By working together, we can ensure not only the smooth adoption of international standards, but also that our financial system will not be burdened by unnecessary rules and unintended consequences. 2  BIS central bankers’ speeches  The third direction is the emerging role of macroprudential regulation. The global financial crisis has shown that traditional or microprudential regulation which focuses on the safety and soundness of individual financial institutions fell short of crisis prevention. While financial institutions may be individually safe, collectively they may be at risk due to herd behaviors and their interconnections. There is thus the need to look after the safety and soundness of the financial system in the aggregate, which is why the word “macro” in macroprudential. In essence, macroprudential regulation reduces systemic risks by building up resilience of the financial system during periods of credit boom and rising leverage as well as limiting spillovers from interconnections of financial institutions. It is indeed easy to see that several aspects of Basel III are macroprudential in spirit such as the countercyclical capital buffer and the requirement of large global banks to hold more capital. It is noteworthy that even before the global financial crisis, central banks in the Asia Pacific have routinely used macroprudential tools such as the loan-to-value or LTV ratio and minimum income requirement for credit card borrowers. We just did not call them macroprudential. In some way, it took the West their own crisis to realize the importance of restraining the buildup of systemic risks early on.
Ladies and Gentlemen, The global financial crisis that erupted in 2008, or 2007 if you count the U.S. sub-prime crisis as its first incidence, has brought fundamental changes to how central banks approach economic and financial stability. In particular, the crisis has led to a general reorientation of central bank policies in three major directions. The first is the reorientation of monetary policy to take into account financial stability concerns. The second is the shift from “deregulation” to “re-regulation”. And the third is the supplementation of traditional microprudential regulation with macroprudential one. In the realm of monetary policy, the pre-crisis consensus was that the attainment of price stability, or low and stable inflation, was enough to ensure a smooth progress of the economy. While central banks were well aware that financial disruptions could have a serious negative impact on the economy, they were of a view that financial stability was the job of prudential regulation and that monetary policy should focus on inflation and output stabilization. The dichotomy between monetary policy and financial stability policy was well observed across the central banking community. Central banks like the Bank of Thailand, which also looks at financial imbalances when making monetary policy decisions, represented only a small minority before the crisis. The global financial crisis has prompted a fundamental rethinking of central banks’ monetary policy conduct. Now it is recognized that price stability alone does not guarantee economic and financial stability and that there exists an intricate relationship between monetary policy stance and financial stability.