Implementation of Basel III in the US will bring back the regulatory arbitrage problems under Basel I
Takeo Hoshi 23 December 2012
Rejigging financial regulation is in vogue. But, in the world of international finance, how well do different regulatory systems join up? This column argues that the US Dodd Frank Act and Basel III are, in part, incompatible and that harmonising them may lead to unintended consequences. The US ought to tread carefully here but should also try hard to maintain the spirit of better financial regulation.
This column is a lead commentary in the VoxEU Debate "Banking reform: Do we know what has to be done?"
regulation, banks, Basel, Dodd-Frank, Finance
The implicit subsidy of banks
Joseph Noss, Rhiannon Sowerbutts 17 June 2012
A credible threat of failure is an integral part of any industry. But this does not always apply to banks as failure may result in unacceptable economic costs. As a result, unprecedented amounts of public money have been used to avert bank failure. This column explains why the subsidy arises, why it is a public policy concern, and how it can be quantified.
The experience of the crisis has revealed that a credible threat of failure does not always exist for banks. While equity holdings were severely diluted through state intervention, debt holders of some failed banks did not incur losses and were guaranteed by governments. To the extent that neither banks nor their creditors paid for this guarantee, it can be considered an implicit subsidy.
UK, banks, implicit subsidy
The impact of corporate governance in financial institutions
Hamid Mehran, Alan Morrison, Joel Shapiro 06 April 2012
A recent op-ed by a former Goldman Sachs employee has led to an outcry over two important themes which came to the fore during the crisis, ie corporate culture and incentives. This column argues that neither regulation nor market forces has put either of these issues to rest. It adds that bank complexity and the too-big-to-fail policy both serve to undermine market discipline.
A recent op-ed by former Goldman Sachs employee Greg Smith has led to an outcry over Goldman Sachs’ perceived mistreatment of their customers. This illustrates two important themes in the financial sector, both of which came to the fore during the crisis, ie corporate culture and incentives. Obviously, neither regulation nor market forces has put either of these issues to rest. In this column, we look at both through the lens of corporate governance and we highlight the contribution of recent research to these topics.
corporate governance, banks, too-big-to-fail
Time to set banking regulation right
Jacopo Carmassi, Stefano Micossi 28 March 2012
Excessive risk-taking by large banks was among the main causes of the 2008–09 financial crisis. This column argues that the antidote to excessive risk-taking should come from the elimination of the subsidies of the banking charter and the implicit promise of bailout in case of major losses, and the introduction of strong incentives for management and shareholders to preserve the capital of their bank. This requires deep changes in Basel prudential rules.
Excessive leverage and risk-taking by large international banks were among the main causes of the 2008–09 financial crisis and the ensuing sharp drop in economic activity and employment. Enormous costs were borne by taxpayers and societies at large. In reaction, world leaders and central bankers undertook to overhaul banking regulation, including by rectifying the failed Basel prudential rules with the new Basel III Accord. Many scholars have commented on the proposed reforms, especially the US’s Dodd-Frank Act (eg Acharya and Richardson 2011).
banking regulation, banks, BASEL III
Macroprudential policy: What instruments and how to use them? Lessons from country experiences
Francesco Columba, Alejo Costa, Cheng Hoon Lim 16 March 2012
In the wake of the 2008 financial crisis, there has been burgeoning interest in macroprudential policy as an overarching framework to address the stability of the financial system as a whole rather than only its individual components. This column, based on a new dataset from 49 countries, shows that some macroprudential instruments are effective in reducing procyclicality in the financial system, and thus systemic risks.
Macroprudential policy is quickly gaining traction in international circles as a useful tool to address system-wide risks in the financial sector (see for example Borio 2011, Galati and Moessner 2011, Viñals 2010, 2011). Yet the analytical and operational underpinnings of a macroprudential framework are not fully understood and the effectiveness of the instruments is uncertain. In a recent IMF working paper (Lim et al 2011), we assess the effectiveness of macroprudential instruments using three different approaches.
banks, systemic risk, Macroprudential policy
Capital shortfall: A new approach to ranking and regulating systemic risks
Viral Acharya, Robert Engle, Matthew Richardson 14 March 2012
The effective regulation of banks requires identification of systemically important financial institutions. This column discusses a method to estimate the capital that a financial firm would need to raise if we have another financial crisis. This measure of capital shortfall is based on publicly available information but is conceptually similar to the stress tests conducted by US and European regulators.
The most severe impacts of the financial crisis of 2007–09 arose immediately after the failure of Lehman Brothers on 15 September 2008. It is natural to wonder whether the US should have arranged for an orderly rescue of Lehman as it did for Fannie Mae and Freddie Mac the week before and as it did for AIG, Merrill Lynch, Citigroup, Bank of America, Morgan Stanley, Goldman Sachs, Washington Mutual, and Wachovia as well as many smaller and foreign banks over the next days and weeks. How much capital would have been necessary ex post to arrange such an orderly rescue?
Financial markets International finance
banks, systemic risk, capital
Contagion during the Greek sovereign debt crisis
Jakob de Haan, Mark Mink 23 February 2012
Since 2010, Eurozone countries have engaged in unprecedented rescue operations to avoid contagion from a potential Greek sovereign default. This column argues that news about Greek public finances does not affect Eurozone bank stock prices, while news about a Greek bailout does. This suggests that markets consider news about a Greek bailout to be a signal of Eurozone countries’ willingness to use public funds to combat the financial crisis.
In the course of 2010, the financial problems of Greece became so severe that the Eurozone countries together with the IMF agreed to provide emergency loans for a total amount of €110 billion, to be disbursed over the period May 2010 through June 2013. In addition, the European Financial Stability Facility was created, which issues bonds fully guaranteed by Eurozone countries and, after an enlargement in 2011, can provide up to €440 billion in financial support to distressed member states.
Financial markets International finance
banks, Greece, sovereign default, news
Home bias and the credit crunch: Evidence from Italy
Andrea F Presbitero, Gregory F Udell, Alberto Zazzaro 12 February 2012
Understanding credit crunches is a major concern for policymakers. This column suggests that the severity of a credit crunch in a specific area depends on the hierarchical structure of the banks operating in that credit market. It explores the Italian case and shows that, in the months following the collapse of Lehman Brothers, banks retracted disproportionally from markets that are more distant from their headquarters.
The management of the Eurozone sovereign debt crisis will have significant effects on the stability of national banking systems, as argued in some recent Vox columns (Acharya et al 2011, Wyplosz 2011). The interaction between the debt crisis and banking risk will likely affect bank capital positions and might also affect bank liquidity and the fragility of the interbank markets.
Italy, Credit crunch, banks, cross-border banking
Next-generation system-wide liquidity stress testing
Christian Schmieder, Heiko Hesse, Benjamin Neudorfer, Claus Puhr, Stefan W Schmitz 01 February 2012
The global financial crisis has shown that neglecting liquidity risk comes at a substantial price. This column presents a new framework to run system-wide, balance sheet data–based liquidity stress tests. The liquidity framework includes a module to simulate the impact of bank-run type scenarios, a module to assess risks arising from maturity transformation and rollover risks, and a framework to link liquidity and solvency risks.
Bank liquidity was traditionally viewed as of equal importance to solvency. Liquidity risks are inherent in maturity transformation, ie the usual long-term maturity profile of banks’ assets and short-term maturities of liabilities. Banks have commonly relied on retail deposits, and, to some degree, on long-term wholesale funding as supposedly stable sources of funding. Yet, attention to liquidity risk diminished in recent decades and was symbolised by the absence of consideration of liquidity risk in the 1988 Basel I framework (Goodhart 2008).
liquidity, banks, stress tests
Stop coddling Europe’s banks
Morris Goldstein 11 January 2012
Throughout the European debt soap opera, Europe’s leaders have expressed their willingness to “do whatever it takes” to restore stability and save the euro. This column argues that, too often, policymakers have in fact been “doing whatever it takes” to serve the banks.
After initial denials, Europe’s leaders have started to acknowledge that IMF Chief Christine Lagarde was right. Through their statements and decisions, policymakers are showing their agreement with her assessment in August 2011 at the Federal Reserve’s Jackson Hole symposium that there was an urgent need for recapitalisation of Europe’s banks (Lagarde 2011).
EU policies International finance Politics and economics
ECB, IMF, financial regulation, banks, Eurozone crisis, EFSF, euro bonds