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The global crisis exposed gaps in the public policy toolkit to deal with systemic risk that had far-reaching economic and social consequences in many countries. Macro-prudential regulation has become the new frontier of policy development to strengthen financial systems inside countries and across borders. Generally, it is defined as policy that uses primarily prudential tools to limit systemic or system-wide financial risk. However, beyond that general definition, the understanding of how and when to use what instruments in which situation remains at an early stage. Developing a policy framework to fill these gaps is an urgent challenge and has become the subject of widespread interest among policymakers and academics.
"We have a lot of work ahead of us," IMF Managing Director Dominique Strauss-Kahn told participants in his opening remarks. "We need good methods of systemic risk identification and monitoring, a well developed toolkit to limit systemic risk, and clearly assigned responsibilities and accountability. And we need an effective coordination mechanism to ensure that macro-prudential policy comes together with other policies to avoid the build-up of risk."
Financial stability tends to be a shared interest of various types of public policy, reflecting the deep and complex interactions between the financial system and the broader economy. It also has a global dimension, in the sense that each country needs to take into account the policies of other countries and, conversely, be mindful of the impact their decisions can have beyond their own borders. Institutional arrangements for macro-prudential policy, to be effective, need to ensure a policymaker's ability and willingness to act. This can be challenging because the benefits of taking action are typically realised over the longer term, while the costs will often be visible immediately. This can create a strong bias in favour of inaction that can be exacerbated by industry lobbying or political pressures and prepare the ground for the next crisis.