An answer to financial crisis

A good understanding of systemic risk and its forms is at the core of macro-prudential regulation policymaking. It is difficult to judge in advance whether a rise in asset prices is a bubble, and to work out when to move a capital buffer up or down. Furthermore, it is an extremely difficult job to draw a complete picture of potential "lines of dominos", where the default of one institution could bring down others, and eventually trigger a system-wide crisis.

Therefore, macro-prudential regulation must rely on the continuous and rigorous monitoring of financial institutions, markets and the economy at large so as to detect potential vulnerabilities. It requires developing early warning indicators and a broad range of financial stability indicators in risk analysis and identification process based on solid statistical information and market intelligence efforts.

A strong governance framework arranged with clear and specific mandates assigned to various authorities is crucial in implementing effective macro-prudential regulation. This can ensure accountability and transparency. As most of the policy tools in the context of macro-prudential regulation, such as changes in capital ratio, loan loss provisions ratio or loan-to-value ratio, should be applied to individual institutions, there is a need for coordination in the use of those tools by sharing information, which should be supported by the framework clearly allocating responsibilities. Macro-prudential regulation policies are not intended to be a substitute for micro-prudential ones.

Obviously, macro-prudential policies and monetary policies have shared a common nature of "leaning against the wind", but they are isolated and could indeed complement one another. Macro-prudential measures cannot take the place of monetary policy in affecting aggregate demand and inflationary expectations.

Given its function as a lender of last resort, the central bank can provide emergency liquidity assistance to a bank that falls into difficulties, preventing the negative impact on both the banking sector and the real economy. Hence, central banks play a key role in managing systemic financial crises.

Macro-prudential regulations could be called both a science and an art. For it to function, a wide range of reliable data must be carefully analyzed; yet on the other hand, it requires experience and a degree of personal judgment to decide when action should be taken.

China's financial industry has revealed some pro-cyclicality features in common with other countries, so it is time for the country to implement macro-prudential regulations.

Being both a new policy area and an item on the world agenda, macro-prudential regulations are still at an early stage. It is imperative to continue existing international cooperation to enhance the ability, effectiveness and efficiency in this key area, thus better serving the global recovery.

Xiao Gang, former chairman of Bank of China, is now chairman of the China Securities Regulatory Commission.