Macro Prudential Supervision and the Financial Crisis of 2007: The Aegis of the Central Banks

Abstract

One key element which has risen like the phoenix from the ashes of the financial crisis of 2007 is the concept of Macro-Prudential Supervision contrary to the soft touch regulation now widely accepted as the predominant reason for fueling the crisis. Though the concept has it origin nearly thirty years ago but history charts out the numerous events highlighting the systemic risk failures triggering financial cataclysms. Through this paper the author wishes to state that although what the world witnessed in 2007 had common macro-economic rationale but the way regulators were swayed by the market exuberance and kept a blind eye to the indicators of the crisis, raises a serious doubt on the effectiveness and viability of the macro-prudential supervision framework being so heavily prophesized in the post crisis era.

While I analyze the various reasons for the crisis and the supervision policies followed by the regulators across the world, for the purpose of the present paper, I seek to ask four principal questions, namely:

(i) What is the origin of macro prudential supervision and did it exist prior to the emergence of the crisis? (ii) What were the macro-economic causes for the financial crisis of 2007 and did the regulators of the affected economies have sufficient indication of the brewing problem? (iii) In the light of the above, what were and are the tools of macro prudential supervision policy in the pre and post crisis era? (iv) What is the future of macro prudential supervision?

What I have sought to bring out through this paper is macro prudential supervision, in its essence, existed much prior to the emergence of the crisis in 2007. Secondly the regulators choose to oversee the indicators of the brewing problem despite the ever increasing opaqueness and risky ventures being undertaken by the market participants prior to the crisis. I seek to make people understand, that formulation of elaborate macro supervision framework will be fairly ineffective, unless the existing indicators and tools of supervision that has been lying latent for long and have been conveniently ignored under the exuberance of the market forces are first put to use.

Keywords: macro prudential supervision, financial crisis, systematic risk