international financial regulatory reforms: are we on the right track? patrick leblond

International Financial Regulatory Reforms:

Are We on the Right Track?

Patrick Leblond

CERIUM Summer SchoolJune 30, 2010

2© Patrick Leblond – June 30, 2010

Paul Zanetti, Australia


Session Plan

• Introduction

• Financial regulation: the basics

• The G20 process: where are we?

• Conclusion


Introduction


The value of bank assets was falling quickly…

Source: IMF, Canada 2009 Article IV Consultation, Staff Report


…while banks had a lot of debt

Source: Bank of Canada, Financial Stability Report, December 2008, p. 24.


So, banks did not want to lend money to each other anymore

Source: Bank of Canada


Governments had to intervene

http://topforeignstocks.com/2009/10/20/government-bailout-of-banks-as-a-percentage-of-gdp/


Financial Regulation:The Basics


Basic Principles

• Equilibrium between – System stability and security– Risk taking

• Competition is necessary for risk taking• Benefits must be superior to costs• International trade in financial services

must not be impeded– No discrimination

• International coordination is a must


John Cole -- The Scranton Times, 1 April 2008


What are the financial risks that must be regulated?

• Liquidity risk– Run on the bank

• Systemic risk– Contagion– Credit freeze

• Moral hazard– Capitalism for the gains, socialism for the

losses


What are the solutions?

• Liquidity risk– Minimum liquidity reserves– Deposit insurance– Central bank credit

• Systemic risk– Minimum capital ratios– Leverage ceiling for all financial activities– Limits on asset riskiness– Stress tests– Bankuptcy (resolution) regime for banks

• Moral Hazard– No implicit guaranteed bailouts


International Regulation

• International coordination of rules and standards – Financial Stability Board– Basel Committee on Banking Supervision– IOSCO– IASB– IMF

• National implementation of those rules and standards


Source : Davies and Green (2008, p. 33)


The G20 Process: Where Are We?


What has been proposed (1)

• Bank tax– On bankers’ bonuses– On banks’ profits– On financial transactions

• Higher minimum capital ratios (capital to assets)– Ratio levels?– Risk weights?– Definition of capital?– Countercyclical?

• Maximum leverage ratio (assets to capital)– On what activities?– No weighting of assets according to risk


What has been proposed (2)

• Separate investment banking activities from commercial banking activities

• Contingent capital• Clearing mechanism for financial derivatives• Regulation of hedge funds• Regulation of credit-rating agencies• Systemic stress-testing with disclosure• Harmonized accounting standards


What is for sure to be there internationally

• Minimum liquidity ratios• Higher minimum capital ratios• Leverage ratio

– But to all financial activities?

• Stress-testing with public disclosure– Large multinational financial institutions– National level

• Harmonized accounting standards– Fair value everywhere?


Example of Capital RatioAsset Category

Risk Weight

Capital Ratio

Amount RWA Minimum Capital requirement

Treasury Bond

0% 8% $1,000 $0 $0

Municipal Bond

20% 8% $1,000 $200 $16

Residential Mortgage

50% 8% $1,000 $500 $40

Unsecured loan

100% 8% $1,000 $1,000 $80


What might be missing?• Who assesses the riskiness of assets and

liabilities?• Supervision of multinational banks

– Who supervises what?

• Bankruptcy mechanism for multinational financial institutions

• Countercyclical (i.e. dynamic) policies to prick asset bubbles– Make borrowing more expensive as risk increases

• Global stress-testing?• Monitoring of national implementation

– Sanctions?


Conclusion


Conclusions• The global financial crisis showed that the

existing financial regulatory regime does not work– We cannot rely on markets to regulate themselves

• Let the G20 process run its course– It is on the right track– Seoul will be the key meeting– New regulatory standards will come in to play starting

in 2012– But the devil will be in the details and national

implementation• Will it be enough to prevent the next crisis?

– Probably not– Hopefully, it will be less acute and spread out


My Contact Information

• University of Ottawa• Graduate School of Public and

International Affairs• 55 Laurier Street East, Office 11154• Ottawa, ON K1N 6N5• Canada• Tel: +1 613 562 5800 (ext. 2953)• E-mail: [email protected]


THANK YOU!

international financial regulatory reforms: are we on the right track? patrick leblond

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