Transcript Rethinking Regulation for Financial Stability and Growth

Rethinking Regulation for Financial
Stability and Growth
David C. L. Nellor
International Monetary Fund
May 2009
Outline
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Financial Stability – why does it matter
Regulatory Framework – what went wrong
Specific Proposals – is there a solution
Policy Choices – confronting the trade offs
Conclusions – what does it mean for Nigeria
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Financial Stability – why does it matter
Estimates of Bank Restructuring Costs
60
Percent of GDP
50
40
30
20
10
0
-10
Indonesia
Korea
Thailand
Official Est.
US S&Ls
Sweden
Final adj.
3
Financial Stability – why does it matter
Index - Ratio of Private Sector Credit to GDP
Indonesia 0=1997
Sweden 0=1990
120
100
80
60
40
20
0
-5 -4 -3 -2 -1
0
1
2
3
4
5
6
7
8
9 10 11
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2. Regulatory Framework – what went
wrong?
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Macro versus Micro Supervision
Regulatory and Supervisory Perimeter
Supervisory Capacity
Pro-cyclicality
Global Architecture
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Macro versus Micro Supervision
 Macroeconomic developments – asset
markets, macro imbalances
 Regulators are micro focused and not on
interlinkages across financial institutions
 Basel based on bank’s own risk models
 Presence of foreign intermediaries in some
countries and cross-border capital flows
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Regulatory and Supervisory Perimeter
 Coverage of supervision and regulation
 Systemic importance of non-banks
 Too big to fail – did not mean subject to
prudential supervision & regulation
 Reporting requirements
 Information from wider range of financial
institutions & off-balance sheet items
 Supervisory insight – “ticking boxes”
versus knowledgeable supervision
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Supervisory Capacity
 Regulators/supervisors did not keep pace
with developments
 “Sophisticated financial engineering” structured products & off balance sheet
entities
 Interlinkages across financial institutions
and markets (contagion effects) - use of
credit risk mitigants and contingent
liabilities
 Risks of under-resourced supervisory
agencies
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Regulatory System Procyclical
 Risk-based capital ratios - capital
requirements through the cycle
 Loan loss provisions – rules unrelated to
expected losses through the cycle
 Liquidity risk - liquidity risk management did
not require stress tests sensitive to firms’
credit ratings & off-balance sheet obligations
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Global Architecture
 Coordination: inability to address global
imbalances or manage crisis effectively at
multilateral level
 Crisis framework: shortcomings in
legislation dealing with cross-border bank
resolution and bankruptcy
 Liquidity and Financing: limitations of
central bank liquidity support; reputational
risk to accessing IMF support
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3. Specific Proposals – is there a
solution
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Turner Review
Issing Group
G 30 (Volcker)
De Larosiere
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Turner Review
 Highly regulated broad-based financial sector
with central bank and FSA doing macro
prudential supervision
 Increased capital requirements and avoiding
pro-cyclicality through introduction of capital
buffers
 Limitations on scale of debt/leverage
 No specific limitations on activities of banks
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Issing Group
 Risk map – global financial intermediation
(net exposures) and risk factors.
 Pre-arranged link between findings and
actions such as on capital requirements
 Regulation of hedge funds
 Systematic cooperation of regulators
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G30 (Volcker)
 Redesigning the regulatory structure –
overlaps, gaps, limit scope for regulatory
arbitrage
 Central bank take a lead responsibility on
financial stability – may need to be given
tools and mandate
 Limit scope of bank activities – proprietary
trading limited, no hedge fund operations
 Prevent non-banks from taking deposits
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De Larosiere
 Macro prudential supervision is essential
 Macro supervision must impact the micro
supervisors
 Macro authority has to be at the regional
(global?) level
 Consistency of supervision across the region
(globally?)
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4. Policy Choices – confronting the trade
offs
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Global versus national
The macro prudential regulator
Narrow or broad banking
Market and regulatory failure
Risk and reward preferences
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Global versus national
 Internationally integrated banking system
operating with national level regulatory
structure – a mismatch?
 Feasibility versus ideal – think globally act
nationally
 Challenge of building links between
surveillance and actions
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The Macroprudential Regulator
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Is a separate/new agency required?
Central bank independence and policy focus
Dealing with the non-bank financial sector
Analytic capacity
Could vary capital and liquidity requirements
over time – discretion versus automaticity
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“Narrow” or “Broad” Banking
 Where is the balance?
 As deposit takers, want banks to be
conservative
 As allocators of capital, want banks to be
flexible risk takers
 Solution – regulatory overlay versus
regulation plus limiting activities
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Market versus Regulatory Failure
 Incentives for regulatory arbitrage will persist
whatever the structure
 Markets are dynamic, can regulators match
that change?
 Does this favor simplifying the regulatory
task by moving to “narrow” banking?
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Risk and Reward Preferences
 Countries at different stages of development
and other reasons mean that preferences
might not be the same
 Global coordination does not mean that all
need to be the same
 But, some shared principles otherwise
regulatory arbitrage will dominate
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Conclusions
 Can agree
 the regulatory framework failed
 some areas where it failed
 Can agree some principles
 markets are not self regulating
 investors should reap the reward and incur the
losses associated with risks they take
 markets are dynamic – regulatory structure must
match this
 Cannot agree on definitive regulatory solutions
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Conclusions
 Need to secure international agreement on
principles of regulation and supervision.
 Countries will need to define their regulatory
and supervisory structures within these
international principles
 Coordination within regions and
internationally will be needed.
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What does it mean for Nigeria?
 Develop regional frameworks and participate in
international solutions
 CBN as financial stability agency; advisory
committee including all regulators
 Consider containing scope of banking
recognizing supervisory capacity
 Accept somewhat greater risk recognizing
development needs
 A transparent and clear bank resolution
framework is essential if take greater risk –
bank entry and exit is a sign of a healthy system
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Thank you!
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