Calibrating macroprudential policy

Publication date: 29 Apr 2010 | Publication type: NIESR Discussion Paper | NIESR Author(s): Barrell, R; Davis, P; Liadze, I | External Author(s): Karim, D. | JEL Classification: C52, E58, G21 | NIESR Discussion Paper Number: 354

Policy proposals on the new international standards for bank capital and liquidity are being debated without any methodical evaluation of their effects on both crisis probabilities and concurrent social costs. Using data for 14 OECD economies for the years 1980 Ð 2007, we conduct a systematic evaluation of crisis determinants and find that bank capital adequacy, liquidity, the current account deficit and changes in house prices are the principal factors associated with OECD banking crises. There is no evidence of procyclical risks being generated by credit or GDP growth. We explicitly quantify the regulatory changes to capital and liquidity that would be required in each OECD economy over time in order to ensure systemic stability. We show that an international consensus on regulatory changes will generate 'winners' and 'losers' in terms of capital and liquidity adjustments, and we suggest that raising capital and liquidity by 4 percentage points of total assets across the board will reduce the average probability of a financial crisis to around 1%. Our results have important implications for the next generation of international banking regulations.

Keyword tags: 
macroprudential policy
bank regulation
early warning models of banking crises