Central banks in achieving financial stability

Abstract

The main objective of this paper is to analyze the evolving role of central banks in fostering financial stability and look at some current issues that have practical and operational relevance. Since the last global financial crisis in 2008-09, an increasing attention has been devoted to maintaining overall financial system stability and central banks have played strong roles in domestic financial stability policy, but the full scopes of their financial stability mandates are ambiguous. Over the past ten years, prudent macroprudential policy has served the European zone well in cushioning the impact of the global financial crisis in 2008-09. However, today the global economic outlook remains highly uncertain, credit risks, prolonged environment of low interest rates, the growing corporate liabilities and households liquidity pressures may morph into insolvencies that may have implications for the financial stability in the medium term. Since the credibility of macroprudential policy greatly influences the management of the systematic risks in the financial markets and also the effectiveness of monetary policy, central banks in EU zone and worldwide have become more involved in dealing and monitoring closely the financial stability. Generally, financial stability is its ability to facilitate and enhance economic processes, manage risks, and absorb shocks. This paper also discusses some of the existing efforts to construct an aggregate financial stability index and its application. To summarize the discussion below, financial stability has been a fundamental objective of central banks. Indeed, many central banks including the Federal Reserve and ECB were established financial stability as part of their mandate. The paper argues that central banks may contribute to financial stability in four different ways: 1) as crisis managers - as lenders of last resort, in an acute financial crisis; 2) through focusing their regular monetary policy on the right objective and using macroprudential policy on decisions and 3) may act as prudential regulators and supervisors themselves and 4) through their communication and or information policy. In relation to the above, policy coordination between the central banks and the government is crucial to promote financial stability. JEL: E52 E58 E63 H63