The Effects of Macroprudential Policies on Financial Stability in Developing Countries

Introduction

The idea that macroeconomic risks are affected by global financial markets in open economies has become increasingly widespread with the advent of globalization. Changes in risk perception owing to expansionary monetary policies by developed countries after the 2008 global financial crisis and capital flows becoming excessively volatile as a result of this approach are deemed as major macroeconomic risks. Capital flows are mostly directed towards developing countries, implying that domestic currencies of developing countries become overvalued and banks reach excessive credit levels. In other words, emerging economies encounter additional challenges owing to their vulnerability to inconsistent international capital flows. This situation has led to increased imports and an imbalance in demand, followed by the rapid deterioration of current account balances for developing countries. Disruption of short-term capital inflows, credit expansion and current account balances have caused financial fragility post-2008 financial crisis, thus leading many countries to re-examine their existing economic policies (CBRT, 2015; Hannoun, 2010) At this point, the most important change is the abandonment of the idea that financial stability will occur spontaneously when price stability is attained. At the same time, this idea has led to central banks using diverse and highly complex policy tools. Individual countries have developed different policy tools according to their circumstances to mitigate the effects of the global crisis. In this context, many countries have attached particular importance to variables such as credit growth and exchange rate, and have thus developed new policy instruments that can control these variables in order to provide financial stability. These instruments, which have been used to provide financial stability, together with price stability policies, used to monitor and mitigate the risks that may arise in the financial system, are included in macroprudential policies. These policies are mainly designed to reduce the adverse effects on the financial system and the real economy of the risks that may arise owing to financial problems. Financial sector stability plays a vital role in achieving sustainable economic growth. Overcoming market friction and encouraging economic growth is realized through effective financial institutions and markets.

In this chapter, the aim was to determine how macroprudential policies related to credit growth and exchange rate fluctuations affect the financial stability of developing countries with a current account deficit. The rest of the chapter is organized as follows. In the next section, the concept of financial stability is defined and the importance of financial stability is addressed. In the third section, the roles of central banks in ensuring financial stability are discussed and policy tools are examined. In the fourth part, a time-varying panel causality test is applied to 11 countries with a current account deficit. In the final section, the findings are summarized and recommendations for future research are provided. This chapter will make an important contribution as it assesses financial stability in terms of central bank policies.