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Does new international regulation help crisis prevention? The European sovereign debt crisis PowerPoint Presentation
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Does new international regulation help crisis prevention? The European sovereign debt crisis

Does new international regulation help crisis prevention? The European sovereign debt crisis

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Does new international regulation help crisis prevention? The European sovereign debt crisis

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  1. Does new international regulation help crisis prevention? The European sovereign debt crisis Warwick lecture February 2012 Prof Stephany Griffith-Jones, sgj2108@columbia.edu

  2. Overall context Aims of the financial system • Managing risk and avoiding crisis • Allocating capital to the real economy efficiently • Financial system did neither leading to crises Do we need a completely different financial system? • Restricting or isolating speculation • private banks to lend to real economy • Role of public banks to fund real economy

  3. Some key problems • One major problem: increased leverage and maturity mismatches which increase systemic risk • Crisis revealed too low core capital, leverage too high and • Both accounting and regulation was pro-cyclical, reinforcing procyclicality of finance • Lack of instruments like GDP linked bonds

  4. Basel 3 • Size and quality of core capital improved (but is it enough?) • Simple leverage ratio 1:30 (too generous) • Counter-cyclical regulation • Liquidity coverage ratio positive

  5. Lack of debt management tools • Growth or GDP linked bonds to smooth debt service payments to avoid debt crises and allow counter-cyclical fiscal policies • More ambitiously, international orderly workout arrangements needed • Would help in both developed (eg European) and developing country crises

  6. Higher capital requirements – cost benefit analysis • Benefits: • Stronger Financial System => Lower probability of banking crises => Lower crisis-induced output losses • Reduction of amplitude of output fluctuations • Costs: • Higher lending rates => lower output level (but trend growth rate unaffected)

  7. Impact of increasing capital • Increasing capital by 1%: • Increases lending spreads by 0.13% • Decreases output by 0.09% • Therefore, even if temporary crisis-generated output losses are assumed: Net benefits of increasing capital from 7% to 8% = = Benefits – Costs = 0.30% - 0.09% = 0.21% > 0 Source: BIS estimates

  8. Countercyclical regulation • Need for countercyclical regulation to compensate for pro-cyclical finance • History; dynamic provisioning • Rules preferable to discretion • The gap between credit-to-GDP ratio from its long-term trend is the benchmark guide for Basle • International coordination

  9. Implications for national implementation • Several elements of Basel 3 positive, such as countercyclical buffers and liquidity ratios; increasing quantity and quality of core capital if needed • Too slow and gradual introduction of reforms desirable to accelerate ?

  10. Shadow Banking system definition • Buiter definition (2008) : • “The shadow banking sector consists of the many highly leveraged non-deposit-taking institutions that lend long and illiquid and borrow short in markets that are liquid during normal or orderly times but can become very illiquid when markets become disorderly. • They are functionally very similar to banks but : • -are barely supervised or regulated. • -hold very little capital, • -are not subject to any meaningful prudential requirements as regards liquidity, leverage or any other feature of their assets and liabilities.”

  11. Challenges of regulating shadow banking - Regulate all financial activity in comprehensive and equivalent manner, for capital adequacy, leverage and liquidity (D’Arista and Griffith-Jones, 2010) - What quacks like a duck should be regulated like a duck! - Put all banking activity on banks balance sheet - Aim: reduce shadow banking scale

  12. Dodd-Frank Act • More rigorous than initially expected, but weakened by lobbying, e.g. Volcker rule and derivatives, further diluted in implementation • Positive institutional developments: consumer protection agency (prevents abuse) and systemic risk regulator also in EU (prevents silo-thinking about systemic risk)

  13. Policy suggestions for developing countries • Key: link financial sector to its main aim, financing the real economy • Counter-cyclical regulations and instruments • Increase of quantity and quality of core capital; increase liquidity requirements • Regulate all shadow banking system in equivalent way • Putting all transactions on the balance sheet • Forcing derivatives on exchanges • Borrow less internationally; issue GDP linked bonds