Preventive macroprudential policy

This piece discusses the framework for macroprudential policy in concrete terms. It raises three points. It makes a strong case for preventive tools over ex-post intervention, seeking to complement the Basel III individual buffer approach by targeting risk externalities. Next, it discusses a ladder of enforcement tools for fixed prudential standards, and possible new tools, which are more flexible. To avoid forbearance, we suggest prioritizing a timely use of low adjustment cost instruments. These can be escalated or toned down as required to nudge intermediaries towards capital and stable funding norms. We suggest combining flexible instruments with robust medium term standards, to minimize resistance to adjustment along the credit cycle, while ensuring a rapid effect on risk incentives. Flexible tools can thus help maintain the commitment to robust standards, while allowing fine tuning of the transition according to market conditions. Finally, borrowing from organization theory, this paper argues for a contingent governance framework for macroprudential councils that assigns pre-eminence to different authorities depending on the specific emergency. Specifically, we argue for: assigning to microprudential regulators' tools for the implementation of liquidity and capital ratios; to macroprudential authorities within central banks tools for aggregate liquidity risk management, including charges for unstable funding; and to fiscal authorities overall control once capital support requires fiscal means.