Macroprudential Supervision in the Dominican Republic

Introduction

The recent economic crisis exposed the systemic vulnerabilities of the global financial system. Five years after the pinnacle of the crisis, the financial regulatory agenda is still unfinished due to a lack of consensus. One of the few points on which there is some agreement, is on the need to preserve global public goods: financial stability and the adequate functioning of international payment and settlement systems (Wolf, 2011). The recent trend is towards macroprudential regulation and supervision in order to preserve financial stability (IMF, 2013).

What is macro-prudential supervision?

In recent years, the macroprudential approach has dominated the international monetary and financial regulatory scenario (Galati & Moessner, 2011). Macroprudential supervision aims to preserve the stability of the entire financial system (FSB, IMF & Basel Committee, 2011). It differs from the microprudential perspective, which focuses on the safety and soundness of individual institutions. Professor Dr. Rosa Lastra uses the analogy of the forest and the trees. (Lastra, 2011). Supervisors should take into account the preservation of the forest (macroprudential approach) — even when this may involve sacrificing individual trees.

One of the great lessons of the recent crisis is that there are international financial institutions (banks and non-bank entities) of domestic and cross-border systemic importance. This was underscored by the collapse of Lehman Brothers and the bailout of international insurer AIG. Systemic importance means that the failure or the financial difficulties of one of such institutions can spread to other entities in the system. Systemic risk spills over quickly through various transmission channels-like the payments system and the derivatives market (Lastra, 2011). Eventually, it has the potential to spread from the financial economy to the real economy (in more than one country, causing financial instability. Financial instability can sclerotize economic growth, and can also reduce production and consumption of goods and services. Financial instability can also trigger a sovereign debt crisis.

The global interconnectedness of financial markets and the proliferation of cross-border financial and banking activities mean that systemic risk can also be exported across borders. The negative externalities that can result from the failure of a systemically important institution can spillover to other countries. Financial decalcification can also be imported (Tracthman, 2010).

The main standard-setting bodies for international financial regulation have focused on improving global financial stability. The two most important fora behind these reforms are the G20´s Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS). The FSB has published guidelines on the supervision of Global Systemically Important Financial Institutions (“G-SIFIs”). In October 2012, the BCBS published its Principles for the supervision of Domestic Systemically Important Banks (“D-SIBs”). Both forums have also published many papers developing the institutional frameworks for the implementation of macro-prudential supervision, on an international and a domestic level.

It is worthy to note that macroprudential supervision is different from consolidated supervision approach, which already exists in the Dominican monetary and financial regulations. The latter seeks to identify the risks that an associated company, within a financial group, can have on a financial intermediary of that same group. The macroprudential approach is interested in the bigger picture: the potential impact that the failure of any financial entity can have on the entire system.

Although the concept of macroprudential supervision seams fairly recent, the instruments and tools that have been identified for its implementation are not entirely innovative (Elliott et al., 2013). The macroprudential toolkit is made-up of instruments that have traditionally been used in other areas of economic policy.

The Dominican Republic needs to adopt a macroprudential supervisory approach in order to combat systemic risk. In the next post, I will discuss how to implement a custom-made macroprudential institutional arrangement for the Dominican Republic.

References

  • Basel committee on banking supervision (BCBS), “Marco Aplicable a los Bancos de Importancia Sistémica Local”, Octubre de 2012. Disponible en la Web en: http://www.bis.org/publ/bcbs233_es.pdf
  • Elliott, Douglas et al., “The History of Cyclical Macroprudential Policy in the United States”, Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs, Federal Reserve Board, Washington, D.C., WP 2013-29, May 15, 2013.
  • Financial stability board (FSB), international monetary fund (IMF) & Bank for International settlements (BPI), Macroprudential Policy Tools and Frameworks: Progress Report to G20”, 27 October, 2011.
  • Financial Stability Board (FSB), “Policy Measures to Address Systemically Important Financial Institutions”, November 4, 2011. Disponible en la Web en: http://www.financialstabilityboard.org/publications/r_111104bb.pdf
  • Galati, Gabriele and Richhild Moessner, “Macroprudential policy – a literature review”. Bank for International Settlements (BIS), Monetary and Economic Department, BIS Working Papers No. 337, February 2011.
  • International monetary fund (IMF) “Key aspects of macroprudential policy”. June 10, 2013.
  • Lastra, Rosa M., “Systemic risk, SIFIs and financial stability”, Capital Markets Law Journal, Vol. 6, No. 2, 2011, pp. 197-213.
  • Trachtman, Joel, “The International Law of Financial Crisis: Spillovers, Subsidiarity, Fragmentation and Cooperation”, J Int Economic Law (2010) 13 (3): 719 1 September 2010.
  • Wolf, Martin, “The World´s Hunger for Public Goods”, The Financial Times, 24 de Enero de 2012. Disponible en la Web en: http://www.ft.com/intl/cms/s/0/517e31c8-45bd-11e1-93f1-00144feabdc0.html#axzz2XbooyGiL
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