Register, Issue, Cap and Trade: a proposal for ending current and future financial crises

1. Register, Issue, Cap and Trade:a proposal for ending current and future financial crises Alistair Milne Loughborough University LSE Financial Regulation Seminar, Oct 1st, 2012

2. Economics eJournal • Published article • But only in draft form • Any comments today can be incorporated • Please read and comment online ! http://www.economics-ejournal.org/economics/discussionpapers/2012-34

3. Summary of the proposal • Register of short term liabilities • across the financial system, not just banks • A cap on total volume • Issue of corresponding tradable licences, with penalty for registered liabilities that do not have matching license • Institutions trade licenses, so they are held where gains from short funding are largest • Closely related to proposals of Jeremy Stein/ Anil Kashyap and Javier Suarez/ Enrico Perotti

4. Background/ motivation • Liquidity risk central to the financial crisis • Policy response • Liquidity Coverage Ratio (LCR) • Enough high quality liquidity assets to cope with a one-month stressed runoff • Binding by January 2015 • Major impact on business models • Net Stable Funding Requirement (NCFR) • Enough stable (long term) funding to cover long term assets • Minimum standard by January 2018 • Major regulatory changes • Much more fundamental than higher capital

5. Why liquidity regulation? • In order to control a (systemic) risk externality • “Firesales” • In particular to allow orderly resolution • limit credit booms and asset price instability • Stein (2010), Kashyap and Stein (2011) • Formal model of firesales and maturity mismatch • Alternative view (Gorton) • maturity mismatch good • Not enough “informationally insensitive assets

6. How? • Quantity controls on individual institutions • Proving highly controversial • Major impact on business models • Affects some banks much more than others • Fierce ongoing battle over LCR • Tax on liquidity eg on maturity mismatch • Limited tax already in place • But what level of tax is appropriate? • If we can determine acceptable degree of maturity mismatch • Then “cap and trade” is sensible approach • MUST extend to shadow banking

7. More detail • A central register of financial assets and liabilities, updated in real time. • Only registered liabilities legally enforceable • Upper limit on short term liabilities of financial intermediaries. (t/365 weighting) • Increased gradually to target e.g. ratio of short term liabilities to GDP • Licenses for this amount are distributed to financial institutions (e.g. based on usage) • In advance of each quarter auction of licenses. • Daily monitoring of usage, fines for excess.  

8. Criticisms 1 • Easily evaded • Not a system of credit control, credit financed with long term debt unaffected • Shadow banking included • Better in this respect than LCFR • Also deals with unregistered maturity mismatch • Offshore exposures not covered • Yes this is possible, but only evades if assets are offshore as well, so limits credit boom/ externality

9. Criticism 2 • Profound change of business model • End of pricing off LIBOR • Yes, but this is also true of LCR • Will greatly reduced transmission of monetary policy • Yes, but this is also true of LCR • Will limit leveraged trading and price discovery in security markets • Yes, but as well as this being true of LCR may be a benefit not a cost

10. Helicopter money? • Separate issue • Curtailing of “conventional” money transmission (via short term interest rates) • May need us take helicopter money proposals more seriously • Register can regarded as a neutral distribution mechanism • But many other possibilities

11. Current thinking on redraft • More link to LCR and other current liquidity policies • Less on helicopter money, except in relation to change in monetary transmission • Emphasise: liquidity regulation is the BIG issue in Basel III, far more important than capital changes