Kristin Forbes | Macro Paper Warehouse

Macroprudential FX regulations: Shifting the snowbanks of FX vulnerability?

Borrowing in a foreign currency exposes an economy to sudden stops, sharp depreciations and banking crises, and constrains what monetary policy and the exchange rate can do; so a growing number of countries regulate how much foreign currency (FX) exposure their banks may carry. This paper asks two questions about those rules – do they work, and do they merely move the risk – and answers both, with a model first and then a purpose-built dataset. The model extends Holmstrom and Tirole (1997) by adding a currency dimension: banks can pay to screen borrowers and so distinguish unproductive, low-productivity and high-productivity firms, while market investors “can only lend indiscriminately”; FX funding is cheaper than domestic-currency funding but carries exchange rate risk, and when the domestic currency depreciates low-productivity firms and their banks default. Tightening FX regulation raises banks’ FX funding cost (if liability-side) or the lending rate they charge (if asset-side), banks stop lending to low-productivity firms, and those firms shift part of their FX borrowing to investors – so total factor productivity falls and the welfare effect is explicitly ambiguous, trading the reduced social cost of bank failure after depreciations against the output cost of a less efficient allocation of FX credit. Four testable predictions follow: banks borrow and lend less in FX with no change in domestic-currency borrowing; some firms shift to FX borrowing from market investors with no increase in non-FX borrowing by firms or banks; banks’ exchange rate exposure falls significantly; and firms’ exposure falls moderately, by less than banks’. The empirical test uses a new dataset assembled from four existing sources covering 132 tightenings or loosenings of macroprudential FX regulation across 48 countries (17 advanced, 31 emerging) from 1995 to 2014, with reserve-issuing economies and most offshore centres excluded, run against quarterly BIS banking and international debt statistics over 1996Q1-2014Q4 in panels with country and global-time fixed effects. All four predictions are borne out. Cross-border FX loans to banks fall by 0.50 to 0.66 percent of GDP over the following year – about a third of the sample median of 1.9 percent of GDP, and more than half for countries such as Brazil and Indonesia – with no significant change in banks’ non-FX borrowing. Corporate international FX debt issuance rises by 0.05 to 0.06 percent of GDP, roughly 10 percent of median annual FX issuance overall and 15 to 20 percent for Brazil and Indonesia, with no significant change in corporate non-FX issuance or in bank issuance in any currency. Comparing the two, about 10 percent of the FX exposure withdrawn from banks reappears as corporate debt issuance, rising to 16 percent when only liability-side measures are used. On resilience, a one percentage point depreciation cuts financial-sector stock returns by 1.46 percentage points when the regulatory stance is neutral but only 0.67 points when FX regulations have been tightened; for the broad market index the corresponding fall is from 1.18 to 0.75 points, and the interaction is statistically significant at 5 percent only for banks. The authors are explicit about what this does not settle: the data miss FX exposure that never crosses a border, third-country transactions, and hedging of any kind, and the paper “does not provide a full cost-benefit calculation of the impact of macroprudential regulations.”

Quantitative Tightening Around the Globe: What Have We Learned?

Drawing on the recent experience of seven advanced-economy central banks (Australia, Canada, the euro area, New Zealand, Sweden, the UK and the US), this paper offers the first cross-country assessment of quantitative tightening (QT) — the unwinding of bond holdings accumulated under quantitative easing. In an event study that pools QT announcements across countries and over time while controlling for policy-rate surprises and economic data surprises, the authors estimate that a QT announcement corresponds to a small but significant increase of about 4–8 basis points in government bond yields at horizons of one year and longer, with an effect of about zero at three months; aggregating announcements by country over 2021–2023 gives cumulative increases in yields averaging roughly 20–26 bps, with substantial heterogeneity across countries — from no impact up to about 69 bps for the UK. These effects are larger for “Main Announcements” carrying concrete program details, for active bond sales than for passive run-off, and when the program involves government bonds; estimated effects on equity indices, exchange rates, financial conditions indices and inflation compensation point in the direction of tighter financial conditions but are usually statistically insignificant, the noteworthy exceptions being a significant decline in corporate bond indices and in the government bond “convenience yield.” Implementing QT shows no significant pricing effect for government bonds on the narrow implementation dates — including no difference between securities actively sold and comparable securities not sold on the same date — but over time is consistent with a significant reduction in banking-system liquidity balances, a modest rise in overnight funding spreads, and a decline in the convenience yield, while the authors find no evidence that QT has directly worsened government bond market liquidity or weakened auction demand. As central banks stepped back, domestic nonbank investors absorbed an important share of the shift — in the US, the “households” category (which includes hedge funds) has been a particularly important replacement for the Fed’s unwind. The authors explicitly caution against a causal interpretation and stress that almost all these episodes occurred during the unusual post-pandemic recovery alongside aggressive rate hikes, rest on limited observations, and may understate the true impact; on their reading QT has had more of an impact than watching “paint dry,” but far less than simply reversing the effects of QE programs launched during periods of market stress.

Spillovers at the extremes: The macroprudential stance and vulnerability to the global financial cycle

The existing evidence says macroprudential regulation does little to portfolio capital flows; this paper argues that finding is an artefact of looking only at averages. It links two literatures – one on the leakages and spillovers from macroprudential policy, one on extreme events in capital flows – and asks whether a country’s ex-ante macroprudential stance changes how sensitive its bond and equity portfolio flows are to the global financial cycle. The answer is yes, in the tails and not at the mean. Tighter prior regulation amplifies risk shocks in both directions: bigger inflows during risk-on episodes, bigger outflows during risk-off ones. Four innovations make the result visible. Rather than dummy variables for recent policy changes, the paper builds four measures of the regulatory stance that incorporate intensity, combining Bank for International Settlements and European Systemic Risk Board data on countercyclical capital buffer levels with the IMF’s iMaPP database, including its quantitative loan-to-value ratios. Risk is measured by the RORO index of Chari, Dilts-Stedman and Lundblad (2020), the first principal component of daily changes in advanced-economy credit spreads, equity returns and volatilities, funding-liquidity spreads, the dollar and gold, whose distribution is skewed toward risk-off. Flows come from weekly EPFR data covering over 14,000 equity funds and 7,000 bond funds with more than $8 trillion under management, cleansed of valuation effects. And reverse causality – policymakers tightening because flows surged – is handled with a policy-shocks approach that regresses the stance on eighteen crisis, credit, growth and institutional variables and uses the residual, with first-stage F-statistics around 100. On a sample of 65 countries excluding the United States, Japan and Switzerland, the second stage reproduces the two known facts: a one-unit rise in RORO cuts weekly bond flows by 0.09 to 0.10 percent, about $2.3 to $2.4 billion, while the macroprudential stance on its own is insignificant. The interaction is where the new result sits: negative and usually significant, but modest at the mean, worth only $151 to $543 million of extra bond outflow. Evaluated across the risk distribution it grows sharply – for the preferred Broad Intensity Index, a one-unit tighter stance adds nothing at median risk but -$636 million, -$1,529 million and -$2,076 million at the 95th, 99th and 99.5th percentiles, against an unconditional risk effect of about -$2 billion, and +$631 million to +$1,215 million at the 5th to 0.5th percentiles. At a 99th-percentile shock (a RORO of 3.49, reached in 2008-09, 2011 and 2020), the amplification of bond outflows is 22 to 87 percent across all four measures and 45 to 67 percent for the two preferred ones. The pattern holds for equities with smaller coefficients but larger dollar amounts, and it is driven by tools that target specific exposures – LTV ratios, FX measures, bank credit supply – while the countercyclical capital buffer and demand-side measures show the same sign but no significance. The authors are explicit about the inference they are not making: “we do not suggest that macroprudential policies render the broader economy less resilient or more sensitive to risk shocks – as the increased resilience of banks may outweigh the greater sensitivity of non-bank financial intermediation.”