Financial regulation
Background: pre-crash financial regulation
Governments have long been aware of the danger that a loss of confidence following the failure of one bank could lead to the failure of others, and to limit that danger they traditionally required all banks to maintain minimum reserve ratios. Following the crash of 1929 they also imposed restrictions upon the activities of the commercial banks. In the United States, for example, the Glass-Steagall Act prohibiting their participation in the activities of investment banks. In the 1980s, however, there was a general move toward "deregulation", those restrictions were dropped and reserve requirements were relaxed. There followed a period of financial innovation and substantial change in the nature of banking[1]. The perception of a resulting increase in danger of systemic failure led, in 1988, to the publication of a set of regulatory recommendations that related a bank's required reserve ratio to the riskiness of its loans [2] and, in 2004, to revised recommendations [3] requiring banks to take more detailed account of the riskiness of their loans. Those recommendations were widely adopted, but their inadequacy was revealed by the crash of 2008 when the global banking system suffered its "most severe instability since the outbreak of World War I" [4]. and threatened the collapse of its entire financial system. That narrowly-averted catastrophe prompted the urgent consideration of measures to remedy the deficiencies of the regulatory system. Recognition of the international character of the problem led to the inauguration of a series of G20 summits, initially to formulate measures to combat the recession of 2008 and subsequently to consider measures to reduce the danger of a future collapse of the international financial system.
Post-crash proposals
Micro- and macroprudential regulation
Problems and remedies
Leverage
The Turner Review recommended raising banks' reserve ratio requirements to levels substantially above those required under Basel 2 and introducing a discretionary cyclical element that would raise the required ratio during economic booms [5]
Risk management
Asset-price bubbles
Too-big-to-fail
The UK's Financial Standards Authority identified three aspects of the too-big-to-fall problem as:
- the moral hazard created if uninsured creditors of large banks believe that a systemically important bank will always be rescued' removing the incentive to impose discipline and prompting them to reduce their interest rates;
- the costs of rescue operation and the unfairness of the "socialisation of losses"; and
- the possibility that rescue might cost more than the host country could afford[6].
The US Treasury, in a paper published in September 2009, suggested that "systemically important firms" should be subject to higher capital requirements than other firms [7], and a G20 finance summit made the same suggestion[8].
Bonus incentives
Credit ratings
Mark-to-market accounting
Policy decisions
References
- ↑ Claudio Borio and Renato Filosa: The Changing Borders of Banking, BIS Economic Paper No 43, Bank for International Settlements December 1994
- ↑ The Basel Capital Accord (Basel I) Basel Committee for Banking Supervision 1988
- ↑ Revised International Capital Framework, (Basel II) Basel Committee on Banking Supervision 2006
- ↑ Overview of the November Inflation Report, Bank of England 2008
- ↑ The Turner Review: A regulatory response to the global banking crisis, Financial Services Authority, March 2009
- ↑ Turner Review Conference Discussion Paper: A regulatory response to the global banking crisis: systemically important banks and assessing the cumulative impact, Financial Services Authority, October 2009
- ↑ Principles for Reforming the U.S. and International Regulatory Capital Framework for Banking Firms, US Treasury Department, September 2009
- ↑ http://www.g20.org/Documents/FM__CBG_Declaration_-_Final.pdf Declaration on Further Steps to Strengthen the Financial System, Meeting of Finance Ministers and Central Bank Governors, London, 4-5 September 2009]