An Overview of Macroprudential Policy and Countercyclical Capital Requirements

The recent severe financial crisis which led to the “Great Recession” represented a serious failure of economic management and financial regulation. Post mortem analysis of the crisis has brought to the fore a set of ideas for the use of “macroprudential” tools to improve regulation. This awkward term refers to an approach to financial regulation that fills the gap between conventional macroeconomic policy and traditional “prudential” (or “safety and soundness”) regulation of individual financial institutions. The concept is to manage factors that could endanger the financial system as a whole, even if they would not be obvious as serious threats when viewed in the context of any single institution. Risks that are common to many financial institutions simultaneously, such as excessive exposure to housing credit, can combine with a high degree of interconnections between financial institutions to create systemic risks even when each individual institution appears sound, absent the potential for financial contagion.

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