Stronger financial stability governance leads to greater use of the countercyclical capital buffer

New York, New York, USA - Sept. 22, 2011 - Busy trading floor of the New York Stock Exchange

Since the global financial crisis, countries have been setting up new governance arrangements to implement macroprudential policies. Using data for 58 countries, Rochelle Edge of the Federal Reserve Board and Nellie Liang of the Hutchins Center on Fiscal & Monetary Policy at the Brookings Institution look at whether governance, including multi-agency financial stability committees (FSCs), have affected decisions to use the countercyclical capital buffer (CCyB). The CCyB is designed to be increased when systemic risks are building to ensure that banks will have a capital cushion to absorb future losses, and to be released after stresses have materialized to prevent a severe pullback in lending.  

Between 2015 and early 2019, 14 countries have used the CCyB, with many countries having raised it multiple times. The authors find that the probability of using the CCyB is significantly higher when countries have FSCs with stronger governance mechanisms than weaker ones, where strong governance is determined by whether the FSC is established by law, has a voting process, has an identified chair, and can take action or direct the actions of other agencies. This higher probability is more sensitive to credit growth, consistent with using the CCyB to reduce systemic risks. In addition, the probability of using the CCyB is higher when the FSCs have fewer agencies, consistent with fewer coordination problems, the authors suggest.  

Finally, the estimated probability is substantially higher when the FSC or the ministry of finance has the direct authority to set the CCyB or make a formal recommendation rather than when the bank regulator retains the authority.  This is probably because the decision to give the FSC or finance ministry these authorities involves creating new processes to assess systemic risks for decision-making and to provide accountability; when the bank regulator sets it on its own, there is less opportunity for others to influence the decisions and accountability for systemic risk is less clear.   

In short, Edge and Liang find that strong governance structure of FSCs and clear accountability for the CCyB significantly affect its use. But, the authors warn, most FSCs do not have strong governance structures, raising questions about effective decision-making for macroprudential policy.  

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The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Neither is currently an officer, director, or board member of any organization with an interest in this article.