Thread by @CentralBankJA

BOJ invites comments on its recently published discussion paper on Macroprudential Policy Tools. The paper discusses macroprudential policy and effective implementation. This thread highlights the paper; for full details, read it here: bit.ly/39ux0JY
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2. Macroprudential policy entails the use of prudential actions to contain systemic risks, that if realized, would cause widespread implications for the overall financial system and the real economy.
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3. Effective macroprudential policy requires the ability to detect risk to financial system stability, the formulation and application of appropriate instruments, and the communication of such actions to relevant stakeholders and the public at large.

4. As part of its role in macroprudential oversight, BOJ intends to strengthen its ability to respond to threats to system stability by having the option of various macroprudential tools available.

5. As such, the Bank is now in the process of examining an initial set of macroprudential policy instruments to be used for the direct management of systemic risks.

6. The tools in question would include a countercyclical capital buffer, a capital buffer for systemically important financial institutions, and a time-varying loan-to-value limit plus a loan-to-income limit.

7. Experiences with various financial and economic crises highlighted the economic and financial costs associated with excessive leverage and interconnectedness of financial systems. Consequently, these crises have reinforced the need for robust macroprudential policy.

8. In 2010, the Basel Committee on Banking Supervision released the Basel III capital standards, in which the countercyclical capital buffer forms a part of the standards for risk-based capital.

9. This countercyclical capital buffer is a potentially powerful instrument for the reduction of systemic risk associated with cyclical financial developments.

10. Counter-cyclical capital tools allow for enhancement of a financial institution’s capital base above the prudential minimum requirement during periods of economic expansion, and then allows draw-downs on this surplus capital to help absorb losses during a downturn.

11. Although it sounds - and is - much more complicated in this context, the underlying principle is basic, and goes back to the age-old principle of saving for a proverbial rainy day.

12. It is within this context that BOJ proposes formalizing its ability to include a time-varying component of capital requirements - countercyclical capital buffers through regulatory adjustments.

13. Financial supervisors have taken a risk-based approach to prudential supervision that has required enhanced supervision for the largest entities.

14. BOJ proposes formalizing its ability to require additional prudential requirements when deemed necessary, for banks identified as a systemically important financial institution (SIFI).

15. Formalization of the role of the Financial System Stability Committee (FSSC) in monitoring risks and recommending macroprudential policy associated with SIFIs requires the FSSC to identify and list systemically important institutions on an annual basis.

16. The process will also involve amending legislation to designate systemically important financial institutions, allowing BOJ to apply additional requirements when deemed necessary.

17. Comments on the discussion paper can be submitted through September 30, 2020. Thank you for your kind attention!