Download building the new regulatory framework: challenges ahead

BUILDING THE NEW REGULATORY
FRAMEWORK: CHALLENGES AHEAD
Xavier Freixas
UPF, Barcelona GSE and CEPR
Based on “Systemic Risk, Crises and
Macroprudential Regulation” with Luc Laeven and
José Luis Peydró
Banking externalities:
• Banks bankruptcy costs
– Cost to small uninformed depositors
– Cost of severing relationship banking
– Contagion and systemic risk
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Fire sale and liquidity crises
Herding
Cost of fiscal resources
Credit crunch
Sovereign crises (Deadly embrace)
Zombie lending
• Financial Market imperfections and the misallocation of
resources
– credit cycles
– credit rationing
– excessive risk taking
Basic principle
• An externality should be dealt with at the
point where it originates, thus limiting the
impact on other markets and institutions.
Cost-benefit of bank regulation
• Multiplicity of instruments imply that the costbenefit is to be determined for every
combination of instruments.
• The per dollar marginal net benefit should be
equal accross different instruments.
Basel III Micropru Achievements
• Correcting risk-weight errors (Internal models,
Accepting models without considering
systemic risk…)
• Accounting harmonization
• Risk provisioning (Expected loss)
• Restructuring and resolution
• Macroprudential
– Procyclical provisions
– New institutions
The Net Benefit of Liquidity Regulation
• The role of banks in maturity transformation
• Credit supply reduction? (No, Banerjee y Moi,
2014)
• Market segmentation between HQLA and nonHQLA
• Causes fire sale prices when one asset stops
being HQLA
• Increases Repo funding and decreases unsecured
interbank lending (peer monitoring)
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Concerns on microprudential elements
• Internal models ((Mariathasan and Merrouche
2012, Haldane, 2013)
• Accounting rules
• Regulatory ratios: numerator or denominator?
• What about market discipline? (Laeven and
Huizinga, 2011, Parwada, Ruenzi and Sahga,
2013)
Consumer protection
• Search goods, experience goods vs. Credence
goods depending on consumer’s financial
literacy.
• Examples: real estate financed in foreign
currency.
• Link to systemic risk: Hungary for foreign
currency, Spain for banks’ preferred shares.
Link macro/monetary policy and credit
risk justifies a macroprudential policy
• Savings glut
• Impact of low interest rates on banks’ risk taking
(Borio and Zhu, 2008, Adrian and Shin, 2011, Bordo et al.,
2011, Paligrova and Santos, 2011, Dell’ Ariccia et al., 2013.
Ioannidou et al.,2013, Jimenez et al. 2012, 2014)
• Impact of excessive credit growth on systemic risk
(Maddaloni and Peydró, 2011, Dell’Ariccia et al., 2012, Jorda et al.,
2013)
• Impact of excessive leverage (Reinhart and Rogoff, 2008,
Schularick and Taylor, 2012, Gourinchas and Obstfeld, 2012)
• Impact of excessive asset growth prices (Reinhart and
Rogoff, 2008)
The complexity of the macroprudential
task
• Weighting financial stability vs. economic growth
• Measuring systemic risk
– Time dimension
– Cross-sectional dimension
– A dichotomy of models
• Choosing the right instrument
– Aggregate countercyclical buffer
– Targeted: LTV, DTI
– Effectiveness and lags
• Measuring the impact of the instrument
Creating the right institutions (FPC,
ESRB, FSOC)
• Information from the Central Bank
• Independence in risk prevention, cooperation
in crisis management!
• Accountability
– Transparency?
– Only type 1 errors (miss the buildup of a crisis) are
visible
• Limit political pressures and forbearance
• Limited communication policy
The contercyclical credit buffer
• Credit to GDP (Repullo and Saurina, 2012)
• Two different views : cycles vs. crises.
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Overarching concern: the international
dimension
• Underresearched topic
• Bubbles may be financed by other countries
savings. Restrictions on domestic banks will not
apply to foreign ones.
• Liquidity movements from subsidiaries to parent
companies (Peek Rosengren 1997, Cetorelli and
Goldberg 2012)
• Regulatory «race to the bottom » (Dell’Aricchia
and Marquez 2006, Houston, Lin, and Ma, 2012)
The Architecture Of Regulatory
Responsibilities: The Coupling of Micro
and Macroprudential
• CGFS 2012: top-down and bottom-up.
• Systemic risk estimates should be an input for
internal models.
• Microprudential regulation is an input for
macroprudential risk: example, LTV or DTI vs.
countercyclical buffers in bubbles prevention.
Ex ante prevention vs. Mopping up ex
post
• As there is a cost in ex ante prevention, a balance
should be found between ex ante prevention and
crisis management costs. The marginal dollar
should produce the same net return.
• Define strong restructuring and resolution
mechanisms (bail-ins, cocos, loss absorbing debt
capacity) so as to reach the efficiency frontier.
• Olivier Jeanne and Anton Korinek : ex-post policy
are better targeted but distort incentives and
create moral hazard . Ex-ante measures are
blunter since they depend on crisis expectations.
On Bail-outs
• Bail-ins, Cocos and restructuring will make a
lower cost of bail-outs
• Bail-outs may limit the cost to the deposit
insurance company. Still:
– The legal design should make bail-ins and Cocos
renegotiation proof (legal certainty) even if the
bank does not go bankrupt.
– The incentives impact on uninsured deposits and
junior debt should be negligible.
Banks corporate governance
Price manipulation: FX, libor
Consumer abuse: misselling of pension funds or of
Bankia’s stocks
Disclosure: Lehman Repo 105
Empirical evidence:
– Laeven and Levine (2009) and Ellul and Yerramilli (2013)
show that the presence of institutional investors increases
the risk of the bank.
– Fahlenbrach and Stulz (2010) CEO’s objective aligned to
shareholders ones implies more risk taking.
Incompetence (risk supervision failure) or shareholder
value maximization?
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Remuneration policy
• Say on pay, caps on bonuses,… may not really
change managers’ incentives to take risk.
• Fines and insurance fees paid by the bank
• Woody Allen: « I think crime pays »
• UK Parliament commission on Banking
Standards proposed criminal sanctions.
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Improving banks’ corporate governance
Acknowledge that banks are different
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Opacity
Deposit insurance (lack of market discipline)
Collateralization of assets
Leverage
Access to instruments to change the risk profile
Importance of expertise, independence and
engagement
Maximize value of the bank rather than
shareholders’ value. Structure compensations
accordingly (Bolton, Mehra and Shapiro).
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Capture theory
• Political economy/lobbies
• Assessing the costs and benefits of regulation:
Regulatory cycles. Excessive regulation today
will lead to inefficiently low levels of
regulation tomorrow.
• Regulatory cycles reacting to political
immediacy
• Macroprudential decisions are political
• Checks and balances (Norway)
Should macro Prudential policy rules
based or discretionary?
• The political economy framework implies rules based are
desirable
• Accountability depends upon a well-defined task and
simple, verifiable, rules
• Discretion needed:
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New financial innovation
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changes in the macro financial framework
– Future sources of imbalances
– Methodologies not fully developed
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