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.