Compliance with risk targets – will the Volcker Rule be effective?
Jussi Keppo, Josef Korte 07 September 2014
Four years ago, the Volcker Rule was codified as part of the Dodd–Frank Act in an attempt to separate allegedly risky trading activities from commercial banking. This column presents new evidence finding that those banks most affected by the Volcker Rule have indeed reduced their trading books much more than others. However, there are no corresponding effects on risk-taking – if anything, affected banks take more risks and use their trading accounts less for hedging.
The Volcker Rule, passed as part of the Dodd–Frank Act in July 2010, has been appraised as one of the most important changes to banking regulation since the global financial crisis. By restricting banks’ business models and prohibiting allegedly risky activities, the rule ultimately aims at increasing resolvability and reducing imprudent risk-taking by banks, and therefore at increasing financial stability. This is done by banning banks from proprietary trading and limiting their investments in hedge funds and private equity.
Financial markets Microeconomic regulation
banking, regulation, Volcker rule, Dodd–Frank, banking regulation, proprietary trading, risk, hedging, financial stability
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
Service sector regulation and exports: Evidence from Spain
Rafael Doménech, Mónica Correa-López 10 August 2014
Exporting goods requires services. This column discusses new evidence showing that the improvement in services regulations that took place over the 1990s and 2000s in Spain substantially increased the volume of exports of manufacturing firms, especially of large corporations.
During the crisis, recommendations to improve market functioning in advanced economies have ranked consistently high in the policy portfolio of international institutions (OECD 2014, Buti and Padoan 2013). Among the guidelines, the removal of anti-competitive regulations in the provision of key services that are inputs to other stages of production may be especially relevant to firm performance.
services, regulation, service sector, liberalization
Credit ratings and regulatory risk weights
Harold Cole, Thomas F Cooley 22 June 2014
In the aftermath of the sub-prime crisis, the major credit rating agencies have been criticised for giving overly generous ratings to mortgage-backed securities. Whereas many commentators have blamed the ‘issuer pays’ market structure for distorting incentives, this column argues that the key distortion came from regulators’ use of private ratings to assign risk weights. This induced investors to focus on the risk weights attached to ratings rather than their information content, thus undermining the reputation mechanism that had previously kept ratings honest.
One of the casualties of the financial crisis has been the reputation of the major credit rating agencies. To many, the problem with the credit ratings business seems obvious:
- The ‘issuer-pays’ market structure, in which the issuers pay the agencies to rate their debt instruments, distorts incentives.
The issuers want higher ratings to lower their cost of borrowing, and can shop among raters to get higher ratings (Pagano and Volpin 2010). Seems obvious, right?
Financial markets Global crisis Microeconomic regulation
regulation, credit rating agencies, capital requirements, risk weights, sub-prime crisis, reputation
Net neutrality: A simple goal with some difficult implementation ahead
Joshua Gans 11 June 2014
Netflix recently agreed to pay Comcast for faster access to Comcast’s customers, intensifying the debate over ‘net neutrality’ – the principle that internet service providers should treat all data equally. This column argues that without net neutrality regulation, ISPs can capture the benefits of higher-quality content, thereby discouraging innovation from content providers. To be effective, net-neutrality regulation must prevent content-based price discrimination on both sides of the market.
Net neutrality has a simple goal – to ensure that consumers face an undistorted choice in choosing where to devote their attention on the Internet. The rationale for that goal is to ensure a ‘level playing field’ for those who provide content, applications, or anything else via the Internet.
Competition policy Industrial organisation Microeconomic regulation
US, technology, market power, regulation, internet, price discrimination, net neutrality, Federal Communications Commission
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
Spillovers from systemic bank defaults
Mark Mink, Jakob de Haan 24 May 2014
To date, much uncertainty exists about how large the spillovers would be from the default of a systemically important bank. This column shows evidence that the market values of US and EU banks hardly respond to changes in the default risk of banks that the Financial Stability Board considers globally systemically important (G-SIBs). However, changes in all G-SIBs’ default risk explain a substantial part of changes in bank market values. These findings have implications for financial-crisis management and prevention policies.
Financial-crisis management and prevention policies often focus on mitigating spillovers from the default of systemically important banks. During the recent crisis, governments avoided large bank failures by insuring and purchasing intermediaries’ troubled assets, by providing them with capital injections, and even by outright nationalisations. After the crisis, financial regulators designed additional requirements for those institutions that the Financial Stability Board designated as globally systemically important banks (G-SIBs).
financial stability, spillovers, regulation, banking, banks, systemic risk
Determinants of generic medicine adoption
Joan Costa-i-Font, Alistair McGuire, Nebibe Varol 10 May 2014
Generic medicines are cheaper than their branded counterparts, offering potential savings in healthcare budgets. Medicine-price regulation plays an important role in the expansion of the market for generic medicines. This column presents new evidence that higher levels of price regulation, by lowering the expected price to generic manufacturers, lead (ceteris paribus) to greater delays in generic entry.
With healthcare budgets around the world under pressure, switching to generics seems a natural cost saver. Generic drugs are cheaper alternatives to branded medicines, offering an obvious source of efficiency gains to any health system.
Competition policy Health economics
competition, pharmaceuticals, health, regulation, healthcare, drugs, medicine, generics
Is cannabis use really so harmful?
Ali Palali, Jan van Ours 01 May 2014
There is a robust positive association between support for cannabis liberalisation and cannabis use, but it is unclear whether users have discovered that cannabis is innocuous, or if these types are inherently more liberal regarding drug policy. This column exploits variations in opinion between current and former cannabis users to work towards establishing causality. Results suggest that supporters of liberalisation are speaking from experience rather than personal interest.
Cannabis is prohibited in many countries. The European Monitoring Centre for Drugs and Drug Addiction (2013) discusses several alternatives to prohibition, varying from decriminalisation to regulation and legalisation.
cannabis, regulation, Prohibition, drug policy, legalisation, decriminalisation
How much is enough? The case of the Resolution Fund in Europe
Thomas Huertas, María J Nieto 18 March 2014
The European Resolution Fund is intended to reach €55 billion – much less than the amount of public assistance required by individual institutions during the recent financial crisis. This column argues that the Resolution Fund can nevertheless be large enough if it forms part of a broader architecture resting on four pillars: prudential regulation and supervision, ‘no forbearance’, adequate ‘reserve capital’, and provision of liquidity to the bank-in-resolution. By capping the Resolution Fund, policymakers have reinforced the need to ensure that investors, not taxpayers, bear the cost of bank failures.
During the crisis, individual institutions such as Hypo Real Estate required public assistance of €100 billion or more.1 So how can a European Resolution Fund of only €55 billion possibly suffice for all banks in the Eurozone?
It could, provided the Fund is part of a well-designed architecture for regulation, supervision, and resolution, that makes banks not only less likely to fail but also safe to fail – meaning that they can be resolved without cost to the taxpayer and without significant disruption to financial markets or the economy at large.
EU institutions Financial markets International finance
eurozone, regulation, banking, systemic risk, microprudential regulation, bank resolution, Macroprudential policy, bail-in, European Resolution Fund