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by Dr.

María J. Nieto


The present financial crisis, whose epicenter was in the most sophisticated financial markets in the United States and the European Union (EU), has tested the national and international preparedness to deal with financial instability.1 In their quest to ensure financial stability, governments launched bail-outs that have been costly for taxpayers and have prompted policymakers to review a wide range of policy areas including monetary policy, prudential supervision and resolution of failed financial institutions. In this context, central banks´ macro prudential policy has attracted particular attention. Although the theoretical and empirical literature is still in its very early stages, there is a consensus among policymakers that the main objective of macroprudential policy is to reduce systemic risk and enable the continuous functioning of the financial system, without costly bail-outs for taxpayers. In contrast to microprudential policy, macroprudential policy takes into consideration risk factors that go beyond individual financial institutions, including shock correlations and interactions between institutions in their response to shocks. The macroprudential approach relies on the notion that “risk” is endogenous.

For the purpose of this paper, systemic risk is defined as the risk of a widespread crisis in the financial system. Other definitions also highlight the impact on the real economy. IMF/BIS/FSB (2009) define systemic risk as “a risk of disruption to financial services that is (i) caused by an impairment of all parts of the financial system and (ii) has the potential to have serious negative consequences for the real economy.” Systemic risk is a negative externality that policymakers need to tackle via macroprudential regulation.

The only recent academic and policy literature on the operational framework of macroprudential policy has focused on crisis prevention and not on crisis management (Borio and Drehman, 2009). The present paper challenges Borio and Drehman´s view that crisis management policies are not pre-emptive in their orientation and are relevant only when the crisis has unfolded. Their view neglects the preventive policy aspects of failed bank resolutions that aim at minimizing the aggregate credit and liquidity losses to the financial system by allowing markets to continue functioning. Supervisors´ prompt corrective policy together with banks´ mandatory contingent convertible bonds and a credible resolution regime if an institution is clearly insolvent, and ideally combined with bail-in approaches, contribute to preserving not only financial stability but also the information content of market signals.

This paper focuses on market discipline as a necessary condition to preserve the signaling content of balance sheet indicators and market prices as macroprudential tools. It argues that market discipline enhances the information content of market prices by reflecting the expected private cost of financial distress, including the systemic importance of particular firms. This paper also argues that three conditions are necessary for market discipline to be effective: adequate and timely information on financial institutions´ risk profiles; financial institutions´ creditors must consider themselves at risk; and the reaction to market signals needs to be observable. The analysis relies on the existing financial literature and it is … http://www.bde.es/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosOcasionales/12/Fich/do1202e.pdf




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