RD News 18Jan12

• Andrew Sheng: The natural evolution of markets
• There were two major reasons for the large profits in finance.
• The first is that the physical cost of creation of a financial derivative is almost zero, as it is an abstract product of its creator’s imagination. For many, the reason to buy a derivative is to hedge and reduce risk. If a buyer believes that the hedge is useful, which it can be under specific circumstances then he or she will be willing to pay a premium for that hedge.
• A second reason is leverage. The greater the leverage, the larger the profits are for both lender and borrower. But there is a catch – it adds systemic risk to the entire market and can be fatal to the over-leveraged borrower.
• The Holy Grail of financial theory and practice in the world’s advanced economies is to identify at what level of complexity financial markets exceed the limits of social stability.

• CPSS: OTC derivatives data reporting and aggregation requirements - final report
• Trade repositories, by collecting data centrally, would provide authorities and the public with better and more timely information on OTC derivatives. This would make markets more transparent, help to prevent market abuse, and promote financial stability.
• Questions remain regarding how best to address current data gaps and define authorities' access to TRs.
• The FSB will establish an ad hoc group of experts to further consider means of filling current data gaps, while the CPSS and IOSCO will establish a joint group to examine authorities' access to TRs.

• Elizabeth Duke (Fed Board): Opportunities to reduce regulatory burden and improve credit availability
• Vital to have regular feedback from bankers and consumers of banking services to understand the impact of regulation - both its effectiveness in achieving intended results and in limiting any unintended consequences.   

• K C Chakrabarty (Dep Gov Reserve Bank of India): Crisis preparedness in interconnected markets – prevention is better than cure
• Focussing on only one part of the financial system can obscure vulnerabilities that may prove very important from the perspective of systemic stability.
• A highly interconnected world tends to increase both the probability and the impact of crisis.
• The potential for systemic risks increase, for example, due to potential build-up of leverage and liquidity mismatches at the same time or due to exposures to common networks of intermediaries.
• This leaves the financial system vulnerable to adverse changes in the macrofinancial environment, on the one hand, while, on the other, pervasive interconnections can result in a rapid transmission of adverse shocks across the global financial system at an amplified speed.
• The system dynamics of a set of networked markets and institutions can, thus, play a critical role in the amplification as well as the propagation mechanisms of shocks.

• Adam Posen (BoE): What the return of 19th century economics means for 21st century geopolitics
• As US hegemony, that is relative economic dominance, recedes into multipolarity, the international economic system will have less strict rule enforcement and be subject to greater economic volatility.
• The erosion of (intellectual and other) property right enforcement will have significant effects on the global division of labour, which will reinforce this multipolarity and income convergence.
• International diversification of investment will increase, and so will the gross flows of capital, with capital accounts in the major emerging markets moving more towards balance if not deficit.

• Court of BoE: Response to Treasury Committee on accountability of BoE
• Propose establishment of an Oversight Committee, with direct access to the policymaking processes and papers in the Bank, and formed of non-executive directors.
• Role of this Oversight Committee should be to assess whether the processes employed in making financial stability policy decisions have considered a full range of options and have taken reasonable account of the relevant information, analysis (including of the lessons from the past), differing views amongst policymakers, and challenges from outside the Bank.
• Future Governors of the Bank should be appointed for a single eight-year term.

• BIS (Claudio Borio): Stress-testing macro stress testing: does it live up to expectations
• Given current technology, macro stress tests are ill-suited as early warning devices, ie as tools for identifying vulnerabilities during seemingly tranquil times and for triggering remedial action.
• As long as properly designed, stress tests can be quite effective as crisis management and resolution tools.
• Generating more realistic non-linearities and feedback effects is a priority.
• Sceptical of attempts that see the secret of success in modelling network effects or the iterative bottom-up aggregation of individual responses.

RD News 16Jan12

• FSB: Proposed extensions to SIFI framework
• Framework will be extended to include domestic systemically important banks, and globally systemically important insurance companies, as well as other types of financial institution.

• BIS: Currency internationalisation: lessons from the global financial crisis and prospects for the future in Asia and the Pacific

• CFTC: Commissioner suggests Volcker rule rethink needed
• Scott O’Malia: rule is too complex, and may ‘fall short of providing an appropriate foundation for a rigorous and reliable rulemaking process’.
• CFTC and other agencies will have to re-propose the rule in order to combat complexity and clarify roles between regulators.
• Reservations about the compliance programme mandated by the proposed rule, as well as the viability of enforcement, and the extraterritorial implications.

• Stiglitz: Many Americans gave up hope last year – 2012 will be worse
• Middle-aged people who thought that they would be unemployed for a few months have now realised that they were, in fact, forcibly retired.
• Austerity will only exacerbate the economic slowdown. Without growth, the debt crisis – and the euro crisis – will only worsen.
• Increased investment to retro-fit the economy for global warming would help to stimulate economic activity, growth, and job creation.
• Global economic rebalancing is likely to accelerate, almost inevitably giving rise to political tensions.#

• IMF: Foreign Banks: Trends, impact and financial stability
• There has been a substantial increase in foreign bank presence. Current market shares of foreign banks average 20% in OECD countries and 50% elsewhere.
• Foreign banks have higher capital and more liquidity, but lower profitability than domestic banks do.
• In developing countries is foreign bank presence negatively related with domestic credit creation.
• During the global crisis foreign banks reduced credit more compared to domestic banks, except when they dominated the host banking systems.

• IMF: A Toolkit to Assessing Fiscal Vulnerabilities and Risks in Advanced Economies
• Short term pressures:
• Gross funding needs
• Market perceptions of default risk
• Stress dependence among sovereigns
• Medium/long term pressures:
• Budgetary adjustment needs
• Susceptibility of debt projections to growth and interest rate shocks
• Stochastic risks to medium-term debt dynamics.

• BIS: Masaaki Shirakawa (Gov, Bank of Japan): Deleveraging and growth – is the developed world following Japan’s long and winding road?
• Of the three factors that define the length of time needed for deleveraging, the first one – the initial size of excess debt – is a given once a bubble bursts, but we can still influence the remaining two factors: the growth potential of individual economies and growth momentum in the global economy as a whole.
• Financial institutions’ activities are influenced not only by the expectation that a stable environment will continue but also by incentives created by the regulatory and supervisory framework.
• Supervisors must find the right balance between two important tasks: restraining excessive risk taking and securing the profitability of financial institutions.

RD News 10Jan12

• BIS: Basel III liquidity standard and strategy for assessing implementation of standards endorsed by Group of Governors and Heads of Supervision – press release
• Committee will review the compliance of members' domestic rules or regulations with the international minimum standards in order to identify differences that could raise prudential or level playing field concerns.
• Will also review the measurement of risk-weighted assets to ensure consistency in practice across banks and jurisdictions.
• Liquidity Coverage Ratio - central principle that a bank is expected to have a stable funding structure and a stock of high-quality liquid assets that should be available to meet its liquidity needs in times of stress.
• Once the LCR has been implemented, its 100% threshold will be a minimum requirement in normal times. But during a period of stress, banks would be expected to use their pool of liquid assets, thereby temporarily falling below the minimum requirement.
• The GHOS also reaffirmed its commitment to introduce the LCR as a minimum standard in 2015.

• BIS: William C Dudley appointed Chairman of the Committee on the Global Financial System
• President NY Fed Jan 09-, Ch Committee on Payment and Settlement Systems May 09-.

• IMF: Financial stability reports: what are they good for?
• In reports forward-looking perspective and analysis of financial interconnectedness are often lacking.
• Higher-quality reports tend to be associated with more stable financial environments.
• However, there is only a weak empirical link between financial stability report publication per se and financial stability.

• IMF: Next generation system-wide liquidity stress testing
• Framework to run system-wide, balance sheet data-based liquidity stress tests includes three elements:
• a module to simulate the impact of bank run scenarios;
• a module to assess risks arising from maturity transformation and rollover risks,
• a framework to link liquidity and solvency risks.
• The framework also allows the simulation of how banks cope with upcoming regulatory changes (Basel III), and accommodates differences in data availability.
• We need a better understanding of the link between banks’ solvency and liquidity strains. Both are inherently interrelated, and stand-alone stress tests that only examine either solvency or liquidity stress testing, potentially risk producing downward biased results.

• EBA: Guidelines for advanced measurement of capital
• Firms may use Advanced Measurement Approaches (‘AMA’), based on their internal risk models to determine the regulatory capital charge for operational risk, provided these internal models are expressly approved by the competent authorities.

• ECB: Risk sharing or risk taking? Counterparty risk, incentives and margins
• Despite an object of much hedging being to share risk, the effect can in fact be an increase in risk-taking, as negative news about the hedge creates an incentive problem for the seller.
• The development of derivative markets, such as forwards, futures or credit default swaps, can enhance risk-sharing opportunities. Yet, it can also induce greater risk-taking in the financial sector.
• A moral hazard problem arises when the protection seller finds out his position is likely to be loss-making.
• There is no moral hazard problem at the beginning of the derivative contract as there are no liabilities on average. But bad news about the hedged risk undermine risk-prevention incentives.
• This incentive problem limits the scope for risk-sharing and can lead to endogenous counterparty risk.

• Andrew Sheng: Global finance’s supply chain revolution
• Financial supply chains and those in the manufacturing sector share three key features – architecture, feedback mechanisms, and processes – and their robustness and efficiency depend upon how these components interact.
• Interdependent networks tend to concentrate in powerful hubs. Two financial centers, London and New York, dominate international finance. Such concentration is very efficient, but it also contributes to greater systemic risks.
• Open feedback mechanisms ensure a supply chain’s ability to respond to a changing environment, but, in the case of financial supply chains, feedback mechanisms can amplify shocks until the whole system blows up. The Lehman Brothers collapse triggered just such an explosion, with the financial system saved only by government bailouts.
• The processes within supply chains, and the feedback interactions between them, can make the system greater or smaller than the sum of its parts. Since a complex network comprises linkages between many sub-networks, individual inefficiencies or weaknesses can have an impact on the viability of the whole.
• Innovation in the last century focused on processes, products, and services. Today, the financial sector needs innovation of a higher order, involving business models, strategy, and management approaches that restore trust in finance.

RD News 6Jan12

• FT: Peter Praet to head Economics Division at ECB
• Peter Praet, a Belgian who joined the ECB’s six-man executive board last June, will head the economics division, which prepares recommendations on interest rate decisions. He takes over from Jürgen Stark, who stood down in December.
• Praet is also a member of the ICFR’s International Advisory Council.

• CPSS: Statistics on payment, clearing and settlement systems in the CPSS countries - 2010

• Bloomberg: CFPB to crack down on shadow banks
• The CFPB will begin supervision of mortgage servicers, payday lenders and student-loan companies in an immediate expansion of its authority under the Dodd-Frank Act, according to new agency Director Richard Cordray.
• Will clamp down on nonbank firms ‘that often compete with banks but have largely escaped meaningful federal oversight.’

• FT: Only one MMF ‘broke the buck’ – Letter
• Corrects statement that ‘a number (of MMFs) broke the buck and incurred losses during the financial crisis’ – only the Reserve Primary Fund did.
• The Reserve Primary Fund Held $785m in Lehman commercial paper.
• Investors in the funds recovered more than 99%.
• Oct 08 Treasury Temporary Guarantee Program for MMFs ended after a year with no claims being paid.

• WSJ: MMF assets fall ending 8-week net inflow streak

• Economist: Britain’s financial industry – death by a thousand cuts
• 60-70% of proposed financial transactions tax would be collected in Britain.
• Cumulative impact of regulatory onslaught, combined with the 50p tax rate and curbs on immigration of skilled employees, will count against London when financial firms look to expand or move.
• The gap between London and New York, in first and second place, and Hong Kong and Singapore in third and fourth has narrowed in recent surveys.
• London’s advantages:
• Incumbency has powerful network effects – virtuous circle.
• London is in middle of global trading day – starts as Asian markets are closing and still working as NY opens – ideal for global asset managers.
• Highly respected body on commercial law and experienced judges make it ideal place to strike international deals.

• EBA: 2012 work plan
• Working towards the single rule book for the EU banking system -  prioritising system capital and capital buffers, liquidity, remuneration and leverage ratios.
• To deliver independent and high quality analysis of EU banks and the EU banking sector.
• Promote supervisory convergence.

• Andrew Sheng: Global financial situation
• Macro numbers did not suggest 2011 was that serious a crisis year - US GDP growth 1.8%, Euro area GDP growth 1.5%.
• But the Eurozone had a sharp downturn in the fourth quarter of -2%. Japan did slip into minus 0.9% growth, due to the disruptive effects of the tsunami and nuclear disasters.
• We should treat the period 2007 to 2011 as a double dip crisis – can be seen be behaviour of inflation.
• But good news is global re-balancing is finally happening. The biggest threat to blow this process off course is a European crisis.
• Ultimately, the integrity of the Eurozone hangs on the solvency of the whole. If the interest rate and debt burden is too heavy, it will break.
• The real concern is that ECB is the only credible institution that can act fast enough to deal with the liquidity situation, but it does not have the fiscal powers to tax and pay its way out of the mess.

RD News 3Jan12

• ESRB: Capital raising urged
• European banks should adhere to the EBA’s (EBA) recommendations and raise a 9% capital buffer, by restricting remuneration and dividends, in a way which avoids ‘a disorderly or excessive deleveraging process’.
• There currently exists ‘a climate of extreme risk aversion’ which is impairing financial markets.
• The swift and coordinated implementation of EU decisions is now of utmost importance.

• India issues Basel III guidelines
• RBI guidelines set Common Equity Tier 1 capital at 5.5% of RWAs, with Tier 1 capital of 7%, and overall capital of at least 9% of RWAs.
• A capital buffer of 2.5% of RWAs, made up of Common Equity, will also be required.
• The implementation is ahead of the Basel III timetable in some respects, to be complete by 31 March 2017.
• The RBI said ‘banks would be expected to strive to operate’ a minimum Tier 1 leverage ratio of 5% - stricter than the Basel minimum of 3%, although the RBI points out that on average, Indian commercial banks already operate within this ratio.

• Andrew Sheng: Risk and uncertainty will continue into the new year
• Discusses Benoit Mandelbrot and Richard Hudson's 2008 book on The Misbehaviour of Markets: A Fractal View of Risk, Ruin and Reward:
• Prices are not independent of each other. Their evolution goes through periods of quiet and then extreme volatility.
• Power laws (curves with long tails) are more common in nature than "normal" statistical bell curves.
• Intrinsic value is meaningless in a world of ever-changing prices. At the height of a bubble, the astronomical prices transacted bear no relationship to replacement cost.
• Our value systems are determined by our culture and that is today more determined by Mother Nature, technology and forces that we do not understand.

• Obama nominates 2 new Fed Board members
• Jerome Powell – visiting scholar, Bipartisan Policy Center, Washington. Served in Treasury Dept under Bush, former partner, The Carlyle Group.
• Jeremy Stein - Moise Y. Safra Professor of Economics at Harvard. Fomerly taught at MIT’s Sloan School and HBS. Served as a senior advisor to Treasury Secretary Timothy Geithner, and on the staff of the Obama Administration’s National Economic Council.

• WSJ: The 2012 Regulatory and Market Landscape
• Which non-banks will be designated SIFIs by FSOC?
• Analysts widely expect that GE Capital, and insurers Prudential Financial and MetLife will be labeled systemic; the latter are the two largest U.S. life insurers by assets.
• AIG is also seen as a likely pick because it was the recipient of one of the biggest federal bailouts of the 2008 financial crisis after losses in a financial-products unit almost caused the company to collapse.
• Some observers say asset managers like BlackRock Inc. also will be tagged.
• MMF reform tussle:
• SEC Ch Mary Shapiro arguing for additional overhauls after 2010 changes – possibly bank-like capital buffers.
• But most of her fellow commissioners are not convinced, concerned the capital-buffer idea that Ms. Schapiro has outlined would hamper ‘small to midsize companies that rely on money funds to meet their payroll, without adding to investor protection.’

RD News 22Dec11

• EIOPA: Financial Stability Report 2011 – Second half-year report
• Insurance and occupational pensions industry faces risks resulting from high concentrations of exposures to sovereigns and banks.
• Stress tests indicate that a period of low yields would make the solvency position of the insurance industry worse on average, after a year of high losses resulting from natural disasters.

• ECB: Crisis Management and Bank Resolution – Legal working paper
• Examines the legal difficulties of cross-border resolution – argues that the risks that complex groups generate” must be met with “the imposition of costs”.
• Existing national resolution regimes, notably the UK and Germany, are a big step forward, but they cannot accommodate cross-border issues.

• BIS: Jaime Caruana: Financial stability and risk disclosure
• To be effective in promoting market discipline, disclosure must be complemented by strong incentives for counterparties to engage in monitoring.
• The public sector's role in promoting transparency arises from a number of market failures, including the externalities to be gained from common standards, the "free rider" problems that may lead to too little investment in producing and gathering financial information, and the tendency of markets to overreact to bad news when the information environment is clouded.
• Guided by these considerations, the Financial Stability Board and the Basel Committee on Banking Supervision have long supported improvements in transparency, through their work on accounting, disclosure templates and aggregate market data.
• At the same time, industry and investor representatives need to play a key role in developing disclosure standards.
• Accounting standards need to converge, standards for the discussion and analysis that accompany financial statements need to be established, and external auditors need to insist on higher-quality risk disclosures.