/Macroprudential ring-fencing

Macroprudential ring-fencing

The financial sector has an essential role to play in addressing the economic fallout from the Covid-19 pandemic. This column discusses the link between financial stability and restrictions on the mobility of capital along national borders of cross-border banking groups in the context of macroprudential capital buffers. It argues argue that apart from the direct absorption of systemic shocks, such macroprudential policies also enhance the performance of existing risk-sharing mechanisms, in particular in the case of synchronous shocks in the EU. The ESRB recommendation for restrictions of distributions during the pandemic contributes to the stabilising role of macroprudential capital buffers in the EU.

The unprecedented policy measures to mitigate the impact of the Covid-19 pandemic, such as the release of capital buffers, have been accompanied with communications by public authorities to financial institutions to refrain from dividend payouts or related actions. These initiatives reflect the essential role of the financial sector in addressing the economic fallout of the Covid-19 pandemic and the subsequent recovery, as well as the efforts to maximise the effect of adopted policy measures. Given the need for  broad-based and coordinated action at the EU level, the European Systemic Risk Board (ESRB) has published recommendations on distribution restrictions during the pandemic that also address cross-border banks (ESRB 2020, Beck et al. 2020). These recommendations provided a (time-limited) compromise on the degree of internal resource mobility of cross-border banks as distribution restrictions were maintained at the EU group level and, where appropriate, at the sub-consolidated or individual level.

In a recent article (Konečný and Pfeifer 2020), we address the close and complex link between internal resource mobility of cross-border banks and financial stability in the EU. Our primary interest lies in restrictions on the mobility of capital and liquidity along national borders of cross-border banking groups as a result of the setting of macroprudential capital buffers, often referred to as ‘ring-fencing’. Ring-fencing of capital and liquidity tends to be perceived as an obstacle to the development of the ‘single market’ in financial services in the EU and as such a contributing factor to financial fragmentation (Nouy 2018). Moreover, ring-fencing is perceived to undermine financial stability by restricting the ability of cross-border banks to withstand financial stress (Bénassy-Quéré et al. 2018). We focus primarily on the latter argument as many policies with potential ring-fencing effects use the financial stability justification as much as the criticisms against them. 

This inherent antagonism is particularly apparent in the case of macroprudential policies that aim to mitigate and prevent systemic risk in the financial system with the ultimate objective of safeguarding financial stability (ESRB 2013). In order to do so, macroprudential policies often rely on capital-based instruments that enhance the loss-absorbing capacity of banks in case of systemic events. While such instruments (primarily, capital buffers) might technically restrict the flow of capital within cross-border banking groups, they simultaneously help preserve financial stability across individual EU member states and thus financial stability in the EU economy as a whole.  

We argue that apart from the direct absorption of systemic shocks, such macroprudential policies also enhance the performance of existing risk-sharing mechanisms, in particular in case of synchronous shocks. Especially to the extent that macroprudential policies prevent the amplification of shocks through the financial system to the real economy and hence reduce the need for a subsequent fiscal response, they fulfil an important stabilisation role that complements the existing risk-sharing mechanisms in the banking union. Equally relevant, however, might be an ongoing subdued relevance of the credit channel for private risk-sharing in the banking union (Alcidi et al. 2017, Cimadomo et al. 2020, Nikolov 2016). While the potential for credit-driven risk-sharing may be rather limited in EU member states where foreign penetration of banking sectors is relatively limited, it gains more traction in the EU states with substantial presence of cross-border systemic banks.1 In such instances, macroprudential policies that reduce procyclicality of credit supply support rather than undermine the currently subdued credit risk-sharing channel within the banking union. 

The case for macroprudential policies with potential ring-fencing effects becomes even stronger when a systemic shock is synchronous rather than asymmetric. An asymmetric shock might be diversified away by transferring resources from parts of cross-border banking groups with relatively abundant capital. However, in case of a synchronous shock, as illustrated by the Covid-19 pandemic, the relevance of existing (public and private) risk-sharing mechanisms might be partly compromised by the simultaneous nature of the shock that limits opportunities for risk diversification and tests the adequacy of available resources. Capital buffers – both of a structural and cyclical nature – play a critical role in this respect as they are aligned with specific systemic risks across the EU. 

These arguments aim to emphasise the close, positive, and dynamic link between macroprudential policies with potential ring-fencing effects and financial integration in the EU which seems to be somewhat neglected in the public debate. We consider it essential to acknowledge these synergies as they contribute to the stability and cohesion of the single market and ultimately support the mobility of capital and liquidity within the EU. By providing an additional loss absorption capacity and thereby improving bank resilience and credit provision, macroprudential policies not only contribute directly to the absorption of systemic shocks, but also enhance the performance of existing risk-sharing mechanisms, in particular in a case of synchronous shocks.

Authors’ note: This column relates to work Tomas Konecny undertook while at the Czech National Bank. The views expressed are solely those of the authors and should not be represented as those of the International Monetary Fund, its Management, or Executive Board.


Alcidi, C, P D’Imperio and G Thirion (2017), “Risk-sharing and consumption smoothing patterns in the US and the euro area: a comprehensive comparison”, CEPS Working Document No. 2017/04.

Beck, T, F Mazzaferro, R Portes, J Quin, CH Schett (2020), “Preserving capital in the financial sector to weather the storm”, VoxEU.org, 23 June.

Bénassy-Quéré, V, M K Brunnermeier, H Enderlein, E Farhi, M Fratzscher, C Fuest, P O Gourinchas, P Martin, J Pisani-Ferry, H Rey, I Schnabel, N Véron, B Weder di Mauro and J Zettelmeyer (2018), “Reconciling risk sharing with market discipline: a constructive approach to euro area reform”, CEPR Policy Insight No. 91.

Cimadomo, J, G Ciminelli, O Furtuna  and M Giuliodori (2020), “Private and public risk sharing in the Euro area”, European Economic Review 121.

ESRB (2013), “Recommendation on intermediate objectives and instruments of macro-prudential policy”, European Systemic Risk Board, 4 April.

ESRB (2019), “Macroprudential policy implications of foreign branches relevant for financial stability”, European Systemic Risk Board.  

ESRB (2020), “Recommendation of the European systemic risk board of 27 may 2020 on restriction of distributions during the COVID-19 pandemic“, ESRB/2020/7.

Nikolov, P (2016), “Cross-border risk sharing after asymmetric shocks: evidence from the euro area and the United States”, Quarterly Report on the Euro Area (QREA) 15: 2.

Nouy, D (2018), “Risk reduction and risk sharing – two sides of the same coin”, Speech at Financial Stability Conference Berlin. 


[1] In some central and eastern European countries, and Luxembourg, foreign institutions represent a significant share in (or even the majority of) designated O-SIIs. In eight EU member states, foreign institutions designated as O-SIIs hold more than 50% of total banking sector assets. See also ESRB (2019).

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