Regulatory reform : integrating paradigms

The Subprime crisis largely resulted from failures to internalize systemic risk evenly across financial intermediaries and recognize the implications of Knightian uncertainty and mood swings. A successful reform of prudential regulation will need to integrate more harmoniously the three paradigms of moral hazard, externalities, and uncertainty. This is a tall order because each paradigm leads to different and often inconsistent regulatory implications. Moreover, efforts to address the central problem under one paradigm can make the problems under the others worse. To avoid regulatory arbitrage and ensure that externalities are uniformly internalized, all prudentially regulated intermediaries should be subjected to the same capital adequacy requirements, and unregulated intermediaries should be financed only by regulated intermediaries. Reflecting the importance of uncertainty, the new regulatory architecture will also need to rely less on markets and more on"holistic"supervision, and incorporate countercyclical norms that can be adjusted in light of changing circumstances.Debt Markets,Banks&Banking Reform,Emerging Markets,Labor Policies,Financial Intermediation

Machine learning methods for systemic risk analysis in financial sectors.

Financial systemic risk is an important issue in economics and financial systems. Trying to detect and respond to systemic risk with growing amounts of data produced in financial markets and systems, a lot of researchers have increasingly employed machine learning methods. Machine learning methods study the mechanisms of outbreak and contagion of systemic risk in the financial network and improve the current regulation of the financial market and industry. In this paper, we survey existing researches and methodologies on assessment and measurement of financial systemic risk combined with machine learning technologies, including big data analysis, network analysis and sentiment analysis, etc. In addition, we identify future challenges, and suggest further research topics. The main purpose of this paper is to introduce current researches on financial systemic risk with machine learning methods and to propose directions for future work.This research has been partially supported by grants from the National Natural Science Foundation of China (#U1811462, #71874023, #71771037, #71725001, and #71433001)

A Conference on Postcrisis Banking

This essay provides an introduction to the special issue. We focus on four themes which are important for policymakers and researchers alike in view of the experiences of the global financial crisis of 2007-2009 and the ensuing sovereign debt crisis in the euro area: the relevance of the banking sector for the real economy; the future structure and regulation of the banking sector; the efficacy of past and current regulatory reforms; and the impact of crossborder banking on economic stability and financial development

Rationales and Designs to Implement an Institutional Big Bang in the Governance of Global Finance

The colossal challenges facing international finance pertain to both its governance system and its dual utility and speculative functions, which have become ever more intertwined with the advent of financial innovation. In the aftermath of the Global Financial Crisis (GFC), a number of significant reforms are under way to address the second issue, including additional capital and liquidity requirements for banks, measures to battle interconnectedness in the financial sector, new resolution regimes that would allow banks to fail more easily, and stricter frameworks for bank supervision and monitoring of systemic risk. Yet limited progress has been made with respect to governance structures, which, thus, will be the main focus of present analysis. In this Article, I provide an outline of a proposal for a new model of governance for global financial markets to address most of the above challenges in a way that would be more effective than the preexisting regime or the architecture emerging as a result of the GFC

An Evaluation and Management of the Systemic Risk of the Banking System -A Literature Review

There is consensus among financial regulators that the recent global financial crisis has highlighted the need of addressing incomplete reforms, one of them being the contribution of financial risks in destabilizing the financial markets. One of the most important form of financial risks is the systemic risk that is imposed by the inter linkages and interdependencies in a financial system. The purpose of this paper is to review some of the updated research articles published on the evaluation and management of the systemic risk between 2005 and 2015 by using diverse systemic risk analytics. The paper highlights the main contributions of the authors to the research. The discussion on the literature is classified into two parts namely empirical and non-empirical studies. The results show that the cross section measures proposed down by Acharya et al (2010) and Adrian and Brunnermeir (2011) MES and CoVaR respectively have gained popularity in evaluating the systemic risk, however the proposed measures should be used with warning. Moreover, despite the fact that the interest in the topic of management of systemic risk has grown tremendously, but little research has been conducted in developing countries. Keywords: Macroprudential policy, Systemic risk, Systemic financial institutions, financial regulation

Bank regulation and the network paradigm : policy implications for developing and transition economies

Current issues in banking policy range from the need to construct basic institutions and incentive structures in transition economies, to the challenges posed by the increasingly complex interactions involved in contemporary banking. The authors of this report outline the basic regulatory framework needed to reduce bank failures, as shown by recent experience. Theoreticians note that banking increasingly displays network characteristics that may call for corrective action but make policy intervention ineffective or counterproductive. Networks are susceptible to externalities, redundancy, (ensuring that flows cannot be obstructed by blocking just one path), and a tendency to adapt to disturbances in a complex manner. Regulation is justified, but the complexity of the network makes successful interventions hard to design. Supervision has a role, and the authors outline the basic regulatory measures needed, but the blurring of boundaries between banking and the rest of the financial network has placed an upper bound on the effectiveness of supervision. The authors conclude that although bank failures--mitigated by deposit insurance to protect small savers--must be put up with in designing banking policy, the social cost of bank failure is not as high as is sometimes thought.Payment Systems&Infrastructure,Economic Theory&Research,Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Banks&Banking Reform,Financial Intermediation,Financial Crisis Management&Restructuring,Economic Theory&Research,Environmental Economics&Policies

The New Global Financial Regulatory Order: Can Macroprudential Regulation Prevent Another Global Financial Disaster?

This Article posits that the success of macroprudential regulation will depend on four factors. First, the economic philosophy of the central banker in charge of the domestic institution with jurisdiction over macroprudential regulation will prove crucial in the implementation of adopted regulation. If, like Chairman Greenspan, the banker is averse to the exercise of the Central Bank\u27s regulatory oversight authority, then no amount or volume of policy or regulation will prevent or mitigate systemic risks and the accompanying shocks. Second, a sufficiently deep level of international cooperation is required to mitigate regulatory arbitrage, without being so broad that the ensuing harmonization of regulatory regimes will result in a homogenized global regulatory system that will possibly give rise to a productization of risk and therefore a far more rapid spread of systemic risk and shock. Third, the acceptance of macroprudential regulation by disparate domestic regulators will require a new guiding philosophy for the financial industry that will allow the macroprudential regulator the opportunity to meet its mandate and provide a foundation for system-wide success. Fourth, there needs to be a sufficient level of political willpower on the part of domestic legislatures and regulators in the face of what may be fierce opposition to macroprudential regulation by the largest and most politically powerful institutions the policy aims to supervise. To counter this, macroprudential regulation is primarily under the purview of the Central Bank, and therefore less prone to regulatory or political turbulence. To explore the present and possible future impact of macroprudential regulation, one must recognize the possible implications of the current regulatory proposals. One way to ascertain such information is to examine the strengths and weaknesses of macroprudential regulation as it is currently proposed and implemented. As such, this Article considers the possible opportunities and threats that lay ahead within a policy and regulatory framework that considers the economic, political, and international implications of macroprudential regulation proposals

Regulation, valuation and systemic liquidity.

It is a commonly held view that International Financial Reporting Standards (IFRSs), adopted by the European Union in 2005 and by other jurisdictions, compounded the recent fi nancial crisis. Application of the IAS 39 rule that governs loan-loss provisions and extends mark-to-market valuation of assets meant that when credit prices fell sharply in 2007 and assets were revalued using the new lower prices, it triggered a need for institutions to raise capital by selling assets, which pushed prices down further, causing more revaluations and more selling in a vicious circle. Mark-to-market volatility added to this unstable dynamic by keeping new buyers away. Fair value accounting rules are pro-cyclical and can contribute to the systemic disappearance of liquidity.1 The price of assets if they were to be sold immediately fell substantially below the price of the same assets if they were to be held to maturity or for some time period beyond the crisis. This liquidity premium was no longer a fraction of a percentage point, but tens of percentage points. A number of observers have concluded that mark-to-market accounting should be suspended during a crisis. On its own, I believe this initiative would further weaken incentives for responsible lending in the good times. Nor would it solve the problem in bad times. The pro-cyclical use of market prices is not the preserve of accounting standards –it also lies at the heart of modern financial regulation. Financial crashes are not random. They always follow booms. Offering forbearance from mark-to-market accounting or other rules during a crisis, yet using these rules at other times, such as during the preceding boom, would promote excessive lending and leverage in the good times. This asymmetry would contribute to more frequent and severe crashes. Second, crises are a time where a rumour becomes a self-fulfilling prophesy, as panic and fear spread. It is, arguably, not the time to generate a rise in uncertainty by changing accounting standards. There is room for a revision to the application of mark-to-market rules, but not a revision based on relying on the messenger’s every last word in good times and shooting him in the bad times. But the mechanisms that lead market participants to greet price declines with sell orders have not all to do with value accounting. Current prices, including spot and forward prices, play an important role in the market risk and credit risk management systems approved by financial regulators. Risk limits and sell orders are triggered in response to a rise in price volatility and/or a fall in price. The very philosophy of current banking regulation –risk sensitivity– is about incorporating market prices into the assessment and response to risk. It should be no surprise that if prices, both prices for current and future delivery, are pro-cyclical, then placing an increasing emphasis on price in the management and regulation of risk, will lead us to systemic collapse. This article examines the role of valuation and systemic liquidity and argues that an approach to how we apply mark-to-market accounting and market prices or risk that is driven more by an economic view can improve the systemic resilience of the fi nancial system.