Effectiveness and channels of macroprudential policies: lessons from the Euro area

Author:Yuanyan Zhang, Thierry Tressel
Position:European Department, International Monetary Fund, Washington, District of Columbia, USA
Pages:271-306
SUMMARY

Purpose The design of a macro-prudential framework and its interaction with monetary policy has been at the forefront of the policy agenda since the global financial crisis. However, most advanced economies (AEs) have little experience using macroprudential policies. As a result, relatively little is known empirically about macroprudential instruments’ effectiveness in mitigating systemic ... (see full summary)

 
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Effectiveness and channels of
macroprudential policies: lessons
from the Euro area
Yuanyan Zhang and Thierry Tressel
European Department, International Monetary Fund, Washington,
District of Columbia, USA
Abstract
Purpose The design of a macro-prudential framework and its interaction with monetary policy has been
at the forefront of the policy agenda since the global nancial crisis. However, most advanced economies (AEs)
have little experience using macroprudential policies. As a result, relatively little is known empirically about
macroprudential instruments’ effectiveness in mitigating systemic risks in these countries, about their
channels of transmission, and about how these instruments would interact with monetary policy. This paper
aims to ll in the gap.
Design/methodology/approach The authors develop a new approach using the euro area bank
lending survey to assess the effectiveness of macro-prudential policies in containing credit growth and house
price appreciation in mortgage markets. Estimation is performed under the panel regressions (OLS, GLS) and
panel VAR setup. Endogeneity issues arising from measures of macro-prudential policies are addressed by
introducing GMM estimation and various instruments.
Findings The authors nd instruments targeting the cost of bank capital most effective in slowing down
mortgage credit growth, and that the impact is transmitted mainly through price margins, the same banking
channel as monetary policy. Limits on loan-to-value ratios are also effective, especially when monetary policy
is excessively loose.
Originality/value With limited data on macroprudential policy measures in the AEs, this paper
proposed a new methodology of using answers from bank lending survey as proxies to assess the
effectiveness of specic macroprudential measures and their transmission channels.
Keywords
Paper type Research paper
1. Introduction
The design of a macro-prudential framework and its interaction with monetary policy has
been at the forefront of the policy agenda since the global nancial crisis (IMF, 2011,2013;
ESRB, 2013;Borio, 2011). However, most advanced economies (AEs) have little experience
using macro-prudential policies, while there is, by contrast, more evidence about
macro-prudential instruments aimed at moderating the volatility of capital ows in
emerging markets (Cerutti et al., 2015). As a result, relatively little is known empirically
about macro-prudential instruments’ effectiveness in mitigating systemic risks in these
countries, about their channels of transmission, and about how these instruments would
interact with monetary policy. Many countries publish bank lending surveys (BLSs) that
provide very useful information on how banks modify the price and non-price terms of loans
to the private sector, and on the drivers of these lending conditions. Some of the terms of
loans [such as actual loan-to-value ratios (LTVs)] or some of the drivers of the lending
standards (such as the cost of bank capital or the liquidity position of a bank) are directly
JEL classication – E32, E4, E5, G01, G21
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Lessons from
the Euro area
271
Journalof Financial Regulation
andCompliance
Vol.25 No. 3, 2017
pp.271-306
©Emerald Publishing Limited
1358-1988
DOI 10.1108/JFRC-10-2016-0094
related to macro-prudential instruments considered to be key in the policy toolkit of many
jurisdictions (BCBS, 2011;ESRB, 2013). In this paper, we make use of the European Central
BLS to develop a methodology and estimate empirically the likely effectiveness of some of
these macro-prudential policies, their channel of transmissions and their interactions with
monetary policy.
There is thus far limited knowledge about how (policy driven) changes in the cost of bank
capital (which could be the result of the implementation of a countercyclical capital buffer, of
time contingent or sectoral risk weights, or more generally of bank specic changes in the
capital adequacy ratio) or in the bank liquidity position would be transmitted to credit
supply. Specically, would such policy actions be transmitted through non-price factors
(such as LTVs, collateral requirements or maturity) or through price factors (such as price
margins or fees)? There is also relatively little knowledge about whether limits on LTVs
could signicantly slow down house price appreciation and/or mortgage loan growth in AEs.
Should measures affecting capitalization be complemented by non-price measures
constraining lending standards? Can some of these macro-prudential policies be effective
during housing booms when traditional monetary policy is typically too loose? Assessing
such interactions and the transmission channel of macro-prudential instruments, with a
specic focus on the real estate market, is important, as shocks to the real estate market have
been a key source of systemic risk during the recent nancial crisis.
The euro-system BLS contains information on overall changes in lending standards, or
net tightening of lending standards and changes in lending standards related to non-price
factors (LTVs, collateral requirements, maturity), price factors (such as margins) and factors
contributing to the changes in lending standards, including balance sheet characteristics
(such as capital and liquidity ratios) which can be mapped to specic macroprudential
targets set by national regulators. However, identication of the impact of macro-prudential
policies requires addressing specic challenges. The BLS does not require banks to specify
the exact nature of the shocks that cause a change in lending standards or in the cost of
capital, even though it provides information on perceptions of risks, economic activity and
competition pressures, and their contribution to the change. Hence, our approach is
potentially subject to omitted variable bias, reverse causality and measurement bias (as
expectations about house prices and credit growth may be mis-measured). Moreover, our
observable variables (lending standard, and the contribution of balance sheet factors to
lending standard) are not policy variables, which in our case are unobserved shocks affecting
our observables. To address these issues, we develop methodologies relying upon
instrumental variables and GMM estimators; our study also includes various control
variables such as growth prospects, nancial conditions, perception of risks and monetary
policy cycle. Still, a potential advantage of our approach is that we would be able to capture
the impact of the announcement of macro-prudential measures on lending standards, even
before the actual implementation of the policy.
Our main ndings are the following. First, our estimates suggest that measures that
increase the cost of bank capital are effective in slowing down credit growth and house price
appreciation. Second, changes in LTV also impact credit growth and house price
appreciation but their impact tends to be less signicant. Third, macro-prudential policies
affecting the cost of capital are transmitted mainly through price margins, with very little
impact on LTV ratios or other non-price characteristics of mortgage loans. The evidence also
suggests that tightening of LTVs is more effective in slowing down credit growth and house
price appreciation when monetary policy is too loose and it complements capital-related
measures. We also nd that our main results are consistent across the different
methodologies we implement, in particular the ndings that changes in the cost of capital are
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transmitted to mortgage loan growth, and the nding on the interaction between monetary
policy and changes in LTVs.
These ndings have the following policy implications. First, monetary policy and
macro-prudential policies related to bank capital are likely to be transmitted through the
same channels in the banking system, as they both affect the cost of loans. So, they should be
expected to reinforce each other. Second, capital buffers or liquidity ratios targeting specic
sectoral exposures are likely to be effective in slowing down credit growth in the mortgage
market. Third, macro-prudential instruments affecting the cost of capital or the liquidity
position could usefully be complemented by instruments related to non-price dimensions of
mortgage loans such as limits on LTVs.
2. Literature
Since the global nancial crisis, a fast-growing literature has studied theoretically and
empirically the role of macroprudential policies in mitigating volatility in nancial markets.
Indeed, the macroprudential approach has come to play a visible role in policy discussions
only very recently, as nancial stability has been seen as an independent policy objective and
policy-makers have aimed at pinning down the denition of nancial stability and the design
and goals of macroprudential policies. However, we lack a thorough understanding and
established models of the interaction between the nancial system and the macroeconomy
(Galati and Moessner, 2011).
Our paper is related to several strands of the literature. First, our paper is related to
several papers that explore how monetary policy affect bank lending standards. Notably,
using the same lending survey, Maddaloni and Peydro (2013) study the impact on lending
standards of monetary policy rates and macro-prudential policy in euro area countries. In
contrast to their paper, we identify how shocks affecting the balance sheet of banks affect
price and non-price dimensions of lending standards while they focus on the specic impact
of shocks to a Taylor rule. This allows us to a priori identify the transmission channels of any
policies that affect bank capital or the liquidity position. Moreover, in contrast to their paper,
we study how lending standards and shocks to bank balance sheets affect mortgage loans
growth and house price appreciation. Second, our paper is related to papers that estimate the
impact of changes in capital requirements or limits on LTVs on credit growth. For example,
using bank-specic and time-varying capital requirements imposed by the regulator, Aiyar
et al. (2012) show that capital measures have a signicant impact on credit growth in the UK.
Third, our paper is also related to the theoretical literature that quanties the optimality and
effectiveness of macro-prudential instruments (see for instance, in the case of the euro area,
Quint and Rabanal (2013)). Last, our paper is relevant to the emerging literature that
identies the risk-taking channels of monetary policy (Dell’Ariccia et al., 2013).
Recently, an increasing number of theoretical papers have attempted to capture the
macro-nancial linkages by incorporating nancial intermediaries and housing sector in
DSGE models. This approach allows testing the effectiveness of macro-prudential policies
and their interaction with monetary policy. The link between nancial sector and the
macroeconomy is typically modeled by the spread between bank lending rate over the
deposit rate which is a function of borrowers’ net worth, following Bernanke et al. (1998) and
Aoki et al. (2004) which allows to study the impact of macro-prudential policies (Angelini
et al., 2011;Lambertini et al., 2011;Beau et al., 2012;Quint and Rabanal, 2013; and Kannan
et al., 2009). For example, Angelini et al. (2011) model two macro-prudential instruments: a
countercyclical capital requirement, and a LTV ratio. The former has an immediate impact
only on the lending rate. The later affects the stringency of the borrowing constraint – as the
collateral constraint tightens, borrower’s ability to nance consumption and housing
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Lessons from
the Euro area

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