macroprudential policy transmission in a small open ... .pdf•fiscal policy •monetary policy ......

Macroprudential Policy Transmission in a Small Open Economy: A DSGE model with Traditional and

Matter-of-Fact Financial Frictions

Fabia Carvalho Marcos Castro

Research Department

Research Department

WORK IN PROGRESS – PRELIMINARY RESULTS

The views expressed in this work do not necessarily represent those of the Central Bank of Brazil or its members

Motivation

Brazil: sound banking system

• Basle Index: 16.6%* (13.2%)

• Tier 1 capital: 12.2%

• Core capital: 11%

• Leverage ratio: 7.3%

• Liquid assets/credit: 23%

• Liquidity index: 1.51

* As of August 2014

Capital/Assets (%)

• But we have to stay vigilant

• Total stock of bank loans: 57% of GDP

• low by international standards, but trending upwards

• Consumer loans:

• 15 % of GDP

• Moderate default rates: 6.5%

• No physical collateral

• Implicit debt-to-income constraints

• Housing loans

• 8% of GDP

• Heavily regulated market

• Debt-to-income constraints + LTV

• Low default rates: 2%

Motivation

• Important flows of foreign investment

• Macroprudential policy in Brazil

• Capital requirements

• Risk weights

• Sector-specific LTV ratios

• Active use of reserve requirements, with general or specific targets

• Tight surveillance

• Impact assessment tools

• Stress tests

• VARs

• FAVARs

• Partial-equilibrium models

• Satelite models

• Semi-structural models

• Can we improve our understanding and quantification of transmission channels?

Motivation

Purpose

• Relevant questions:

• Are these macroprudential instruments similar w.r.t. their impact on credit and output?

• Do their stabilizing properties depend on the source of economic disturbances?

• Given that changes in countercyclical capital buffers should be announced one year in advance, should they focus on contemporaneous variables or should they be forward looking?

• Map the transmission channel of macroprudential policy instruments in the Brazilian economy and quantify their impact on credit and output

• Reserve requirements

• Capital requirements

• Sectoral risk weights on banks’ assets for capital adequacy computation

• Countercyclical capital requirements

Methodology

•What we do:

• DSGE model with realistic ingredients to decision

making in Brazilian credit markets

• Bayesian estimation with Brazilian data

• Preliminary results

• Savers

• Borrowers

Households

Entrepreneurs

• Intermediate goods producers

• Importers

• Retailers/Distributers

• Final goods producers

• Exporting firms

Government

Domestic investment fund

• Asset and Liability Management

• Specialized deposit branches

• Specialized lending branches

Bank conglomerate

Foreign economy

Firms

Foreign investment fund (FPI)

The main features of the model

• Fiscal policy

• Monetary policy

• International reserves management

• Macroprudential regulation

• Consumer loans:

• 15 % of GDP

• Mostly absent physical collateral

• Implicit debt-to-income constraints

• Default rates: 6.5% Hou

• Housing loans

• 8% of GDP


• Debt-to-income + Loan-to-value constraints


• sing loans

• 8% of GDP


• Debt-to-income constraints + LTV



• Total household borrowing constrained by expected labor income

• Possibility of default

• Bank can seize a fraction of household’s labor income

• Housing loans are senior to consumer loans

• Regulated interest rates

• Collateral, with some inertial behavior

• Commercial loans

• Non-earmarked loans:

• working capital + investment: 12% of GDP

• Moderate default rates: 4%

• Earmarked loans:

• Investment: 15% of GDP

• Very low default rates: 0.5%

• Steady and strong inflows of FDI

• Foreign trade credit lines:

• 3 % of GDP

• Working capital


- Entrepreneurs as in BGG, but

- LTV varies over time

- Foreign investors purchase shares of entrepreneurs’ net

worth (FDI)


• Foreign trade bank credit lines:

• 3 % of GDP

• Working capital


- Exporters take working capital loans from bank trade lines


- Banks optimally choose an intertemporal plan of dividenddistribution s.t.

- Regulatory constraints

- Reserve Requirements

- Capital Requirements

- Risk weights on CAR

- Regulation on housing loans

- Frictions

- liquidity targets

- rigidity to raise deposits

- desired balance sheet allocations

- Taxes and operational costs

The model

- Financial deepening trend driving credit variables in themodel

- International capital flows (FPI, FDI and debt)

- International reserves management

- Intermediate goods producers, retailers, importers and laborunion as usual in the literature.

- Traditional monetary and fiscal rules

- Standard macroprudential instruments initially represented aspersistent AR(1)

- Countercyclical capital buffers (for simulation)

The model

Macroprudential Policy Transmission

Comparing policy shocks: 4 quarters + linear decay

0 5 10 15 20

-20

-10

0

10

Bank's liquid assets (% ss dev)

0 5 10 15 20

0

50

100

LR: Non-earm. loans (bp, yearly)

0 5 10 15 20-1

-0.5

0

Non-earm. loans (% ss dev)

0 5 10 15 20-50

0

50

Housing lending rate (bp, yearly)

0 5 10 15 20-0.4

-0.2

0

Housing loans (% ss dev)

0 5 10 15 20

-0.5

0

Total credit (% ss dev)

0 5 10 15 20-10

0

10

Bank dividend distr. (% ss dev)

0 5 10 15 20-1

0

1

Bank capital (pp)

0 5 10 15 200

0.1

0.2

Basel ratio (pp)

0 5 10 15 20-0.4

-0.2

0

GDP (% ss dev)

0 5 10 15 20-1

0

1

Inflation (4-Q % ss dev)

MP:+1 pp

Capital req: +1 pp, no MP

RR time dep: +10 pp, no MP

Anticipated vs. unanticipated changes in capital requirement

0 5 10 15 200

5

10

Bank's liquid assets(% ss dev)

0 5 10 15 20

0

50

100

LR: Non-earm. loans(bp, yearly)

0 5 10 15 20-0.8

-0.6

-0.4

-0.2

0

Non-earm. loans(% ss dev)

0 5 10 15 20-50

0

50

Housing lending rate(bp, yearly)

0 5 10 15 20

-0.4

-0.2

0

Housing loans(% ss dev)

0 5 10 15 20

-0.6

-0.4

-0.2

0

Total credit(% ss dev)

0 5 10 15 20

-10

-5

0

Bank dividend distr.(% ss dev)

0 5 10 15 20-2

0

2

Bank capital(pp)

0 5 10 15 200

0.5

Basel ratio(pp)

0 5 10 15 20

-0.2

-0.1

0

GDP(% ss dev)

0 5 10 15 20-0.05

0

0.05

Inflation(4-Q % ss dev)

0 5 10 15 200

0.5

1

1.5

Bank Capital Requirement(pp)

Capital Req.: Unanticipated

Capital Req.: Anticipated

- Remunerated RR on time deposits have the strongest impactwithin the set of RR’s- Highest incidence base

- If we increase RR’s such that the nominal increase in reservesat the CB is equal across types of RR:- Unremunerated RR on demand deposits have the strongest impact

- Main variable of adjustment is bank liquidity

The model

Some Policy Exercises

The countercyclical capital requirement

• Reaction to credit gap

• Smoothing component

• Immediate vs. 4-quarter delayed implementation

• Contemporaneous vs. forward looking

Título Assunto

Loose international MP(Foreign interest rate)

0 10 20-400

-200

0

Foreign Interest Rates

(bp, yearly)

0 10 200

0.5

FPI Stock

(pp)

0 10 200

0.1

0.2

FDI

(% ss dev)

0 10 20-10

-5

0

Real FX rate

(% ss dev)

0 10 20-1

-0.5

0

Inflation

(4-Q % ss dev)

0 10 20-100

-50

0

Interest rate

(bp, yearly)

0 10 200

0.5

1

Consumption

(% ss dev)

0 10 20-1

-0.5

0

GDP

(% ss dev)

0 10 20-100

-50

0

LR: Non-earm. loans

(bp, yearly)

0 10 20-0.5

0

0.5

Non-earm. credit

(% ss dev)

0 10 20-40

-20

0

Housing lending rate

(bp, yearly)

0 10 200

1

2

Housing loans

(% ss dev)

0 10 20-0.5

0

0.5

Total credit

(% ss dev)

0 10 20-1

0

1

Bank dividend distr.

(% ss dev)

0 10-0.5

0

0.5

20 Benchmark

CC Buffer-immediate implementation

CC Buffer-delayed impl., contemp.

CC Buffer-delayed impl., fwrd looking

Basle Index

(% ss dev)

Sudden Stops(FDI)

0 10 20-20

0

20

FDI

(% ss dev)

0 10 20-10

0

10

20

Real FX rate

(% ss dev)

0 10 200

1

2

Inflation

(4-Q % ss dev)

0 10 200

200

400

Interest rate

(bp, yearly)

0 10 200

5

Consumption

(% ss dev)

0 10 20-1

0

1

GDP

(% ss dev)

0 10 200

200

400

LR: Non-earm. loans

(bp, yearly)

0 10 20-1

0

1

Non-earm. credit

(% ss dev)

0 10 200

50

100


(bp, yearly)

0 10 20-4

-2

0

Housing loans

(% ss dev)

0 10 20-0.5

0

0.5

Total credit

(% ss dev)

0 10 200

5


(% ss dev)

0 10 20-0.5

0

0.5

Basel ratio

(pp)

0 10 20-1

0

1

Capital Requirement

(pp)

Benchmark

CC Buffer-immediate implementation

CC Buffer-delayed implement., contemporaneous

CC Buffer-delayed implement., fwrd looking

Loose bank credit standards(Shock to banks’ liquidity preference)

0 10 20-1

0

1

Non-earm. credit

(% ss dev)

0 10 20-200

0

200

LR: Non-earm. loans

(bp, yearly)

0 10 200

0.05

0.1

Consumption

(% ss dev)

0 10 20-0.2

0

0.2

Hours

(% ss dev)

0 10 200

0.05

0.1

Real wage

(% ss dev)

0 10 200

0.5

Housing loans

(% ss dev)

0 10 20-50

0

50


(bp, yearly)

0 10 20-1

0

1

Total credit

(% ss dev)

0 10 20-0.2

0

0.2

GDP

(% ss dev)

0 10 20-0.02

0

0.02

Inflation

(4-Q % ss dev)

0 10 20-50

0

50

Interest rate

(bp, yearly)

0 10 20-20

-10

0

Banks' liquid assets

(% ss dev)

0 10 20-4

-2

0


(% ss dev)

0 10 20

-0.4

-0.2

0

Basel ratio

(pp)

0 10 20-2

0

2

Bank Capital Requirement

(pp)

Benchmark

CC Req. immediate implementation

CC Req. delayed implement., contemp.

CC Req. delayed implement., frwd looking

Negative shock to bank capital

0 10 20-1

-0.5

0

Non-earm. credit

(% ss dev)

0 10 200

50

100

LR: Non-earm. loans

(bp, yearly)

0 10 20-0.2

-0.1

0

Consumption

(% ss dev)

0 10 20-0.15

-0.1

-0.05

Hours

(% ss dev)

0 10 20-0.1

-0.05

0

Real wage

(% ss dev)

0 10 20-0.5

0

0.5

Housing loans

(% ss dev)

0 10 20-2

0

2


(bp, yearly)

0 10 20-0.6

-0.4

-0.2

Total credit

(% ss dev)

0 10 20-0.2

-0.1

0

GDP

(% ss dev)

0 10 20-0.05

0

0.05

Inflation

(4-Q % ss dev)

0 10 20-5

0

5

Interest rate

(bp, yearly)

0 10 20-20

-15

-10

Banks' liquid assets

(% ss dev)

0 10 20-20

0

20


(% ss dev)

0 10 20-2

-1

0

Basel ratio

(pp)

0 10 20-0.5

0

0.5

Bank Capital Requirement

(pp)Benchmark

CC Req. immediate implementation

CC Req. delayed implement., contemp.

CC Req. delayed implement., frwd looking

• Model with more realistic assumptions wrt the credit market and banks’ balance sheet decisions

• Different macroprudential instruments have different transmission mechanisms

• Macroprudential instruments impact macroeconomic variables distinctly from monetary policy, wrt both dynamics and intensity

• The configuration of countercyclical capital requirement rules can generate different stabilizing properties, and this seems to depend on the source of the economic disturbance

Final remarks

Thank you!

Balance sheet:

Reserve Requirement:

Capital Accumulation:

Loan Demand (plus Calvo rigidity in interest rates):

Cash flow:

The bank’s program (complete)

The illustrative optimization problem of the representative bank is extended in the complete model to incorporate:

• Three kinds of deposits – demand, savings and time deposits – with different reserve requirement ratios and remunerations.

• Three kinds of loans - consumer, corporate and housing loans – with different risk weight factor.

• Loan-to-value borrowing constraints were introduced to help explaining upward trends in credit volume data series.

The complete bank optimization problem is analogous to the simplified version presented above, but will not be presented here, as it is considerably big.

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