Macro-prudential policies to mitigate financial system vulnerabilities

Macro-prudential policies aimed at mitigating systemic financial risks have become part of the policy toolkit in many emerging markets and some advanced countries. Their effectiveness and efficacy are not well-known, however. Using panel data regressions, we analyze how changes in balance sheets of some 2800 banks in 48 countries over 2000–2010 respond to specific policies. Controlling for endogeneity, we find that measures aimed at borrowers – caps on debt-to-income and loan-to-value ratios, and limits on credit growth and foreign currency lending – are effective in reducing leverage, asset and noncore to core liabilities growth during boom times. While countercyclical buffers (such as reserve requirements, limits on profit distribution, and dynamic provisioning) also help mitigate increases in bank leverage and assets, few policies help stop declines in adverse times, consistent with the ex-ante nature of macro-prudential tools.