In praise of the emerging-market regulatory model
Jun 14th 2011, 11:47 by A.M | LONDON
THE Brazilian Finance Minister Guido Mantega spoke for many emerging markets in April when he fumed against, “countries responsible for the deepest crisis since the Great Depression…eager to prescribe codes of conduct to the rest of the world”. Mr Mantega might be pleasantly surprised by a Bank of International Settlements paper on central banks and financial stability, which holds up emerging markets as a model for the developed world.
It turns out that the only governments to make central banks responsible for financial stability before the crisis were emerging markets. Emerging-market central banks were also far more likely than their developed world counterparts to use “macroprudential” instruments—the suite of tools including capital requirements for banks and systemic risk charges for key institutions, which the BIS now wants central banks worldwide to deploy.
The logic for central bank involvement is well established. The financial crisis showed that central banks are ultimately lenders of last resort to the financial system, and so should pay proper attention to its overall health. Moreover central banks’ primary policy mandate, monetary policy, has a strong influence on financial stability; think quantitative easing today, or the consistently low interest rates in America that encouraged a bubble in real estate prices in the 2000s.
The BIS wants all central banks to be given legal responsibility for financial stability, arguing that macroprudential regulation requires the same autonomy as monetary policy. On this count, the Bank of England’s interim Financial Policy Committee (FPC), which meets for the first time this week, comes in for praise.
Like the Bank’s Monetary Policy Committee, the FPC will be highly autonomous. The Chancellor of the Exchequer (Britain’s Finance Minister) will only provide a broad mandate. The FPC will publish regular surveys of financial stability, and it will have complete authority over macroprudential instruments. This is widely expected to include the power to vary bank-capital requirements over time, although one of the first tasks of the FPC will be to determine the tools most suited to macroprudential supervision. (The BIS report acknowledges there is still substantial disagreement among academics about which macroprudential tools work best, and what side effects they might have.)
Other developed world proposals do not accord central banks the same autonomy, authority and transparency as the FPC. BIS notes that the European Systemic Risk Board will not publicise its recommendations, nor will banks be statutorily required to implement them. In America the Financial Services Oversight Council will be chaired by the Treasury Secretary, rather than the Chair of the Fed Board of Governors.
However on one key issue the Bank of England’s FPC appears to fall short. The potential trade-offs between monetary policy and financial stability are not addressed. In an opinion piece today, the former Bank of England Monetary Policy Committee member Sushi Wadwhani has highlighted the dilemma.
For example, suppose we have an emerging house price bubble and the FPC increases capital requirements which, through widening lending margins, slow the economy, and this leads the MPC to expect inflation to undershoot the target over the next two years. Under the proposed structure, it is envisaged that the MPC would lower interest rates in order to keep inflation at target. If so, would this not largely offset the actions of the FPC and keep the house price boom going?
The BIS report concedes that the short-term interests of monetary policy and financial stability policy may occasionally diverge. Mr Wadwhani argues this means a single committee should be responsible for both monetary policy and financial stability. While BIS accepts that would facilitate coordination and force policy makers to confront the trade-offs at stake, it concludes that responsibility for the two policies can be separated, as long as it is clear which takes priority.
Here other countries fare better than Britain. Under the ECB’s two pillar monetary strategy, for example, financial stability is considered, but price stability is given explicit priority. Again an emerging market is held up as an example. In the Philippines the central bank is responsible for financial stability, including oversight of payment systems, but BIS applauds recent legislation to make this responsibility explicit and clearly secondary to monetary policy.
Britain appears to be relying on good communication to overcome potential conflicts between monetary and financial stability policy. The FPC will share many members with the monetary policy committee, including the Governor of the Bank of England and deputy Governors. Separating the two responsibilities also allows the two committees to bring in external members with relevant expertise—a labour-market economist sits on the monetary policy committee, whereas the FPC might benefit from a member with expert knowledge of, say, clearing and settlement.
For now though, the direction of travel is clearly towards legally defined responsibilities for financial stability and the centralisation of power within central banks. Unusually that points towards emerging market structures, rather than American or European ones.