BIS: The regulatory framework: balancing risk sensitivity, simplicity and comparability. New_map_for_global_banks_strategy_and_regulation. Finance: From fat tails to Fat Tony. Meaningful banking reform and why it is so unlikely. Over the last few decades, banking regulators and supervisors have failed to do their job.
This column argues that a failure of political will enabled stakeholders to pursue bad practices, and suggests a roadmap for reform. Enforcing a reform agenda marked by simplicity is plausible, and would avoid much of the collateral damage that comes from many hundreds of pages of complex, costly and misguided mandates that typically act as substitutes for credible reform.
Overcoming the challenge of political will, however, remains a challenge. This column is a lead commentary in the VoxEU Debate "Banking reform: Do we know what has to be done? " In the decades leading up to the recent banking crisis, regulators and supervisors consistently failed in three key areas: The failures of prudential bank regulation have been visible for decades and have motivated many regulatory reform proposals by financial economists (den Haan 2012). Discussion of Capital Regulation. Ending the Financial Arms Race. Exit from comment view mode.
Click to hide this space CAMBRIDGE – People often ask if regulators and legislators have fixed the flaws in the financial system that took the world to the brink of a second Great Depression. The short answer is no. Yes, the chances of an immediate repeat of the acute financial meltdown of 2008 are much reduced by the fact that most investors, regulators, consumers, and even politicians will remember their financial near-death experience for quite some time. As a result, it could take a while for recklessness to hit full throttle again. But, otherwise, little has fundamentally changed. In his recent speech to the annual, elite central-banking conference in Jackson Hole, Wyoming, the Bank of England’s Andy Haldane made a forceful plea for a return to simplicity in banking regulation. Legislative complexity is growing exponentially in parallel. The roots of shadow banking. Shadow banking operates outside the regulatory perimeter, but it replicates the structure of banking in many ways.
As such, its prudential standards should be brought into alignment to avoid further regulatory arbitrage. Shadow banking assets at the time of the crisis had grown larger than the banking sector proper. The rapid withdrawal of funding to this segment played a major role in the credit crunch of 2007-2008. My new CEPR Policy Insight No. 69 updates and fleshes out the analysis in my June 2012 Vox column (reproduced in full below).
The Policy Insight reviews recent work that is finally shedding some light on this ill-defined and poorly understood segment of the financial system. The Policy Insight offers a structural definition of shadow banking activities, showing that even proper banks use them to avoid stricter capital requirements. The ‘shadow banking’ sector is an ill-defined financial segment that expands and contracts credit outside the regulatory perimeter. The (sizable) Role of Rehypothecation in the Shadow Banking System; by Manmohan. Forcing frequent failures. I’m sympathetic to the view that financial regulation ought to strive not to prevent failures but to ensure that failures are frequent and tolerable.
Rather than make that case, I’ll refer you to the oeuvre of the remarkable Ashwin Parameswaran, or macroresilience. Really, take a day and read every post. Learn why “micro-fragility leads to macro-resilience”. Note that “micro-fragility” means that stuff really breaks. It’s not enough for the legal system to “permit” infrequent, hypothetical failures. So we need a regime where banks of every stripe actually fail, even during periods when the economy is humming. Squirrels don’t lobby Congress, when the ranger decides to burn down the bit of the forest where their acorns are buried. First, let’s think about what it means for a financial institution, or any business really, to “fail”. Forcing failure by rendering banks illiquid is not a good idea, for lots of different reasons. Failure isn’t supposed to be fun. Acknowledgments:
Shadow Banking. The dog and the frisbee – paper by Andrew Haldane. In a paper given at the Federal Reserve Bank of Kansas City’s 36th economic policy symposium in Jackson Hole, Wyoming, Andrew Haldane – Executive Director for Financial Stability and member of the Financial Policy Committee – explores why the type of complex financial regulation developed over recent decades may be sub-optimal for crisis control.
In doing so, he draws out a number of public policy lessons. The paper is co-written with a Bank colleague, Vasileios Madouros. Andrew Haldane presents evidence from a range of real-world settings to demonstrate that decision-making in a complex environment can benefit from the use of simple decision rules of thumb. He argues that complex rules often: have punitively high costs of information collection and processing; rely on “over-fitted” models that yield unreliable predictions; and can induce defensive behaviour by causing people to manage to the rules. performance. And market risk, on a broad asset class basis, could be used.”