How insurers differ from banks: Implications for systemic regulation
Christian Thimann 17 October 2014
Having completed the regulatory framework for systemically important banks, the Financial Stability Board is turning to insurance companies. The emerging framework for insurers closely resembles that for banks, culminating in the design and calibration of capital surcharges. This column argues that the contrasting business models and balance sheet structures of insurers and banks – and the different roles of capital, leverage, and risk absorption in the two sectors – mean that the banking model of capital cannot be applied to insurance. Tools other than capital surcharges may be more appropriate to address possible concerns of systemic risk.
Regulation of the insurance industry is entering a new era. The global regulatory community under the auspices of the Financial Stability Board (FSB) is contemplating regulatory standards for insurance groups that it deems to be of systemic importance. Nine insurance groups received this FSB classification in 2013, and the design of systemic regulation for these groups is now in progress.
insurance, reinsurance, banking, financial intermediation, regulation, systemic risk, maturity transformation, BASEL III, investment, capital, capital requirements, bail-in, loss absorption
The impact of capital requirements on bank lending
Jonathan Bridges, David Gregory, Mette Nielsen, Silvia Pezzini, Amar Radia, Marco Spaltro 02 September 2014
Since the Global Crisis, support has grown for the use of time-varying capital requirements as a macroprudential policy tool. This column examines the effect of bank-specific, time-varying capital requirements in the UK between 1990 and 2011. In response to increased capital requirements, banks gradually increase their capital ratios to restore their original buffers above the regulatory minimum, reducing lending temporarily as they do so. The largest effects are on commercial real estate lending, followed by lending to other corporates and then secured lending to households.
The financial crisis has led to widespread support for greater use of time-varying capital requirements on banks as a macroprudential policy tool (see for example Yellen 2010 and Hanson et al. 2011). Policymakers aim to use these tools to enhance the resilience of the financial system, and, potentially, to curb the credit cycle. Under Basel III, national regulatory authorities will be tasked with setting countercyclical capital buffers over the economic cycle.
Macroprudential policy, capital requirements, regulation, bank regulation, BASEL III, Bank of England, financial crisis, bank lending, UK
Are banks too large?
Lev Ratnovski, Luc Laeven, Hui Tong 31 May 2014
Large banks have grown and become more involved in market-based activities since the late 1990s. This column presents evidence that large banks receive too-big-to-fail subsidies and create systemic risk, whereas economies of scale in banking are modest. Hence, some large banks may be ‘too large’ from a social perspective. Since the optimal bank size is unknown, the best policies are capital surcharges and better bank resolution and governance.
Large banks have grown significantly in size and become more involved in market-based activities since the late 1990s. Figure 1 shows how the balance-sheet size of the world’s largest banks increased two- to four-fold in the ten years prior to the crisis. Figure 2 illustrates how banks shifted from traditional lending towards market-oriented activities.
regulation, economies of scale, bank regulation, banking, Too big to fail, systemic risk, BASEL III, bank resolution, bank capital
Estimating the impact of changes in aggregate bank capital requirements during an upswing
Joseph Noss, Priscilla Toffano 06 April 2014
The impact of tighter regulatory capital requirements during an economic upswing is a key question in macroprudential policy. This column discusses research suggesting that an increase of 15 basis points in aggregate capital ratios of banks operating in the UK is associated with a median reduction of around 1.4% in the level of lending after 16 quarters. The impact on quarterly GDP growth is statistically insignificant, a result that is consistent with firms substituting away from bank credit and towards that supplied via bond markets.
The recent financial crisis and economic contraction that followed highlighted the crucial role that banks play in facilitating the extension of credit and enabling economic growth. This underlies the economic rationale for imposing regulations on the banking industry, including minimum capital requirements designed to mitigate risks banks would not otherwise account for in their behaviour.
regulations, bank regulation, banking, capital requirements, banks, BASEL III, credit, Macroprudential policy, bank capital
Bank capital requirements: Risk weights you cannot trust and the implications for Basel III
Jens Hagendorff, Francesco Vallascas 16 December 2013
Recent research shows that capital requirements are only loosely related to a market measure of bank portfolio risk. Changes introduced under Basel II meant that banks with the riskiest portfolios were particularly likely to hold insufficient capital. Banks that relied on government support during the crisis appeared to be well-capitalised beforehand, suggesting they engaged in capital arbitrage. Until the regulatory concept of risk better reflects actual risk, the proposed increases in risk-weighted capital requirements under Basel III will have little effect.
One of the primary purposes of bank capital is to absorb losses. Where bank capital holdings are insufficient to absorb losses, banks will either fail or – if bank failure is deemed too costly for the economy – be bailed out. In practice, banks frequently receive public funds where capital holdings are insufficient to cover losses in order to prevent bank failure. Whether or not bank capital holdings are sufficient and in line with the risk of bank portfolios is therefore an important question that is hotly debated among policymakers and in the press.
Financial markets Microeconomic regulation
Basel II, financial crisis, capital requirements, BASEL III, Basel, bank capital, risk weighting, capital adequacy
The new market-risk regulations
Jon Danielsson 28 November 2013
Basel III is coming into focus. The fundamental logic of the regulatory changes seems sensible, but the devil is in the detail – empirical implementation. This column discusses a detailed quantitative study, incorporating analytical calculations, Monte Carlo simulations and results from observed data. It concludes that the Basel Committee has taken three and a half steps backwards and half a step forward. If implemented, the framework is likely to lead to less robust risk forecasts than current methodologies.
The final shape of the Basel III proposals is increasingly becoming clear, (see Basel Committee 2012, 2013). While the proposals are generally quite technical, the fundamental elements of the market-risk proposals are simple and easily evaluated, providing means to evaluate the quality of the overall proposal.
BASEL III, market risk
The impact of liquidity regulation on monetary-policy implementation
Clemens Bonner, Sylvester Eijffinger 14 October 2013
Liquidity requirements like the Basel III Liquidity Coverage Ratio are aimed at reducing banks’ reliance on short-term funding. This may have implications for the implementation of monetary policy, which usually operates through short-term interbank interest rates. This column looks at how banks reacted to the Dutch quantitative liquidity requirement. The authors conclude that liquidity requirements will only reduce overnight interest rates if they cause an aggregate liquidity shortage.
In response to the recent financial crisis, the Basel Committee on Banking Supervision has drafted a new regulatory framework (henceforth Basel III) with the aim to achieve a more robust banking system. While it also tightens the existing requirements for capital, the proposal stands out as it is the first to attempt harmonised liquidity regulation across the globe. Specifically, the framework includes the short-term Liquidity Coverage Ratio (Liquidity Coverage Ratio) and the long-term Net Stable Funding Ratio.
Financial markets Monetary policy
monetary policy, liquidity, financial regulation, BASEL III, liquidity coverage ratio
How much capital should banks have?
Lev Ratnovski 28 July 2013
After much negotiation, Basel III regulations set capital requirements to be between 8% and 12%. This column suggests this may not be enough. It looks at how much capital banks would need to fully absorb asset shocks of the size seen in OECD countries over the last 50 years. The answer is 18% risk-weighted capital, corresponding to 9% leverage. This benchmark is highly conservative, so the true 'optimal' bank capital may be lower.
There is an active debate on how much capital banks should have. Yet establishing an 'optimal' level of bank capital is more art than science. Any conclusion is model-specific and contains a degree of judgement. The purpose of this column is to contribute to the debate by offering one more benchmark.
banks, BASEL III, capital ratios
Capital adequacy and hidden risk
Mike Mariathasan, Ouarda Merrouche 29 June 2013
The regulation of bank capital has recently come under renewed scrutiny. This column argues that the way we implement capital regulation needs to be reconsidered because banks under-report risk, thereby escaping government intervention and maintaining market access. One possible way forward, something already implemented under Basel III, is to ask banks to satisfy a capital requirement relative to total (rather than risk-weighted) assets. Overall, simple, transparent, workable rules are what we should be aiming for.
The regulation of bank capital has recently come under renewed scrutiny. While some commentators argue for higher requirements (e.g. Admati and Hellwig 2012), others – and the banking industry in particular – are quoting the risk of reduced credit and the corresponding costs for the economy. At the same time, there have also been frequent reports suggesting that banks were hiding risks during the Crisis, in order to escape governmental intervention and to maintain market access (Hume 2012, Comfort 2012).
BASEL III, capital regulation, RWA, risk weighted assets, IRB, internal ratings based approach
A viable alternative to Basel III prudential rules
Stefano Micossi 09 June 2013
Global banking regulation is undergoing a massive reform, known as Basel III. This column argues that the proposed reforms will fail to correct flaws in the old system. The new rules are even more complicated, opaque and open to manipulation. What is needed is a radical shift to prudential rule based on a straight capital ratio.
There is something surreal in the process for the implementation of the new Basel capital framework for banks in the EU and US. The new rules, known as Basel III, have the full support of financial officialdom (see BCBS 2013b for the latest official update by Basel Supervisors). Implementation is a different story. Implementation appears fraught with frictions and resistances, while the system is by now utterly discredited in the eyes of financial markets and academia (e.g. Dewatripont et al. 2010, Goodhart 2013, Admati and Hellwig 2013).