By Edda Zoli
Booming real estate markets, rapid credit growth and—at least before the Fed’s tapering announcement last year—sustained capital inflows have raised financial stability challenges across many parts of Asia. To address them, policymakers have increasingly made use of macroprudential policies that address the stability of the financial system as a whole rather than that of individual institutions. In some cases they have also resorted to capital flow management measures to counter large capital inflows.
As new analysis in the IMF Asia and Pacific Department’s latest Regional Economic Outlook finds, macroprudential policies, especially measures related to the housing market, have helped mitigate the buildup of financial risks in Asia. In the event of sharp decreases in credit and asset prices going forward, however, it may become useful to ease certain of these measures to avoid excessive deleveraging.
Macroprudential policies more extensively used in Asia than elsewhere
While macroprudential measures have become more widespread around the world, Asia stands out. In particular, many economies in the region have been heavy users of housing‑related measures, especially caps on loan-to-value ratios (the ratio between the size of the mortgage loan and the value of the house being purchased). Indeed, since 2000 tightening of loan-to-value ratios has occurred more than twice as often in Asia as it has in Central and Eastern Europe/Community of Independent States, advanced Europe, and North America.
Likewise, while macroprudential policies have generally become more stringent over time in all regions, this has been most striking in Asia. They were most heavily tightened in the pre‑crisis boom period during 2006–07, and then again after the crisis as capital flowed back into the region and asset prices soared.
Economies that experienced large capital inflows or housing and credit booms (Hong Kong SAR, Korea, Singapore, and Thailand) were the heaviest users. By contrast, Asian economies, which have relatively less open financial accounts, have taken a smaller number of residency-based capital flow measures or actions to discourage transactions in foreign currency than countries in Central and Eastern Europe and Latin America.
Some of these measures had a measurable impact on asset prices and credit growth
New empirical evidence on 13 Asian economies since 2000 indicates that housing-related macroprudential instruments—particularly caps on loan-to-value ratios and the taxation of housing transactions—have helped lower credit growth, slow house price inflation, and dampen bank leverage in the region (although the latter effect is fairly small). And while no such effects are found for non-housing related macroprudential policies and capital flow measures, some of these policies may still have boosted resilience to shocks. For example, the measures introduced in Korea in 2010 to discourage foreign currency transactions have been followed by a decline in banks’ short-term foreign currency borrowing, thus reducing their vulnerability to foreign funding shocks. Overall, while macroprudential policies are no substitute for warranted macroeconomic policy adjustment, they seem to have served the region well.
Recalibrating macroprudential policies
Macroprudential policies have thus done their job of helping to mitigate the buildup of risks in the upward phase of the financial cycle. Looking ahead, the question that may arise is how they should be used in the event of asset price declines, slowing credit growth, and/or capital flow reversals further down the road.
Macroprudential policies were loosened in a counter-cyclical fashion during the 2008–09 global financial crisis. But more experience needs to be gained on whether and how these instruments should be recalibrated as the financial cycle turns. The main challenge for policymakers is to strike the right balance between preserving future resilience to shocks on the one side, and averting asset price collapses and excessive deleveraging on the other side.
The rolling back of policies may therefore ultimately depend on factors such as how acute is the downturn in the financial cycle and how strong are local balance sheets, and may vary across different measures. Accumulated capital buffers, for instance, would typically be used to avoid a procyclical contraction in loan supply. This would suggest a widespread adoption across Asia of countercyclical capital requirements and dynamic provisioning in the future could be helpful to foster the buildup of buffers in the upward phase of the cycle. In a downswing of the financial cycle, reserve requirements could also be lowered to release additional liquidity. Whether policymakers should ease housing-related tools and measures to discourage foreign currency transactions is more controversial. But where regulation is currently very tight, there may be a case for relaxing these instruments after assessing the soundness of banks’ and households’ balance sheets.