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The regulatory response to the financial crisis

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by

Agnieszka P

on 20 March 2014

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Transcript of The regulatory response to the financial crisis

Contents
1. Introduction
2. Deposit insurance
3. Bank insolvency regimes
4. Money market operations
5. Procyclicality in CARs
6. The boundaries of the banking system
7. Crisis management
7.1. The UK
7.2. Cross-border issues
4. Central Bank Money market operations
2. Deposit insurance
Image by Tom Mooring
Goodhart, C.A.E., (2008) The regulatory response to the financial crisis.
Journal of Financial Stability

Main objective
Examination of lessons from 2007 financial crisis with regards to banking regulations.

* Focus is laid on the UK experience.
3. Bank insolvency regimes
5. Procyclicality in CARs
6. The boundaries of the banking system
'originate and distribute' → 'originate and pretend to distribute'
banks transferred assets to vehicles closely related to themselves
7. Crisis management
The UK
Cross-border issues
Agnieszka Pietkiewicz, Qian Zhang, Hung-Yu Chin
Schemes
1st Scheme
no protection for large deposits, potential long pay-out (up to 180 days)
2nd Scheme
increased protection, quicker pay-out
increased moral hazard
Can be diminished by introduction of
prompt corrective action.
p.c.a. - Law allowing governments to close 'bad banks' and apply penalties to risky banks.
Moral hazard
Mervyn King - The Governor of the Bank of England claimed that p.c.a. was the most important reform to be introduced after crisis.
It is a protection guaranteed by government in case of bank insolvencies and recessions.
Purpose:
To protect economy

Two schemes:
1. small deposits insured in 100%,
medium to some limit (90%), large deposits without protection (>£33,000)
2. 100% deposit insurance + quick pay-out
Insolvency - failure to meet contractual pay obligations.
BUT
banks with 100% deposit insurance can raise funds in the case of illiquidity.
Thus, banks become bankrupt when their liabilities can't cover their assets.

Lessons from the crisis
In the US, when the capital ratio falls below 2%, it means that bank is
critically undercapitalised
. Then, it has some time to recapitalise itself.
In the UK, the trigger is capital adequacy ratio, which proved to be poor (eg. Northern Rock).
Thus -> White Paper(2008) proposes changes (more subjective test of failure)

What about shareholders?
Goodhart's proposal
government required to auction off illiquid bank to pay debt holders and shareholders (value of equity on the day of takeover)
auction up to 5 years
if auction was unsuccessful, government required to pay
Consequential issues
how to provide continuity of banking operations of recapitalised bank?
how to run government-owned bank without unfair competitive advantage?
lack of administrative body to handle bank closures in the UK (US -FDIC)
Thank you for your attention !
7.1 The UK
Criticism on the UK's Tripartite Committee: Financial Services Authority, the Bank of England and the Treasury
The Bank was reluctant to assist Northern Rock
7.1 The UK
FSA failed to assess funding/liquidity risk
Dual supervision: by the FSA and the Bank
7.2 Cross-border issues
No failure happened so far
The problem is understood, but not resolved
The Coyne Affair
A dispute between Governor Coyne of the Bank of Canada and the Treasurer in 1961
Failure
of inter-bank and wholesale funding markets, forces banking system to
obtain liquidity from central banks
(previous by wholesale markets).

Difficulties
1, The market closure impacted differentially on banks, Central Bank injected liquid cash
on average
. Some are still short of cash, more borrowing at the upper bound, cause
stigma of reputation risk
!
2, Authorities provide enough cash to immediate needs, but could have additional funding requirement. so Central Bank provide
Long-term auction facility (TAF
).
problem 1.
problem 2.
Illiquidity and insolvency intertwined.

regulatory requirement
banks to hold more liquidity asset, so bank accept
lower grade
private asset. Once crisis happens, they are all illiquidity asset.
Solution:
forecast crisis?

need is: contra-cyclical instrument of monetary authorities. offsetting fluctuations in liquidity condition.
The main trend in regulatory and accounting system have exacerbate the
pro-cyclicality
, because
CARs
(capital adequacy requirement)
and mark-to-marke
t valuation are risk-sensitive.
Base III & Mark-to-market regulation
Advantage:
better-defined individual risk, more conscious of risk analysis.
Disadvantage:
not contain systemic risks & possibility of contagion.

Solution of the Disadvantages
-System as whole more stable, rather than individual.

-Basis of CARs from levels of risk-weighted asset to rates of growth

-Against both bubble and bust

- Requiring additional capital and liquidity when bank increase lending and asset price rising.
Full transcript