1 The Regulatory Response to the Financial Crisis by C.A.E. Goodhart Financial Markets Group There are, at least, seven fields where the recent turmoil.

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Presentation transcript:

1 The Regulatory Response to the Financial Crisis by C.A.E. Goodhart Financial Markets Group There are, at least, seven fields where the recent turmoil has thrown up issues for discussion. These are:- 1.Deposit Insurance; 2.Bank Insolvency Regimes, a.k.a. ‘prompt corrective action’; 3.Money market operations by Central Banks; 4.Liquidity Risk Management; 5.Procyclicality in CARs, i.e. Basel II, and general lack of counter-cyclical instruments; 6.Boundaries of regulation, Conduits, SIVs and reputational risk; 7.Crisis management:- (a)within countries, Tripartite Committee (b)cross-border

2 (1)Deposit Insurance (a)UK system, 100% up to £2000, 90% up to £35,000; it was never intended to prevent runs. To allow banks to be closed with less ‘political’ fuss. (b)Only 100%, and speedy provision, will prevent runs, but (i) Coverage (ii) Cap, (£35,000 would cover more than 95% of depositors) (iii) Allows bad bankers to continue, so long as they can persuade auditors to attest to solvency (c)Leads to urgent need for p.c.a. Not generally available in Europe.

3 (2)Bank Insolvency Regimes (a)Over-rides property rights: (i) Need to allow CEO/Chairman to rectify. (ii) What is trigger?: (leverage ratio in USA, but might need to be different in Europe?) (iii) Need for both independent assessment, and political assent. (iv) Consistent with Human Rights? Judicial Review. (b)Operational issues (i) Alternative management (ii) Bridge bank (c)Procedural issues (i) Separate institution? (ii) If not, where situated (CB or FSA)?

4 (3)Money Market Operations Five problems:- (a)Stigma (b)Maturity (c) Collateral (d)Incentives to hold liquidity (e)Need for adjustable instrument

5 (4)Procyclicality in CARs (a)Procyclicality worsened by:- (i)Risk sensitive CARs; (ii)Mark to market; (iii)Ratings agencies (?) (b)What is purpose of regulation? (i)Externalities, not individual behaviour (ii)Herding, endogenous risk (c)Relate CARs more to rates of growth, not to risk- weighted levels. (d)But what are boundaries?

6 (5)Boundaries Contingent Commitments:- (a)legal status? (b)Reputational Risk (c)Calls on contingency will be systematic (d)Information (e)What to do.

7 (6)Crisis Management UK experience:- (a)Nothing to do with CB independence. (b)Concern about who is ‘in charge’. Were HMT and FSA unable to force BoE to act? (c)Use of Coyne approach? (d)FSA failed to assess liquidity risk. Generic to culture of FSAs? Need for over-lap as in USA/Japan? Cross-border (a)Not (yet) needed, thankfully. (b)Problem understood, but not resolved; (i)ex ante burden sharing (ii)Federal euro funding (iii)?