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Economic aspects of
financial regulatory reform
Richard Reid
Director of Research & Chief Economist
International Centre for Financial Regulation
LSE, November 25th 2011
© International Centre for Financial Regulation 2009. All rights reserved.
THE REGULATORY CYCLE
Phase 1 - crisis management and stabilisation (rescue packages,
fiscal and monetary policy)
Phase 2 - the “grand plans” emerge. Crisis avoidance.
International cooperation, G20, the FSB. Economies begin to
steady – The hunt for who to blame gathers pace. Who bears the
cost?
Phase 3 - detailed legislation, economies start to recover, the
blame game picks up, the tension between international
cooperation and domestic agendas heighten Industry pushback
more manifest.
Phase 4 - legislative details & aims challenged. Costs! Be seen to
punish. Behaviour, culture, ethics. Economies falter - Industry
pushback grows - G20 wilts then regroups – wilts again?. Long
implementation phase begins. Regulatory capture?
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Another aim of regulation
“Financial regulation is not just
about preventing crises: it is also
about cultivating financial systems
that provide growth-promoting
services”
Ross Levine in “Regulating Finance and Regulators to Promote Growth” August 2011
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MANAGING FINANCIAL DEVELOPMENT
Size of financial system
(FIR – financial intermediation ratio: GDP)
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3
Alternative financial paths
b.
FIR
2
a.
1
Time/GDP
Source: adapted from Gurley, 1969
© International Centre for Financial Regulation 2009. All rights reserved.
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Credit & Growth
(cumulative real credit and GDP growth, end 2002 – August 2011)
Source: Citi October 21 , 2011
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Risk and Financial Depth
(risk, probability of instability and financial depth – a stylised depiction)
instability
Source: IMF Discussion Note “Financial deepening and international monetary
stability” Oct 2011
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RISK FROM UNBALANCED INTERMEDIATION
(Euro area flow of funds, 1999 & 2008)
Source: ECB Financial Stability Review, 2009 and ECB calculations.
Notes: The thickness of the lines shows the size of the gross balance sheet exposures (assets plus liabilities) between two sectors. The size of the circle illustrates the amount
of gross exposures within sectors. NFC stands for the non-financial corporations sector, MFI for the monetary financial institutions sector, OFI for the other financial
intermediaries sector, INS for the insurance sector, GOV for the government sector, HH for the households sector and RoW for the rest of the world.
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© International Centre for Financial Regulation 2009. All rights reserved.
Vickers vs. Volcker
(xxx)
Source: IMF WP “Making banks safer – can Volcker and Vickers do it?”, Nov 2011
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Scope & shadow intermediation
(bank models pre- and post- reform)
Pre-reform
Reform
Post-Reform
Volcker
Shadow intermediation
Vickers
Source: ICFR
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COMPETITION FROM OUTSIDE EUROPE
(pan-European banks assets and equity as % of global total)
Assets
Equity
European Equity, 23%
Non-European Equity, 77%
Source: Citigroup Investment Research , November 2011
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© International Centre for Financial Regulation 2009. All rights reserved.
Is small beautiful?
(riskiness of institution by size, complexity, incentive structure)
Incentive Structure*
Bigness
Complexity
Note – the further from the source, the greater the riskiness of the institution, Area of triangle represents the systemic riskiness
of institution. *Incentive structure/governance, agency issues, ERM, internalisation of externalities, ethics, ROE, etc.
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REGULATORY CYCLE: NEXT
1. IMPLEMENTATION – CAPTURE?
2. INCENTIVES IN BANKING (FRANCHISE)
3. GROWTH & REGULATION
4. SIZE, SCOPE, STRUCTURE
- INDUSTRIAL ORGANISATION/COMPETITION
5. SHADOW INTERMEDIATION
ICFR-Financial Times Essay Competition
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© International Centre for Financial Regulation 2009. All rights reserved.
Economic aspects of
financial regulatory reform
Richard Reid
Director of Research & Chief Economist
International Centre for Financial Regulation
LSE, November 25th 2011
© International Centre for Financial Regulation 2009. All rights reserved. 13
APPENDIX
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© International Centre for Financial Regulation 2009. All rights reserved.
UK borrowing costs
(key UK borrowing rates, %)
Source: Citi Sterling weekly Oct 28
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FINANCIAL CRISES & TREND GROWTH
(Euro area: long term effect of the crisis on GDP)
Source: Gros and Alcidi “Impact of Financial Crisis on the real economy” CEPR 2010
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© International Centre for Financial Regulation 2009. All rights reserved.
RECOVERING FROM A CRISIS
(schematic GDP recovery paths after a financial crisis)
Pre-crisis trend growth surpassed
output
Pre-crisis trend growth
Pre-crisis trend
growth recovered
pre-crisis growth
trend never
recovered
post-crisis trend
growth lower?
crisis
time from financial crisis
Source: ICFR
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© International Centre for Financial Regulation 2009. All rights reserved.
RECOVERING FROM A CRISIS (2)
(GDP per capita, actual and trend, advanced and developing economies)
Advanced nations
Developing nations
Source: EU Autumn forecasts, November 2011
© International Centre for Financial Regulation 2009. All rights reserved.
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GROWTH & FINANCIAL DEPTH
(share of retail lending to GDP and per capita GDP)
Source: IMF Nov 14 2011 China FSSA
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© International Centre for Financial Regulation 2009. All rights reserved.
ECONOMIC IMPACT OF BASEL III
xxxx
Source: BIS
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© International Centre for Financial Regulation 2009. All rights reserved.
Economic aspects of
financial regulatory reform
Richard Reid
Director of Research & Chief Economist
International Centre for Financial Regulation
LSE, November 25th 2011
21
© International Centre for Financial Regulation 2009. All rights reserved.