Macro prudential policies (MaPPs) have made a remarkable presence in almost every country’s manuscript of policies for financial stabilization. The wider realization of the resilient financial sector came when the 2007-09 financial crisis also known as the global financial crisis (GFC) sparked a great recession. The downturn of the subprime lending market and proliferated risk-taking without proper cushioning by BFI paved the path for the Great Recession which was later crowned with the bankruptcy of Lehman Brothers on September 15, 2008. This triggered an international financial crisis. Since

MaPPs have proved to be effective in mitigating the risk aroused by 2007-09 GFC. Since then, there has been a shift in focus from micro-prudential policies to macro-prudential policies without undermining the importance of macro-prudential policies. Ostry and others (2012) found macro prudential policies to be effective in strengthening the financial market from the global financial crisis. Similarly, Neanidis (2019) showed that comprehensive bank supervision diminishes the detriments of unstable capital flows on stable economic growth.

Does this mean macro prudential policies are the capsule solutions to the financial crisis? Of course, the application of these policies will result in a smoother financial system but these instruments are not exactly a copy-paste solution to cut and undo the risk situations. They can be tricky and needs scrupulous analysis on the part of policymakers.

A host of varying MaPPs instruments itself calls for due diligence and precision. MaPP instruments cannot be limited to be defined in some countable numbers probably because of the uniqueness of the crisis but over the years some instruments have been most frequently used and have scored the vote of confidence from policymakers and economists. Some of which are: Caps on the loan-to-value (LTV) ratio, Limits on maturity mismatch, Caps on the debt-to-income (DTI) ratio, Reserve requirements, Caps on foreign currency lending, Countercyclical capital requirements, Ceilings on credit or credit growth, Time-varying/dynamic provisioning Limits on net open currency positions/currency mismatch and Restrictions on profit distribution.

According to the diverse nature of the situation, these instruments call for using varying ways such as use of single or multiple instruments considering whether the risk is well defined from a single source or not, Use of Broad-based or Targeted framework based on the level of complexity, use of a fixed or time-varying schedule of application of these policies based on longevity of the crisis, application of rules or use of discretion based on risk management and supervision capacity.

MaPPs has its two sides just like a piece of paper irrespective of its thinness. Economists and researchers have come across a few side effects of MaPPs along with their positive results. Diminishing marginal return was evident in its dampening effect on the global financial shocks. The level of stringency of the application of macroprudential regulation in dampening the effects of global financial shocks is one important concern. A recent study by IMF has revealed that an increase in global risk aversion which in turn results in a decline of the inflow of foreign capital will reduce the economic growth of a country if the Macroprudential regulation is not sufficient enough to bolster the crisis aftermath. These risks can be less prominent if the country has an appropriate MaPPs framework in place. However, when the Macroprudential regulations are already prominent, further distending of the MaPP regulation may prove to be less effective in strengthening resilience. Excessive macro-prudential regulation may result in financial activities threatening the presence of regulatory perimeter and upshot of unwarranted financial activities.

Another factor is its correlation with monetary policy. The responsibility of the application of MaPPs is linked with central banks because they have the information and capacity to analyze systemic risk. Central banks also formulate monetary policies. So, naturally, the question arises on how the MaPPs impact the monetary policy to respond to crisis situation. An IMF working paper concluded that macro-prudential regulation allows monetary policy to respond more counter-cyclically to global financial shocks. MaPPs moderate concern about financial instability thus allowing monetary policy to focus solely on macroeconomic stabilization and growth. Even though the concern about negative spillover was negated a study from the IMF, some researchers raised concern about the possibility of macroprudential policies resulting in waterbed effects. These trepidations call for further analysis of the optimality of Macroprudential regulations for countries in numbing the consequences of the global financial crisis.

Nepal has also implemented macroprudential policies as a response to the ongoing financial stress caused by the pandemic Nepal Rashtriya Bank (NRB) dropped its cash reserve ratio from 4 to three percent and reduced the rate of interest on the standing liquidity facility rate from 6 to five percent. Banks are not required to realize a 2 percent countercyclical capital buffer that was due in July 2020. The Reporting norms were relaxed for a brief duration which made BFIs to not be penalized for non-compliance with regulatory and supervisory requirements in April. For banks meaning to lend at a concessional rate to priority sectors including small and mid-size enterprises suffering from the pandemic, the dimensions of the refinance fund were increased to supply subsidized funding. Banks also will defer loan repayments due in April and should until mid-July. Banks will extend the repayment schedule of the quantity due during the lockdown up to 60 days for capital loans. Businesses of affected sectors can qualify for extra capital loans of up to 10 percent of the approved amount of their existing capital loans, to be repaid within a year at the most. Banks were directed to use lower interest rates (up to 2 percentage points) when calculating the interest due for the amount of mid-April to mid-July, applicable to borrowers from affected sectors. a short-lived ban on luxury goods imports, like gold over 10 kg and vehicles worth over US$50 thousand on April 1 and can temporarily provide a minimum currency exchange facility to qualifying students abroad (less than US$500 per student). (Source: IMF policy Tracker)

In order to answer the question as to whether these macroprudential measures were sufficient to address the forthcoming uncharted economic crisis, let’s look at the possible risk of BFIs. Due to the COVID pandemic, depositors are naturally inclined to hold cash but the recent lack of investment opportunities could offset the risk of liquidity crisis but at the cost of economic growth. The prolonged delay in repayment of loans and mortgages installment can pose a risk of systemic failure, BFIs who have invested in those projects that could not be executed will suffer long term loss and also the possibility of the value of the assets against which the loan was approved might go down which will result in the disruption in the balance sheet. The reduction in remittance which has been the major source of foreign currency for over the years and the tourism sector is unable to yield foreign currency can cause duress in the foreign currency reserve especially when the Indian currency against which the Nepali currency is pegged is also facing severe depreciation.

The efforts and MaPP measures set forth by NRB efforts seem to be targeted in easing the liquidity crisis of the BFIs, reducing loan stress among borrowers, and maintaining or shielding from excessive deterioration of foreign currency reserve. But these actions definitely are short term oriented and considering the COVID pandemic to last for over a year, NRB surely needs to revamp these measures.

MaPP has a lot to offer to sustain the financial stability and help a country get through the vulnerabilities aroused from the uncharted economic crisis caused by the pandemic. Nepal like many other countries can succeed in offsetting the excruciating economic effects of COVID-19 through formulation and execution on MaPP framework with meticulous planning, proactive decision-making, diligence, and foresighted thinking.

 Account Officer 
 Financial Comptroller general Office, Ministry of Finance