The dilemma between macroprudence and collective idiocy

April 13, 2020
by Noriyuki Morimoto

When individual financial institutions engage in business activities based on their own rationality, the accumulation of actions taken by all the financial institutions can lead to extremely unwelcome and irrational consequences for themselves and the entire society. Even if they make wise decisions on an individual basis, if they generate foolish results as group, that is collective idiocy.

Therefore, the Financial Services Agency (FSA) needs to pay attention not only to the actions of individual financial institutions, but also to the possible impacts the financial institutions’ actions have on the economy and financial industry. This is the issue of financial administration called macroprudence.

Prudence is to have a thoughtful attitude, so it means giving sufficient prior and reasonable consideration to the potential effects of one’s actions on its surroundings. In some cases, this results in a cautious approach.

Macro is positioned against micro: micro refers to the effects of the actions of individual financial institutions, while macro refers to the effects resulting from the aggregation of the actions of all financial institutions. Although each of the financial institutions can strive to be prudential in its own actions from a micro perspective, it cannot affect the consequences of aggregate actions of the entire financial industry. But the FSA is not in the position to overlook the macro effects.

Therefore, the FSA calls on each financial institution to consider macro effects, but this almost amounts to forcing the impossible. You can pay attention to macro effects, but you can’t suspend what you believe as a prudential act in your position.

Suppose a financial institution intends to sell a large amount of government bonds. A careful deliberation will be made prior to the sale. If it is then determined that the action is sufficiently reasonable, the sale is executed. This is completely prudential behavior for one financial institution from a micro perspective.

However, it may not always produce prudent results from a macro perspective, because it is highly likely that many other financial institutions have made similar deliberations that reach similar conclusions under similar objective circumstances. Thus, the government bond price collapses, causing a devastating impact on society.

Therefore, while the FSA focuses on macro prudence, it is a difficult issue as it cannot deny that its regulations have the aspect of causing uniformity in the behavior of financial institutions. This is a dilemma of financial regulation.


[ Category /Financial Regulations]

Noriyuki Morimoto
Noriyuki Morimoto

Chief Executive Officer, HC Asset Management Co.,Ltd. Noriyuki Morimoto founded HC Asset Management in November 2002. As a pioneer investment consultant in Japan, he established the investment consulting business of Watson Wyatt K.K. (now Willis Towers Watson) in 1990.