Journal launch: Journal of Financial Regulation and Compliance: Policy responses to the Great Financial Crisis: edited by Charles Enoch (PEFM, St Antony’s, Oxford), Tom Huertas (Ernst and Young), David Llewellyn (Loughborough) and Maria Nieto (Bank of Spain)
On 29 September, 2017 PEFM hosted a conference to mark the launching of a double-number special edition of the Journal of Financial Regulation and Compliance (JFRC), looking at policy responses to the global financial crisis (GFC)—see programme attached. The event was co-sponsored by Ernst and Young and the JFRC, together with PEFM. Speakers were largely contributors to the special edition.
Tom Huertas, introducing the conference, noted that the volumes were divided into sections on firefighting, macro policy and micro responses. As to the first, the US and UK had provided solvency support. Through the G20 a comprehensive reform agenda was agreed at the Pittsburgh summit, and the Financial Stability Board (FSB) was enhanced as the overall coordinating body. As regards recovering the public costs incurred, in the US over $300 billion of restitution fees have been levied over the past five years.
On the other hand, Fannie Mae and Freddie Mac continue to operate. There was limited interest in Congress to reform the housing market, leaving a high share of financial risk unaddressed. Also, the valuation of euro area bonds remains hanging. There also remains the issue that policy makers feel that they can model monetary policy without looking at financial issues. And now there are moves to repeal elements of Dodd Frank, in particular title 2, under which there is a division between a parent bank holding company and its bank subsidiary so that the holding company can go into bankruptcy while the subsidiary continues: there is no idea what the replacement to this structure would be. Also, the Fed is now much more constrained than earlier: it no longer would have the power to give credit to AIG. And there remains serious concern at valuation effects in the event of fire sales: this would have implications for collateral valuation, and could lead to downward price spiral. This shows why provision of liquidity is so important: liquidity from central banks may be the only game in town. If for instance Citibank is in trouble, it will need to have liquidity in Tokyo when Tokyo opens; otherwise it will not survive half an hour. This implies liquidity availability much greater than that presently envisaged. And, that said, the Chinese banking system, at 37 trillion dollars is now twice the size of that of the US.
Olivier Frecaut (IMF) argued that the best way forward would be a stronger analytic framework. A key lesson was the criticality of macrofinancial linkages, through their generation of negative feedback loops. The IMF’s review of the crisis highlighted the lack of integration of the financial sector into macroeconomic analytical work. This area is still a work in progress.
Nadege Jassaud (Single Resolution Board) noted that IFRS has not been enforced consistently across countries, for instance as regards the valuation of collateral. The EBA has now given guidance on forbearance, and the establishment of the Single Supervisory Mechanism enables a harmonized approach across the Euro area. Edouard Vidon (Bank of France) noted that there is no NPL market in Europe, so banks keep hold of them and prices would be very low. The authorities could encourage securitization, through increasing transparency, facilitating the establishment of asset management companies, and repackaging the assets. There have been recent EU initiatives, but largely dealing with the flow of new NPLs. The legacy issue may be a major stumbling block to the completion of the banking union. Ms. Jassaud noted the difficulties in creating an NPL market: it was hard to get information on vintages; the banks that sold them were those that were well-resourced, and one has the Akerlof lemons problem. John Fell (ECB) noted that there was oligopsony in these markets: there are few investors, and they collude to have widespread “imperfect excludability”.
Artie Ng (Polytechnic University, Hong Kong) spoke on the emergence of fintech and cybersecurity in a global financial centre, pointing out the benefits and the risks, and setting out the policy initiatives of the Hong Kong Monetary Authority in the face of possible threats. He noted the concerns in the People’s Bank of China, and their actions against Bitcoin. He also discussed the major initiatives to stimulate “green bonds” in China. Why is fintech special? It pushes banks to become more like utilities; fintech companies have access to much information. In regulation, consumer protection is the biggest risk to address.
John Fell reported his work at the European Systemic Risk Board on how to spread NPL losses over time: there could be recoveries if the process could be improved. Governments could for instance help in the establishment of AMLs if they would share in the upside. But there can be intra-government issues, in particular between finance ministries and justice ministries. In Greece there was a collapse in credit discipline, since nothing happened to those who stopped paying their debts. An EBA paper recommended transferring assets above present market prices, but at a long run price. This was unacceptable to DGCOMP three years ago, but seems to be discussable now. State aid is seen as part of the bank resolution directive to pay for precautionary recapitalization. The crisis showed that monetary policy cannot solve both monetary and financial sector issues: we see a revival of the Tinbergen rule. On the macroprudential side, there are now too many instruments for assignment: one has to look at their relative effectiveness.
Thiery Tressel (IMF) discussed the impact of loan-to-value ceilings on reducing the rise in house prices. Monetary policy and macroprudential are complementary, especially regarding LTVs, since they serve to dampen house price increases especially when monetary policy is too loose. National authorities control LTV limits; the ECB controls capital requirements; there is a question as to whether this is consistent.
Charles Goodhart (LSE) asked whether the financial reforms have been misdirected. He noted that capital requirements are effectively now 5 to 10 times their level before the GFC. But this has not dampened credit growth. Also, one cannot say that the 1% cyclical capital surcharge will have much effect. Increases in the capital ratios could imply dilution, and benefits to bondholders, so the banks reduced their assets through massive deleveraging, especially cross-border in Europe. There were huge fines on the banks, which hits shareholders, and ultimately the customers. This comes from an anthropomorphic view of the banks. One should focus instead on the individuals, and the concept of responsibility. In New Zealand, for instance, each director is required to read and sign a statement saying that they are happy with the controls. Limited liability should be adjusted for senior management. There is insurance for directors: one needs to make their activities non-insurable, since it is against the public interest. Bail-in is over-sold, and there has been little attention on how to rein in house prices: Fannie Mae and Freddie Mac go on as before. The structure of housing finance was as much to blame for the crisis as were the banks.
Emiliano Tornese (DG FISMA) reported on progress to completing the banking union. The Commission has proposed the European Deposit Insurance system (EDIS) with resolution as backstop. It has also looked at harmonizing insolvency rankings, but received negative feedback from member states. The bank resolution and recovery directive (BRRD) has a 2018 deadline for review, but there have been some delays in transposing it. The EDIS is more controversial than the BRRD. There are basically two factions: those stressing risk reduction measures, and those who argue to spread the risks.
Dirk Schoenmaker (Duisenberg School of Finance, Amsterdam) hoped that summaries of resolution plans would soon be published, in particular as regards choice of single and multiple points of entry. All banks previously wanted to avoid being classified as G-SIBs, because of the higher capital requirements. Now they wish to be in, because of higher visibility. The fiscal backstop will be very important for the Euro Area: the ESM should not be there just for countries, also for the banks. The relocation of Nordea is very significant: it shows the power of the banking union. The proposed common backstop to the Single Resolution Fund is agreed; however, there is not agreement even in principle for the EDIS: it is not clear that the technical work in that area will lead to anything. ESM recapitalization for banks has been limited at 60 billion euros out of total resources of 580 billion euros. Also, the ESM has market access and procedures in place for lines of credit. It is critical for bank safety that resources are sufficient: if one has clearly sufficient resources one will not need them. But one will not have a full banking union if there is no full European banking group in place—separate capitalization requirements for self-standing entities are still a problem.
David Llewellyn concluded the conference, bringing out a few key points. One should look again at risk-weighted assets (RWAs) vs leverage—there seems to be a fundamental problem with RWAs. There is also a risk of excessive complexity: there is a distinction between precision and accuracy. He also referred back to the issue of anthropomorphism and the lack of personal responsibility. Finally, it is important to look at the culture within banks, and the risks of regulatory capture.
Charles Enoch (PEFM Director, St Antony's College, Oxford)
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