Effectiveness of Macroprudential Policies in Developing Asia: An Empirical Analysis

8/20/2019 Effectiveness of Macroprudential Policies in Developing Asia: An Empirical Analysis

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ASIAN DEVELOPMENT BANK

EFFECTIVENESS OF

MACROPRUDENTIAL POLICIES

IN DEVELOPING ASIA:AN EMPIRICAL ANALYSIS

Minsoo Lee, Ruben Carlo Asuncion, and Jungsuk Kim

ADB ECONOMICSWORKING PAPER SERIES

NO.

July


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ADB Economics Working Paper Series

Effectiveness of Macroprudential Policies in Developing Asia:

An Empirical Analysis

Minsoo Lee, Ruben Carlo Asuncion,and Jungsuk Kim

No. | July

Minsoo Lee ([email protected]) is Senior Economist at theEconomic Research and Regional CooperationDepartment (ERCD), Asian Development Bank (ADB).Ruben Carlo Asuncion ([email protected]) is aconsultant at the ERCD, ADB. Jungsuk Kim([email protected]) is a researcher at the Institute of

International and Areas Studies, Sogang University.



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CONTENTS

TABLES AND FIGURES iv

ABSTRACT v

I. INTRODUCTION

II. MACROPRUDENTIAL POLICY: CONCEPTUAL BASIS AND LITERATURE REVIEW

III. EMPIRICAL METHODOLOGY AND DATA

IV. EMPIRICAL RESULTS

A. People’s Republic of China B. Hong Kong, China C. Indonesia

D. India E. Republic of Korea F. Malaysia G. Singapore H. Thailand I. Taipei,China J. Philippines

V. CONCLUDING OBSERVATIONS AND POLICY IMPLICATIONS

REFERENCES


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TABLES AND FIGURES

TABLES

Conceptual Basis of Macroprudential Policy Instruments Specific Use of Macroprudential Policy Instruments by Economy, –

FIGURES

Latent Propensity to Macroprudential Policy Tightening in the People’s Republicof China, –

Credit-Related Macroprudential Policy Tightening in the People’s Republic of China Liquidity-Related Macroprudential Policy Tightening in the People’s Republic of China Credit-Related Macroprudential Policy Tightening in Indonesia Liquidity-Related Macroprudential Policy Tightening in Indonesia Credit-Related Macroprudential Policy Tightening in India

Credit-Related Macroprudential Policy Tightening in the Republic of Korea Credit-Related Macroprudential Policy Tightening in Singapore


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ABSTRACT

The global financial crisis highlighted the need for national bank supervisory authorities to improvesurveillance systems and to detect early on the buildup of macroeconomic risks that could threatenthe entire financial system. This paper presents an empirical framework for analyzing how effectivemacroprudential policies control credit growth, leverage growth, and housing price appreciation. Twosignificant findings emerge. Broadly, macroprudential policies can indeed promote financial stability inAsia. More specifically, different types of macroprudential policies are more effective against differenttypes of macroeconomic risks.

Keywords: developing Asia, financial stability, macroprudential policy

JEL Classification: G, G, L


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I. INTRODUCTION

Before the global financial crisis, financial regulation largely took the form of microprudential policiesand centered on monitoring prudential risks to individual institutions. As such, financial regulationfailed to consider the buildup of macroeconomic risks and vulnerabilities that could pose systemic riskby destabilizing a number of institutions simultaneously. The global financial crisis underlined anurgent need for financial regulatory authorities to identify and monitor early on the buildup ofmacroeconomic risks that could threaten the financial system. Such early detection and preventionrequires strong macroprudential policy measures—for example, caps on the loan-to-value (LTV)ratio—designed to mitigate financial stability risks that stem from vulnerabilities building up in thebroader financial system.

A macroprudential approach has two dimensions: a time dimension and a cross-sectionaldimension (Borio ). In the time dimension, the source of system-wide distress can be theprocyclicality of the financial system. That is, financial institutions and markets overexpose themselvesto risks during an upswing in the financial cycle and then become overly risk averse during a downswingleaving the entire financial system and economy vulnerable to booms and busts. On the other hand,

the cross-sectional dimension of systemic risk arises from the interconnectedness of financialinstitutions and markets that can result in joint vulnerabilities and failures of financial institutions, i.e.when the actions and problems of individuals or financial institutions have spillover effects on theoverall financial system. Given their interconnectedness, the contemporary market-based financesector should be thought of not only as the deposit-taking, loan-making activities of commercial banksbut also as investment banks, money market funds, insurance firms, and other financial institutions.

This paper presents the basic framework of an empirical analysis to gauge how effectivelymacroprudential policies target credit-, liquidity-, and capital-related financial stability risks. Theframework looks at the impact of three different types of macroprudential policies on three keyindicators of financial stability: credit growth, leverage growth, and housing price escalation. Wedocument the macroprudential tightening policies that developing Asian economies have actually

used.

An important innovation in this paper is to apply the qualitative vector autoregressiveregression (Qual VAR) model to estimate the latent propensity to three types of macroprudentialpolicy measures and then to generate the dynamic impulse responses of financial stability indicatorswith respect to the macroprudential policy measures. Overall, our results suggest that credit-relatedmacroprudential policy instruments can effectively dampen credit expansion and housing priceinflation while liquidity-related macroprudential policy tools moderate leverage growth and housingprice escalation.

II. MACROPRUDENTIAL POLICY: CONCEPTUAL BASIS AND LITERATURE REVIEW

The Basel Committee on Banking Supervision is increasingly guided by the need for a macroprudentialperspective on financial regulation in addition to the traditional microprudential perspective. Althoughprogress has been made on the regulatory front—especially with Basel III tightening the rules on thequantity and quality of bank capital including the requirement of a countercyclical capital buffer—regulations apply to only some financial institutions. In contrast, macroprudential policy aims to limitthe buildup of risk in the entire financial system and to enhance its resilience following shocks. Efforts


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| ADB Economics Working Paper Series No.

are geared mainly toward identifying systemic threats to financial markets that could affect the realeconomy and thus to preventing a financial crisis.

Macroprudential policy measures fall into the following three broad categories (Table ):(i) credit controls including caps on ratios of LTV and of debt-to-income (DTI) and on foreigncurrency lending as well as ceilings on credit or credit growth; (ii) liquidity regulations that place limitson net open currency positions or currency mismatches and on maturity mismatches whileestablishing reserve requirements; and (iii) capital requirements including countercyclical capitalrequirements, time-varying and dynamic provisioning, and restrictions on profit distribution.Macroprudential tools such as minimum capital ratios and LTV ratios have been used for some time.Reserve requirements could provide liquidity cushions while dynamic provisioning could help buildcapital buffers during upturns.1

Table : Conceptual Basis of Macroprudential Policy Instruments

Instruments Conceptual Basis

) Caps on the loan-to-value ratio (LTV)

The LTV imposes a down payment constraint on household capacity to borrow. In theory, theconstraint limits the procyclicality of collateralized lending since housing prices and household

capacity to borrow based on the collateralized value of the house interact in a procyclical manner.Set at an appropriate level, the LTV addresses systemic risk whether or not it is frequentlyadjusted; however, the adjustment of the LTV makes it a more potent countercyclical policyinstrument.

) Caps on the debt-to-income ratio (DTI)

The DTI represents prudential regulation aimed at ensuring banks’ asset quality when used alone.When used in conjunction with the LTV, however, the DTI can help further dampen the cyclicalityof collateralized lending by adding another constraint on household capacity to borrow. As withthe LTV, adjustments in the DTI can be made in a countercyclical manner to address the timedimension of systemic risk.

) Caps on foreigncurrency lending

Loans in foreign currency expose the unhedged borrower to foreign exchange risks which, in turn,subject the lender to credit risks. The risks can become systemic if the common exposure is large.Caps (or higher risk weights, deposit requirements, etc.) on foreign currency lending may be usedto address this foreign exchange induced systemic risk.

) Ceilings on

credit/Credit growth

A ceiling may be imposed on either total bank lending or credit to a specific sector. The ceiling on

aggregate credit or credit growth may be used to dampen the credit/asset price cycle—the timedimension of systemic risk. The ceiling on credit to a specific sector, such as real estate, may beused to contain a specific type of asset price inflation or limit common exposure to a specificrisk—the cross-sectional dimension of systemic risk.

) Reserverequirements

This monetary policy tool may be used to address systemic risk in two senses. First, the reserverequirement has a direct impact on credit growth, so it may be used to dampen the credit/assetprice cycle—the time dimension of systemic risk. Second, the required reserves provide a liquiditycushion that may be used to alleviate a systemic liquidity crunch when the situation warrants.

) Countercyclicalcapital requirements

The requirement can take the form of a ratio or risk weights raised during an upturn as a restrainton credit expansion and reduced during a downturn to provide a cushion so that banks do notreduce assets to meet the capital requirement. A permanent capital buffer, which is built up duringan upturn and deleted during a downturn, serves the same purpose. Both can address thecyclicality in risk weights under Basel II based on external ratings that are procyclical.

continued on next page

1 Other tools such as limits on profit redistribution could also have countercyclical buffer effects helping banks’ willingness

to maintain or at least reduce their balance sheets during recessions. More generally, there are reasons to doubt that thesetools will usually be effective, particularly in economies that have fully liberalized capital accounts and otherwise quiteliberal finance sectors.


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Effectiveness of Macroprudential Policies in Developing Asia: An Empirical Analysis |

Table continued

Instruments Conceptual Basis

) Time-varying/Dynamicprovisioning

Traditional dynamic provisioning is calibrated on historical bank-specific losses, but it can also beused to dampen the cyclicality in the financial system. The provisioning requirement can be raisedduring an upturn to build a buffer and limit credit expansion and lowered during a downturn tosupport bank lending. It may be adjusted either according to a fixed formula or at the discretion ofthe policy maker to affect bank lending behavior in a countercyclical manner.

) Restrictions on profitdistribution

These prudential regulation requirements are intended to ensure the capital adequacy of banks.Since undistributed profits are added to bank capital, the restrictions tend to have acountercyclical effect on bank lending if used in a downturn. The capital conservation buffer ofBasel III has a similar role.

) Limits on net openpositions/Currencymismatch

Such prudential regulation tools limit banks’ common exposure to foreign currency risks. Inaddition, the limits may be used to address an externality—sharp exchange rate fluctuationscaused by a convergence of purchases/sales of foreign exchange by banks. This externalityincreases the credit risk of unhedged borrowers with heavy foreign currency debt.

) Limits on maturitymismatch

These prudential regulation tools may be used to address systemic risk since the choice ofasset/liability maturity creates an externality—fire sales of assets. In a crisis, the inability of afinancial institution to meet its short-term obligations due to maturity mismatches may force it toliquidate assets thus imposing a fire sale cost on the rest of the financial system. The fundingshortages of a few institutions could also result in a systemic liquidity crisis due to the contagioneffect.

Source: Lim et al. , Appendix VI, p. .

The greater attention to macroprudential policy is evident in both advanced and developingeconomies. Compared with other regions, developing Asia has a lot of experience in implementing avariety of macroprudential measures consisting of credit-related, liquidity-related, and capital-relatedpolicy instruments to prevent or to address asset price bubbles and other threats to financial stability.This experience is derived primarily from dealing with previous threats to financial stability, especiallyarising from volatile capital flows. Since and partly in response to the Asian financial crisis of, in order to cope with potentially volatile, large-scale capital inflows, macroprudential measureshave been widely used in developing Asia.

While advanced economies seldom used macroprudential policies during the s, theyimplemented many of these tools after the global financial crisis as part of a broader trend towardmore stringent financial regulation. Moreover, major advanced economies have recently establishedregulatory frameworks for macroprudential policy. Since the global economy began to recover fromthe global crisis, many economies in developing Asia have been actively using macroprudential policyto deflate potential bubbles in the property and equity markets. Risks had accumulated during theperiod of high growth and low inflation, particularly in real estate-related sectors.

Recent literature on financial crises has centered on explaining how leveraging in financialmarkets causes bubbles and influences economic activity. Measures of economy-wide financialactivity such as deviations from the long-run trend of the credit-to-gross domestic product (GDP)

ratio are considered to be informative and potential guides for macroprudential policy. There are anumber of empirical studies on macroprudential policy, but little empirical evidence exists on itseffectiveness, most notably as to which policies work best in a country-specific context. Quantifyingthe effectiveness of macroprudential policy is challenging because it involves a multitude ofinstruments with inconsistent intervals and frequencies targeting different segments of the financialsystem (Tillmann ) which complicates standard empirical analysis. Some papers have analyzedthe effects of macroprudential policy on various measures of financial vulnerability and stability (IMF, a, and b). Lim et al. () reviewed the use of key macroprudential instruments in economies up to and estimated the effectiveness of tightening individual instruments in reducing


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the procyclicality of financial risks. They concluded that many of the frequently used macroprudentialinstruments have been effective in lowering systemic risks.

The main contribution from applying modern versions of dynamic stochastic generalequilibrium (DSGE) models to financial-real linkages lies in explaining the mechanisms through whichreal and financial factors interact and how this interaction can generate systemic risks. In particular, thecombination of a macroeconomic boom, a credit boom, and low interest rates can provoke a crisiswhen the credit boom turns supply driven (Boissay, Collard, and Smets ). Christensen, Meh, andMoran () examine countercyclical capital ratio requirements; and Christensen and Meh ();Gelain, Lansing, and Mendicin (); and Walentin () derive models for setting up acountercyclical LTV ratio based on a specific feedback rule. Crowe et al. () delve into a time-varying LTV regulation, and Funke and Paetz () and Wong et al. () both estimate a DSGEmodel specifically for Hong Kong, China.

Aiyar, Calomiris, and Wieladek () examined the effect that the time-varying minimumcapital requirement introduced in the United Kingdom (UK) had on credit growth and alsoinvestigated the degree of regulatory arbitrage resulting from the introduction of new regulations.

Alberola, Trucharte, and Vega () investigated dynamic provisioning in Spain. Although theytypically found that a countercyclical LTV ratio can moderate housing price volatility and creditgrowth, their results were calibrated from a set of linearized equilibrium conditions that are of limitedvalue in understanding the buildup of housing price bubbles (Tillmann ). Furthermore, some ofthese models depend on extreme simplification of the banking sector that makes them too abstract forpolicy-oriented analysis (Kawata et al. ).

Another strand of literature exploits information on various policy actions to explain asset pricemovements and credit growth by conducting event studies or by coding policy episodes with a binaryindicator. This strand employs a set of standard macroeconomic control variables to examine theimpact of macroprudential policy instruments on housing price escalation and credit growth.Claessens, Gosh, and Mihet () examined the effectiveness of different macroprudential policies

aimed at banking system vulnerabilities. Their regression results showed that measures such as caps onDTI and LTV as well as limits on credit growth and foreign currency lending are effective in reducingleverage, asset, and noncore to core liabilities growth during booms. They also suggest thatmacroprudential policies are much more effective in booms than in busts, implying the presence ofasymmetric effects.

III. EMPIRICAL METHODOLOGY AND DATA

In theory, macroprudential measures can safeguard the stability of the banking system and of thebroader financial system by mitigating risks that affect the entire financial system and therefore the

economy. The question is, as always, whether they actually work in practice. This section presents thebroad contours of the methodology and data along with the basic framework of an empirical analysis togauge how effectively macroprudential policies control credit growth, leverage growth, and housingprice appreciation.

A major innovation of this analysis is defining macroprudential policy as a continuous variablerather than as a binary variable. Tillmann () and Meinusch and Tillmann () recently extendeda multivariate dynamic probit model—the Qual VAR model that Dueker () originally applied toforecast business cycle turning points—to uncover the latent propensity to macroprudential policy


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tightening from observed binary policy data. This modified methodology can examine the dynamiceffectiveness of macroprudential policy and unconventional monetary policy by addressing theexogenous treatment of binary macroprudential policy indicators that are likely endogenous and bytracing out the dynamic adjustment of the endogenous variables following different macroprudentialpolicy shocks.

The binary macroprudential policy indicators often do not properly represent a policy stancethat leans toward tightening, easing, or maintaining a neutral stance. One advantage of using the QualVAR is to uncover latent and unobservable propensity for macroprudential tightening from observedbinary policy data that provide an endogenous continuous series reflecting the business cycle. Astandard VAR with the generated latent series can provide estimates and dynamic impulse responsefunctions for macroprudential policy shocks.

Following Tillmann () and Meinusch and Tillmann (), suppose we identify a binarydependent variable ∈ ,, which is driven by a continuous latent variable ∗

0 if ∗ 01 if ∗ 0

()

with

∗ ∗ , ~0,1, ()where is a set of lagged explanatory variables such as the growth rate of real GDP, the change inthe short-term interest rate, the growth rate of real credit, and changes in real housing prices.

Equation () is dynamic in the sense that the latent variable setting to determinemacroprudential policy displays autoregressive properties. A Qual VAR incorporates this equation in aVAR system of the vector. The Qual VAR model with endogenous variables and lags can now berepresented as

() where

∗ , ()

consists of macroeconomic data , and the latent variable ∗.The Qual VAR estimation is continuous with the use of a Markov Chain Monte Carlo (MCMC)

method, a class of algorithms for sampling from probability distributions that are based on the Markovchain that has a desired distribution as its equilibrium distribution. Three crucial assumptions aremade. First, the VAR coefficients

are normally distributed with the mean and the variance given by

the ordinary least squares (OLS) estimates. Second, an inverted Wishart distribution, a generalizationto multiple dimensions of the Chi-square distribution, is assumed for the covariance matrix . Lastly,the latent variable ∗ that is required to be positive whenever is equal to is assumed to follow atruncated normal distribution. Given ∗, the conditional distribution of the VAR coefficients is given bythe OLS estimates. Since neither of the latter two conditioning assumptions mentioned holds, theMCMC estimation is used. When sufficient numbers of iterations are executed, as those of Dueker() and Tillmann (), a draw from either conditional distribution can be seen as a draw fromthe joint posterior distribution.


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The Qual VAR is estimated over a sample period from the first quarter (Q) of to thefourth quarter (Q) of . The vector consists of the growth rate of real GDP to proxy for thestate of the economy’s business cycle, the change in interest rates to control for the monetary policystance that can affect the effectiveness of policies and its financial cycle, the growth rate of real credit,and the change in real housing prices. Data came from varied sources such as the InternationalMonetary Fund’s (IMF) International Financial Statistics, CEIC Data Company, the Bank forInternational Settlements (BIS), the Economist Intelligence Unit, and other central bank sources. Adatabase of macroprudential policy instruments draws from Lim et al. (, ); Shim et al. ();Zhang and Zoli (); documents posted on the websites of central banks such as annual reports andfinancial stability reports; the Annual Report on Exchange Arrangements and Exchange Restrictionsdatabase; and research papers on macroprudential policy in individual economies and the region. TheConsumer Price Index (CPI) was used to deflate nominal variables. Leverage was also used and ismeasured as assets over equity obtained from CEIC Data Company. GDPs, the CPI, interest rates, andcredit came from International Financial Statistics and the BIS.

IV. EMPIRICAL RESULTS

Table shows information about the macroprudential instruments that economies have mostactively applied in developing Asia during the sample period. In the sample, credit-relatedmacroprudential policy instruments such as ratios of LTV and of DTI were used most frequently inIndonesia, the Republic of Korea, Singapore, and Thailand while liquidity-related macroprudentialpolicy instruments such as reserve requirements and limits on net open currency positions wereemployed most commonly in the People’s Republic of China (PRC), India, and the Philippines. Capital-related macroprudential policy tools were rarely applied except in India. The tools implemented mostoften were credit-related macroprudential policy measures.

Table : Specific Use of Macroprudential Policy Instruments by Economy, –

MPP type

Economy

Total

SIN HKG INO MAL KOR IND TAP THA PHI PRC

Credit-relateda .

Liquidity-relatedb .

Capital-relatedc .

Total .

PRC People’s Republic of China HKG Hong Kong, China; IND India; INO Indonesia; KOR Republic of Korea; MAL Malaysia;MPP macroprudential policy, PHI Philippines; SIN Singapore; TAP Taipei,China; THA Thailand.Notes:a Caps on loan-to-value ratio, caps on debt-to-income ratio, caps on foreign currency lending, and ceiling on credit/credit growthb Limits on net open currency positions/currency mismatch (NOP), limits on maturity mismatch, and reserve requirementsc Countercyclical/time-varying capital requirements, time-varying/dynamic provisioning, and restrictions on profit distributionSource: Authors’ calculations.

A. People’s Republic of China

Among the developing Asian economies studied in this paper, the PRC authorities mostfrequently implemented macroprudential policies to address systemic risk from Q to Q .The latent propensity to macroprudential policy tightening uncovered by the Qual VAR reflects the


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People’s Bank of China’s frequent use of macroprudential policies between Q and Q (Figure ). The policy instruments were implemented to regulate financial institutions’ liabilities and tocurb the credit boom and housing price escalation and at the same time to avoid cross-sectionaldimension systemic risk.

Figure : Latent Propensity to Macroprudential Policy Tightening

in the People’s Republic of China, –

Note: The solid line is the latent propensity to macroprudential policy tightening uncovered by the QualVAR and the shaded area indicates episodes for which such instruments were actually implemented.Source: Authors’ calculations.

The People’s Bank of China and the China Banking Regulatory Commission launchedmacroprudential instruments simultaneously to improve financial stability. They tightenedmacroprudential measures more than times; at least were liquidity-related instruments includingreserve requirements.

The results show that credit-related macroprudential tightening immediately dampened creditexpansion and reduced housing price appreciation with lags, but it had no effect on leverage growth(Figure ). On the other hand, liquidity-related macroprudential tightening had an initial effect onreducing leverage, but the impact on housing price inflation occurred starting in the second period(Figure ).

B. Hong Kong, China

Housing prices in Hong Kong, China have increased steeply since early with the level in more than double that in . This rapid rise in residential real estate prices was attributed both tolow interest rates and to the very tight housing supply.

–4

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2001 2003 2005 2007 2009 2011 2013


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Figure : Credit-Related Macroprudential Policy Tightening in the People’s Republic of China

IR = impulse response.Source: Authors’ calculations.

Figure : Liquidity-Related Macroprudential Policy Tightening

in the People’s Republic of China


The possibility of a housing-market bubble has been the most important financial stabilityconcern for the Hong Kong Monetary Authority (HKMA) in the past several years. 2 In November, the government introduced a special stamp duty of as much as for properties resold within years; in October , it raised the rate to as much as and covered properties resold within years. It also introduced a buyer’s stamp duty on residential properties acquired by companies and

2 Over the past decades, the HKMA has used limits on the LTV ratio as one type of targeted policy tool to manage banks’

credit exposures to the property market and to lean against the amplitude of property price cycles. In the s, amaximum LTV ratio of was applied to all property types, then more differentiated ratios were introduced over time,depending on the property type and its value.

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1 2 3 4 5 6 7 8 9 10

Response of credit growth

Response of credit growthLower/Upper bound

IR

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IR

Response of leverage growth


Lower/Upper bound

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Response of house price

Response of house priceLower/Upper bound

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nonlocals, which had accounted for about of total transactions.3 Policy instruments such as capson LTV ratios should be aimed at targeting leverage, credit growth, or property prices.

The empirical results support that the dampening effect of LTV policies on property prices ismore apparent than its effect on leverage and credit growth. Higher transaction taxes with stampduties levied by the government appear to be effective in constraining housing demand and inrestraining housing price growth; however, the dampening effects of LTV and tax policies on housingprices and transaction volumes seem to be short lived and negligible in Hong Kong, China.

C. Indonesia

Policy makers in Indonesia face a complex challenge in managing strong domestic demand in anuncertain global economic and financial environment. The key question is how to balance pricestability for sustainable growth while maintaining external and financial system stability in the face ofhighly volatile capital flows, exchange rates, and global commodity prices. This tripartite nature of themacroeconomic challenge calls for efficient coordination to avoid conflicts between policies thatmight weaken domestic demand. In such circumstances, monetary policy alone would not be sufficient

to pursue not only price stability but also financial system stability. Therefore, a mix of macroprudentialpolicy and other macroeconomic policies has been stressed to deal with the multiple challenges inpreserving monetary and financial system stability.

Macroprudential measures along with monetary and exchange rate policies have beenfrequently implemented since .4 The latent propensity to macroprudential tightening reflectspolicy makers’ responses to the Lehman collapse and the subsequent repercussions posed by the shiftin allocating capital from advanced economies to Indonesia from the beginning of through (Bank of Indonesia , , and ). These macroprudential policy tools targeting creditgrowth were significantly effective in dampening the credit boom. Credit-related macroprudentialtightening measures had an immediate effect on credit expansion while they had a lagged impact onleverage growth in Q (Figure ). On the other hand, liquidity-related macroprudential tightening

measures had no effect on dampening housing prices, but they had an instantaneous effect on creditexpansion with a lagged impact on leverage growth in Q after the initial shock (Figure ).

3 In February , the government doubled the rates of existing ad valorem stamp duties for transactions for all types of

properties except for local individuals who did not own any other residential property in Hong Kong, China at the time ofacquisition. That seemed to have helped to moderate housing price inflation for a short period only. Elevated valuations athistorically high levels indicate that it is premature to conclude that the risk of a collapse in housing prices has beenaverted.

4 In , the rupiah reserve requirement was increased from to to absorb domestic liquidity and to enhance the

liquidity management of the banks without exerting a negative impact on the lending needed to stimulate growth. In ,authorities introduced LTV ratio for lending for automobiles and property and also tightened standards for credit cards toreduce excessive lending to these sectors while maintaining overall lending growth consistent with the macroeconomicoutlook.


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Figure : Credit-Related Macroprudential Policy Tightening in Indonesia


Figure : Liquidity-Related Macroprudential Policy Tightening in Indonesia


D. India

Aggregate bank credit growth has been an important monitor in the conduct of monetary andmacroprudential policies. The Reserve Bank of India (RBI) has been using various macroprudentialpolices, including capital-related policies, since as a toolkit for ensuring financial stability.Leverage growth and housing price inflation could be marginally affected by implementing credit-related macroprudential measures; however, credit tends to continue to grow. The impacts ofliquidity-related measures appear to be marginally effective in curbing credit growth but significantlyeffective in impacting housing price escalation.

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RBI’s capital-related macroprudential policies have focused on banks, and applyingcountercyclical policies to the shadow banking system5 has been challenging. Time-varying risk weightsand provisioning norms on standard assets for certain specific sectors wherein excessive credit growthin conjunction with a sharp rise in asset prices have caused apprehension about a potential build-up ofsystemic risk and about asset bubbles. Those capital-related policies targeting credit expansion hadthe desired effect of moderating the credit boom in particular (Figure ).

Figure : Credit-Related Macroprudential Policy Tightening in India


E. Republic of Korea

The Republic of Korea had systematically enacted several macroprudential policy instruments prior tothe financial crisis in . From as early as , several types of liquidity ratio regulations designed to

cure the potential weaknesses in domestic banking and foreign currency transactions were in effect.6 Nevertheless, another round of crisis-like events hit the country in . In fact, there was a new typeof financial imbalance in domestic banking as well as in foreign exchange transactions associated inpart with the housing market boom. To meet the growing demand for foreign exchange derivativetransactions, banks had begun to rely on short-term foreign borrowings.7 The macroprudential policytightened in and when housing prices hit a peak and then eased after the Lehmancollapse. From to , policy makers implemented macroprudential measures on occasions,mostly credit-related instruments. The impact of credit-related macroprudential tightening8 showed alagged decline for housing price inflation until the second period and an immediate decline in leveragegrowth. Also, the instruments had an instantaneous impact on dampening credit expansion with asustained effect of at most four periods after the initial shock (Figure ).

5 the nonbanking financial companies

6 Later, with a housing boom becoming apparent, government authorities introduced limits on the LTV and DTI ratios in

order to stabilize housing prices.7 The situation of the Republic of Korea in the s provides a basis for evaluating several macroprudential measures

from various viewpoints. The choices of options—such as single versus multiple measures, broad-based versus targetedrisks, or fixed versus time-varying applications—can also impact macroprudential policy effectiveness (Lim et al. ).

8 In , authorities imposed a levy of up to . on bank noncore financial liabilities to manage speculative inflows of

foreign capital (IMF ).

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IR



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Response of leverage growthLower/Upper bound

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Figure : Credit-Related Macroprudential Policy Tightening in the Republic of Korea


F.

Malaysia

In order to mitigate excessive investment and speculative activity in the property market and tocontain substantial increases in property prices, in Q Bank Negara Malaysia (BNM) introduceda maximum LTV ratio of for loans to purchase third houses. In the following quarter, BNMimposed risk weights from to to strengthen banks' resilience against risky portfolios for loanswith an LTV ratio of over that had been approved and disbursed on or after February .9

The latent propensity to macroprudential tightening illustrates policy makers’ strong intentionto implement measures during and . Specifically, in , there were notable shocks to theglobal economy that contributed to inflationary pressures prompting BNM toward tightening

measures. Amidst the Lehman collapse, BNM focused on easing measures in and early .The divergence in growth performance and consequent differences in policy responses in both theadvanced and emerging economies had important implications for global capital flows, asset prices,and exchange rates in prompting Malaysia to address upward pressure on its exchange rates andasset prices. The unexpected credit-related macroprudential policy tightening had an immediatelessening impact on the housing price boom and a marginally significant effect on credit and leveragegrowth, and liquidity-related macroprudential instruments had an instant impact on credit growth anda marginally significant effect on dampening leverage and housing price expansion.

G. Singapore

Although the highly developed financial system of Singapore is well-regulated and supervised by theMonetary Authority of Singapore (MAS), some risks to financial stability have emerged in recent yearsstemming from galloping real estate prices that have now surpassed their peak. There is concernthat these price trends could rekindle inflation expectations and threaten financial stability, especiallyas the property boom is financed by easy credit. Property loans continue to grow at an elevated rate,

9 BNM raised the reserve requirement ratio by percentage point per quarter from in Q to in Q of that year.

In , the government issued Guidelines on Responsible Financing to promote prudent, responsible, and transparentretail financing practices as well as to ensure that the household sector and credit market remained resilient.

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and household debt increased rapidly for years and reached of GDP at the end of with acorresponding increase in the exposure of locally incorporated banks to the property sector. Theauthorities have continued to respond proactively to new sources of systemic risk as they emerge, theyhave enhanced their surveillance and analytical frameworks for assessing the likelihood and impact ofemerging systemic risks, and they have designed new policy instruments to effectively respond to suchrisks.10 The bank resolution framework should also be strengthened by enhancing the operationalindependence of the resolution agency and by allowing speedy and decisive action by MAS to addressbank fragility.

Most recently, Singapore has tightened the limit on the ratio of mortgage service to income,capped the LTV ratio, imposed an additional buyer’s stamp duty and increased the minimum cashdown payment. These measures have largely targeted the more speculative segments of the market,but further tightening has been recommended on the segment owned mainly by foreigners andpermanent residents.

The measures have been broadly successful. Housing price inflation has moderated recently,and housing affordability metrics remain contained.11 The effectiveness of macroprudential policies

can be influenced by the degree of international financial integration. Singapore’s highly developed andglobally interconnected financial system with a large foreign bank presence makes it harder to preventthe circumvention of some macroprudential policies, but most measures have focused primarily on theproperty market that brought substantial dampening effects on housing prices and credit expansionwith minimal impact on leverage growth (Figure ).

Figure : Credit-Related Macroprudential Policy Tightening in Singapore

IR impulse response.Source: Authors’ calculations.

10 The International Monetary Fund’s Financial Sector Assessment Program for Singapore conducted in November

recommended that Singapore enhance its existing supervisory and regulatory frameworks, further develop its crisismanagement arrangements, and remain vigilant over credit growth.

11 Moreover, MAS required Singapore-incorporated banks to meet the Basel III minimum standards by January ahead

of the January timeline. Taking into account the capital conservation buffer requirement of ., Singapore-incorporated banks should maintain at least common equity tier compared to the Basel III minimum of .

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H. Thailand

The latent tendency to macroprudential tightening such as limits on net open currency positions, theLTV ratio, capital surcharges, and reserve requirements depicts the Bank of Thailand’s reaction to theinstability brought about by uncertainty domestically and internationally that diminished investorconfidence to a certain extent. In , various negative factors affected Thailand’s economicperformance and contributed to macroprudential tightening including uncertainties about the globaleconomic recovery after , domestic political unrest, exchange rate volatility, and a naturaldisaster. Specifically, the Financial Institutions Policy Committee imposed additional regulatorymeasures on housing loans to encourage prudent lending among financial institutions as the housingmarket buoyantly expanded in (Bank of Thailand and ). Credit-related regulatorymeasures had a minor impact on housing price appreciation, an insignificant effect on creditexpansion, but an immediate impact on leverage growth.

I.

Taipei,China

The economy has begun to pick up, but it and bank risk profiles remain hamstrung by high private

leverage, excess capacity, and relatively sluggish prospects for small to medium-sized enterprises. Themain challenge for the banks arises from the large existing stock of private credit at of GDP in; about of these loans are property-related. Mortgage debt accounts for nearly of totalproperty loans and has risen to levels where household debt servicing has become vulnerable to a shiftin interest rates.12 Macroprudential measures have been moderately successful at best. Tighter LTVratios and reserve requirements have been implemented to curb property market speculation andreduce credit growth.

J.

Philippines

The latent propensity to macroprudential tightening features much of the Philippine Central Bank’s(BSP) role in controlling excess liquidity in domestic financial markets by regularly tweaking liquidity

reserve requirement ratios of banks and other banking institutions as needed. Despite the financialshocks brought about by the global economic slump in , the Philippines continued to meeteconomic growth goals of . in and . in the succeeding year. Some changes13will be fullyimplemented years from their announcement by the BSP. With the BSP mulling a new LTV ratio forbanking institutions to control bank lending, the impulse response function on the response of housingprices suggests a significant impact on its expansion. Liquidity-related macroprudential policies, on theother hand, seem to have a more significant impact on leverage growth, while credit growth ismitigated more by credit-related policies.

12 At of disposable income, households are the most indebted in developing Asia with the exception of those in the

Republic of Korea.13

Recently, the BSP revealed that Philippine bank exposure to real estate had increased by . at the end of March compared to the end of December . The Monetary Board, the major policy-making body of the BSP, approved majoramendments to regulations governing credit-risk taking activities of banks and quasi-banks after a comprehensive policyreview done by the BSP. Thus, the BSP announced major policy changes regarding the cap on bank lending to ofcollateral value, down from previously.


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V. CONCLUDING OBSERVATIONS AND POLICY IMPLICATIONS

There is a growing consensus in developing Asia and elsewhere that macroprudential policy measurescould be useful for safeguarding financial stability, but their empirical effectiveness has not yet beenwell-established. We document three types of macroprudential policies—credit-related, liquidity-related, and capital-related—that economies in developing Asia have used and empirically examinetheir effectiveness in influencing three indicators of financial stability: credit growth, leverage growth,and housing price inflation. This paper innovates by utilizing the latent propensity to macroprudentialpolicy to generate dynamic impulse responses of the three financial stability indicators tomacroprudential policy.

Two significant findings emerge. Broadly, macroprudential policies can indeed promotefinancial stability in Asia. More specifically, different types of macroprudential policies are moreeffective against different types of macroeconomic risks. For example, the results suggest that credit-related macroprudential policy dampened credit growth in India, liquidity-related policy reined inleverage growth in Indonesia, and credit-related policy helped to control housing price escalation inthe Republic of Korea. The general pattern of the evidence from the economies suggests that

credit-related macroprudential policies can effectively dampen credit expansion and housing priceinflation while liquidity-related macroprudential policy tools moderate leverage growth and housingprice escalation. The salient implication for Asian financial regulators is that while they should explorethe use of macroprudential policies, they should assess which specific policies are appropriate for theparticular macroprudential risk they face.

Overall, our evidence indicates that macroprudential policies can be a valuable additional toolfor Asia’s financial regulatory authorities. The recent financial crises have shown that microprudentialpolicy based on surveillance of individual financial institutions was not sufficient to safeguard thestability of the financial system. The crises also underscored the challenges associated with theinterconnectedness of financial institutions and markets and global financial integration and revealedthe costs of systemic instability. In order to prevent crisis and mitigate systemic risk, it is critically

important for policy makers to detect undue risk accumulation and to identify emerging vulnerabilitiesand risks to financial stability. After detecting undue risk accumulation, policy makers shoulddiscourage excessive risk taking by providing appropriate incentives to financial market participants.They may also consider implementing macroprudential measures, especially those that have beeneffective in their own economies.

The global financial crisis has forced policy makers to review their policy frameworks, toexamine how they could identify time-dimensional and cross-sectional risks in the finance sector, andto deal with those risks. Often procyclical systemic risk rises in tandem with cross-sectional systemicrisk. Therefore, policy makers should be fully aware that time-dimensional risk during the peak of afinancial cycle can trigger cross-sectional systemic risk that renders banks vulnerable to a common

shock. Henceforth, in detecting systemic risks and tackling them, policy makers should avoid anycomplacency and should build a prudent and efficient macroprudential policy framework. At the sametime, policy makers should realize that macroprudential policy alone may not be sufficiently effectivein achieving financial stability; rather, a judicious mix of both microprudential and macroprudentialpolicy instruments can be more effective than the stand-alone implementation of either.


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REFERENCES

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Effectiveness of Macroprudential Policies in Developing Asia: An Empirical Analysis

The global financial crisis highlighted the need for improving national bank supervisory authorities’

surveillance systems and detecting early on the buildup of macroeconomic risks. This paper presentsan empirical framework for analyzing how effective macroprudential policies control credit, leverage,

and housing price growth. Two findings emerge: (i) macroprudential policies can promote financial

stability in Asia and (ii) different types of macroprudential policies are effective against different types ofmacroeconomic risks.

About the Asian Development Bank

ADB’s vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member

countries reduce poverty and improve the quality of life of their people. Despite the region’s many successes,it remains home to the majority of the world’s poor. ADB is committed to reducing poverty through inclusiveeconomic growth, environmentally sustainable growth, and regional integration.

Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for

helping its developing member countries are policy dialogue, loans, equity investments, guarantees, grants,and technical assistance.

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