Examples of Macroprudential Policies
Discuss about the Macroprudential Policies Used in Australia and Other Parts of the World to Control Housing Bubble.
The housing market in Australia is being faced with the risk of bursting, the higher prices attracts many investors in this market. This is not bad, but the issue may arise if this market fails and there is a burst, some people are already dependent on the income received from the housing investment. Considering the aftermath of the global recession that was experienced in 2008 and 2009, the government is carefully to prevent such an incidence from recurring. There was a burst in the U.S. housing market while contributed to the GFC (Braude, 2013). Many governments in the world are employing various policies towards controlling the possibility of a bubble. Some of these policies include the monetary policies of influencing the money supply circulating in the economy or the interest rate for which people obtain capital for investment; this is done by the Central Bank of each nation. For Australia it’s done by the Reserve Bank of Australia (RBA). Other policies include direct influence by the government by using fiscal policies of influencing the taxation rate on citizens’ income and for corporations, or a change in the spending by the government. The last type of policies is the macroprudential policies which are many; the most common one include regulation on counter cyclical buffers and capital adequacy and leverage caps.
Tougher rules on bank loans by the Reserve Bank could minimize the heat in a highly priced housing market. Han (2014) noted that risky lending is the chief aspect behind the heat in the housing market and thus the policy implemented should be targeted to improve the conditions for lending; risky lending should be cracked down. Monetary policies are not efficient in this case because Australia being faced with the problem of low economic growth demands for the interest rate to be maintained at a lower level. Using monetary policies would only mean raising the interest rate which in return would hurt other sectors in the Australian economy. Most of the times, monetary policies make one situation better off while making another worse off. The government aim is to prevent the housing bubble but at the same time maintain the interest rate at a lower level to boost the rest of the economy. Only macroprudential policies can help the government to achieve the two conflicting goals at the same time (Maino, Imam, Ojima, 2013).
Macroprudential measure mean toughening the rules governing housing loans (Galati and Moessner, 2017). Their aim is to discourage banks from provision of riskier loans which accelerates the bubble eventually resulting in a market crash. In 2014, Macroprudential policies were considered the latest fad for the government by Glenn Stevens the Chief of Reserve Bank. Saul Eslake a chief economist in Merrill Lynch Bank of America sketched some steps that regulators might take in implementing these macroprudential measures; this also includes the likelihood of being used.
This is a macroprudential measure most likely implemented by many governments. The banks are required to gauge the ability of the borrower to repay his/her loan if the interest rate rose above the current rate (APRA, 2012). This is most common for banks regardless of whether there is an intervention by the government or not; some of the banks employ this measure on its normal lending. The source of risk that the financial system could be exposed to is directly targeted by implementing this measure which makes it more advantageous. Some of these risks boosting of property demand and demand for credit fueled by low interest rates (Laureys & Meeks, 2017). Borrower still need to benefit from low rates of interest. The head of financial stability for RBA Luci Ellis was reported to be keen on the use of this tool. In 2013, he wrote that regulatory landscape would use stress test as a permanent feature to be an automatic stabilizer without lags implementation.
This macroprudential measure is most likely to be implemented. It makes a requirement for more capital to be held by banks against interest-only loans; this is intended to induce the banks to charger higher interest rates to the risky borrowers. This is a form of measure that is specific and well targeted. The problem is that it’s not guaranteed that the cost of retaining capital will induce banks to pass on to the risky borrowers. Some of the disadvantages of this measure as provided by the RBA is that the change in borrowing costs is very small, the speed of implementation is low and there is risk that borrowers from the prudentially regulated sector will borrow from the less regulated lenders (non-banks).
Kiwis on Loan-to-valuation Caps
This is macroprudential measure is not likely to be implemented. It involve the Central Bank setting down a minimum deposit level which need to be put down by an investor who seek to get a housing loan; loans are only advanced after this condition is met. New Zealand is imposing a limit on mortgages the banks advance to the borrowers on loan-to-valuation ratios basis. These limits are known as ‘LVR caps’ and the RBA could follow this measure. In New Zealand risky home buyers when borrowing new residential loans are only eligible for not more than 10% as per the set regulation unless they have 20% deposit. The deposits held by first home borrowers is less than that of investors and thus this policy cap is most likely to hit them harder compared to the investors. The measure seemed to be ruled out by the RBA and thus less likely to be implemented (Han, 2014).
The intensity of macroprudential measures in Australia is regulated by Australian Prudential Regulation Authority (APRA); the financial institutions in Australia are regulated by this body (IMF, 2013). It supervises banks and other deposit-taking institutions, holds a wide range of powers that are directive and purposive. This agency has the sole power of varying the behaviors of these financial entities (Gai, 2016). Hence it exercise most of Australian macroprudential policies. The biggest attention for macroprudential measures is on the capacity of the borrowers to repay back their loans and the standard of loans advancement (Ellis, 2014). The financial system is bound to be faced by systemic risks and thus the macroprudential measures are meant to lower the possibility of such risks (Masson, n.d).
In 2014, the macroprudential policy and the supervisory had a close interaction to reinforce the practices on residential housing. At that time, great concerns were raised on the risks that were facing the financial institutions from advancing loans to house buyers. The funding costs were lower and price competition was intensive. Greater loans were obtained which ended up in financial institutions relaxing the terms of lending (Orsmond and Price, 2016). The APRA’s advice in December 2014 was for (i) Supervisors being alert to growth of annual house lending above the 10% benchmark; (ii) inclusion of at least a 2% interest rate buffers above the effective variable rate on the new mortgage lending serviceability assessment; and at least a 7% minimum floor assessment to make borrowers accommodate future interest rate increments; (iii) supervisors to be alert of increased borrowing of mortgages by risky borrowers. The first hypothetical borrower’ exercise was undertaken by the APRA in 2015 where serviceability practices and lending limits across the industry were revealed to have large variability. Owing to this concerns, the APRA responded by; (i) increment in its analysis of the underwriting standards for the lenders which included the strengthening of the definitions for household income in the calculation of pre-loan serviceability. These concerns were then presented to the senior bank management and chief risk officers; and, (ii) interest-only lending requirements were tightened. In 2016, the APRA provided a Prudential Practice guide that included the standard tightening on interest-only lending and serviceability buffers for residential mortgages (Orsmond and Price, 2016). Since then, the non-price and price lending terms have undergone various changes according to the expectations by the supervisory. The high-LVR lending of above 90% was further cut for new loans while the serviceability criteria was tightened for new loans. The result was a great decline in the pace of housing credit from 11 to 5%.
Macroprudential rule are very essential for an economy. A housing bubble crash is one of the riskiest event that would happen to the Australia economy, it would be hard to get the economy back to its initial position because the impacts are severe. Even if it were possible, the recovery would take a longer time to be achieved as was the case in 2008 and 20009; many economies haven’t managed to achieve some full recovery. These measure are meant to safeguard the resilience of individual financial institutions to financial risks and thus make them to employ proper risk management frameworks. Policy inertia risks can only be reduced by the macroprudential policy having a clear mandate. The results reported in 2016 proves that the measures are effective.
APRA (2012). Macroprudential Analysis and Policy in the Australian Financial Stability Framework. Retrieved from https://www.apra.gov.au/AboutAPRA/Publications/Pages/MAP-AUS-FSF.aspx .
Braude, J. (2013). The great recession. Cambridge, Mass.: MIT Press.
Ellis, L. (2014). Why Financial Stability Matters, and What We Can Do About It’.
Gai, P. (2016). Macroprudential Policies in Australia: Design and Effects. Australian Economic Review, 49(1), 83-85. Doi: 10.1111/1467-8462.12145.
Galati, G. & Moessner, R. (2017). What Do We Know About the Effects of Macroprudential Policy? Economica.
Han, M. (2014). Bubble-busting: 'macroprudential policies' for home loans explained. Retrieved from https://www.smh.com.au/business/the-economy/bubblebusting-macroprudential-policies-for-home-loans-explained-20141002-10ozww.html.
IMF (International Monetary Fund) (2013). Key Aspects of Macroprudential Policy’, IMF Policy Paper.
Laureys, L., & Meeks, R. (2017). Monetary and Macroprudential Policies under Rules and Discretion. SSRN Electronic Journal. Doi: 10.2139/ssrn.3135259.
Masson, P. (n.d.). Macroprudential policies, commodity prices and capital inflows. Retrieved from https://www.bis.org/publ/bppdf/bispap76f.pdf.
Maino, R., Imam, P. & Ojima, Y. (2013). Macroprudential policies for a resource rich economy: The case of Mongolia. Washington, D.C.: International Monetary Fund. Orsmond, D. and Price, F. (2016). Macroprudential Policy Frameworks and Tools. Retrieved from https://www.rba.gov.au/publications/bulletin/2016/dec/pdf/rba-bulletin-2016-12-macroprudential-policy-frameworks-and-tools.pdf
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