ESRB report studies allocation of macro-prudential powers

Coordinating monetary and macro-prudential policies is easier if the powers lie within a single institution, according to a report published by the European Systemic Risk Board (ESRB), which pointed to Sweden as an example of what can go wrong when they are separated.

Macro-prudential powers rest with the central bank in 19 of the 28 EU member states (68%), while in six states they reside with the financial authority. Very rarely does it rest with the government (Denmark) or a committee (France, Poland).

The report, produced by members of the ESRB's advisory scientific committee, said macro-prudential policy requires "a combination of a system-wide perspective with complete independence from short-term political pressures" and this is "most likely to be found in a central bank".

The key issue when deciding how to allocate the powers is "the expertise and corporate culture" of the institutions in question, the report said, as macro-prudential policy "requires a macroeconomic approach that focuses on the entire financial system".

Although macro-prudential and monetary policies have both synergies and conflicts, they share the same methodological approach, and this is, again, "commonly found at central banks".

"Allocating macro-prudential powers to a central bank is therefore most likely to maximise synergies between policy objectives under most circumstances," the report said, though it noted "to ensure appropriate trade-offs a central bank may assign responsibility for the two policies to separate departments."

In Sweden, macro-prudential powers were handed to the country's financial authority at the start of 2014. Before then, the report said, there was a "power vacuum".

"If no institution has any macro-prudential power, other policy processes are affected: for example, the central bank may be induced to tighten its monetary stance also to improve financial stability, so that monetary policy ends up partly surrogating the role of macro-prudential policy," it said.

"Moreover, Sweden's experience suggests that allocating macro-prudential powers to the central bank is preferable, since monetary policy and macro-prudential policy are closely connected."

The report pointed to October 2010, when the authority imposed a loan-to-value limit on new mortgages in an effort to contain household debt. "But the effect of this LTV limit was deemed uncertain by the majority of the Riksbank's executive board in December 2010, motivating further tightening of monetary policy at the margin," it said.