1. Lecture 8. FINANCIAL REGULATION
Economics 1490
THE WORLD ECONOMY:
GROWTH OR STAGNATION?
with
Professor Dale W. Jorgenson
Lecture 8. FINANCIAL REGULATION
September 26, 2017
Harvard University Department of Economics
Fall 2017

2. THE WORLD ECONOMY:
GROWTH OR STAGNATION?
A. Comparing Economies
B. U.S. Crisis and Recovery
C. European Slowdown
D. Asian Economic Miracles
E. Sustainability of Economic Growth
F. World Economic Outlook

3. B. U.S. CRISIS AND RECOVERY
6. U.S. Financial Crisis
7. Monetary Policy 
8. Financial Regulation
9. Fiscal Policy 
10. Secular Stagnation

4. SUPPLEMENTARY READINGS ON FINANCIAL REGULATION: The Official Documents
Basel Committee on Banking Supervision (2011, 2013), International Regulatory Framework for Banks (Basel III), Basel, Switzerland, Bank of International Settlements. See:
Board of Governors, Federal Reserve System (2013), “Federal Reserve Board Approves Final Rule to Help Insure Banks Maintain Strong Capital Positions,“ Washington, DC, Board of Governors, Federal Reserve System, Press Release,” July 2. See:
Janet Yellen (2017), “Financial Stability a Decade after the Onset of the Crisis,” Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 25. See:

5. DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT OF 2010
Re-organized Regulatory Agencies to Elimination Overlapping Jurisdictions
Undertook Comprehensive Regulation of Financial Markets
Provided a Resolution Mechanism for Insolvent Financial Institutions
Greatly Extended Consumer Protection

6. WHAT IS BASEL III?
“Basel III” is a comprehensive set of reform measures, developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to: improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source; improve risk management and governance; strengthen banks’ transparency and disclosures.

7. WHAT IS THE PURPOSE OF BASEL III?
The reforms target bank-level, or microprudential, regulation, which will help raise the resilience of individual banking institutions to periods of stress, and macroprudential, system wide risks that can build up across the banking sector as well as the procyclical amplification of these risks over time. These two approaches to supervision are complementary as greater resilience at the individual bank level reduces the risk of system wide shocks.

8. PILLAR 1: CAPITAL Quality and Level of Capital
Capital Loss Absorption at the Point of Non-Viability
Capital Conservation Buffer
Countercyclical Buffer

9. PILLAR 1: RISK COVERAGE Securitizations Trading Book
Counterparty Credit Risk
Bank Exposures to Central Counterparties

10. PILLAR 1: CONTAINING LEVERAGE
Non-Risk-Based Leverage Ratio
Backstop to Risk-Based Capital Requirement
Contains Build-Up of System-Wide Leverage

11. PILLAR 2: RISK MANAGEMENT AND SUPERVISION
Firm-Wide Governance and Risk Management
Includes Off-Balance Sheet and Securitization
Managing Risk Concentration

12. PILLAR 3: DISCLOSURE REQUIREMENTS
Market Discipline
Requirements for Securitization and Off-Balance Sheet Vehicles
Disclosures on Components of Regulatory Capital Requirements

13. LIQUIDITY Liquidity Coverage Ratio Net Stable Funding Ratio
Liquidity Risk Management and Supervision
Supervisory Monitoring

14. SYSTEMICALLY IMPORTANT FINANCIAL INSTITUTIONS
Identify Global SIFI’s
Higher Loss Absorbency Capacity
Progressive Common Equity Tier
Additional Loss Absorbency

15. BASEL III PHASE-IN ARRANGEMENTS
Leverage Ratio:
Minimum Common Equity Capital Ratio:
Minimum Total Capital Ratio: 2013
Liquidity Coverage Ratio:

16. U.S. IMPLEMENTATION
July 2, 2013: The Federal Reserve Board approved a final rule to help ensure banks maintain strong capital positions that will enable them to continue lending to creditworthy households and businesses even after unforeseen losses and during severe economic downturns. The rule will implement in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

17. THE VOLCKER RULE
“Volcker Rule” requirements of section 619 (of the Dodd-Frank Wall Street Reform and Consumer Protection Act) generally contains two prohibitions. First, it prohibits insured depository institutions, bank holding companies, and their subsidiaries or affiliates (banking entities) from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity's own account, subject to certain exemptions. Second, it prohibits owning, sponsoring, or having certain relationships with, a hedge fund or private equity fund, subject to certain exemptions.

18. NEW FORMS OF FINANCIAL INTERMEDIATION
The greatest change to intermediation in the history of finance has been spurred by advances in information technology (IT) that have enabled, among other things, better and faster processing of information and trading in a wider range of financial instruments.
Over the past 10 years, these changes have allowed more financial intermediation to take place in markets instead of through bilateral negotiations.

19. RISING SYSTEMIC RISKS Size and Complexity of Financial Institutions
Concentration, Interconnectedness, and Procyclicality  
Wholesale Funding and Market Discipline
Nonbanks and New Financial Products

20. SIZE OF THE GLOBAL FINANCIAL SYSTEM
Sources: Bank for International Settlements; Bankscope; Bloomberg L.P.; and World Federation of Exchanges.

21. RELATIVE SIZE OF TRADITIONAL TO TOTAL BANKING ACTIVITIES

22. SHARE OF TOTAL LOANS AND BONDS BY NON-BANK INSTITUTIONS

23. GLOBAL SECURITIZATION

24. OUTSTANDING OVER-THE-COUNTER CREDIT DERIVATIVES

25. OTC DERIVATIVES Counterparty Risk: The AIG Rescue
Central Clearing Mandates
Minimum Margin Requirements
Data Reporting Requirements

26. HAS THE STRUCTURE OF THE FINANCIAL SYSTEM BECOME SAFER?
Market-Based Financial Intermediation Remains Important
Financial Systems Remain Dependent on Wholesale Funding
Globalization Has Not Been Much Affected
Official Interventions Have Made “Bail-In’s” Less Credible

27. RESOLUTION OF GLOBAL SIFI’S
Core Elements of a Resolution Framework
Statutory Authority to Convert Claims into Equity
Recovery and Resolution Plans
Crisis Management Groups

28. GLOBAL POLICY RESPONSE
Capital Requirements for Global SIB’s
Counter-Cyclical Capital Buffers
Liquidity Rules
Multiple Channels for Reform

29. FINANCIAL REGULATION: SUMMARY
Macro-Prudential versus Micro-Prudential Regulation
Basel III
U.S. Implementation
Resolution of GSIFI’s

30. CONCLUSION
The recent crisis showed that some financial innovations, over time, increased the system's vulnerability to financial shocks that could be transmitted throughout the entire economy with immediate and sustained consequences that we are still working through today. Some of these vulnerabilities were a consequence of innovations that increased the complexity and interconnectedness of aspects of the financial system. In response to the crisis and the weaknesses it revealed, governments around the globe are acting to improve financial stability and reduce the risks posed by a highly interconnected financial system.