Financial stability refers to a well-functioning, liquid, solvent and sound financial system that efficiently facilitates payments, pools funds and allocates resources to the most productive sectors of the economy and their most valuable uses. Furthermore, the financial system must be resilient to both endogenous and exogenous shocks, e.g., poor lending policies and terms of trade shocks, respectively. Conversely, financial instability is characterised by inefficiencies in the payment and settlement systems and infrastructure.
A well-functioning and stable financial system is critical to sustainable economic growth. The global economic crisis of 2007-2009 emanated from the failure of the financial system, resulting in low global economic growth and high unemployment. Disruption in the global financial system had the effect of limiting access to credit for borrowers/investors, thus compromising the smooth functioning of the real economy. This calls for monitoring and concerted effort to stem and/or mitigate vulnerabilities to the financial sector across all sectors of the economy under what is known as macroprudential policy framework.
Macroprudential Policy Framework
The primary objective of the macroprudential policy framework is to limit systemic risk and its transmission to the broader economy. This is predicated on the observation that the financial system is interconnected and vulnerable to contagion risk, with the result that financial crises can spill over more rapidly to the real economy. At the same time, sectoral or broader economic weaknesses could adversely affect the financial system and trigger instability or crisis. In turn, this can cause widespread disruption to the provision of financial services, with serious negative consequences for macroeconomic stability and the real economy.
In order to limit systemic and spill over/contagion risks, financial sector regulators pursue a number of key intermediate objectives, among others: minimising and mitigating excessive credit growth and leverage; mitigating and preventing significant maturity mismatches and market illiquidity; controlling structural vulnerabilities in the financial system that arise through interlinkages; limiting direct and indirect exposure concentrations from domestic systemically important financial institutions (D-SIFIs); reducing the systemic impact of misaligned incentives with a view to reducing moral hazard; monitoring systemic risks from activities outside the banking system, and implementing appropriate policy responses to contain such risks; and strengthening the resilience of the financial system and related infrastructure to aggregate shocks.
The macroprudential policy framework identifies the external sector of the domestic economy, through trade shocks, capital outflows and adverse exchange rate movements, as having the greatest potential for elevated financial stability risks. Financial soundness and macroeconomic indicators are used to assess risks to and within the financial system. Relevant and appropriate policy instruments and tools have been identified for possible use as intervention measures during periods of financial instability. These instruments and policy tools would be adjusted accordingly to mitigate the envisaged threats.
A multi-agency Financial Stability Council (FSC) was established to, among others, discuss policy issues on how the financial system could be strengthened and made more robust, in order to mitigate financial stability risks, and take prompt action in response to a perceived build-up of systemic risks; ensure a coordinated response to financial stability issues that may require cross-agency collaboration; and to request information from any financial institution, exchange information on financial stability issues, and communicate systemic risk warnings. The FSC is not a decision-making body; it is a coordinating and cooperation mechanism. It is the responsibility of the respective entities to ensure that relevant macroprudential instruments are timeously activated to combat vulnerabilities, with a view to maintaining long-term financial stability.
The FSC comprises senior officials of the Ministry of Finance and Economic Development (MFED), the Bank of Botswana (Bank), Non-Bank Financial Institutions Regulatory Authority (NBFIRA) and the Financial Intelligence Agency (FIA). The FSC is chaired by the Governor, while the Bank acts as the secretariat. The work of the FSC is governed by a memorandum of understanding (MoU), which underscores the FSC’s commitment to ensuring a stable and resilient domestic financial system.
Announcement of Macroprudential Policy Decisions
The outcome of the FSC deliberations are communicated through a Press Release, shortly after a Council meeting. The Press Release informs the public of the discussions and conclusions regarding the stability of the domestic financial system. It further highlights the key risks in the financial system and recommendations to address such vulnerabilities. Any issue regarding policy action is communicated through a circular to all affected financial institutions by the relevant agency i.e., the Bank, MFED, NBFIRA or FIA. The circular provides a brief description that links the identified risk with the intermediate objective, and explains how measures taken are expected to mitigate the risk. In addition, the FSC publishes a biannual Financial Stability Report (FSR) that assesses of the vulnerabilities to the stability and resilience of the Botswana financial system. The FSR provides analytical and performance updates for the financial sector and its impact on economic activity and welfare; encourages informed engagement on financial stability issues; and helps provide information that major participants in the Botswana financial industry and elsewhere may use as input into their own financial risk assessment processes.