The Irish Central Bank is planning to impose macroprudential risk regulation on the domestic banking sector (see here). The general approach of the Irish Central Bank has been widely welcomed by economists, although the specifics of the proposals are controversial.
John Cotter (UCD) and I are planning a conference in September 2015 on macroprudential regulation, the fifth in our series of FMCC conferences on financial risk and regulation. Macroprudential regulation is fairly new, and there are many unanswered questions. Can macroprudential constraints on credit be reliably attuned with the business cycle and/or credit cycle? Are a-cyclical constraints on credit safer and more reliable than attempts at anti-cyclical ones? Should regulators take account of market imperfections, such as the poor performance of the Irish property development industry and the high costs of new housing construction in Ireland, in setting constraints on credit growth?
Macroprudential regulation has particular importance in Ireland, a small open economy buffeted by credit flows from bigger neighbours. The failure to impose macroprudential regulatory control on the Irish banking sector was a central cause of the Irish financial crisis of 2008-2011. During 2000-2007, within a flawed eurozone currency system, a politically-neutered Irish Central Bank ignored a runaway inflow of foreign credit into the Irish banking system. This massive credit inflow undermined the stability of the Irish financial system and led to the disastrous failure of the Irish domestic banking sector.
There is a varied range of views among economists on macroprudential regulation. This is clear in the responses to the Irish Central Bank’s policy discussion document. Three thoughtful responses come from David Duffy and Kieran McQuinn (both at ESRI) here, Ronan Lyons (TCD) here, and Karl Whelan (UCD) here. (For full disclosure, my own response to the Irish Central Bank discussion document is here.) Lyons recommends fixed, a-cyclical credit controls whereas Duffy and McQuinn argue for dynamic, anti-cyclical controls. Duffy and McQuinn stress the need for more new housing in light of fast Irish demographic growth, and the positive role of high housing prices (aided by bank credit growth) in eliciting an adequate supply response. Lyons argues that excessive bank credit growth should not be used as a hidden subsidy for a cost-inefficient building industry.
Lyons makes a case for no loan-to-income (LTI) constraint, instead relying only upon a loan-to-value (LTV) constraint for macroprudential credit control. This contrasts sharply with the view of Karl Whelan who argues for LTI-only macroprudential controls in the current Irish case. Duffy and McQuinn advocate for both controls. I share the view of Duffy and McQuinn. Lyons does not consider the importance of dual-trigger mortgage default in Ireland (that is, mortgage default which is triggered jointly by income stress and negative equity). The amount of Irish mortgage arrears is likely to remain large and volatile, and this is a key potential source of market instability. Both initial LTI and initial LTV ratios are linked to subsequent mortgage default probabilities, so both should be controlled.
There are certainly many points for discussion, which should make for an interesting conference! A formal Call for Papers will follow shortly – if there are particular themes or panels that we should include, feel free to mention them in the comments thread below.