What has macropru ever done for you? Macropru announcements can lead to a substantial reduction in systemic risk – Bank Underground

Kristina Bluwstein and Alba Patozi

Measuring financial stability is very difficult. Measuring the effectiveness of policies affecting financial stability even more so. Not only is the objective of financial stability an elusive concept, but policies targeting financial stability are often complex, technical, and very slowly implemented. In spite of this, the usage of macroprudential tools in both advanced economies (AEs) and emerging market economies (EMEs) has more than tripled (Chart 1) over the last 30 years. Communications about these tools have also sharply increased from almost non-existent pre-GFC to hundreds of speeches per year (Chart 2). In a recent working paper, we try to estimate the effect of these macroprudential policy announcements on financial stability in the UK by constructing a novel series of unexpected announcements and measuring their effect on systemic risk in the financial sector.

For that purpose, we borrow from the monetary policy literature and use a high-frequency identification strategy to find truly ‘unanticipated’ macroprudential announcements and evaluate their effect on systemic risk – a key financial stability measure. Systemic risk refers to the potential for disruptions in the financial system to spread broadly, threatening overall economic and financial stability. We find that macroprudential announcements have a sizeable and significant impact on reducing systemic risk. The effect is not confined to the financial equity markets but also spills over to the non-financial equity markets and has a sizeable impact on bond markets.

We construct our own database of macropru announcements based on 44 UK specific and international announcements from 2009–19. These announcements include a wide all-encompassing range from capital tools, leverage constraints, housing tools to liquidity tools (see Chart 3).

Chart 3: Number of macroprudential policy announcements by instrument type

However, how can we find ‘unanticipated’ macropru announcements? As many macropru policies react to financial conditions, forward-looking market participants would likely price in any expected changes in the macropru stance, even before any announcement is officially made. Similarly, given macropru policy is typically implemented over an extended period of time, disentangling its effects from other simultaneous factors and policies can be quite challenging. In the monetary policy literature, high-frequency identification techniques using interest rate futures have allowed researchers to circumvent these problems (Kuttner (2001), Gürkaynak et al (2005), Gertler and Karadi (2015), Nakamura and Steinsson (2018), Jarocinski and Karadi (2020), Braun et al (2024)). However, unlike with monetary policy, there are no financial instruments that trade based on the stance of macroprudential policy.

Nonetheless, to the extent that some of the macropru announcements in our data set are unanticipated, they would be expected to affect UK bank equity prices, which are closely related to expected bank profitability. In this vein, we test which of the 44 macroprudential announcements we collected were truly unanticipated. We do so by conducting a daily event study on the equity prices of the 6 largest UK banks. If the cumulative average equity returns around the announcement window were abnormal, we classify them as being caused by an unanticipated macropru shock. Tightening would correspond to negative abnormal returns, assuming markets perceive banks to be less profitable in the near term, while a loosening would be perceived as positive. In this vein, our shock series would take a value of 1 for announcements perceived to be tighter than expected, -1 for announcements that were looser than expected and zero otherwise. This leaves us with 19 out of 44 unanticipated announcements. Once we filter out any confounding events – that have taken place on the same date but are not of a macroprudential policy nature – we are left with 8 ‘clean’ unanticipated shocks.

Armed with this clean macropru shock series, we want to investigate their effect on systemic risk. We use the Composite Indicator of Systemic Stress (CISS) by Hollo et al (2012), which is a market-based measure of systemic risk that incorporates risks and interlinkages within different segments of financial markets. The CISS is constructed by aggregating stress indicators (such as return volatilities and credit spreads) from five key financial market segments – bond, money, foreign exchange, equity financials and non-financials – using time-varying correlations to capture systemic interactions. A higher CISS value reflects greater market uncertainty about future fundamentals and an increased likelihood of systemic instability. Regressing our shock series against the daily UK CISS (and controlling for various other variables like exchange rates, gilt yields, policy uncertainty) shows that the effect of a macropru shock is not only significant but also quite sizeable. A tighter than expected macropru announcement reduces systemic risk by around 0.5 standard deviations at its peak. As a point of reference, CISS in the UK increased by around 3 standard deviations at the height of the Great Financial Crisis. As shows, it takes roughly 30 days for the peak effect to crystallise – reflecting enough time for markets to digest the news and respond to the perceived reduction in banks’ riskiness.

Chart 4: The effect of macroprudential policy announcements on systemic risk

Moreover, the advantage of using the CISS is that it allows to decompose this result into five subcategories: systemic risk in money markets, FOREX, bond markets, and financial and non-financial equity markets. Unsurprisingly, financial equity markets, as well as bond markets respond strongly to macropru announcements given how macropru directly affects the riskiness of UK’s regulated financial institutions. Interestingly, this spills over to non-financial equity markets, indicating that macropru indeed helps to reduce risk in the whole financial system and does not just affect the banking sector.

Overall, it is good news for policy makers: while macropru can often be perceived as making banks less profitable in the near term by imposing tighter restrictions on them, markets do realise that it ultimately alleviates systemic risk in financial markets. Macropru indeed works as intended.

Kristina Bluwstein and Alba Patozi work in the Bank’s Monetary and Financial Conditions Division.

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