Macroprudential policy uses primarily prudential tools to limit the build-up of systemic risk, thereby minimising the incidence of disruptions in the provision of key financial services that can have serious consequences for the real economy. These tools:
Dampen the build-up of financial imbalances.
Βuild defences that contain the speed and sharpness of subsequent downswings and their effects on the economy.
Identify and address common exposures, risk concentrations, linkages and interdependencies, which are sources of contagion and spillover risks that may jeopardise the functioning of the system as a whole.
Macroprudential policy seeks to address two specific dimensions of systemic risk:
i. The time dimension, which reflects the evolution of systemic risk over time. This represents a cumulative, amplifying mechanism that operates within the financial system as well as between the financial system and the real economy. This mechanism, or pro-cyclicality, is based on the collective tendency of economic agents, to increase significantly their risk exposures during the boom phase of a financial cycle and to then become overly risk averse during the bust phase.
ii. The cross-sectional dimension, which reflects the distribution of risk in the financial system at a given point in time. If pro-cyclicality sets the destabilising mechanism in motion, the cross-sectional dimension provides further impetus and magnifies the impact of financial distress. Distress may also arise as a result of severe problems in the financial system without a build-up of weaknesses over time. It depends on the size of institutions, concentration and substitutability of their activities and the interconnectedness between them.
The range of macroprudential policy instruments is potentially large, not least on account of the need to encompass measures targeting all three components of the financial system. However, the bulk of macroprudential policy tools currently available relates to financial institutions. Instruments in this domain are, for the most part, of a prudential supervisory or regulatory nature, adjusted to address macroprudential policy objectives, i.e. in broad terms, to limit systemic risk.
In accordance with the provisions of the Macroprudential Oversight of Institutions Law 6(Ι), 2015, the Central Bank of Cyprus is from 1 January 2016 responsible, inter alia, for setting the following macroprudential buffers under the Capital Requirements Directive (CRD) of the EU and introducing macroprudential measures under article 458 of the Capital Requirements Regulation (CRR) of the EU: