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Risk Management of Financial Institutions after the Financial Tsunami---Current Reactions
Hsien-hsing LiaoDepartment of FinanceNational Taiwan University
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Contents
The financial failure 2007-?
Basel III
Some points from “NYU Stern
Working Group on Financial
Reform”
Understanding financial failure (G20, June 2010, Toronto )
• Originate-to-distribute model: complex derivatives, but simple maturity mismatches
• Leverage and deleveraging cycle (Minsky-moment)• Contagion cycle: financial real political• Contagion: liquidity solvency Amplifiers • Endogenous risk (behavioural) • Counterparty risks• Off-balance sheet, contingent lines - paradox of trust• Excess reliance on ‘wholesale’ finance
Broad principles underlying reform and regulatory change (G20, June 2010, Toronto )
•Undercapitalized financial system
•Limits of micro-prudential (individual) rationality in regulation, supervision
•Limit size, complexity, in some cases interconnectivity of financial institutions.
•Risk allocation
•Ex-ante incentives (bail-in) vs. ex-post (bail-out, levy, taxes)
•Continuous markets (risk pricing, market clearing, basic transformation functions – ‘market-maker of last resort’)
Summary: status of core issues
High conceptual clarityHigh/reasonable prospect (with modifications)High level consensus
Capital adequacy; capital standards ; trading book changes; leverage ratios; liquidity ratios; countercyclical buffers
Reasonable conceptual clarityReasonable prospect (in some jurisdictions more than others)Some consensus
Charges on SIFI; other macro-prudential systemic risk measures – FAT, FSC (IMF); Financial Crisis Responsibility (FCR) fee (Obama-TARP levy 0.15% of LFI liabilities); market stabilization fund (Germany, US); bonus/payroll taxes (UK, France) Resolution plans –living wills;Volcker-rule
Basic concept, low clarityUncertain prospectsNo consensus
Cross-border resolution regime- its link with national measures (punitive charges, stability funds); bank-tax/levy; FTT/CTT
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Basel III
• The Basel Committee on Banking Supervision reached board “Basel III” agreement on 12 Sep. 2010
• “Basel III” tightens the definition of
regulatory capital;• increases the min. requirement of Tier
1 Capital;• establishes conservation /
countercyclical capital buffers; • introduces a leverage ratio;• a new liquidity coverage ratio and a net
stable funding ratio
• To be phased-in between 1 Jan. 2013 and
1 Jan. 2019
Basel III Proposed Capital Reforms
• Quality, consistency & transparency of the capital base.
• Enhance risk coverage.• Introduce a leverage ratio.• Deal with Pro-cyclicality.• Address systemic risk &
interconnectedness.
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NYU Stern Working Group on Financial Reform
Financial ArchitectureIf the financial system continues to be dominated by institutions with high levels of systemic risk:The creation of a new systemic risk regulator is necessary This new regulator would supervise the growing cohort of financial conglomerates institutions are encouraged to follow more specialized business strategies.
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Systematic Risk• Measuring Systemic Risk
• Managing Systemic Risk
• Taxing Too-Big-to-Fail Institutions
• Capital and Liquidity Requirements
• Is Breaking Up the Big Financial Companies a Good Idea? Size or activities
• Contingent Capital
• Financial Institutions Subject to the Bankruptcy Code
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Markets and Institutions
Securtization reforms Securitization created serious systemic problems
that played a major role in the financial crisis.
Transparency
More Regulations vs. Cost Efficiency
Credit Agenciescentral players in the subprime residential
mortgage crisis