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BRANDEIS INTERNATIONAL
BUSINESS SCHOOL
Regulatory Reform: A Scorecard
Stephen G. Cecchetti & Kermit L. Schoenholtzwww.moneyandbanking.com
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The Five Pillars of Regulatory Reform
BRANDEIS INTERNATIONAL BUSINESS SCHOOL
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Making sure reform does not wither!
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1. Capital: Requirements & levels are up, but not enough
2. Liquidity: One requirement is enough LCR
3. Resolution: Progress, but framework remains untested
4. Central Clearing: Need sufficient safeguards
5. Systemic Regulation: Very early days
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Capital Requirements
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Table 1: Comparing Basel III and Basel II Risk-weighted Capital Requirements
for the Largest Systemic Banks: Impact of Basel III Capital Definition
Basel III range 8% to 10%
Basel II Baseline 4%
Adjustment for hybrid capital -2%
Adjustment for goodwill, intangibles, deferred tax assets, etc. -1%
Adjustment for changes in risk weights -¼%
Effective Basel II converted to a Basel III basis < ¾%
Source: Basel Committee on Banking Supervision (2010) and authors’ calculations.
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Capital Requirements
BRANDEIS INTERNATIONAL BUSINESS SCHOOL
Table 1: Comparing Basel III and Basel II Risk-weighted Capital Requirements
for the Largest Systemic Banks: Impact of Basel III Capital Definition
Basel III range 8% to 10%
Basel II Baseline 4%
Adjustment for hybrid capital -2%
Adjustment for goodwill, intangibles, deferred tax assets, etc. -1%
Adjustment for changes in risk weights -¼%
Effective Basel II converted to a Basel III basis < ¾%
Source: Basel Committee on Banking Supervision (2010) and authors’ calculations.
The reason capital requirements are 10+ times higher than before the crisis is because they were so low!
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Capital Levels
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Figure 1: Risk-Weighted and Unweighted Capital Ratios
Fully phased-in Basel III definitions
Basel Committee Quantitative Impact Study (QIS) estimated ratio of common-equity tier 1 capital to risk-weighted assets or tier 1 capital to total assets. Data from 2011 to 2016 are from a consistent sample of 92 large internationally active banks with capital in excess of €3 billion. Source: Basel Committee on Banking Supervision (2010 and 2017), Tables C.5 and C.36.
Capital levels are up:
Risk-Weighted:+6.6ppLeverage: +3.0pp
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• Strong banks lend more and lend better!
• Social costs of higher equity are overstated (at current levels)
• TLAC is an admission that requirements are too low
• Leverage ratio guards against getting risk-weights wrong
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• Strong banks lend more and lend better!
• Social costs of higher equity overstated (at current levels)
• TLAC is an admission that requirements are too low
• Leverage ratio guards against getting risk-weights wrong
• Solution: Raise equity requirements substantially
IMF and FRB Minneapolis 20+% risk-weighted.
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• LCR: Match runnable liabilities with liquid assets
• NSFR: Fund illiquid assets with stable liabilities
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Assets Liabilities
Liquid Runnable
Illiquid Stable
Simplifying assumptions
1) no off balance sheet exposures
2) assets either perfectly liquid or illiquid
3) liabilities either totally runnable or stable
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11BRANDEIS INTERNATIONAL BUSINESS SCHOOL
Assets Liabilities
Liquid Runnable
Illiquid Stable
Simplifying assumptions
1) no off balance sheet exposures
2) assets either perfectly liquid or illiquid
3) liabilities either totally runnable or stable
LCR: Liquid ≥ RunnableNSFR: Illiquid ≤ Stable
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• LCR Liquid – Runnable 0
• NSFR Stable – Illiquid 0
• Identity Total Assets = Total Liabilities
Liquid + Illiquid = Runnable + Stable
Liquid – Runnable = Stable – IlliquidLCR NSFR
Simple Case: LCR & NSFR are identical!
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LCR implies a shadow NSFR
• Rigorous HQLA higher implied req. stable funding
• Higher run-off rates lower implied avail stable funding
We only need one liquidity requirement:Adjust the LCR!
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• Progress:
US: 80% interest rate & credit derivatives in CCPs
Globally: 76% interest rate swaps are in CCPs
Gross notional exposure fallen by half!
• New risks: CCPs themselves
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• CME has $30+ trillion of gross notional outstanding
Margin: 0.50%
Guarantee fund: 0.02%
CME’s contribution: 0.0007%
• CFTC stress tests: CCPs passed two-thirds of time
• Key vulnerability: still no resolution/recovery regime
(and instant recovery is what will be needed)
Should we be worried?
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• Financial stability is a common resource (non-excludable but rival)
• Agents can deplete stability through hidden actions
• Require dynamic macroprudential policy
• Long list of tools(countercyclical capital, sectoral risk weights, LTVs, concentration & fx limits,….)
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• Adjusting tools is NOT:
• Primarily about managing credit cycles
• Leaning against asset price booms
• Focus of macropru: maintaining resilience
• Stress tests are the most powerful tool
Requires global coordination!
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• Capital: Equity requirements need to be higher
(combined with shift to activity-based regulation)
• Liquidity: Need one, not two requirements
• Resolution: Assure global institutions can be resolved
• Central Clearing: Ensure sufficient safeguards
• Systemic Regulation: We need metrics, models, tools,
governance structures, & international coordination
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The Five Pillars of Regulatory Reform
BRANDEIS INTERNATIONAL BUSINESS SCHOOL
Let’s make sure that regulatory reform does not wither!
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BRANDEIS INTERNATIONAL
BUSINESS SCHOOL
Regulatory Reform: A Scorecard
Stephen G. Cecchetti & Kermit L. Schoenholtzwww.moneyandbanking.com
![Page 21: Regulatory Reform: A Scorecard - Columbia | SIPA · 2017. 11. 28. · Stephen G. Cecchetti & Kermit L. Schoenholtz . 2 The Five Pillars of Regulatory Reform BRANDEIS INTERNATIONAL](https://reader035.vdocuments.us/reader035/viewer/2022070218/6124f6f1701d43067d760db6/html5/thumbnails/21.jpg)
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Assets Liabilities
Liquid (cover runnable) (H) Runnable (D)
Illiquid (require stable) (R) Stable (B)
Equity (E)
Other Assets (OA) Other Liabilities (OL)
Off-balance sheet exposures: OBSL and OBSN
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Assets Liabilities
Liquid (cover runnable) (H) Runnable (D)
Illiquid (require stable) (R) Stable (B)
Equity (E)
Other Assets (OA) Other Liabilities (OL)
Off-balance sheet exposures: OBSL and OBSN
LCR binds if and only if:OA + OBSL> OL + OBSN
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• LCR NSFR:
• Low level of 1 to 12 month unsecured funding
• High level of 35% risk-weight loans
• High level of loan commitments and liquidity facilities
Retail, Mortgage and Universal Banks• NSFR LCR
• High level of 1 to 12 month unsecured funding
• Low level of 35% risk-weight loans
• High level of long-dated derivatives
Wholesale Banks
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