Liquidity risk management.

Liquidity and solvency are the heavenly twins of banking, frequently indistinguishable. An illiquid bank can rapidly become insolvent, and an insolvent bank illiquid. As Tim Congdon noted, (FT, September 2007), in the 1950s liquid assets were typically 30 percent of British clearing banks’ total assets, and these largely consisted of Treasury Bills and short dated government debt. Currently, such cash holdings are about ½ percent and traditional liquid assets about 1 percent of total liabilities. Nor have prior standards relating to maturity transformation been maintained. Increasing proportions of long-dated assets have been financed by relatively short-dated borrowing in wholesale markets. Bank conduits financing tranches of securitised mortgages on the basis of three month asset-backed commercial paper is but an extreme example of this. Northern Rock is another. Such time inconsistency issues are hard to resolve, especially in the middle of a (foreseen) crisis; it is worth noting that many, though not all, of the aspects of this present crisis were foreseen by financial regulators. They just did not have the instruments, or perhaps the will, to do anything about it. If, when trouble strikes, the lifeboats are manned immediately, with extra liquidity being provided on easy terms, then there is encouragement to the banks to build even more densely on the flood plain. Why should the banks bother with liquidity management when the Central Bank will do all that for them? The banks have been taking out a liquidity ‘put’ on the Central Bank; they are in effect putting the downside of liquidity risk to the Central Bank. What is surely needed now is a calm and comprehensive review of what the principles of bank liquidity management should be.

The Rise of China as an Economic Power

In the twenty years since the Cultural Revolution, China has maintained fast real growth. This occurred despite China having similar problems to other transitional economies, eg loss-making State Owned Enterprises (SOEs), eroding fiscal revenues and inflation, (Section 3). Although China initially adopted the Soviet central planning model, after the 1950s break Chinese planning changed towards a regionally-based system with local planning (Section 2). In contrast to the centrally-based, functionally-specialized (U form or unitary structure) Soviet model, the Chinese-economy is organized on a multi-layer-multi-regional (M form) basis. This encouraged development of small size township and village enterprises (TVEs), the main engine of Chinese growth. Power and control remained with the Party and the State, but was diffused much more widely, regionally and locally. This allowed initiatives at lower (political) levels to establish institutions, both in agriculture (the 'household responsibility system') and industry (TVEs), without state protection. Even among regionally controlled SOEs, 'tournament rivalry' between regions, etc, and between SOEs and TVEs provided competition.

How, if at all, Should Credit Rating Agencies (CRAs) be Regulated?

The role of credit ratings agencies (CRAs) is to forecast the probability that the issuer of a debt liability will default on the due repayment (its probability of default, PD). In this respect, CRAs are one of a large set of institutions and people who seek to forecast certain aspects of the future. As a generality, the only, or at any rate the most important, requisite of a forecast is its accuracy. So long as the forecast is accurate, it is largely beside the point how the forecaster behaves otherwise, whether they lead a blameless life, or alternatively are rude to their parents, beat their children or cheat on their spouses, etc. Moreover, in the case of CRAs, (unlike the Delphic oracle), the forecast is not only relatively clear in content, (though we shall consider later how it could, and should, be made even clearer), but also the status of the event being forecast, i.e. whether the issuer defaults, or not, on due repayment, is also relatively clear – and any remaining fuzziness often becomes subject to a legal decision. So the forecasting activities of CRAs should be susceptible to ex post accountability. Compare forecast with out-turn; assess and publish the comparative accuracy of the various CRAs' and leave competition to do the rest. We shall review what extra steps need to be taken to enhance such ex post accountability, comparing forecast with outcome, and comment briefly on how, perhaps, to enhance competition

Richard Sidney Sayers (1908–1989)

Richard Sayers’s greatest strength was as an economic historian of institutional changes within the British financial system, especially relating to the Bank of England, for which he became the second official historian covering the years 1891-1944; but also writing the histories of Lloyds and Gilletts, and a wider study entitled Financial Policy, 1939-45. Nevertheless, he is best known for two other contributions. First, his textbook, Modern Banking, remained required reading on this subject for all British undergraduates from 1937 until the early 1970s; second, he played the major role in the domestic monetary analysis of the Radcliffe Report (1959). This latter role was often not well received, and his historical and institutional approach to the subject began to be treated as unfashionable and outdated, so that Sayers, always a lone introvert, had a somewhat sad end to his lif

Lender of Last Resort and moral hazard

In this paper we revisit the Lender of Last Resort (LOLR) function of the central bank and the associated moral hazard incentives. We argue that, from an economic perspective, the strict application of penalties to the operation of LOLR actions can make that instrument unworkable. Instead, we suggest that both penalties and publication should only be applied after such LOLR had been in place for a time. Normative frameworks ought to be adjusted in this regard

A note on the differences between European and international methodologies of banking regulation and supervision

Although monetary policy is the main tool for central banking in order to control inflation/deflation, micro- and macroprudential instruments are also essential for crisis management. In this paper, we aim to clarify the differences between European and international banking methodologies. The European approach as represented by the European Banking Union, is based on a harder legalistic approach, whereas the international approach implemented by the Basel Committee on Banking Supervision has a soft-law methodology. We propose two comparative standpoints: “uniformity” versus “diversity”, and a “legislative” versus "principle-based” approach

The surprising recovery of currency usage

Currency usage began a long trend decline in the decades after World War II. This was expected to continue, and even accelerate, owing to payment technology innovations. Surprisingly, however, such usage as a percentage of GDP stopped falling and has increased quite sharply in recent years in most countries, with Sweden the major outlier. We examine to what extent this may have been due to increasing interest elasticity, nearing the zero lower bound, and also to rising tax evasion, as indirect taxes rise. We also show how currency holdings increased temporarily as the financial crisis struck in 2008