Financial Stability News

News about financial stability, central banking and theory of money

Tag Archives: Basel 3

IMF: Financial stability reform lagging behind

This VOX post by one of the leading authors of this years Global Financial Stability Report  Not making the grade: Report card on global financial reform | vox. argues that the pace of reform and restructuring of the financial sector is too slow. Important issues remain unresolved, including

  • Financial systems are still overly complex.
  • Banking assets are highly concentrated (Figure 3), with strong domestic interlinkages.
  • The too-important-to-fail issues are unresolved.
  • Banking systems are still over-reliant on wholesale funding (Figure 4)

There is still little progress (or politicla will?) to tackle the TBTF problem, and the financial system remain too complex. Shadow banking continue to be a problem, as well.

Key question is whether “traditional” program of reform, inkl. Basel 3, will deliver the required reforms in time? The lobbying pressure is intense, ref. the latest defeat of the SEC on money market reform. May be we need other approaches, ref. Haldane’s critique of Basel 3?

On Covered Bonds, Collateral Crunches, And The Circular Logic Of Central Banks

This post by Zero Hedge gives a subjctive interpretation of the current rush of covered bonds by Europeans banks, some of them soon approaching the limits for such issuance. Many banks retain large portion of the new bonds themeselves; which raises the interesting question if you can own your own debt!

The post goes on to argue that central banks are painting themeselve into a corner, where lack of collateral and requirement of collateralized lending (from CBs to banks) will finally meet.

If, however, the covered bond bridge is pushing up against its very real statutory and quality limitations, that might mean the ECB is now fighting a two-front funding war – retail deposit flight and collateral diminishment at the same time. 

At that point the system will collapse or central bank will be force to relax collateral requirements, ref. Tuckers discussion of this problem under the heading of “central banks’ time inceonsistency problem”, for a discussin of this dillemma see my Levy WP here on The Collateral Squeeze, p. 17

Alternatively (and better), central banks should let failing banks go into resolution and stop the collateral chasing. Better to start on this process before it becomes too late.

Debuty Governor Paul Tucker on how to avoid a new banking crisis

Somewhat old interview (August 1), but still interesting points about central bank lending to CCPs, how to solve the TBTF problem, and the need for more liquidity for trading activities:

Since then, I have wanted trading book positions to incorporate an element of capital against illiquidity risk, because these books get marked to market so even if there is no change in fundamentals but the market suddenly dries up, values will fall as a result and the net worth of the dealer or bank falls sharply.

And also about how to prevent a new “blow-out” of the financial system:

Risk: Do you see any danger in a more prescriptive approach to capital modelling?

PT: This is a genuine consultation by the Basel Committee, but I would point out that there are something like 15 million people unemployed in the western world because finance imploded, and finance imploded because the rules of the game in finance were inadequate. That’s a terrible price to pay. So this business of debating exactly how to calibrate things, this is for grown ups. It’s not about whether we – if the following rich assumptions hold – can optimise capital levels. It’s about whether we can avoid having a financial system that is fragile in ways that have very high social costs.

Agree fully with Tucker!

The Financial System Five Years from Now

The IMF hosted a one day conference end of March on the structural challenges in banking and on shadow banking. Some of the presentations and papers have now been posted (unfortunately not all). See in particular presentation by Arnoud Boot, which gives an interesting overview of the issues, but provides more questions than answers. Andrei Shleifer et al. have a paper on shadow banking where they show how vulnerable the financial system becomes if tail risk is ignored and securitization allowed. They support some form of regulation, preferably through a leverage ratio.

Goodhart on how to prevent another banking crisis

Charles Goodhart and Enrico Perotti have an interesting VOX note on “Preventive macro prudential policy”. They suggest a five step PCA-like policy response with emphasis on liquidity and punitive charges for non-compliance with the Net Stable Funding ratio. National supervisors should be empowered to charge “prudential risk surcharges” on the gap between the banks’ current liquidity position and the new Basel III norms.

I am not so sure about the novelty of this, or how it would work. It resembles the old PCA framework, although transferred to a liquidity framework. Still interesting to read and could form the basis for some supplementary PCA reactions to the current capital based system.

For a review of the US experience with their PCA system during the latest crisis, see this report from the US Financial Stability Oversight Council. It was issued late 2011, but is still relevant for the ongoing discussion on how to prevent another banking crisis.

OECD: A new Basel III is required

A senior OECD official claims that the risk weights of Basel III should be scrapped:

a more fundamental rethink of the Basel framework for determining minimum capital requirements for banks is needed. Basel III is just a quick and dirty repair job, consisting of patches applied to fix things that went visibly wrong during the past four years. But it involves no reconsideration of the structure of a fundamentally flawed system that is opaque and far too complex. The risk weight system at the core of the approach for calculating capital charges needs to be scrapped in its entirety and a more coherent approach to exposures arising from derivatives, notionally in excess of $600 trillion at the end of 2010, must be found.

Read the rest at VOX

For and Against the Volcker Rule

New York Times carries a story today that the so-called Volcker rule, that would bar US banks for carry out proprietary trading, could seriously harm the liquidity in foreign bond markets and drive borrowing cost up. This is not something the European countries want just now. Even Canada is upset and claims the rule would be a breach of the North-American free trade agreement.

The rules are out for hearing, based on a rather inept proposal from the Treasury with as many open questions as there are pages (around 300). This prompted one of the sponsors of the bill, senator Merkley, to tell the regulators recently to do a much better job of drawing up clear, bright lines so as to avoid another repeat of the financial crisis of 2008. In his words, the Volcker rule is about taking deposit-taking, loan-making banks out of the hedge fund business. Hedge funds should be able to make bets, but not with taxpayers money.

If you want another view, look up this post by our friend Doug Elliot at Brookings. In a testimony before Congress he claims the the Volcker rule is fundamentally flawed. This is basically because the current proposals try to regulate on the basis of (speculative) intent, which according to him, will be near impossible. He also notes that the blurring between traditional lending and securities lending have made the securities business an integral part of banking. Preventing banks from holding securities inventories would be paramount to ban banking, according to him.

With the FDIC, Fed and Treasury all against the new regulation, and now foreign government adding pressure to delay, my guess is it will take some time before the Volcker rule is enacted in the US.

Tightening the Limits on Big US Banks

On December 20 the Federal Reserve issued new proposals for tighter regulations of US financial institutions. This blog post from Harvard Law School brings the essence of the proposals. Their conclusion is that the effect will probably be small for large US banks that already have beefed up their capital, but that some of the new non-bank SIFIs may find it harder to comply with the new rules.

The EBA 9% rule and the Eurozone crisis

FT Alphaville cites today Richard Koo from Nomura Research on the ongoing funding crisis among European banks. With reference to Japan, he notes that Japan had a similar situation back in 1997 when Bank of Japan insisted on implementing stricter Basel capital rules in the midst of a prolonged crisis. His conclusion is clear:

EBA’s 9% rule should be scrapped

Indeed, much of the EU’s policy response to the ongoing crisis appears to be directed at preventing the next crisis and has actually aggravated the current situation. Prime examples in this regard are the EBA’s 9% rule and the German government’s insistence on fiscal austerity and the adoption of balanced budget amendments.

Negative impact of Basel 3 thiny

As FT has already reported today, the Basel Committee have released a new report showing that the negative impact of higher capital charges under Basel 3 will be small. The costs are estimated to below 0,5 % of GDP, whereas the benefits could easily be over 2,5 %. But as usual, more studies are required to test the robustness of the results. The report is fairly short (38 p), but would probably not be a good weekend read. Go for the Vanity Fair article on EW.