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fixing global finance

Page history last edited by Brian D Butler 11 years, 10 months ago

From GloboTrends, see also: 



  1. Increased tier one capital ratios - force banks to hold more.  "HSBC Holdings Plc Chief Executive Officer Michael Geoghegan said in an interview with the Financial Times this week that he expects banks will be required to have core tier one capital ratios of about 10 percent, higher than the 8 percent that regulators had been suggesting in private discussions."  see discussion on deleveraging
  2. ask financial companies to develop “living wills” that set out procedures for creditors to unwind a failed bank.
  3. moral hazard - since last year, Lehman aside, no big firms have been allowed to fail, trading books are about the same size and bonuses are back.  According to the Economist: " The crucial thing is to wean banks off state support—not just the explicit guarantees but the implicit assumption that the state will step in. Change that, and everything else, including pay and the heads-I-win, tails-you-lose culture, will move too."
  4. Bonuses:  And bonuses are, for the most part, the symptom not the disease. They certainly have done damage, persuading traders to load the system with toxic securities and sucking away capital: in the year before its demise, Lehman paid out at least $5.1 billion in cash compensation, equivalent to a third of the core capital left just before it failed.
  5. too-big-to-fail??:  finance now has every incentive to be as big as possible




Recommended Reading:


RGE Monitor:  On the anniversary of the Lehman Bros collapse, RGE Monitor put out the following excellent analysis.  Please sign up for their service to read updated analysis on a regular basis (highly recommended by GloboTrends!)


"Looking forward, here are the three reform priorities RGE analysts see as the most important:

  1. Resolution Authority From a systemic perspective, the establishment of a new resolution mechanism outside of bankruptcy for systemically important institutions, including non-banks, bank holding companies, or insurers like AIG, is a regulatory necessity. Oliver Hart and Luigi Zingales of Harvard and the University of Chicago, respectively, propose an innovative regulatory approach for too-big-to-fail banks in general: "To ensure that LFIs [large financial institutions] do not default on either their deposits or their derivative contracts, we require that they maintain a capital cushion sufficiently great that their own credit default swap price stays below a threshold level. If this level is violated the LFI regulator forces the LFI to issue equity until the CDS price moves back below the threshold. If this does not happen within a predetermined period of time, the regulator intervenes. We show that this mechanism ensures that LFIs are solvent with probability one, while preserving the disciplinary effects of debt." Willem Buiter (LSE) proposes a similar approach for insolvent institutions, where creditors are in line for a haircut according to their seniority.\
  2. Countercyclical, macro-prudential regulatory and policy framework 

    The root of systemic instability lies in leverage and pro-cyclical herding behavior. While economists including William White, the former chief economist at the BIS, have pointed this out for years, the recognition is finally setting in that ensuring the stability of each financial institution by itself (micro-prudential regulation) is a necessary but not sufficient condition to ensure the stability of the financial system as a whole (macro-prudential regulation). One way to internalize externalities are systemic risk insurance premiums charged to any institution engaging in risky activities as a form of compensation to society should a public bailout be required. Applied to the economy as a whole, a macro-prudential policy framework aims to prevent imbalances from building up in the first place. This would represent a paradigm shift for central bankers, in that it would require active engagement to monitor not only inflationary pressures as measured by consumer prices, but also asset prices.

  3. Systemic Risk 

    Another key feature of this crisis is how quickly stress spread from one institution to the next, even across national borders. One explanation is the increasing reliance on uninsured wholesale funding as a share of total bank liabilities. Once market liquidity in securities markets, which is used for repurchase agreements and short-term securities lending, dries up, the institution is immediately exposed to a potential liquidity mismatch. Unless the institution has access to a lender of last resort facility, contagion can spread quickly through the repo channel. After the demise of the shadow banking system, it is not yet clear how the up to US$2 trillion financing shortfall can be met as policy makers slowly withdraw their support.

    In the OTC derivatives markets policymakers and academics are promoting central counterparties (CCP) and exchange-trading with strict margin requirements as a possible solution to reduce the pro-cyclicality and systemic risk inherent in the OTC trading activity. The strand of research that analyzes how contagion spreads through complex and interconnected systems—and how to stop it—is the network theory literature, featuring for example Andrew Haldane from the Bank of England and Rama Cont, Andreaa Minca and Amal Moussa of Columbia University. In the latter paper the authors suggest that sound CDS risk management by a CCP requires liquidity reserves proportional to gross rather than net exposures in order to address systemic risk efficiently


    Read more from RGE Monitor



What's Different?

  • After the G20 finance minister meeting September 4-5, the Bank of International Settlements issued a comprehensive response to the global banking crisis which reviews the current regulation, supervision and risk management of the banking sector with respect to capital adequacy
  • Moreover, the G20 finance ministers vowed to align remuneration incentives with the long-term performance of banks. 
  • OTC Derivatives Central Counterparties (CCP): There is new consensus that a central counterparty is necessary to reduce potential knock-on effects (systemic risk) from the failure of a large player. However, the riskiest products are not standardized enough for a clearinghouse and therefore remain exposed to bilateral counterparty risk which regulators want to mitigate by imposing higher capital charges and disclosure of aggregate position holdings. 
  • There is new recognition that derivatives can have an economic impact. One transmission channel from derivatives to real economy includes for example corporate credit lines which are increasingly based on CDS performance. Furthermore, there is the empty creditor phenomenon that provides "overhedged" bondholders with an incentive to push for bankruptcy instead of restructuring. 
  • A new paradigm of economic thought is voiced by economist Keiichiro Kobayashi at VoxEU: "The existing theoretical structure of macroeconomics is incapable of addressing macroeconomic performance and the stability of the financial system in an integrated context." The author proposes a paradigm shift to explicitly include the financial sector, credit markets and asset/collateral prices in standard economic modeling. 

What's Still the Same?

  • Too big to fail banks are now even bigger and leverage has increased across the board. With the incorporation of insolvent competitors and the forced re-intermediation of formerly off-balance sheet vehicles, the leverage ratio of global banks has jumped to around 40-50 in the U.S., Europe, and the UK in 2008, according to InvestorsInsight. In 2010, up to US$900 billion of remaining off-balance sheet vehicles will have to be consolidated. 
  • While systemic banks benefit from implicit and explicit government backstops, a resolution regime for all systemically large and complex institutions like Fannie and Freddie, for example--arguably one of the most important measures-- is stalling in Congress amid waning political support. Moreover, there is strong lobbying against the Consumer Protection Agency, whose fate is unclear. It is not decided yet who will be the systemic risk regulator: the Fed or the Systemic Risk Council. 
  • The lack of any disciplining mechanism represents an incentive for large players to engage in risky trading activities with value-at-risk (VaR) measures back at record levels in Q2 2009 for the top five banks, with US$1.04 billion at risk to be lost at any given trading day, according to press reports. 
  • The TARP Oversight Panel mentioned in its August 2009 report that toxic assets are still on banks' books. They are likely to be found in the Level 3 accounting category (mark-to-model) due to valuation difficulties. As of Q1 2009, the large banks have US$657 billion of Level 3 assets on their books. 
  • Commercial Real Estate (CRE) Risk: Fitch reports that "while CRE loans, excluding the more problematic construction and development portfolios, represent more than 125% of total equity for the 20 largest banks rated by Fitch, the risk is even higher for banks with less than $20 billion in assets, as average CRE exposure represents more than 200% of total equity for these institutions." Fitch also announces ratings review by September. 
  • Dependence on wholesale funding markets is likely to remain an issue. The financing shortfall from the lack of securitization left a funding hole of about US$2 trillion and the market is still damaged from an overhang in legacy assets.



Parsing the most recent data on Capital flows to the U.S., Rachel notes that incoming foreign investment has shifted back to long-term U.S. assets including U.S. Treasury bonds, which means the U.S. should have little problem, at least for now, to cover its shrinking current account deficit. Even though the U.S. is marginally less reliant on foreign creditors, financing the record levels of debt may be more costly going forward. However, China's share of Treasury holdings kept pace, now accounting for almost 12% of total treasuries outstanding. Read The July TIC Data: In for the Long Term? 





Capital Ratios:  banking 


Higher Capital Ratio: 


HSBC Holdings Plc Chief Executive Officer Michael Geoghegan said in an interview with the Financial Times this week that he expects banks will be required to have core tier one capital ratios of about 10 percent, higher than the 8 percent that regulators had been suggesting in private discussions.


Before the crisis started...BBVA may report core Tier 1 capital, a measure of solvency, of 6.1 percent for the end of 2008, Barron said. Santander, which raised 7.2 billion euros in a rights offering in November, said it’s targeting a core Tier 1 ratio around 7 percent.








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