causes, the great crash is widely considered as a major factor. notably, the great crash motivated the establishment of the so - called “ regulation t ” which allowed the federal reserve board to set minimum margins for partially loan - financed transactions of stocks. and from 1947 until 1974, the federal reserve board frequently changed these minimum margin requirements. the evidence on the success of this macroprudential tool in curbing excessive credit in securities transactions and stock market volatility is at best mixed. [ 3 ] importantly, however, the limited scope of regulation t – which allowed investors to avoid its impact by substituting other forms of borrowing for margin loans – has been identified as

cleared and non - bis central bankers ’ speeches centrally cleared transactions. this is a key result from the calibrated general equilibrium model which shows that regulation with limited coverage is doomed to be ineffective due to leakages. notably, the potential for regulatory arbitrage in case of tools that only target specific markets is a central issue in macroprudential policy more generally. moreover, as i already noted, research shows that the fact that the federal reserve board had the limited power to only set time - varying margins on listed equities bought on margin, was an important reason for the limited effectiveness of regulation t in the decades after the great crash of 1929. the second key result is that setting minimum margins and haircut floors – on a broad scale – would limit the build - up of leverage and reduce the procyclicality of current margin and haircut setting practices. with minimum margins and haircuts, the same minimum quantitative requirements would apply over the financial cycle. basically, such a minimum floor assures conservative margins and haircuts, and would have prevented the very low baseline margin and haircut levels that we have seen before the global financial crisis. importantly, introducing minimum floors can also limit the need for market participants to raise margins and haircuts in a downturn, since the initial margin and haircut levels are already higher when the cycle turns. third, and finally, both the theoretical and empirical results suggest that allowing competent authorities to add time - varying add - ons on top of minimum margin and haircut requirements could have the potential to increase welfare even more than a minimum floor would. overall, the theoretical and empirical findings in the special feature support intervention powers for macroprudential authorities. taken together, the key message is that only a comprehensive regulation of margins and haircuts applied on several different types of securities or transactions can reduce the build - up of leverage and asset market volatility in an economically meaningful way. in practice, i envisage minimum margins and haircut floors on both centrally cleared and noncleared derivatives and sfts as an essential reform to enhance the resilience of the financial system. let me now step away from these analytical underpinnings and conclude with some thoughts on how to design and implement such macroprudential tools in practice, and the challenges we face. how to design and implement a macroprudential framework for margins and haircuts the existing evidence and experience in previous crises in my view presents