Macroprudential policy is a concept in the banking regulation and supervision literature which has to do with defining conditions which can result in financial instability and how to prevent such outcomes through public policy.

Origin

Macroprudential is a term originating some decades ago in banking regulation circles referring to banking practices that may undermine the stability of the financial system and effective regulation to prevent it. The concept has gained wide currency in the wake of the major financial crisis that hit the world in 2007. Macroprudential is an antonym

Antonym

In lexical semantics, opposites are words that lie in an inherently incompatible binary relationship as in the opposite pairs male : female, long : short, up : down, and precede : follow. The notion of incompatibility here refers to the fact that one word in an opposite pair entails that it is not...

 to microprudential. The latter concept relates to the regulation and supervision to ensure the health and soundness of individual banking institutions.

Meaning

The term macroprudential is seen to have two complementary dimensions. One, refers to the behaviour of individual banks which serves to increase systemic risk

Systemic risk

In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by...

 for the banking sector as a whole at any given point in time. The other dimension focuses on the interaction of bank lending on risks in the wider economy over time. A pro-cyclical influence results in a boom which is then followed by a bust

Boom and bust

A credit boom-bust cycle is an episode characterized by a sustained increase in several economics indicators followed by a sharp and rapid contraction. Commonly the boom is driven by a rapid expansion of credit to the private sector accompanied with rising prices of commodities and stock market index...

, which can be enoromously costly for the economy and tax payers.

Policy

The main approach being developed seems to rely on upgrading existing capital adequacy requirements, in order to have financial firms pay up front for the social insurance extended to distressed financial firms. A new liquidity requirement is also being developed. While the modalities have not yet been defined, such instruments are aimed at giving support to monetary policy instruments, notably the interest rate, to restrain credit growth such that an unsustainable asset bubble, followed by a crash, does not develop. Also, efforts to identify endogenous

Endogeneity (economics)

In an econometric model, a parameter or variable is said to be endogenous when there is a correlation between the parameter or variable and the error term. Endogeneity can arise as a result of measurement error, autoregression with autocorrelated errors, simultaneity, omitted variables, and sample...

 risks could potentially improve stress testing of bank balance sheets.