Macroprudential policy urges income transfers

Extending macroprudential rules to corporate debt is necessary for systemic stability but will reduce spending.

Traditional monetary tools, which rely on new debt, cannot offset this demand loss without reigniting leverage.

Central bank-financed income transfers provide a sustainable solution by supporting consumption without new debt creation.

A combination of broad deleveraging, central bank income transfers, and CBDC issuance can maintain demand, reduce systemic fragility, and tackle the root problem of rising inequality and debt dependence.

Deleveraging the Private Sector

The 2008 Global Financial Crisis (GFC) revealed the vulnerability of highly leveraged households, particularly in the U.S. mortgage market. Household debt-to-GDP reached 98% in 2007, with mortgage debt at 73% of GDP (Federal Reserve, 2020). As delinquencies soared, the international community agreed to strengthen banking regulation under Basel III, introducing liquidity coverage ratios (LCR), net stable funding ratios (NSFR), and higher capital buffers (BIS, 2010). These reforms, along with voluntary deleveraging by banks, contributed to a decline in U.S. household debt-to-GDP from nearly 98% in 2007 to 75% by 2020 (FRED, 2021).

Some countries implemented macroprudential tools such as loan-to-value (LTV) ratios and debt-to-income (DTI) ratios to prevent household overleveraging. For example, South Korea and Canada introduced strict LTV limits, which successfully reduced mortgage risk (IMF, 2014). In contrast, U.S. authorities have been slower to impose such constraints, relying instead on market-driven deleveraging after the crisis.

However, corporate debt was largely untouched. According to the IMF (2014), of 38 countries applying sectoral macroprudential tools, only six targeted the corporate sector. This regulatory gap facilitated a shift of leverage from households to corporations. U.S. nonfinancial corporate debt-to-GDP surged from 40% in 2010 to 50% by 2019 and exceeded 55% during the COVID-19 crisis (Dallas Fed, 2019; BIS, 2021).

Source: https://www.dallasfed.org/research/economics/2019/0305.aspx

The COVID-19 shock demonstrated the fragility of this structure. Corporate debt concentration triggered liquidity stress in March 2020, prompting the Federal Reserve and other central banks to deploy emergency lending facilities and large-scale quantitative easing (QE) to prevent widespread defaults (Federal Reserve, 2020). Yet, as research emphasizes, liquidity support delays but does not prevent insolvency (Acharya et al., 2020). Defaults will eventually materialize if income does not recover, exposing the systemic risk of high corporate leverage.

Macroprudential Tools Addressing Corporate Leverage

1. Corporate Debt-to-Income (DTI) Limits

Objective: Prevent excessive corporate leverage relative to earnings.Mechanism: Caps on debt service/income ratios.

Key Examples:

• South Korea (2017):

  • Imposed 300% DTI on chaebols (conglomerates like Samsung) to curb speculative borrowing. Reduced corporate debt/GDP by 8% within 3 years (Bank of Korea, 2020).

• China (2020):

  • PBOC set 70% DTI for property developers (e.g., Evergrande). Forced deleveraging but triggered defaults in 2021.

Countries with DTI Rules:

Country	Authority	Year Introduced	Threshold	Target Sector
South Korea	BoK	2017	300%	Conglomerates
China	PBOC	2020	70%	Real Estate
Hong Kong SAR	HKMA	2018	50%	All corporates
Thailand	BoT	2019	60%	SMEs
Malaysia	BNM	2021	40%	Construction

Source: IMF Macroprudential Policy Database (2023).

2. Sectoral Capital Requirements

Objective: Increase bank resilience to sector-specific shocks.Mechanism: Higher risk weights for exposed loans.

Key Examples:

• India (2016):

  • RBI raised risk weights from 100% to 150% for commercial real estate loans. Slowed sectoral credit growth by 12% (RBI, 2018).

• Sweden (2023):

  • 2% systemic risk buffer for banks lending to property firms (e.g., SBB crisis).

Countries with Sectoral Capital Rules:

Country	Authority	Year	Sector Targeted	Risk Weight Increase
India	RBI	2016	Real Estate	+50%
Eurozone	ECB	2022	Leveraged Loans	+25%
Canada	OSFI	2019	Energy	+30%
Sweden	Riksbank	2023	Property	+2% buffer

Source: BIS (2023)

3. Corporate Loan-to-Value (LTV) Limits

Objective: Reduce collateral-driven bubbles.

Key Examples:

• Singapore (2020):

  • LTV capped at 50% for commercial property loans. Prices fell 5% in 2021 (MAS, 2022).

• Malaysia (2018):

  • 70% LTV for construction firms to curb overbuilding.

Countries with Corporate LTV Rules:

Country	Authority	Year	LTV Cap	Sector
Singapore	MAS	2020	50%	Commercial RE
Malaysia	BNM	2018	70%	Construction
New Zealand	RBNZ	2019	60%	Agriculture

Source: FSB (2022).

4. Large Exposure Frameworks

Objective: Prevent concentrated risks.

Key Examples:

• EU (2014):

  • 25% limit on bank exposures to single corporates (e.g., Deutsche Bank’s Adani Group loans).

• USA (2015):

  • 15% limit for systemic firms (e.g., JPMorgan’s Boeing exposure).

Countries with Exposure Limits:

Country	Authority	Year	Limit (% of Bank Capital)
EU	ECB	2014	25%
USA	FRB	2015	15%
Switzerland	FINMA	2016	20%

Source: Basel Committee (2023).

5. FX Debt Regulations

Objective: Mitigate currency mismatch risks.

Key Examples:

• Brazil (2010s):

  • 6% IOF tax on corporate FX loans. Cut dollar debt by 40% (BCB, 2021).

Countries with FX Debt Rules:

Country	Authority	Measure	Year
Brazil	BCB	6% IOF tax on FX loans	2010
Indonesia	BI	30% hedging requirement	2019
Argentina	BCRA	Central Bank approval for FX debt	2022

Source: IMF AREAER (2023).

Policy Lessons

1. DTI/LTV tools work best in real estate/construction sectors (Asia).

2. Sectoral capital buffers are effective but require frequent recalibration (EU/Canada).

3. FX rules reduce vulnerabilities but may raise borrowing costs (Emerging markets).

Restoring Spending Through Income Transfers

Expanding the macroprudential framework to constrain corporate leverage is essential for financial stability but carries contractionary effects. Deleveraging reduces credit growth, depresses spending, and risks deepening recessions. Traditional monetary policy—whether via rate cuts or QE—relies on debt creation, which conflicts with the goal of deleveraging (Blanchard & Summers, 2017). Fiscal stimulus through government transfers can offset lost demand, but persistent public debt growth poses political and market risks, with U.S. federal debt surpassing 120% of GDP by 2021 (CBO, 2022).

A sustainable approach is to provide income transfers without new debt creation. Central banks could directly credit household accounts with newly issued central bank money, booked as “transfers” on the liability side of the central bank balance sheet. This method aligns with the logic of Modern Monetary Theory (MMT), which highlights that a sovereign issuer of currency faces no solvency risk in its own money (Kelton, 2020). Unlike debt-financed fiscal stimulus, such transfers would permanently increase disposable income without raising public debt ratios.

Addressing the Safe Asset Problem

Another challenge of broad deleveraging is the safe asset shortage. When corporate debt is constrained, investors’ demand for safe, liquid instruments can exceed supply, inflating sovereign bond prices and potentially fueling asset bubbles elsewhere (Caballero et al., 2017).

A solution lies in Central Bank Digital Currency (CBDC) issuance. By allowing savers to hold risk-free digital currencies outside of the central bank balance sheet, CBDCs can absorb excess savings and reduce reliance on private safe assets like short-term corporate debt or repo agreements (BIS, 2021). This dampens asset bubble risk while supporting financial stability during deleveraging periods.

The Root Cause of Financial Crises

The deeper structural problem is the long-term deterioration of income and wealth distribution. Since the 1980s, the top 1% of U.S. households has increased its share of total wealth from 23% to 32%, while the bottom 50% lost nearly all net wealth (Saez & Zucman, 2020). To sustain consumption, lower- and middle-income households leveraged aggressively, with debt acting as a substitute for income growth. This dynamic underpins Hyman Minsky’s theory of financial fragility, where rising leverage eventually leads to widespread defaults (Minsky, 1992).

Household deleveraging post-2008 merely shifted leverage to the corporate sector, leaving systemic fragility unresolved. A comprehensive deleveraging strategy—covering both households and corporations—combined with permanent central bank income transfers and CBDCs can sustain spending without debt accumulation. This approach tackles both financial fragility and the root inequality problem.

Macroprudential Policy

Macroprudential policy must evolve from a sectoral to an economy-wide framework, constraining both household and corporate leverage. However, deleveraging reduces private credit creation and risks contraction. To maintain demand without new debt, central bank-financed income transfers and CBDC issuance should accompany macroprudential tightening. By providing safe assets for savers and direct income for consumers, this approach breaks the cycle of leverage-driven growth. It offers a pathway toward financial stability, mitigating systemic risk without sacrificing economic activity.

References

• Acharya, V., Engle, R., & Richardson, M. (2020). Capital Shortfall: A New Approach to Ranking and Regulating Systemic Risks. American Economic Review, 102(3), 59–64.

• Bank for International Settlements (BIS). (2010). Basel III: A global regulatory framework for more resilient banks. https://www.bis.org/publ/bcbs189.pdf

• Bank for International Settlements (BIS). (2021). Annual Economic Report 2021.

• Blanchard, O., & Summers, L. (2017). Rethinking Stabilization Policy: Back to the Future. Peterson Institute for International Economics.

• Caballero, R., Farhi, E., & Gourinchas, P. (2017). The Safe Assets Shortage Conundrum. Journal of Economic Perspectives, 31(3), 29–46.

• Congressional Budget Office (CBO). (2022). The 2022 Long-Term Budget Outlook.

• Federal Reserve. (2020). Financial Accounts of the United States.

• Federal Reserve Bank of Dallas. (2019). Corporate Debt and Financial Stability. https://www.dallasfed.org/research/economics/2019/0305.aspx

• FRED. (2021). Household Debt to GDP Ratio (US). Federal Reserve Bank of St. Louis.

• International Monetary Fund (IMF). (2014). Staff Guidance Note on Macroprudential Policy: Detailed Guidance on Instruments.

• Kelton, S. (2020). The Deficit Myth. PublicAffairs.

• Minsky, H. P. (1992). The Financial Instability Hypothesis. Jerome Levy Economics Institute, Working Paper No. 74.

• Saez, E., & Zucman, G. (2020). The Triumph of Injustice. W.W. Norton & Company.