Macro- and Microprudential Regulations and Their Effects on Procyclicality of Solvency and Liquidity Risk

This paper aims to identify the effect of macroprudential policies and microprudential regulations and their interactions on the sensitivity of leverage and liquidity funding risk to the business cycle during both non-crisis and crisis period. In this paper we focus on major types of macroprudential instruments as designed by the International Monetary Fund, and on microprudential regulations’ indices. Applying the two-step robust GMM estimator to 782 banks from over 60 countries covering the period of 2000–2011 we find that both macroprudential and microprudential instruments have insignificant impact on procyclicality of leverage in the non-crisis period. Macroprudential instruments decrease procyclicality of liquidity during non-crisis period and increase procyclicality of leverage during the crisis. Restrictions on the range of activities conducted by banks reduce procyclicality of liquidity risk during non-crisis period. Interaction between macroprudential instruments targeted at risk-taking by borrowers and restrictions on the range of activities taken by banks has been found to be effective in reducing procyclicality of leverage during the crisis period.