A newly released IMF working paper examines the impact of macroprudential controls, including lifting capital ratios, and reducing allowable loan to value (LVR) ratios. They find that first, monetary policy and macroprudential policies related to bank capital are likely to be transmitted through the same channels in the banking system as they both affect the cost of loans. So, they should be expected to reinforce each other. Second, capital buffers or liquidity ratios targeting specific sectoral exposures are likely to be effective in slowing down credit growth in the mortgage market. Third, macro-prudential instruments affecting the cost of capital or the liquidity position could usefully be complemented by instruments related to non-price dimensions of mortgage loans such as limits on LTVs. The evidence also suggests that tightening of LTVs is more effective in slowing down credit growth and house price appreciation when monetary policy is too loose.
The design of a macro-prudential framework and its interaction with monetary policy has been at the forefront of the policy agenda since the global financial crisis. However, most advanced economies (AEs) have little experience using macroprudential policies, while there is, by contrast, more evidence about macro-prudential instruments aimed at moderating the volatility of capital flows in emerging markets. As a result, relatively little is known empirically about macroprudential instruments’ effectiveness in mitigating systemic risks in these countries, about their channels of transmission, and about how these instruments would interact with monetary policy.
Many countries publish bank lending surveys that provide very useful information on how banks modify the price and non-price terms of loans to the private sector, and on the drivers of these lending conditions. Some of the terms of loans (such as actual loan-to-value ratios (LTVs)) or some of the drivers of the lending standards (such as the cost of bank capital or the liquidity position of a bank) are directly related to macro-prudential instruments considered to be key in the policy toolkit of many jurisdictions. In this paper, we make use of the European Central Bank Lending Survey to develop a methodology and estimate empirically the likely effectiveness of some of these macro-prudential policies, their channel of transmissions and their interactions with monetary policy.
There is thus far little knowledge about how (policy driven) changes in the cost of bank capital (which could be the result of the implementation of a countercyclical capital buffer, of time contingent or sectoral risk weights, or more generally of bank specific changes in the capital adequacy ratio) or in the bank liquidity position would be transmitted to credit supply. Specifically, would such policy actions be transmitted through non-price factors (such as LTVs, collateral requirements, or maturity) or through price factors (such as price margins or fees)? There is also relatively little knowledge about whether limits on LTVs could significantly slow down house price appreciation and/or mortgage loan growth. Should measures affecting capitalization be complemented by non-price measures constraining lending standards? Can some of these macro-prudential policies be effective during housing booms when traditional monetary policy is typically too loose? Assessing such interactions and the transmission channel of macro-prudential instruments, with a specific focus on the real estate market, is important, as shocks to the real estate market have been a key source of systemic risk during the recent financial crisis.
The Euro-system Bank Lending Survey (BLS) contains information on overall changes in lending standards, or net tightening of lending standards and changes in lending standards related to non-price factors (LTVs, collateral requirements, maturity), price factors (such as margins) and factors contributing to the changes in lending standards, including balance sheet characteristics (such as capital and liquidity ratios) which can be mapped to specific macroprudential targets set by national regulators. However, identification of the impact of macro-prudential policies requires addressing specific challenges. The BLS does not require banks to specify the exact nature of the shocks that cause a change in lending standards or in the cost of capital, even though it provides information on perceptions of risks, economic activity, and competition pressures, and their contribution to the change. Hence, our approach is potentially subject to omitted variable bias, reverse causality and measurement bias (as expectations about house prices and credit growth may be mis-measured). Moreover, our observable variables (lending standard, and the contribution of balance sheet factors to lending standard) are not policy variables, which in our case are unobserved shocks affecting our observables. To address these issues, we develop methodologies relying upon instrumental variables and GMM estimators; our study also includes various control variables such as growth prospects, financial conditions, perception of risks and monetary policy cycle. Still, a potential advantage of our approach is that we would be able to capture the impact of the announcement of macro-prudential measures on lending standards, even before the actual implementation of the policy.
Our main findings are the following. First, our estimates suggest that measures that increase the cost of bank capital are effective in slowing down credit growth and house price appreciation. Second, changes in LTV also impact credit growth and house price appreciation but their impact tends to be more moderate. Third, macro-prudential policies affecting the cost of capital are transmitted mainly through price margins, with very little impact on LTV ratios or other non-price characteristics of mortgage loans. The evidence also suggests that tightening of LTVs is more effective in slowing down credit growth and house price appreciation when monetary policy is too loose.
Note: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.
