The euro and us: Macroprudential policy in the euro area and beyond
In this blog article from our series “The euro and us”, we focus on macroprudential policy in euro candidate countries, which – alongside monetary and fiscal policy – is an important part of economic policy. In this instalment, we will first briefly describe the main parameters and importance of macroprudential policy. We will then outline the main changes in the functioning of macroprudential policy after a country joins the euro area.
The 21st century has seen the emergence of macroprudential policy (MaP). The Basel-based Bank for International Settlements (BIS) spearheaded the development of MaP at the start of the new millennium. The collapse of Lehman Brothers in 2008 and the subsequent Global Financial Crisis and its aftermath confirmed the realisation that the supervision of individual banks alone may not guarantee the stability of the banking and financial system as a whole.[1] This recognition, heightened by the debt crisis experienced by some European countries in 2010–2013, led to the creation of a European Systemic Risk Board (ESRB)[2] mandated to oversee the EU financial system as a whole and to contribute to the prevention and mitigation of systemic risk in the EU. The legislative foundations of macroprudential policy (MaP) were incorporated into the capital regulation of banks[3] (CRD/CRR) at the European level in 2014. A visible step forward on the practical level was the publication of the ESRB handbook on operationalising macroprudential policy in the banking sector.[4] In individual EU countries, MaP is implemented by the national competent authority, most often the central bank.[5] The national competent authority in the Czech Republic is the Czech National Bank.[6]
Another important milestone for euro area countries – one that is only indirectly related to the development of MaP – was the creation of the banking union. It was established to strengthen long-term financial stability, i.e. to ensure that the banking sector across the euro area – and in EU countries that join it – is stable, safe and reliable thanks to single regulation and minimal internal barriers. This was the European Council’s rationale for creating the banking union. However, the union can be regarded as a pragmatic institutional response by the euro area to the debt crisis and the interconnectedness of its banks and government debts, as well as a reaction to the events following the Global Financial Crisis. In its final phase, the banking union should be based on three pillars: (i) the Single Supervisory Mechanism and (ii) the Single Resolution Mechanism (SRM), both of which are already operational, and (iii) a European deposit insurance scheme, which is still currently under discussion, with no agreement on its final form yet in sight. A non-euro area Member State may also join the banking union even if it is not joining the euro area in the near future. However, an EU Member State cannot become part of the euro area without joining the banking union.
MaP has firmly secured its place among economic policies at both the European and national levels. MaP involves applying instruments to reduce the vulnerability (or increase the resilience) of the financial system by containing the risks that individual financial institutions or the links between them may create for the system as a whole. In this way, MaP ensures the stability of the financial system, which is a precondition for the successful long-term development of the economy. MaP effectively complements national fiscal and monetary policy – whether conducted by the ECB for the euro area countries or by national central banks – especially where the two policies create or increase risks to financial stability. MaP is most active when these policies are not, or cannot be, optimally coordinated for various reasons and are suboptimal for the country in terms of risks to financial stability. While the combination of too loose (expansionary) or loose for too long monetary and fiscal policies can lead to overleveraging and asset price bubbles, too tight (restrictive) or tight for too long policies undermine economic growth and can cause economic agents to fail.
The importance of MaP in a euro candidate country may increase when it joins the euro area. The current euro area does not fully align with the ideal parameters of an optimum currency area as envisioned by its intellectual father, Robert Mundell, and his followers.[7] The risk of suboptimal monetary policy may thus be higher. In other words, the ECB’s monetary policy stance may not be fully suited to all the euro area countries in terms of risks to financial stability. The euro area is suboptimal as a monetary area because the structures of its individual economies differ and their business cycles are therefore not perfectly aligned (the alignment is greater within certain groups of countries, such as the industrial nations of the euro area). This is logical in a sense, as the likelihood of there being significant differences between countries increases with an increasing number of monetary union members. The less aligned business cycle and the response to “asymmetric shocks” (shocks that are positive for one economy and negative for another) complicate the conduct of ECB monetary policy, even though that policy is set on the basis of data for the euro area as a whole, not for the individual Member States. The fiscal policy of a euro area Member State can play quite an important role in mitigating the impacts of asymmetric shocks on that country and correcting negative side effects of the common monetary policy stance. Alongside fiscal policy, MaP can also help reduce the impacts by adjusting its tools appropriately to mitigate a suboptimal monetary policy stance.
What tools does MaP have? The first category contains instruments governed by European legislation, mostly macroprudential capital buffers. The second consists of instruments governed by national legislation,[8] including, for example, borrower-based measures. Let’s review them in brief.
Macroprudential capital tools comprise four or five types of capital buffers[9] (see Figure 1). The capital conservation buffer (CCoB) is generally used to preserve banks’ capital for covering risks that are difficult to measure and identify. Another tool is the countercyclical capital buffer (CCyB), which is used to mitigate systemic risks arising in the growth phase of the financial cycle. It is applied during periods when banks take on increased credit risk in their balance sheets and is typically not released fully until significant credit losses occur. The systemic risk buffer (SyRB) is used to mitigate longer-term structural systemic risks. This buffer can be applied on either a general or a sectoral basis and is released depending on the level of structural risks identified. The capital buffer for other systemically important institutions (O-SIIs) is used to mitigate the risk of moral hazard and problems in banks that are systemically important to the economy. If a bank is designated as a global systemically important institution (G-SII), a G-SII buffer is used to mitigate similar risks. Both the O-SII and G-SII buffers are applied on an individual basis and are adjusted as the bank’s significance in the financial system changes (through mergers and acquisitions or significant growth/decline in market share). When both buffers are set, the bank is required to maintain “only” the higher of the two.
Figure 1 – Structure of capital requirements under European legislation
Note: The combined capital buffer generally represents the sum of the capital buffers required of a bank. The CCyB and CCoB apply to all banks. The SyRB can be applied to either all or part of the banking sector. The O-SII, G-SII and Pillar 2 buffer requirements are applied individually.
How are EU countries currently using capital buffers? There is some heterogeneity in the use of capital buffers, stemming from differences in the structure of financial sectors and the evolution of financial cycles, or a preference for using other macroprudential tools. As of June 2024, the total capital buffer requirement (the “combined capital buffer”) for banks ranged from 2.5% to 8.5% across EU countries (see Chart 1). The minimum buffer requirement of 2.5% – corresponding to maintaining the CCoB “only” – applies to systemically insignificant banks in nine countries. The lowest buffers are applied in Portugal, followed by Greece and Spain. By contrast, the highest buffers of 8.5% are maintained by banks in Bulgaria and Sweden, followed by 8% in Denmark and Croatia. All countries have an O-SII buffer, while four also apply a G-SII buffer. As of June 2024, eight countries were not applying a positive rate for releasable buffers (CCyB or SyRB).[10]
Chart 1 – Capital buffers in EU countries
(individual buffers in pp; combined capital buffer in %; as of 30 June 2024)
Note: The columns represent the maximum selected buffer rate applied by the country. The minimum combined capital buffer is the minimum sum of the buffer rates required of selected banks in the country. The maximum combined capital buffer is the maximum sum of the buffer rates required of selected banks in the country. The required rate for individual banks varies within the range of the minimum and maximum values depending on their systemic importance. Where the G-SII and O-SII buffers are applied simultaneously, “only” the higher of the two is required of the bank, not both. The SyRB in this chart does not include the sectoral SyRB.
Source: ESRB
Other instruments in the common European legislation that can be used to mitigate macroprudential or systemic risk include the sectoral systemic risk buffer (sSyRB) and the application of stricter prudential requirements concerning, for example, risk weights, own funds and liquidity.[11] Countries generally opt to cover risks that do not affect the system as a whole but are specific to certain types of exposures by applying stricter risk weight requirements or using the sSyRB. This most commonly involves systemic risks associated with exposures secured by residential or commercial property (see Chart 2).
Chart 2 – Other macroprudential instruments applied by EU countries under European legislation
(as of 30 June 2024)
Note: The column indicates whether the instrument was being applied in the country on the given date. sSyRB is the sectoral capital buffer to cover systemic risk. RW stands for risk weight. “Other” reflects exposures other than those secured by property. Property refers to residential and/or commercial property.
Source: ESRB
Borrower-based measures are used relatively widely as macroprudential tools in euro area and euro candidate countries (see Chart 3). These measures include upper limits on the loan-to-value (LTV) ratio, the loan-to-income (LTI) ratio, the debt service-to-income (DSTI) ratio and the debt-to-income (DTI) ratio. Required caps on these ratios were included among macroprudential instruments by the ESRB.[12] Borrower-based measures are used on top of the instruments contained in CRD. Each EU country may set rules for their use at its discretion in its national legislation.[13] The instruments are focused on systemic risks associated with the residential property market and housing loans. Countries across the entire EU are addressing this risk quite intensively, as these loans form the largest credit portfolio of the banking sector in many countries.
Chart 3 – Macroprudential tools applied to limit consumer loans secured by residential property
Note: The columns show the types of instruments the individual countries have used since 2013 or plan to use in the near future. “Other restrictions” include limits on the loan term and tests of households' sensitivity to interest rate increases.
Source: ESRB
So how is MaP conducted if a country is outside or inside the euro area and the banking union?[14] Whether a country is part of the banking union or not, its national competent authority may set capital buffers for banks or apply any other of the above-mentioned tools aimed at addressing systemic or macroprudential risks. The various reporting and information duties and approval processes set out in European legislation are also the same for all countries, whether they concern their relationship to the ESRB, the European Commission and other international institutions or to each other. National competent authorities work together across all EU countries. Their representatives meet “at the ESRB” several times a year to discuss and assess risks to financial stability at the EU level. The ESRB can issue recommendations[15] or warnings[16] to individual Member States or the EU as a whole when systemic risks to financial stability are identified in individual countries or in the EU-wide financial system. It then expects an appropriate policy response. In this respect, MaP authorities in countries inside and outside the banking union and the euro area all have the same powers.
Before deciding to apply a macroprudential instrument under CRR/CRD, countries in the banking union are required to notify the ECB – the banking union institution performing prudential supervision of significant credit institutions in the euro area – and to consider any of its objections. However, this required cooperation between micro- and macroprudential authorities does not constitute a major change for a euro candidate country. The CNB applies a similar procedure. Before the CNB Bank Board decides to set a macroprudential instrument, the CNB’s Financial Market Supervision Department and Financial Stability Department exchange information and consult each other. It is very important that they discuss whether the systemic risk identified is already being mitigated by an existing measure or whether the proposed measure is the most appropriate. This is done mainly to make prudential policies as efficient and effective as possible. The same applies generally to countries both outside and inside the euro area.
This can be explained using the example of the application of a capital buffer and Pillar 2 (see Figure 1). Before deciding to apply a capital buffer, the CNB takes into account the extent to which systemic risks are covered by banks’ Pillar 1 and Pillar 2 capital. The Pillar 2 capital add-on is determined by the CNB’s microprudential supervisors. If the Czech Republic joined the banking union, the ECB would take over microprudential supervision of the bulk of the domestic banking sector and start to set Pillar 2 requirements for significant banks.[17] The CNB would thus enter into direct interaction with the ECB in conducting MaP. The CNB’s supervisors would continue to apply a Pillar 2 requirement for domestic banks with a low level of systemic importance and the existing close microprudential and macroprudential policy cooperation inside the CNB would continue.
The ECB can change the MaP stance in member countries of the banking union.[18] The ECB may apply higher capital buffer requirements or more stringent measures to address systemic or macroprudential risks under CRR/CRD than applied by the national competent authority at a given moment. The Governing Council of the ECB is responsible for taking macroprudential decisions. The ECB cannot change the configuration of macroprudential instruments governed by national legislation. This applies in particular to the application of borrower-based measures. In other words, the ECB may tighten some macroprudential policy settings for banking union members, but it cannot ease them.
The national authority and the ECB should not come into “conflict”, as they have a common general goal: a stable financial system. The fact that the ECB can set tighter MaP for a banking union member does not, of course, mean it will do so in “about us, without us” style and hence, for example, put credit institutions in the country concerned at a competitive disadvantage. First, no ECB measure, proposal or policy may directly or indirectly discriminate against any Member State. Second, the ECB must cooperate closely in good faith with the national authority, exchange information with it, take into account the specific situation of the financial system, the economic situation and the economic and financial cycle in the country or part thereof, and, before taking a decision, duly consider any objections raised by that authority. Third, the national authority itself can propose to the ECB to act if it needs to address the specific situation of the financial system and the economy in its country.
How are financial stability aspects taken into account in monetary policy deliberations in the euro area? As the ECB points out in its strategy, its monetary policy takes account of financial stability and the MaP stance. Financial stability is a precondition for price stability and vice versa. Monetary policy and MaP operate through common transmission channels and the scope for policy interaction is wide. However, the ECB adds that its monetary policy is not and cannot be responsible for guaranteeing financial stability in every single Member State. MaP and microprudential supervision are the first line of defence in ensuring financial stability. The ECB monitors risks to the financial stability of the euro area as a whole[19] and cannot take the financial cycle and financial stability situation of only one specific country into account when setting monetary policy. For various reasons, financial cycles are not fully synchronous across euro area countries, nor are the risks to their financial stability homogeneous over time. In other words, the ECB does not conduct a systematic policy of “leaning against the wind” (whereby monetary policy is systematically tightened when systemic risk to financial stability builds up) or of “cleaning” (whereby monetary policy is systematically loosened when systemic risk materialises). Rather, it follows a flexible approach. It considers risks to financial stability in its monetary policy decisions, whenever this is relevant to safeguarding and maintaining medium-term price stability in the euro area (and to countering the risk of significant impairments to the monetary policy transmission mechanism[20]).
What does this mean on the practical level? At its meetings, the ECB’s Governing Council has at its disposal a set of financial indicators and analyses to assess the risk of vulnerabilities in the euro area financial system and their implications for the economy and inflation in the euro area over the medium term. In addition, it discusses and evaluates the extent to which the MaP stance and microprudential supervision mitigate, or can mitigate, risks identified across euro area countries. At the CNB, too, the financial cycle and the potential build-up of vulnerabilities – though primarily in the Czech financial system – are discussed and assessed in the monetary policy decision-making process. In addition to a range of financial indicators and analyses, the Bank Board has at its disposal an opinion prepared by the Financial Stability Department analysing the short- to medium-term implications of the CNB’s monetary policy stance as regards risks to financial stability. This also works in the opposite direction. The Monetary Department provides an opinion on the risks to price stability in the CNB’s MaP decision-making process. This would be less the case if the Czech Republic joined the euro area. The country’s financial stability and the phase of its financial cycle would be taken into account in the broader context of the situation in the euro area. We can therefore assume that, in certain circumstances, the ECB’s monetary policy stance could also give rise to a risk of growth in the vulnerability of the Czech financial system. However, the CNB would certainly respond to this using MaP.
How to sum all this up? As we know, the ECB sets its monetary policy instruments based on aggregate data for the euro area, while the Member States determine their national economic policy mixes individually using other policies to respond appropriately to their economic situation. If a country joins the euro area and the banking union, this logically results in national MaP becoming closely linked with the functioning of the euro area. However, the country retains its sovereignty in setting MaP instruments. As in the case of fiscal policy, this enables it to respond to the potential impacts of different or contrary factors (asymmetric shocks) affecting individual member countries or to a suboptimal single monetary policy stance.[21] In one of the next instalments in our series, we will therefore focus in more detail on the main reasons for the different use of macroprudential instruments across euro area Member States.
Libor Holub – Czech National Bank (libor.holub@cnb.cz), Luboš Komárek – Czech National Bank (lubos.komarek@cnb.cz) and the Faculty of Social Sciences at Charles University, where he lectures on European economic integration and European economic policies, and Zlatuše Komárková – Czech National Bank (zlatuse.komarkova@cnb.cz). The views expressed in this article are those of the authors and do not necessarily reflect the official position of the Czech National Bank.
References:
CNB (2020): The CNB’s Macroprudential Policy Strategy.
ECB (2024): Financial Stability Review.
ESRB (2018): The ESRB handbook on operationalising macroprudential policy in the banking sector.
Komárek, L. (2024a): The euro and us: A few notes on 25 years of the euro area, cnBlog (forthcoming in English).
Komárek, L. (2024b): The euro and us: ERM II and joining the banking union, cnBlog (forthcoming in English).
[1] Section 6.2 of the Opinion of the European Economic and Social Committee on the Report of the de Larosière Group, European Commission (2012): High-level expert group on reforming the structure of the EU banking sector.
[2] Regulation (EU) No 1092/2010 of the European Parliament and of the Council on European Union macro-prudential oversight of the financial system and establishing a European Systemic Risk Board.
[3] The banking sector dominates the financial system across EU countries. However, given the significant role of non-bank financial institutions in some EU countries, MaP has recently been expanding into this part of the financial system as well, primarily to address the systemic risks of investment funds.
[4] The ESRB handbook on operationalising macroprudential policy in the banking sector.
[5] The task of conducting MaP at the national level is usually conferred on the central bank. However, there are also instances where MaP decisions are taken by another national institution or by the Ministry of Finance. The term “designated authority” is often used in this context. This refers to the national institution’s power to set capital buffer rates (for example, the CCyB rate; see Article 136 of Directive 2013/36/EU).
[6] The CNB’s Macroprudential Policy Strategy.
[7] See Komárek (2024a).
[8] Countries also use other macroprudential tools under national legislation, often in the area of liquidity risk.
[9] Chapter 4 of Directive 2013/36/EU of the European Parliament and of the Council on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms.
[10] The designated national authority is responsible for regularly reviewing the CCyB and SyRB rates. In the event of the economic situation worsening substantially and significant unexpected losses forming in the banking sector, these two buffers can be fully released to support uninterrupted lending to the real economy.
[11] Article 458 of Regulation (EU) No 575/2013 of 26 June 2013 of the European Parliament and of the Council on prudential requirements for credit institutions and investment firms.
[12] ESRB recommendation on intermediate objectives and instruments of macro-prudential policy (ESRB/2013/1).
[13] In the Czech Republic, the rules are laid down in Articles 45a to 45c of Act 6/1993 on the CNB and Decree No. 399 on credit ratios. The latest review of the effectiveness of the EU macroprudential framework recommended incorporating their use into EU legislation. The future incorporation of the indicators into EU legislation should be at a general level and should not lead to any fundamental change in national legislation.
[14] A country that is in the euro area is simultaneously part of the banking union, so microprudential supervision of significant banks operating in that country is carried out by the ECB. However, an EU country can join the banking union without adopting the euro as its currency; see Komárek (2024b). In such case, microprudential supervision of significant institutions in that country is also performed by the ECB.
[15] https://www.esrb.europa.eu/mppa/recommendations/html/index.en.html.
[16] https://www.esrb.europa.eu/mppa/warnings/html/index.en.html.
[17] The group of significant banks comprises commercial banks operating in a euro candidate country that meet the criteria of size, economic importance, significance of cross-border activities, receipt of past direct public financial assistance and national significance. Article 6 of Council Regulation (EU) No 1024/2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions.
[18] Article 5 of Council Regulation (EU) No 1024/2013 conferring specific tasks on the European Central Bank concerning policies relating to the prudential supervision of credit institutions.
[19] See, for example, the Financial Stability Review.
[20] Impairments to the monetary policy transmission mechanism usually occur during financial crises, which are preceded by a longer-term build-up of financial imbalances linked with an increase in the vulnerability of economic agents across the financial market. MaP, supervisory policy and an optimal regulatory framework for financial institutions should prevent systemic crises, in particular by increasing the resilience of the financial sector. However, they have their limitations in the different phases of the cycle. One such limitation is the unfinished macroprudential framework for non-bank financial intermediaries.
[21] The conduct of MaP and other economic policies may also be affected by the fact that a country switches to using a single reserve currency when it joins the euro area. This is likely to lead to some adjustment of the financial system and of individual financial institutions in a euro candidate country.