It requires instruments that impose tighter standards for individual institutions whose contribution to system-wide risk is larger, the so called Global Systemically Important Financial Institutions (G-SiFis), whose list was last updated by the Financial Stability Board (FSB) in November 2012. The second one, looks at how aggregate risk evolves over time. This requires the use of instruments that contribute to moderate the typical pro-cyclicality of the financial system. I will come to that later on, when commenting on the new Basel III capital framework. Before this, allow me to mention the Spanish experience with the so-called “dynamic” or “statistical provisions” which were introduced in 2000. This can be considered a pioneering case of a macroprudential response. The tool proved to be useful in Spain during the financial crisis in the two dimensions identified earlier: mitigating the build-up of risks – even if to a limited extent – and providing capacity of loss absorption to the banks. But the Spanish experience also showed that “dynamic provisions”, although, in my opinion, well targeted and designed, should have been complemented with other instruments. In order to develop and implement this new policy, the main developed economies have created new authorities in charge of macro-prudential supervision, such as the Financial Stability Oversight Council in the United States or the Bank of England’s Financial Policy Committee.
Conducting monetary policy was considered to be relatively straightforward: the central bank controlled the short-term interest rate with effects on the real economy, mainly through three channels: long-term interest rates, inflation expectations and asset prices. The credit channel of monetary policy was deemed weak; and the banking sector was ignored by most macroeconomic models used in Central Banks: banks were believed to work well and most market failures were attributed to product and factor markets. Financial markets were assumed to be efficient at distributing and pricing risk. Financial innovation was welcomed as it promoted gains in efficiency and welfare, leaving a reduced role for central banks on this area. One of the main implications of this consensus was that price stability was considered to be sufficient for macroeconomic stability. This led most Central Banks to limit themselves to a predominantly micro-prudential approach to regulation and supervision, focused mainly on the soundness of individual institutions. There was a certain neglect of the importance of the stability of the system as a whole. After the crisis In 2007, and especially after September 2008, the world was hit by a global financial crisis which not only produced the most severe worldwide economic contraction since the Great Depression, but also put into question our confidence on the “science of monetary policy”. It is probably still premature to identify the new model that will emerge from the crisis.