The contribution of macroprudential policies to banks' resilience: Lessons from the systemic crises and the COVID‐19 pandemic shock

• Published date: 01 December 2023
• Author: Tiago F. A. Matos,João C. A. Teixeira,Tiago M. Dutra
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/irfi.12424

ORIGINAL ARTICLE

The contribution of macroprudential policies to

banks' resilience: Lessons from the systemic crises

and the COVID-19 pandemic shock

Tiago F. A. Matos

1

|Jo

˜

ao C. A. Teixeira

1,2

| Tiago M. Dutra

1,3

1

School of Business and Economics,

University of the Azores, Ponta Delgada,

Portugal

2

Centre of Applied Economics Studies of the

Atlantic (CEEAplA), Ponta Delgada, Portugal

3

Business Research Unit (BRU-IUL), Avenida

das Forças Armadas, Lisbon, Portugal

Correspondence

Jo˜ao C. A. Teixeira, School of Business and

Economics, University of the Azores, Rua da

M˜ae de Deus, s/n, 9501-801 Ponta Delgada,

Portugal.

Email: joao.ca.teixeira@uac.pt

Funding information

Direç˜ao Regional da Ciência e Tecnologia,

Grant/Award Number: 2022 APOIO A

FUNCIONAMENTO-CEEAPLA-A; Fundaç˜ao

para a Ciência e a Tecnologia, Grant/Award

Number: project number UIDB/00685/2020

Abstract

This study examines the effectiveness of macroprudential

policies in reducingthe banks' risk during the COVID-19 pan-

demic and compares these results with the systemic banking

crises years. Basedon a sample of 624 banks across 40 coun-

tries during the period 2006–2020, we find that loosening

capital-aimed macroprudential policies effectively reduced

banks' risk during the COVID-19 pandemic, while thisbehav-

ior led to increased risk during the systemic crises years. In

contrast, tightening the remaining macroprudential policies

during the systemic crises years and during the pandemic

proved effective in reducing banks' risk. Furthermore, we

show that the magnitude of the impact of macroprudential

policies was stronger during the systemic crisis than that dur-

ing the pandemic.Finally, we show that the results are driven

by the capital requirement prudential policy, both during the

systemic crisis and the COVID-19 pandemic, although the

conservation bufferand the leverage limit also contributes to

the ineffectiveness of these policies during the COVID-19

pandemic. The banks' leverage and loan growth also play an

enhancing role of the effects of the macroprudentialpolicies.

KEYWORDS

banks' risk, COVID-19, macroprudential policies, systemic crisis

JEL CLASSIFICATION

I1, G01, G21, G28

Received: 18 October 2022 Revised: 29 April 2023 Accepted: 27 June 2023

DOI: 10.1111/irfi.12424

© 2023 International Review of Finance Ltd.

794 International Review of Finance. 2023;23:794–830.

wileyonlinelibrary.com/journal/irfi

1|INTRODUCTION

The post-great financial crisis (GFC) agenda prompted central banks worldwide to implement a macroprudential

framework to safeguard the stability of the global financial system during distress periods (Ampudia et al., 2021;

BIS, 2021; Borri & Giorgio, 2022).

The use of macroprudential tools has increased globally, prompting a rapidly growing body of literature to ana-

lyze the impact of these policies on credit growth (Bonfim & Costa, 2017; Fendo

glu, 2017; Ghosh, 2015; Schryder &

Opitz, 2021), the housing market (Andries¸ et al., 2021; Carreras et al., 2018; Igan & Kang, 2011; Poghsoyan, 2020;

Vandenbussche et al., 2015; Zhang & Zoli, 2016), the banking sector risks (Altunbas et al., 2018; Blundell-Wignall &

Roulet, 2013; Gaganis et al., 2020; Ghosh, 2014; Laeven & Levine, 2009; Lim et al., 2011; Matos et al., 2022;

Meuleman & Vennet, 2020; Nit¸oi et al., 2019), among others factors. However, as the incidence of recessions in the

post-GFC era have been limited, broader adoption of these tools makes it a challenge to evaluate actual

effectiveness.

The COVID-19 was declared a pandemic at a time when the global economy was already showing signs of a

slowdown (Boissay & Rungcharoenkitkul, 2020; International Monetary Fund (IMF), 2020; Miklaszewska

et al., 2021), thus this unique crisis is the first event that is negatively affecting the global economy, providing the

perfect opportunity to assess if the macroprudential framework implemented post-GFC was adequate to protect the

financial system.

In this study, we analyze if the macroprudential regulatory framework, more precisely capital-aimed policies, alle-

viated banks' risk-taking behavior during the COVID-19 pandemic. Using a sample of 624 banks across a set of 40

countries during the 2006–2020 period, we find that loosening capital-aimed macroprudential policies effectively

reduced banks' risk during the pandemic.

We extend our analysis b y comparing two distin ct crises situations , namely the GFC, common ly denoted as

the systemic crisis that originated in the US housing market and spread worldwide due to linkages in the global

banking system (All en & Gu, 2018;Ramskogler,2015), an d the recent COVID-1 9 pandemic that trigg ered a

humanitarian health crisis. We show that while loosening capital-aimed macroprudential policies during the pan-

demic proved effective, the same loosening would likely translate into greater risk-taking during the years of the

systemic crisis. Con versely, successive t ightening events on othe r macroprudential pol icies were effective du ring

the systemic financ ial crises and the COVID-19 pandemic. Mo reover, we show that macroprudential p olicies have

a significant negat ive effect, that is, a greater magnitude on b anks' risk during the systemic crises year s than nor-

mal times or a pandemic. F urthermore, we show tha t the results are driven b y the capital requirem ent prudential

policy, both during the systemic crisis and the COVID-19 pandemic, albeit the conservation buffer and the lever-

age limit also contribute to the ineffectiveness of capital-aimed macroprudential policies during the COVID-19

pandemic. Finally, we demonstrate that the banks' leverage and loan growth play an enhancing role of the effects

of the macroprudential policies.

Our study's contribution to the literature is multifold. First, our study relates and contributes to two strands of

the literature. The first strand comprises studies on the effectiveness of macroprudential policies, and the second

analyzes why some banks perform better than others during periods of distress. To the best of our knowledge, this is

the first study that examines how macroprudential policies affect banks' risk during an actual negative event—more

precisely, the COVID-19 pandemic. Second, we examine this relationship further and compare how the implications

of macroprudential policies may differ during the GFC and the COVID-19 pandemic to assess if the origin of the cri-

sis also plays an important role and should be considered when implementing such policies. Although Igan et al.

(2022) analyze the impact of macroprudential policies adopted prior to the COVID-19 pandemic in alleviating banks'

risk, they do so only by analyzing this isolated event. We extend this analysis by using a more robust dependent vari-

able that measures not only the market risk but also the idiosyncratic risk, and by comparing two different crises to

see if these results endure during the systemic crisis period. Finally, this study contributes toward a better under-

standing of how policymakers can help mitigate the economic impact of a humanitarian health crisis in the future.

MATOS ET AL.795

Our study, therefore, should be of interest to a broad audience of policymakers, politicians, and scholars as it

uses the pandemic as an opportunity to assess how macroprudential policies can be used to increase banks' resil-

ience and, ultimately, strengthen the global financial system, thus providing a perfect opportunity to calibrate this

toolset for future events.

The remainder of this paper is organized as follows. Section 2provides a brief review of the literature on how

macroprudential policies may affect banks' risk-taking behavior differently during normal times, years of systemic cri-

sis or during the COVID-19 pandemic. Section 3describes the data and variables used in the empirical analysis.

Section 4discusses the results and provides additional robustness checks. Finally, in Section 5, we present our final

remarks.

2|LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

It is widely acknowledged that banks play an important role in the stability of financial markets and the economy

itself. Afterall, the GFC served as a reminder that a single bank can contaminate and expose vulnerabilities in the

entire financial system, even beyond borders. While macroprudential policies deal with this type of idiosyncratic risk

and ultimately reduce financial instability, they do so by influencing banks' individual behavior.

The literature on the impact of macroprudential policies during different phases of the financial cycle comprises

two strands. The first strand includes studies by Gauthier et al. (2012), Berger and Bouwman (2013) and Nit¸oi et al.

(2019), among others, and focuses on the impact on individual banks' risk-taking behavior. The second strand, involv-

ing the studies of Qureshi et al. (2011), Jiménez et al. (2017), and Schroth (2021) evaluates the outcome of these pol-

icies on credit and real output for the entire economy. A consensus exists in these two strands of the literature that

the precrisis implementation of capital macroprudential policies leads banks to reduce their default profitability and

the credit crunch, thereby helping the economy recover faster. In other words, macroprudential policies are effective

if implemented prior to the crisis than during the financial stress period.

The literature also shows that capital-aimed macroprudential policies, that is, policies aiming at building a capital

buffer, have an important role on these effects. Lim et al. (2011), Berger and Bouwman (2013), Claessens et al.

(2014), Bitar et al. (2016), Altunbas et al. (2018), and Teixeira et al. (2020) show that capital-aimed macroprudential

policies mitigate banks' individual risk and reduce externalities stemming from banking interconnectedness, or in

other works reduce systemic risk.

However, there may be consequences beyond policymakers' intentions. As these policies are implemented with

the goal of creating a monetary buffer that banks can use during turbulent times, avoiding default scenarios, as

witnessed during the GFC, the “cost of macroprudential policy”theory indicates that this will reduce economic

growth by constraining credit supply in the economy (Ampudia et al., 2021; Belkhir et al., 2022; Richter et al., 2019;

Sanchez & Rohn, 2016). Therefore, restrictions on lending could potentially lead banks to engage in regulatory arbi-

trage by substituting credit with unsecured and less-regulated activities, potentially increasing banks' individual risk

(Meuleman & Vennet, 2020). Banks can regain lost profitability by directly investing in riskier and unsupervised

assets, thus increasing their individual risk.

Based on these theories, we test the hypothesis that the implementation or tightening of capital-aimed macro-

prudential policies during the period prior to the GFC and the COVID-19 pandemic had a significantly negative effect

on banks' risk-taking behavior.

Comparing the GFC and the COVID-19 pandemic, although both these crises affected the financial markets,

similarities stop th ere. While the GFC originated during a p anic situation, following a sudden d ecline in asset prices

and the global consequ ences of the financial co ntagion (Allen & Gu, 2018), the COVID-19 pandemic i s the result

of a public health emergency of international proportions. Some authors, such as Li et al. (2021) and Gunay and

Can (2022), suggest that th e COVID-19 pandemic ha s contracted global e conomic activities m uch more than

the GFC.

796 MATOS ET AL.