Challenges in Implementing Macroprudential Policy in Africa

May 26, 2014
Like several advanced economies, policymakers in Africa have identified the need to address systemic risks, not through the traditional mix of macroeconomic policies and microprudential measures aimed at individual financial institutions, but through combining policies and measures that target whole financial systems while considering inter-linkages with the macroeconomy. A new approach needed to fill the policy gap and ensure financial stability in both advanced economies and emerging markets is currently being considered, in the form of macroprudential policy. Making macroprudential policy operational is a prime policy challenge for financial regulators in Africa. One of the steps involved is to specify a policy strategy, which links the high level objectives of macroprudential policy to intermediate objectives and presumptive indicators for risk identification and instrument selection. In addition, regulatory authorities attempting to operationalise macroprudential policy have found that the inaction bias inherent in macroprudential policymaking underscores the need for a strong mandate with adequate policy instruments and accountability. Therefore, African central banks should recognise the need for the institutional setting to merge with their core responsibilities for financial stability. Essentially, the overall policy frameworks need to be made more flexible and should be further developed as knowledge on the transmission mechanism between objectives, indicators and instruments is deepened. African central banks will need to put in place effective governance arrangements to ensure that agencies tasked with setting macroprudential policy have a clear mandate. That is, the objectives of macroprudential policy, the tools available to the macroprudential agency and the interaction of macroprudential policy and other public policies must be clearly set out. This is necessary to ensure that there is no ambiguity about the macroprudential agency's role, the macroprudential agency can be held accountable for its actions (or lack of action) and, any overlaps between policy areas or agencies can be better handled. It may be desirable to set out the macroprudential mandate (and objectives) explicitly because this could make it easier for the macroprudential agency to defend unpopular but necessary interventions. Central banks and other financial regulatory authorities in Africa still lack access to the information and analytical capability needed to quickly identify system-wide risks and to determine when and how instruments should be used in response to these risks. Much of the information on exposures between institutions and on exposures commonly held by institutions will need to be obtained from individual institutions and may overlap with the type of information collected for microprudential purposes. Therefore, memorandums of understandings or information-sharing protocols should be used to ensure the free sharing of information between agencies. In the meantime, the analytical skills and tools required for macroprudential policy are likely to draw on those used for macroeconomic analysis and, to a lesser degree, microprudential analysis. In this respect, many central banks have begun to develop system analysis that is required for macroprudential supervision, applied in the assessment of interdependencies and systemic risks, although the analytical techniques remain in their infancy. As system-wide risks can arise in a wide range of ways and from a wide range of sources, the range of macroprudential instruments must be equally broad in scope. Discussions of macroprudential instruments should emphasise the need for instruments that operate in two dimensions: the time or cyclical dimension, in which instruments are designed to counteract elements that amplify cycles; and the cross-sectional dimension, in which instruments are required to isolate or dampen the transmission of risks across the financial system. While it is important that macroprudential agencies have control over instruments to prevent and mitigate system-wide risks, it is not essential for the agencies to implement these instruments itself. Another major challenge to the design of effective governance arrangements is the overlap between different policy areas. The use of an instrument for one objective may conflict with or amplify the effect of instruments used to achieve a different policy objective. This is best illustrated by considering the relationship between macroprudential policy and monetary policy. While the effects of monetary and macroprudential instruments may overlap, they are not perfect substitutes. The macroprudential policy toolkit is likely to include a diverse range of instruments that operate in different ways on different elements of the financial system. And the effect of these instruments on policy objectives other than macroprudential policy will also vary. In general, it is desirable to use instruments with a narrower focus to address specific problems, as they can be better tailored to the problem and will have fewer unintended consequences on the real economy and on other policy objectives. However, there will be times when instruments with a broader scope will be desirable - for example, when there is a danger that developments in the financial system will enable agents to circumvent more narrowly focused instruments. Communication of macroprudential policy also remains a challenge because it is not easily understood; it relies on a range of instruments that may appear technical and yet are often politically controversial. African economies could learn from the evolving nature of communication by leading central banks, which have expanded their range of policy levers. In addition, macroprudential policy is subject to a strong bias in favour of inaction. While the benefits of macroprudential action are not visible as they only accrue in the future, the costs are typically felt immediately-by potential borrowers as well as the financial industry. Lobbying pressures and political interference further increase the inaction bias. Strong and explicit governance and institutional arrangements will be essential, but their implementation may have to overcome significant political hurdles. In conclusion, macroprudential policy needs to be complemented by appropriate macroeconomic policies as well as other financial sector measures. In particular, the appropriate range of macroprudential policy tools may be better able to address the undesired side-effects of monetary policy on financial stability. It thus allows for greater room for manoeuvre for the monetary authority to pursue price stability. Also, to the extent that macroprudential policy reduces systemic risks and creates buffers, this helps monetary policy in the face of adverse financial shocks. For countries where macroprudential policy is missing or is insufficiently effective, monetary policy, while continuing to aim at price stability, needs to take financial stability more into account by leaning against the build-up of financial imbalances. Justine Bagyenda is an Executive Director in charge of the Directorate of Supervision at Bank of Uganda. Charles Augustine Abuka is the Director Financial Stability Department at the Bank of Uganda. REFERENCES
  • Houben, A, van der Molen, R, Wierts, P, "Making macroprudential policy operational", Financial Stability Review 2012, Central Bank of Luxembourg
  • "Making macroprudential policy work", Remarks by José Viñals at Brookings Event, 26th September 2013
  • "Challenges to implementing macroprudential policy", Remarks by Nicolae Dănilă, National Bank of Romania, 23rd April 2012
  • "Challenges for the design and conduct of macroprudential policy", Stefan Ingves, BIS Papers, Bank for International Settlements, 2011

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