Macroprudential Policies and Global Banking

Abstract

This paper examines the ability of macroprudential policies to dampen the pro-cyclicality of credit market cycles and to enhance the macroeconomic stability in countries open to cross-border banking activities. For the analysis, we develop a two-country dynamic stochastic general equilibrium model with collateral constrained investors and global banks. The existence of cross-border lending activities is the source of the transmission of shocks across countries. The macroprudential policies analyzed are loan-to-value ratios and capital requirements, also known as the capital adequacy ratio, which are formulated as Taylor-type rules. Our results show that the effectiveness of capital requirement financial regulations is undermined if borrowers can increase credit from foreign banks originating from a country with more relaxed financial restrictions. When cross-border lending is permitted, national financial regulators can improve the financial stability of credit growth and management of credit by complementing the capital adequacy ratios with loan-to-value ratios.