The 2007-09 global financial crisis challenged many pre-existing conceptions about systemic risk, including the 'composition fallacy' which assumed that if individual entities were robust and subject to adequate micro-prudential supervision, then the whole system would be resilient.
This assumption proved to be misguided. Thus, in response to the need to monitor and control systemic risk, the ‛macroprudential' approach has become one of the defining features of the post-crisis financial reform agenda (together with new resolution tools, enhanced capital and liquidity rules and the regulation of SIFIs or systemically important financial institutions).
Antoine de Saint-Exupéry´s classic book, 'The Little Prince' depicts an illustration of the baobabs (inspired by the Adansonia genus of trees) stifling and smothering the planet with the size of their roots and trunks. Like the baobabs, global SIFIs have extended their nexus of activities across the globe, entrenching their roots across many jurisdictions.[2]
Using an analogy with forest management, the safeguard of the health of the forest (a macro perspective) requires a different type of strategy than the safeguard of the health of each individual tree (a micro perspective). Ecological considerations would also warn us against excessive reliance on a 'static' notion of financial stability.
Contours of 'macropru'
The macroprudential perspective can be a murky concept to grasp, somewhere in between micro-prudential supervision and monetary policy. The contours are not always easy to demarcate. An analogy could be made between the courts of justice and the conduct of supervision. Micro-prudential supervision is akin to a 'court of first instance', macroprudential policy is akin to 'court of appeal', while monetary policy is akin to a 'supreme court'.
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Written for the Macroprudential Matters website, proudly managed by the Qatar Centre for Global Banking and Finance at King's Business School. Read the rest of the article here.
