RD News 22Feb12

• Reserve Bank of India: Issues Guidelines on Basel III Liquidity Standards
• RBI “fully committed” to Basel III. 
• Guidelines indicate how the liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) will be made operational and monitored, with Indian banks needing to comply from mid-2012, before the Basel standards come into force in 2015 and 2018 respectively.
• The Basel standards will supersede India’s existing liquidity regime of a cash reserve ratio and statutory liquidity ratio.

• EU: Adopts Regulation on Short-Selling and Ban on Naked CDS
• Rule gives regulators option to ban so-called ‘naked’ short selling and credit default swaps (CDS) on sovereign debt.
• Text argues that buying CDS without having a long position in the underlying debt or asset is economically equivalent to taking a short position on that underlying instrument, warranting the coverage of CDS in the rule.
• Authorities will have powers of intervention “in the case of adverse developments which constitute a serious threat to financial stability or to market confidence in a Member State of the Union”.
• The European Securities and Markets Authority (ESMA) will be given additional powers to override competent authorities if it is deemed that they “have not taken sufficient measures to address the threat”.
• The regulation is set to come into force by 1 November 2012.

• K C Chakrabarty: Indian banking sector – towards the next orbit
• A combination of strong regulation and supervision and a will to evolve policies that lean against the wind helped insulate the Indian financial system from the crisis. It helped too that the Indian banks were not very sophisticated and excessively leveraged.
• However, in a world where financial systems recognize no boundaries and the fortunes of nations are intertwined, no nation can consider itself an island and remain immune to the changes in the tides of the world economy for a prolonged period.
• While none of the Indian banks feature in this list of 29 G-SIBs, the BCBS and FSB are already working towards laying down a criterion for identification of domestic SIBs which would need to be subjected to additional capital and liquidity requirements on the lines of that applicable to the G-SIBs.

• BIS: Inflation Dynamics in the Presence of Informal Labour Markets
• Consider the effects of informal labour markets on the dynamics of inflation and on the transmission of aggregate demand and supply shocks.
• Results show that the informal economy generates a "buffer" effect that diminishes the pressure of demand shocks on inflation.
• Result implies that, in economies with large informal labour markets, changes in interest rates are more effective in stimulating real output and there is less impact on inflation.
• Furthermore, the model produces cyclical flows from informal to formal employment, consistent with the data.

• Usha Thorat: Recommends Tier I capital of 12% for Non-Banking Financial Companies
• The NBFC sector has been increasing its assets compared to the banking sector. Quite a lot of funds from the banking sector were flowing into NBFCs, and quite a lot of funds from the mutual funds as well.
• Proposal for NBFCs to have higher risks weights on exposure to real estate and to capital markets is a part of the various measures that were recommended for strengthening their regulatory framework.

• FT: The bank needs more than a new governor
• Banker candidates for next governor:
• Lord Green
• Douglas Flint
• Peter Sands
• John Varley
• Favourite remains Paul Tucker.

RD News 20Feb12

• Andrew Sheng: Small is beautiful
• E.F. Schumacher’s ‘Small is Beautiful’:
• "One of the most fateful errors of our age is the belief that the problem of production has been solved. The illusion…is mainly due to our inability to recognize that the modern industrial system, with all its intellectual sophistication, consumes the very basis on which it has been erected. To use the language of the economist, it lives on irreplaceable capital which it cheerfully treats as income."
• The importance of smallness in large organization - as organizations become larger and larger, they become more impersonal.
• Inherent contradictions within large organizations that have alternating phases of centralizing and decentralizing.
• Five principles:
• Subsidiarity –the upper authority should delegate to the lower level powers where it is obvious that the lower levels can function more efficiently than the central authority.
• Vindication – governance by exception. The centre delegates and only intervenes under exceptional circumstances which are clearly defined.
• Identification – the subsidiary must have clear accounting in the form of balance sheets and profit and loss account.
• Motivation –motivation at the lower levels of large organization has little motivation if everything is directed from the top.
• The Principle of the Middle Axiom. He notes that "the centre can easily look after order; it is not so easy to look after freedom and creativity". In practical terms, you set out an objective, but do not detail and direct how that objective is to be achieved, giving some degree of innovation and freedom for the subsidiary levels of the organization to achieve the objectives.

• ESMA: Draft Technical Standards for the Regulation on OTC Derivatives, CCPs and Trade Repositories – Discussion paper
• Asks for input on a wide range of issues, such as when ESMA should consider a derivatives contract to have a direct effect within the EU, what sort of information should be collected through CCPs, and how to ensure consistency of data storage in TRs.

• IMF: From Stress to CoStress: Stress Testing Interconnected Banking Systems
• An integrated framework for assessing systemic risk - models banks’ capital asset ratios as a function of future losses and credit growth using a generalized method of moments to calibrate shocks to credit quality and credit growth.
• Analysis is complemented by a simple measure of systemic risk, which captures tail risk comovement among banks in the system.
• Based on CreditRisk+, which uses analytical techniques—similar to those applied in the insurance industry - to estimate banks’ credit portfolio loss distributions, making no assumptions about the cause of default.

• FT: China cuts banks’ reserve ratios
• PBOC lowering the reserve requirement by 50 bps from 24th Feb.
• Cut will bring the ratio down to 20.5 per cent for the largest banks, and is expected to free up about Rmb400bn ($64bn) for new lending.
• New renminbi-denominated lending dropped Rmb288.2bn to Rmb738.1bn in January from a year earlier.

RD News 17Feb12

• BIS: Hervé Hannoun (Dep GM) Monetary policy in the crisis: testing the limits of monetary policy
• Central banks are increasingly seen by market participants as all-powerful, able to intervene without any limit.
• The trend towards unlimited intervention combined with ultra-low interest rates does not only have potentially serious side effects on the functioning of the market economy, it also gives rise to three major risks:
• financial dominance
• exchange rate dominance
• fiscal dominance
• The ultimate possible consequence is an inflation surprise that could severely damage central banks' hard-earned credibility.
• To prevent these risks from materialising, we need to forge a consensus on what could be called "the new frontier of monetary policy" in order to refocus monetary policy on maintaining lasting price stability. This also implies that central banks should reject the market illusion of unlimited intervention and the associated theory of the "printing press".

• NY Fed: Release of the Tri-party Repo Infrastructure Reform Task Force's Final Report + Statement
• The tri-party repo market's infrastructure exhibits significant structural weaknesses that undermine market stability in a stressed environment.
• Three fundamental areas of concern identified by policymakers at the Federal Reserve:
• (1) market participants' overreliance on intraday credit from tri-party clearing banks,
• (2) risk management practices that are vulnerable to procyclical pressures,
• (3) the absence of an effective and transparent process for the orderly liquidation of a defaulted broker-dealer's collateral.
• Completed improvements:
• the establishment of automated collateral substitution functionality for most trades in the market
• the implementation of a 3-way trade confirmation process for all tri-party repo transactions.
• improved transparency in the tri-party repo market by publishing a monthly report on market size, collateral composition and margining practices.
• Despite these accomplishments, the amount of intraday credit provided by clearing banks has not yet been meaningfully reduced, and therefore, the systemic risk associated with this market remains unchanged.
• Ideas include restrictions on the types of collateral that can be financed in tri-party repo and the development of an industry-financed facility to foster the orderly liquidation of collateral in the event of a dealer's default.
• Ending tri-party repo market participants' reliance on intraday credit from the tri-party clearing banks remains a critical financial stability policy goal.
• While the bulk of the work on operational changes will fall to the clearing banks and FICC, borrowers and investors in the tri-party repo market will also need to modify their credit and liquidity risk management practices to realize the promise of these operational changes.
• Dealers should be taking steps to reduce their reliance on short-term financing and investors should be taking actions to ensure their credit risk management policies and practices are robust to stress events. Such actions can help to ensure that market participants better internalize and price the costs associated with the credit and liquidity risks they bear in tri-party repo transactions.

• Andy Haldane: The Doom Loop
• Consider the effects of the too-big-to-fail problem on risk-taking incentives. If banks know they will be bailed out, those holding their debt will be less likely to price the risk of failure for themselves. Debtor discipline will therefore be weakest among those institutions where society would wish it to be strongest. This encourages them to grow larger still: the leverage cycle isn’t merely repeated, but amplified. The doom loop grows larger. The biggest banks effectively benefit from a disguised, and growing, state subsidy.
• The best proposals for reform are those which aim to reshape risk-taking incentives on a durable basis.
• Under the so‑called Basel III agreements struck in 2010, banks’ minimum equity capital ratios will rise fivefold over the next decade, from 2 per cent to close to 10 per cent of assets for the largest global banks.
• A 10 per cent capital ratio translates into bank leverage of roughly 25. So even once Basel III is in place, an unexpected loss in a bank’s assets of just 4 per cent will be enough to render it insolvent.
• Voting rights could be extended across a wide group of stakeholders, but weighted by stake. Governance and control would then be distributed across the whole balance sheet, curbing the profit-seeking incentives of the equity minority, while weighting voting rights by size of portfolio to avoid the inertia of mutuality. Bank governance would then be a wealth-weighted democracy, a hybrid of the mutual and joint-stock models.

• BIS: Stochastic Herding in Financial Markets: Evidence from Institutional Investor Equity Portfolios
• A structural model of herding behavior in which feedback arises due to mutual concerns of traders over the unobservable "true" level of market liquidity.
• In a herding regime, random shocks are exacerbated by endogenous feedback, producing a dampened power-law in the uctuation of largest sales.
• A stock's realized illiquidity propagates herding and raises the probability of observing a sell-off. The distribution function itself has desirable properties for evaluating "tail risk".

• Reuters: EU to consult on shadow banking rules
• Draft EU rules are being readied for consultation on the shadow banking system.
• As banking regulation is tightened, incentives are created for some activities to be conducted outside of the banking system, in less regulated institutions.
• The draft reportedly recognises the “potentially useful” role of shadow banking in intermediation, but that a range of measures, from registration through to fully macroprudential tools, might be recommended.
• Possibility that banks may be required to limit their exposure to shadow banking entities, or include such entities when calculating capital, liquidity and leverage buffers.
• Paper may be published as soon as March, with a public hearing on 27 April.

RD News 15Feb12

• BCBS/Joint Forum: Report on intra-group support measures
• Overview of the use of intra-group support measures in times of stress or unexpected loss by financial groups across the banking, insurance and securities sectors.
• Majority indicated centralised capital and liquidity management systems are in place. According to proponents, this approach promotes the efficient management of a group’s overall capital level and helps maximise liquidity while reducing the cost of funds.
• However, the respondents that favoured a “self-sufficiency” approach pointed out that centralised management potentially has the effect of increasing contagion risk within a group in the event of distress at any subsidiaries.

• Charles Plosser (Pres Philadelphia Fed): The outlook and the hazards of accelerationist policy
• Prolonged efforts to hold interest rates near zero can lead to financial market distortions and the misallocation of resources.
• Constant acceleration only makes these risks even more hazardous. Slamming on the brakes or abruptly changing course could disrupt the economy. Failing to slow down and exit at the right time risks excessive inflation.

• Jean-Pierre Danthine (SNB): Reconciling price and financial stability
• Two main dimensions of systemic risk:
• the “structural” dimension, which covers the possible risks associated with individual institutions whose failure would endanger the entire system;
• the “cyclical” dimension refers to systemic risks which are not directly linked to an individual institution, but which stem from financial institutions’ collective responses to business or financial fluctuations and adverse shocks.
• “Structural tools” strive to reduce the impact of institutional failure by strengthening individual institutions. Their potential utility is often cited with regard to institutions which are considered “too big to fail” or “too interconnected to be liquidated” and whose failure would impact the entire system.
• “Countercyclical tools” aim to address the cyclical dimension of risk by reducing feedback loops.
• By reducing the probability of a severe crisis, the benefit of countercyclical buffers is on average 10 times higher than their costs in terms of real output growth per year.

• OFR: A Survey of Systemic Risk Analytics
• Survey of 31 quantitative measures of systemic risk in the economics and finance literature.
• ‘Because systemic risk is a multifaceted problem in an ever-changing financial environment, any single definition is likely to fall short, and may create a false sense of security as financial markets evolve in ways that escape the scrutiny of any one-dimensional perspective.’
• In many cases, academic researchers have made do with publicly available data, adjusting their modeling approaches accordingly. This is a constraint that regulators will not necessarily face, given the mandates and authorities granted to them by recent legislation.
• Definitions of each risk measure—including required inputs, expected outputs, and data requirements – in appendix.
• To encourage experimentation and innovation among as broad an audience as possible, we have developed open-source Matlab code for most of the analytics surveyed.

RD News 14Feb12

• Andrew Sheng: The narrative of failure and the failure of narrative
• Financial crisis is basically a story of failure, but the failure is due to lack of understanding of how to prevent or solve the crisis. Hence, it is also the failure of narrative, or how to tell the story to each other so that people communicate and understand what to do.
• The more the world is interdependent, the more important that the East and the West should seek to understand each other. In an age of instant solutions, the West is more likely to be fixated by simple solutions to complex issues.
• There are no simple answers to complex questions. This is the failure of narrative between major trading partners. We need to tell our stories to each other better if we want a more stable world.

• Independent: Sir Mervyn King: Who will reign when the king is gone?
• The last two Governors were chosen from within the Bank. Sir Meryvn was chief economist and his predecessor, Eddie George, appointed in 1993, was a Threadneedle Street insider. That would seem to put the leading internal candidate, the present deputy governor, Paul Tucker, in a strong position.
• Andy Haldane, presently in charge of financial stability and acknowledged as one of the brightest minds at the Bank, has also been mentioned. But this would be a considerable leap for a man of just 44. Some see him as a more natural candidate – at this stage in his career – for deputy governor.
• Other potential candidates: Lord Turner, Sir John Vickers, John Varley, Lord Green, Sir John Rose.

• MMFs: Fight over new rules
• ICI's CEO, Paul Schott Stevens, warned of a "regulatory hat trick" that could "harm investors, damage financing for businesses and state and local governments, and jeopardize a still-fragile economic recovery."
• MMFs are a linchpin of the economy. They hold $2.7 trillion and their investments represent more than one-third of the commercial paper market — the short-term IOUs that companies sell to meet cash-flow needs, such as payroll. They also invest in more than one-half of the short-term municipal debt on the market, which state and local governments rely on to finance roads and building projects.
• To ensure investors are at least earning marginal returns, (ave 0.02%) Federated and its rivals have been waiving investment fees and eating the costs of running money funds. Federated, for example, waived nearly $202 million last year.
• Whether Schapiro can get a required majority of the five-member commission to approve meaningful changes is in doubt, because some members have expressed reservations.
• It could be next year before any rules are finalized, even without litigation that he expects the industry to file.

• G20: Mexico sets out priorities for 2012
• Five priorities:
• Economic stabilization and structural reforms as foundations for growth and employment;
• Strengthening the financial system and fostering financial inclusion to promote economic growth;
• Improving the international financial architecture in an interconnected world;
• Enhancing food security and addressing commodity price volatility, and
• Promoting sustainable development, green growth and the fight against climate change.  
• Ministerial meeting: 4-5th Nov, Mexico City

• EBA: draft ITS on reporting of large exposures – consultation paper
• Aims at implementing uniform reporting requirements which are necessary to ensure fair conditions of competition between comparable groups of credit institutions and investment firms.
• Covers:
• (i) information needed to check institutions’ compliance with the large exposure regime as set out in Articles 376 – 392 of CRR (Capital Requirements Regulation).
• (ii) information on concentration risk which competent authorities need to analyse as per Article 79 of the Capital Requirements Directive (CRD).
• The scope and level of application are in line with the CRR, currently under discussion by the EU legislators.

RD News 13Feb12

• BIS: Jaime Caruana: Building a resilient financial system - Presentation
• Aim - a financial system characterised by less leverage, better risk management especially for liquidity, better incentives, less moral hazard, stronger oversight and more transparency.
• A globalised financial system requires global rules. This does not mean that identical rules must be applied for every country or region. But it does mean that, to be effective, financial regulation and supervision should be guided by broadly consistent approaches. The alternative is a race to the bottom as market players seek to arbitrage across divergent national regimes – and no financial centre would want to win such a race.
• The rules for the countercyclical buffer also represent an important step forward in terms of home-host cooperation. They require an internationally active bank to take account of the prevailing buffers in each jurisdiction in which it has a credit exposure in calculating its overall capital requirement. In other words, a host supervisor can increase the capital buffer required of a foreign-headquartered bank if this is called for by domestic conditions.
• The Basel Framework lets banks use their own internal data and models as inputs for the calculation of capital requirements, so that some variation in risk-weighted assets is inevitable.
• That said, these calculations do vary enough to warrant further investigation. The bottom line is that minimum capital requirements must accurately reflect the risk that banks actually face. Regulators are therefore doing studies based on benchmark or hypothetical portfolios.
• Shadow banks - we should enhance the oversight and consider regulation of the shadow banking system in areas where systemic risk and regulatory arbitrage evidently pose risk.

• EBA: aggregate assessment of banks’ capital plans
• EBA had stressed that capital raising should not impact lending to the real economy through excessive deleveraging, but should instead be met by direct capital raising or curbing discretionary payouts.
• Plans submitted by European banks “are not viewed as having a negative impact” on lending, with the impact being “less than 1% of the total amount”. Further, the plans suggest a capital surplus of 26%, giving room for flexibility. Direct capital raising will account for the majority of action taken.

• IMF: The Global Macroeconomic Costs of Raising Bank Capital Adequacy Requirements
• A single percentage point increase in capital requirements for all banks globally would cause a peak reduction of 0.5% of GDP, with higher losses for emerging markets than advanced economies.

• IMF: Short-term Wholesale Funding and Systemic Risk: A Global CoVaR Approach
• Short-term wholesale funding is a key determinant in triggering systemic risk episodes.
• No evidence that a larger size increases systemic risk within the class of large global banks.
• The sensitivity of system-wide risk to an individual bank is asymmetric across episodes of positive and negative asset returns.
• Since short-term wholesale funding emerges as the most relevant systemic factor, our results support the Basel Committee’s proposal to introduce a net stable funding ratio, penalizing excessive exposure to liquidity risk.

• ECB: Benoît Coeuré: Global liquidity and risk – a re-interpretation of the recent crises
• The self-reinforcing interaction between risk appetite and liquidity ultimately determines the relationship between the official and the overall level of global liquidity.
• Private liquidity is created to a large degree through cross-border operations of banks and other financial institutions, and increasingly within the shadow banking system.
• In normal times, private liquidity dominates official liquidity. But private liquidity is highly procyclical and highly endogenous to the conditions that prevail in the global financial system.
• The inherent endogeneity of private liquidity means that it can easily evaporate in times of financial stress.
• The pro-cyclicality is documented via the strong interaction of private liquidity and the global risk appetite of financial institutions. Indeed, the global risk appetite is one of the main determinants of the multiplier that links levels of overall liquidity to levels of official liquidity.

• H R Khan (Dep Gov RBI): Understanding psychology for responsible financial behaviour
• All of us could use the findings of behavioral economics in our daily lives as well as in policy making.
• The important lesson of life is that we should not evolve into insensitive individuals who care only for short term monetary gains by putting at stake ethics and moral values, thereby disrupting the financial system and causing huge social and economic damage.

RD News 7Feb12

• WSJ: SEC to unveil MMF plan
• Funds must boost their capital reserves in one of three ways: by injecting more cash from corporate coffers; issuing stock or debt securities; or collecting more money from shareholders.
• Investors who wish to sell all of their holdings at once would be able to get only about 95% of their money back immediately, with the remaining 5% returned to them after 30 days.
• Paul Schott Stevens, president ICI, said the ideas under consideration by the SEC could "force an enormous number of sponsors out of the business and leave those that remain with a product that nobody will want to invest in or make available to investors."
• Christopher Donahue, president and CEO of Pittsburgh-based Federated Investors Inc., which manages $255.9bn of money-fund assets, said he plans to sue the SEC if the new regulation interferes with his firm's ability to do business.

• Reuters: Fidelity MMF clients react negatively to SEC proposals
• Half of Fidelity’s money fund clients would move all or some of their assets out of the investments if the net asset value of the funds was allowed to fluctuate.
• Fidelity tested versions of a holdback feature, and said 52% of retail investors surveyed would invest less, or stop investing altogether, in money market funds if a 3% holdback feature was instituted on redemption. Results did not change significantly when the holdback was dropped to 1%.
• "Given the importance retail investors place on the liquidity feature of money-market mutual funds, it is not surprising that investors reacted so negatively to a potential rule that would restrict access to principal."

• Tim Geithner: The state of financial reform
• As we move forward, we want to get the reforms right so that they will endure as the market evolves. We are trying to be careful to look not just at the individual rules in isolation, but also the way rules interact with each other and the broader economy. We want to be careful to get the balance right—building a more stable financial system, with better protections for consumers and investors, that allows for financial innovation in support of economic growth.
• We need a more level playing field globally. This is particularly important in the reforms that toughen rules on capital, margin, liquidity, and leverage, as well as in the global derivatives markets.

• FSA: Delivering ‘twin peaks’ within the FSA
• Firms will be supervised by two independent groups with independent objectives, who will engage in “independent but coordinated regulation”.
• Change from the “old style reactive approach” to the “new style proactive approach”, and emphasised the importance of clarity of regulatory objectives, which he argued the FSA did not have.
• He argued that in a judgment-based regime, mistakes would be made, but that society must recognise that this is a by-product of the new approach, rather than simple failure.

• BoE: Chris Salmon (ED Banking Services & Chief Cashier): Three principles for successful financial sector reform
• First, it is better to manage the costs of change by having a long transition period than to water-down the reform so that change can be implemented more quickly.
• Second, we need strong dialogue between public authorities to maximise consistency of approach. We need strong and open dialogue between market participants and the public authorities to understand the potential impact of the proposed reforms.
• Finally, we need to recognise the limits of foresight and build in mechanisms so that rules can be amended, recalibrated or adjusted to take account of future developments.

RD News 3Feb12

• 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.
• 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.

• BIS: Jaime Caruana The need for effective international collaboration in times of financial stress
• Consistency of regulation, in particular on risk-weighted assets – need to keep the playing field level.
• The Basel Framework lets banks use their own internal data and models as inputs for the calculation of capital requirements, so that some variation in risk-weighted assets is inevitable.
• Minimum capital requirements must accurately reflect the risk that banks actually face. Regulators are therefore doing studies based on benchmark or hypothetical portfolios.
• Treatment of sovereign exposures - sovereigns with strong fundamentals need to earn back their risk-free status by credible and tangible fiscal consolidation.
• Where this is not the case, sovereign risk should be appropriately reflected in the calculation of risk-weighted assets.
• Liquidity – we must ensure that banks have a stable funding structure and maintain the minimum required stock of high-quality liquid assets in normal times - assets that can be drawn down to meet new liquidity needs in times of stress.
• We will provide guidance on the circumstances that would justify a bank's temporary breach of the liquidity requirement, and to ensure that markets do not unduly stigmatise a bank for using the liquidity buffer appropriately.

• Andreas Dombret (Deutsche Bundesbank) Global financial market regulation - need for a coordinated implementation and a global level playing field
• Policy development is currently progressing on how to extend the framework from global SIFIs to non-bank and domestic SIFIs.
• Basel III allows some discretion in national implementation: For example, the transition period permits jurisdictions to determine how quickly they adopt the new rules – which will depend on both the state of the national financial system and the macrofinancial environment.
• Moreover, as Basel III is an international minimum standard, jurisdictions might adopt tougher rules than the internationally agreed versions. Considering the significant differences in the size of banking sectors relative to domestic economies and the implied potential consequences in case of bank failures, I believe this to be a sensible approach, although it will raise level playing field issues.

• Andreas Dombret (Deutsche Bundesbank) Systemic risk analysis and crisis prevention
• Reducing complexity - complexity leads to non-linear dynamics in the system which are very difficult to handle both for the risk management of financial institutions and for supervisors.
• There are a lot of regulatory target variables which involve the use of complex risk-adjusting methods. For example, the core capital ratio is the ratio of core capital to risk-weighted assets. But the models used for adjusting the risk did not perform perfectly and underestimated the true risks stemming from CDOs.
• Communicating risk analysis - important to find the balance between making realistic assumptions about scenarios and avoiding devastating self-fulfilling prophecies of the markets.

• Duvvuri Subbarao (Gov, Reserve Bank of India): Price stability, financial stability and sovereign debt sustainability policy challenges from the New Trilemma    
• Under the old trilemma – the impossible trinity – countries had to sacrifice one of the three objectives – fixed exchange rate, independent monetary policy and free capital flows.
• Under the new trilemma – the holy trinity – no country can afford to sacrifice any of the objectives as the feedback loops can quickly shift the economy from an equilibrium to a disequilibrium.
• The issue really is of managing the inter se prioritization among the objectives and of determining the role of the central bank in this management.

• Stefan Ingves (Ch BCBS): SIFIs: is there a need for a specific regulation on systematically important financial institutions?
• An unqualified yes. Basel III framework is based on the "negative externalities" that these firms create and which current regulatory policies do not fully address.
• The impact caused by the failure of large, complex, interconnected, global financial institutions can send shocks through the financial system which, in turn, can harm the real economy.
• The moral hazard arising from public sector interventions and implicit government guarantees can also have longer term adverse consequences. These include inappropriate risk-taking, reduced market discipline, competitive distortions, and increased probability of distress in the future.
• G-SIB surcharge - the costs of requiring additional loss absorbency for G-SIBs are outweighed by the associated benefits of reducing the probability of a systemic financial crisis.
• Swiss too-big-to-fail package:
• A capital buffer of 8.5% of risk-weighted assets. This is in addition to the Basel III minimum requirement of 10.5%.
• Of this 8.5%, at least 5.5% must be in the form of common equity while up to 3% may be held in the form of convertible capital (CoCos). The CoCos would convert when a bank's common equity falls below 7%.
• The two big Swiss banks, Credit Swiss and UBS will have to hold a total of 10% common equity tier 1 capital. This exceeds both Basel III and the internationally agreed capital surcharge for G-SIBs.
• UK: Ch ICB Sir John Vickers recommended:
• that systemically important retail banks defined as retail banks with RWA exceeding 3% of GDP should have primary loss-absorbing capacity of at least 17-20% of RWA.
• At least 10% must be covered by equity capital while the remaining 7-10% may consist of long-term unsecured debt that regulators could require to bear losses in resolution. These are the so called bail-in bonds.
• The proposed changes related to loss absorbency are intended to be fully completed by the beginning of 2019.

• BoE: Paul Tucker ‘Investing in Change’
• A market economy cannot succeed without a financial system that efficiently allocates capital to investment and development projects, and helps households ride the peaks and troughs in their lifetime income.
• Because of myopia about risk, herding, asymmetric information and incentive issues, the state cannot leave finance entirely to its own devices.
• The greatest failure of all was the absence of a regime for the orderly resolution of distressed financial firms, without taxpayer solvency support.
• We are building macroprudential frameworks under which capital requirements can be adjusted temporarily – or ‘counter-cyclically’ – as and when risks are unusually high, and reduce them back to more ‘normal’ levels as extraordinary incipient threats recede.
• Pursuing reform now is not just a matter of responding to public concern, important though this is. Credible reform is also crucial to restoring confidence in the financial system and thus to delivering a vibrant, effective system.
• This is necessary for durable economic recovery, and for sustainable economic growth over the longer term.

• BoE: ‘Does macropru leak?
• The regulation of bank capital to improve the resilience of the financial system and, related to this aim, as a means of smoothing the credit cycle are central elements of forthcoming macroprudential regimes internationally.
• For such regulation to be effective in controlling the aggregate supply of credit:
• changes in capital requirements need to affect loan supply by regulated banks
• substitute sources of credit should not fully offset changes in credit supply by affected banks.
• International ‘leakage' was material although only partial: it offset - by about one third - the initial impulse from the regulatory change.
• These results suggest that, on balance, changes in capital requirements can have a substantial impact on aggregate credit supply by UK-resident banks.

• IMF: How Risky Are Banks’ Risk Weighted Assets? Evidence from the Financial Crisis   
• Banks with lower RWA performed better during the US and European crises.
• This relationship is weaker in Europe where banks can use Basel II internal risk models.
• For large banks, investors paid less attention to RWA and rewarded instead lower wholesale funding and better asset quality.
• RWA do not, in general, predict market measures of risk although there is evidence of a positive relationship before the US crisis which becomes negative afterwards.

RD News 20Jan12

• FT: US custodian banks hit by shift into cash
• Global custodian banks have adopted a defensive position as fund managers and large institutions shift into cash and ultra-safe assets, putting pressure on the banks’ ability to generate income.
• Low interest rates have put tremendous pressure on custodian banks that manage funds for large institutions and retail brokerages, with the Federal Reserve’s commitment to near-zero rates through 2013 make it difficult to invest customer funds in safe investments that generate return.
• The firms reported a doubling in waivers on fees charged on money-market funds that offer low returns but promise immediate liquidity, with some $90m in fees waived this year. Low rates have forced the banks to forgo fees that would push money-market funds into the negative.
• State Street said it would likely continue to cut staff, having closed a fixed-income trading unit in the fourth quarter.

• SEC to Study Investor Financial Literacy
• Intended to find ways to improve the timing, content and format of disclosures, by identifying the “most useful and understandable relevant information” needed by retail investors.
• Designed to find ways to improve transparency about conflicts of interest.

• Bloomberg: China May Relax Bank Capital Requirements
• China is allowing the nation’s five biggest banks to increase first-quarter lending and weighing a plan to relax capital requirements as economic growth cools.
• CBRC may allow banks to increase the excess bad-loan reserves used in calculating risk buffers.
• Risk weighting on personal operating loans to small businessmen may be cut to 75% from current 100%, while ratio on loans to small and micro-sized firms would be lowered to 50 % from 75%.

• BoE: Andy Haldane: Accounting for banks uncertainty
• Accounting rules in general, and fair value principles in particular, appear to have played a role in both over-egging the financial upswing and elongating the financial downswing. They have tended to over-emphasise return in the boom and under-emphasise risk in the bust.
• Proposed Regulatory Prudent Valuation Return:
• An upside and downside range for fair-valued assets be identified, categorised into distinct buckets. This would give a guide to the potential variation in a bank’s solvency position arising from model uncertainty.
• It also asks banks to identify portfolios where valuation uncertainty is so severe that it is not possible to provide a plausible bound and to make disclosures around portfolios of particular interest to regulators.
• A VaR-equivalent figure needs also to be disclosed for each asset class, with reconciliation to the net and gross values of all fair-valued assets and liabilities.

• Norman Chan (CEO HKMA): Hong Kong – an offshore renminbi business centre 
• After successful development of the offshore RMB market last year, certain regulatory requirements will be relaxed.

• Dan Tarullo: The Volcker Rule
• Volcker Rule generally prohibits banking entities from engaging in two types of activities: 1) proprietary trading and 2) acquiring an ownership interest in, sponsoring, or having certain relationships with a hedge fund or private equity fund.
• Statute applies only to positions taken by a banking entity as principal for the purpose of making short-term profits; it does not apply to positions taken for long-term or investment purposes.
• Permits additional activities if they would promote and protect safety and soundness of the banking entity and the financial stability of the United States.
• Distinguishing between prohibited proprietary trading activities and permissible market-making activities is difficult.
• The statute distinguishes between these activities by looking to the purpose of the trade and the intent of the trader. These subjective characteristics can be difficult to discern in practice, particularly in the context of complex global trading markets in which a firm may engage in thousands or more transactions per day.
• A similar challenge attaches to efforts to distinguish a hedging trade from a proprietary trade.