Recent Regulatory Developments and the Systemic Dimension

1. Recent Regulatory Developments and the Systemic Dimension Andrew Large SCA Annual Conference Abu Dhabi 25 January 2011

2. Outline • Avoiding crises: What went wrong? [slides 3- 6] • Systemic stress: causes [7-9] • Systemic issues: propositions and challenges [10-15] • Creating a macroprudential/systemic framework [16-26] • What is being done and conclusions [27-29]

3. Avoiding crises: What went wrong in 2008? • Regulatory architecture? • Policy vacuum? • Delivery of policy?

4. Avoiding financial crises3 factors Role of architecture Role of individual bank supervision [microprudential policy] Macroprudential framework Mitigating risks of financial crises New policy area for many jurisdictions

5. Architecture 1 • Many models: success/failure random • Unitary • UK failed • Japan neutral • Singapore succeeded • Twin peaks [separate prudential authority] • Australia succeeded • Twin peaks [microprudential within the CB] • Netherlands failed • Canada succeeded

6. Architecture 2 Who is now doing what? Random moves! But trend overall to twin peaks • Moving to twin peaks [supervision at CB] • UK • Belgium • Moving to unitary • Indonesia • Creating separate CP regulator • USA

7. 2. Systemic stress:caused by what and whom? Root cause Excessive broad leverage/borrowing/debt Indicators of systemic tension [‘bubbles and froth’] Asset prices [equities; real estate] Credit spreads Maturity mismatch, inadequate liquidity buffers Other compromised risk areas Sparks can then cause crisis! Random shocks [triggers are never obvious nor predictable]

8. Leverage: who creates? Who uses? Creators of leverage Banks/quasi banks Insurance/guarantees Products … embedded leverage Users of credit Consumers Companies Government Other financial institutions [incl hedge funds, private equity]

9. How to dampen leverage? Act on root cause creators of credit: adjust the cost of creating credit–or prohibition/limits for individual offenders Direct restrictions on users partial or unreliable (but signalling effect): arbitrage squeezed balloon syndrome

10. 3.Systemic issues: four propositions 1 Existence of policy gap 2 Plethora of microprudential[regulatory]initiatives won’t do 3 International issue: needs national initiatives 4 Relevant for all jurisdictions

11. Proposition 1 Policy gap Existing relevant policy areas Monetary Microprudential [regulatory, supervisory] Fiscal Competition Where is systemic/macroprudential policy??? Historically under central bank, but “modern monetarists ignored this aspect”

12. Proposition 2Plethora of microprudential[regulatory]initiatives won’t do Basel, FSB, G20, EU, jurisdictions Capital and liquidity Structural/Volker rules tbtf/living wills AI, ratings Rem incentives Accounting standards……. Etc, etc Where is the oversight? Are they joined up? By whom?

13. Proposition 3 International issue: needs national initiatives Global markets but no global government But: national level implementation vital - where the laws and fiscal authority reside Tough issues of cooperation!

14. Proposition 4 Relevant for all jurisdictions The main problems were in mature economies Too much leverage/debt in US, UK, elsewhere in EU due to easy money Less problem in Canada, Australia, main Asian countries, including China But issues are generic: they impacted UAE/Dubai - And so are the lessons

15. Generic challenges • Four policy areas [macro, micro, resolution, monetary] • Several authorities [MoF, CB, regulators] • Multiple tasks across authorities: who does what? • Choice of instruments • How to create engagement and co-ordination? • Governance [individual authorities] • Accountability • Transparency

16. 4.Creating a macroprudential/systemic policy framework: delivery • Mandate • Institutional vehicle for delivery • Legitimacy and respect • Tasks: indicators and assessment • Engagement of parties • Instruments • Authority to deliver • Relationship with monetary policy • Transparency

17. Policy framework and deliveryA. Mandate/objectives • Secure and maintain financial stability • Overarching mandate 1. Systemic conjuncture • Identify threats • Apply policy instruments • Implement policy actions 2. Resilience of system

18. Policy framework and delivery B.What sort of vehicle? Committee / self standing / department? Anchor with central bank or regulatory authority? Respect, independence Experience macro environment Operational activity/nerve centre Interface with political process Distribution of power Emerging practice favours central banks: but with vital regulatory involvement Time dimension: Steady state Role in triggers and crisis?

19. Policy framework and deliveryC. Creating legitimacy and respect …politicians, bankers and credit users won’t like it! So: Objectives politically set Operationally independent from political process Accountability to political process Transparency of process and decision Authority Dedicated resources

20. Policy framework and delivery D. Tasks Involves several authorities: needs engagement 1. A lot of data! multiple data sources imbalances global and national leverage asset managers exposures and dynamic asset prices new products arbitrage measures of uncertainty /confidence and risk appetite ….relevance is the key 2. Assessment process tough judgements practical vs academic 3. Policy decision ... and enforcement

21. Policy framework and delivery E. Engagement of parties • Skill sets/working knowledgenot available from one institution • NeedsCB, regulators, practitioners, government • Practical experience, crisis and steady state • Academics

22. Policy framework and delivery F.Instruments and policy tools • Capital ratios [promising candidate!] • Gets at root cause: impacts all creators of leverage • In use already for micro….. • ‘Other’ policy instruments • [liquidity, remuneration, LTV ratios etc]

23. Policy framework and delivery F. Instruments: tricky areas • Policy context • Behavioural expectations • Governance of other policymakers • Creators or users? • Political pressure • Squeezed balloons • Calibration • Regulatory assessment • Reaction function • Discretionary/automatic?

24. Policy framework and delivery G. Authority to deliver Overarching oversight assess data deliver response Overarching authority obtain data enforce/influence policy decision influence other policy areas monetary policy fiscal policy etc

25. Policy framework and delivery H.Relationship with monetary policy Interest rates/fx rates Monetary policy and systemic policy: mutual impact Combine or separate policy areas? Experience and capabilities Accountability Assessment process: band vs binary Much to learn! Experience in Asia

26. Policy framework and delivery I. Transparency • Tell people about • Data used • Assessment • Chosen policy response • Regularity • Impacts understanding • Impacts expectations

27. 5. Systemic policySo who’s doing what? • UK FPC Creating committee at Bank of England Participants from regulatory field Authority to deliver policy instruments Transparent process • Mexico Creation of Council • USA Creation of FSOC Treasury in control • EU/ECB ESRB No authority over individual states Source of influence/data/recommendation • UAE Under discussion • G20/FSB Peer group pressure? No global government…….. Needs national machinery

28. Tough questions to debate… Feasibility/legitimacy to create an executive reponsibility like monetary policy?  Impact on growth and welfare? Cost benefit equation?

29. Systemic policy: thoughts for UAE Crisis impacted Dubai; issues are relevant Need for conscious creation and implementation of framework CBUAE should lead But with engagement from SCA and other areas of government