Implementing the macroprudential approach to financial regulation and supervision.

Abstract

There is now a widespread recognition in the policy community of the need to strengthen the macroprudential orientation of financial regulatory and supervisory frameworks. At the same time, the usage of the term “macroprudential” remains ambiguous. This essay summarises the specific definition and characterisation of the term that was developed in the early 2000s at the BIS and outlines the policies needed for implementing the approach. The policies are discussed with reference to two dimensions of the approach. The first is the cross-sectional dimension and is concerned with how aggregate risk is distributed in the financial system at a given point in time. The policy issue here is how to calibrate prudential instruments so as to address common exposures across financial institutions and the contribution of each institution to system-wide tail risk. The second is the time dimension and is concerned with how aggregate risk evolves over time. The policy issue is how to dampen the inherent procyclicality of the financial system, seen as a key source of financial instability. The essay also briefly considers the implications of the adoption of a macroprudential approach for the institutional set-up.