How can we prevent another global crisis? It’s an important question. No-one wants a repetition of what we recently went through: the threat of total collapse of large financial institutions, prolonged unemployment, government bailouts, and the downturns in stock markets.
The International Monetary Fund has therefore designed a framework to help countries implement policies – best suited to their needs – that will help prevent a future crisis.
José Viñals, Financial Counsellor to the IMF’s Managing Director, said:
“This framework is the culmination of a multi-year policy development effort. It is a milestone for the IMF and its member countries because it will help them develop essential crisis-prevention tools.”
Countries should adopt effective macro-prudential policies and identify any risks to the financial system and immediately act to reduce such risk.
When a country’s economy is beginning to heat up, these policies allow the government to control excessive lending and then relax these policies in response to any adverse shocks.
Macroprudential regulation involves financial regulation aimed at mitigating the risks to the financial system as a whole.
Macroprudential policies include:
- Loan-to-value ratios and loan loss provisions
- Cap on debt-to-income ratio
- Cap on leverage
- Countercyclical capital requirement
- Levy on non-core liabilities
- Time-varying reserve requirement
- Liquidity coverage ratio
- Liquidity risk charges that penalize short-term funding
- Minimum haircut requirements on asset-backed securities (% of an asset used as collateral that is deducted from its market value)
The IMF urges institutions with a clearly defined mandate to manage these policies. Although the arrangements may vary according to country, central banks should play a key role in ensuring that these policies are upheld.
The main points the IMF stresses economies focus on are:
- Identify risks before they escalate
- Clearly define the goals of macroprudential policy at the national level
- Monetary and fiscal polices must complement macroprudential policies
- A range of tools, including broad-based capital buffers, more targeted “sectoral” tools such as loan-to-value limits, and liquidity-based tools may be necessary for the effective conduct of macroprudential policy.
- A combination of international standards, regional cooperation, and surveillance that encourages the appropriate policy action.
In conclusion the IMF “can play a key role, in collaboration with standard setters and country officials, to help ensure the effective use of macroprudential policy.”