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Managing emerging risks and macro-prudential regulation

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Macro-prudential policy-making, which aims to preserve the stability of the financial system as a whole, is still in its infancy in most countries, and there are concerns that systemic vulnerabilities may build up again before solid progress is made to prevent it. Financial systems will need to adjust to the new reforms, particularly as the financial recovery takes hold and interest rates rise. New entities that are being established to improve systemic oversight are already collecting and analysing data and issuing policy advice, particularly in light of the present low interest rate environment that could well lay the groundwork for new financial vulnerabilities.

Financial institutions must ensure they can optimise their costs while investing for future growth in a deliberate and sustainable way. But how far have they actually gone down that road? What remains to be done? And how do the institutions view the new requirements?

Survey results

Nearly half of the financial institutions surveyed see new macro-prudential requirements as an opportunity to differentiate themselves from their competitors, according to the results of the emerging risks and macro-prudential regulation survey conducted between November 2011 and January this year.

A total of 123 institutions participated in the survey, with diversified banking firms and insurers forming the largest groups of respondents. Most of these institutions felt compliance with the new rules would have a positive impact on their reputation with investors, customers and rating agencies, and on the safety and soundness of their firms.

Compliance was also largely seen to have a positive influence on an institution’s ability to provide products and services to customers, and on risk management. As a result, most of the firms involved in the survey have set aside considerable sums for investment in this area, with 25.4% of those surveyed having earmarked more than $100 million for the implementation of macro-prudential requirements over the next year.

The improvements will not just be felt at the institution level – the majority of respondents agreed that stronger capital and liquidity requirements are essential to maintaining the stability of the financial system.

However, getting the regime up and running will take time. Just 14.3% of respondents said they were already compliant with the new rules, while 39.1% said it would take between one and two years to be ready. Just less than one-quarter of firms indicated it would take up to five years. However, 15.7% said they were waiting for further guidance from regulators, and a further 6.8% had not yet started.

In terms of the areas that need work, 75.9% of respondents said cross-functional collaboration, especially between risk and finance, needed the most improvement to address macro-prudential requirements and emerging risks. Building common data structures was another factor that was viewed by more than half of the respondents to be an area that needed improvement.

Key among the tools and processes that firms are incorporating into their risk management frameworks is the ability to describe risk and finance data in terms of capital, both in stressed and non-stressed conditions.

While it is clear that institutions have a positive perception of many of the new compliance rules, with many beginning to prepare to invest in this area, they are being realistic about how long the change will take and the collaboration that will be required.

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