Macroprudential Regulation and Banking Regulation

• DOI: http://doi.org/10.1111/1467-8462.12144
• Author: Kevin Davis
• Date: 01 March 2016
• Published date: 01 March 2016

Policy Forum: Macroeconomic Consequences of

Macroprudential Policies

Macroprudential Regulation and Banking Regulation

Kevin Davis*

One of the noticeable changes in banking and

f‌inancial regulation over the past decade has

been the increased focus on macroprudential

regulation. While f‌inancial stability was always

a concern of f‌inancial regulators and policy-

makers, it did not f‌ind explicit recognition in

the original version of the Basel Accord

introduced in 1988—although promoting

f‌inancial stability was a key goal.

1

The initial

accord was ‘microprudential’in nature,

focused primarily upon setting minimum

capital requirements for banks based on an

assessment of their individual risk, rather than

their potential contribution to systemic

instability.

Even the very substantive changes, known

as Basel II, which were eventually agreed upon

in 2006, retained primary focus upon individ-

ual bank risk, rather than interconnectedness

within the f‌inancial system. They endeavoured

to provide a closer link between an expanded

catalogue of risks and capital requirements,

which also took account of recent f‌inancial

innovation, but there were no mechanisms

included to adjust the intensity of regulatory

requirements in response to concerns about

f‌inancial stability, nor to attempt to inf‌luence

the evolution and structure of the f‌inancial

sector in ways thought more compatible with

f‌inancial stability.

Of course, Basel II did aim to inf‌luence

bank behaviour by rewarding improved risk

management practices suff‌icient to gain

accreditation as an ‘advanced’bank by

providing lower capital requirements relative

to ‘standardised’banks (those using less

sophisticated risk management systems).

While that was seen as having benef‌its for

f‌inancial stability by improving the quality of

risk management, some have questioned

whether the resulting complexity and reliance

on bank internal models have had the risk

mitigation advantages that were hoped for.

This changed signif‌icantly following the

Global Financial Crisis, with the subsequent

amendments to the Basel Accord, generally

referred to as Basel II.5 and Basel III, and other

initiatives promulgated by the Financial Sta-

bility Board on instructions from the G20

leaders. One group of changes can be seen as

addressing the cross-sectional element of

systemic stability—attempting to make the

structure of the f‌inancial system more consis-

tent with stability. The second group relates to

the temporal or dynamic element—providing

authorities with techniques for intervening to

dampen undesirable trends in f‌inancial sector

aggregates which are not conducive to f‌inancial

stability.

In the f‌irst category of regulatorychanges are

the following elements. First, the requirement

for use of central clearingcounterparties (CCPs)

for over-the-counter derivatives transactions is

based upon reducing interconnectedness of

exposures and enabling better understanding

of risk exposures of major players in the

system.

2

Second, the designation of certain

institutions as systemically important f‌inancial

institutions (SIFIs), either globally (G-SIFIs)

or domestically (D-SIFIs), and application of

* Department of Finance, The University of Melbourne,

Victoria 3010 Australia, Australian Centre for Financial

Studies, Victoria 3000 Australia, and Department of

Banking and Finance, Monash University, Victoria 3168

Australia; email <kevin.davis@unimelb.edu.au>.

The Australian Economic Review, vol. 49, no. 1, pp. 93–5

°

C2016 The University of Melbourne, Melbourne Institute of Applied Economic and Social Research

Published by John Wiley & Sons Australia, Ltd