Transcript Folie 1

How Special Are They?
Targeting Systemic Risk in Shadow Banking
IMFS Working Lunch
Frankfurt, February 25, 2014
Global regulatory initiatives
G-20 Seoul Summit 2010 mandates FSB task force to develop
recommendations for regulation of shadow banking
Interlinkages of
Banks and
Shadow Banks
Money Market
Funds
Other Shadow
Banking Entities
Securitization
Securities
Lending & Repo
BCBS-consultation
report 7/2012
IOSCO-consultation
report 4/2012
FSB-consultation
report 11/2012
IOSCO-BCBSconsultation report
6/2012
FSB-consultation
report 11/2012
Final
recommendations
12/2013 and 6/2014
Final
recommendations
10/2012
Final
recommendations
10/2013
Final
recommendations
11/2012
Final
recommendations
11/2013
Globally consistent and integrated reaction to financial crisis
Similar initiatives in the US (Dodd-Frank) and EU (greenpaper
and UCITS VI proposal)
Strategy: close loopholes in existing framework with ever
more detailed and complex regulation (e.g. regulation of
securitization in DF §§ 941-46 and CRD II art. 1(30))
Alternative approaches to (shadow) banking regulation
Shadow banking in part reaction to regulation (regulatory
arbitrage; circumvention) → race between hare and turtoise
Functional approach to finance (Schwarcz, 2014)
Functional delineation of regulatory goals facilitates swifter, more
accurate amendment of existing rules (UCC/ALI style)
Shares consensus view of rather narrow, literalist interpretation of
prudential rules
More radical alternatives arguably also require amendments to
existing framework to achieve shifts of paradigms
Judgment led supervision
Activation of private law principles (numerus clausus)
Functions of prudential regulation and jurisprudence
Key posit: functional foundations of prudential regulation should
be imported more vigorously into interpretation of existing rules
more normative construction of available rules that ties treatment
of financial innovation closer to existing rules and policy rationales
limits scope for regulatory arbitrage and need for ever more rapid
updates and increasing complexity of regulatory framework
ends socially wasteful quest for regulatory arbitrage opportunities
does not hamper financial innovation per se (efficient discoveries)
Indirectly addresses key policy question: is non-bank banking a
Coasean-type of efficiency story or one of regulatory
arbitrage/circumvention of prudential rules?
7/20/2015
3
Alternative credit intermediation
Bank
Loan
warehousing
Commercial banks
ABCP conduits
Mortgage finance companies
SPVs
Consumer finance companies
etc.
etc.
Banks, Insurance Companies etc.
Liquidity Facilities,
Credit Enhancements
Distribution/
Wholesale
funding
Securitization/
Arrangement
SIVs
SPVs (structured by securities
companies)
etc.
MMFs
Hedge funds
Commercial banks
CRAs
Rating assignment
etc.
etc.
Supply of liquidity
Demand for liquidity
Loan
origination
Need to identify efficient innovation ex ante?
Paul Volcker’s famous one-liner on ATM and ABS highlights
divergence between social and private benefits
Quest for regulatory arbitrage opportunities engages talent in
unproductive endeavor, e.g. Goldin & Katz (2008); Philippon &
Reshef (2012)
How should policy makers/regulators react?
Posner & Weyl (2013): pre-screening by FDA-like agency requires (full) appreciation of innovation’s effects (guinea pigs?)
Alternative: operationalize crucial divide close to the ground, i.e. in
the enforcement of existing rules vis-à-vis financial innovation
Shadow banking defined
FSB-task force‘s „Background Note“ (April 2011)
“a system of credit intermediation that involves entities and
activities outside the regular banking system, and raises i)
systemic risk concerns, in particular by maturity/liquidity
transformation, leverage and flawed credit risk transfer, and/or ii)
regulatory arbitrage concerns”
EU commission has adopted the definition
ECB and NY Fed staff work on basis of substantively similar
definitions (cf. Bakk-Simon et al., 2012; Pozsar et al., 2010)
Shadow banking defined
Closely related proposals turn towards necessity of backstops
as hallmark of shadow banking (Claessens & Ratnovski, 2014)
risk transforming activities leave residual tail-risks
sometimes ultimate claim-holders do not want to bear
that
if non-bank banks cannot create the risk absorption capacity
themselves, they need a credible private or public sector
backstop in order to become viable counterparties
tallys with FSB (risk transformation activity), yet more specific in
describing the mechanics that breed system wide crises
If it is about stabilizing credit intermediation, is shadow banking
different from the regulatory vantage, after all?
If not, why/inhowfar can we do with existing rules?
Macro-economic function of private sector liquidity supply
Importance of constant and reliable supply of liquidity as a
consequence of sticky adjustment of prices/wages to changes
in money supply
Walras-world: prices/wages adjust immediately to change in
money supply (only nominal value of market transactions
affected; no effect on real economy)
negative impact on economic output if prices/wages do not
adjust immediately (information gaps lead to fractional
adjustment; transaction levels in real economy affected)
Private sector intermediation and money creation: both
depositors and borrowers perceive to hold liquidity
Prevent system-wide destruction of liquidity (bank run),
Diamond & Dybvig (1983); Gorton & Metrick (2012)
Macro-economic function of private sector liquidity supply
Prudential regulation as safeguard to secure stable and
constant liquidity supply
own funds and liquidity requirements, corporate governance,
transparency
deposit insurance, lender of last resort access (backstops)
Why is it needed (market failure)?
particularly insufficient debt governance → representation
hypothesis, Dewatripont & Tirole, 1994
Moral hazard as a result of deposit insurance and/or implicit
government guarantees
Macro-economic function of private sector liquidity supply
Risk-insensitive funding of credit intermediation leads to
excessive risk taking/leverage (systemic risk), Merton (1977);
Merton & Bodie (1993); Adrian & Ashcraft (2012)
Mispriced government support
Information asymmetries, potentially exacerbated by
malfunctioning information intermediaries (CRAs)
Function (liquidity supply) and threats (systemic risk as consequence of risk insensitive funding) are the same for traditional
and shadow banking
Run on MMMFs, repo etc.
Mispriced credit enhancements in securitization
transactions (liquidity facilities)
Regulatory arbitrage concern
Capital and liquidity requirements constitute type of Pigovian
tax that attenuates deficits in debt-governance but also prices
access to safety nets
Chain of alternative credit intermediation, not regulated under
financial stability (systemic) aspects (liquidity supply)
But to which degree is that really true?
What is it that allows financial innovation to escape regulation?
Narrow, quasi-literalist interpretation of prudential rules
Lack of assertiveness of the law despite straightforward functional
foundations
Regulatory arbitrage in securitization transactions
CRA
Asset
(maturity:
3-5 years)
Conduit
Credit
Liquidity
guaratee
facility
Mortgage
finance
company
Sponsor
(Bank)
ABCP:
(maturity:
30 days)
Money
Market
Funds
Available liquidity
Demand for liquidity
AAA
Treatment of ABCP conduits
Only viable if liquidity facilities treated as off-balance sheet,
zero-risk-weight transactions
accounting standards (Bratton & Levitin, 2013)
micro-prudential bank regulation
Banking Directive 2000/12/EC, Annex II on classification of offbalance sheet transactions
„full risk
Guarantees having the character of credit substitutes…
other items carrying full risk…
low risk
Undrawn credit facilities (agreements to lend, purchase
securities, provide guarantees or acceptance facilities)
with an original maturity of up to and including one
year or which may be cancelled unconditionally at
any time without notice.“
New consolidation requirement
In 2009 FASB (US) announced FAS 166 and 167 (similar IFRS
10) that requires consolidations of conduit if sponsor
has power to direct activities that most significantly affect
performance
has obligation to absorb significant losses or right to receive
significant benefits from entity
(Some) ABCP conduits already structured in a way to avoid
accounting consolidation → sell first loss tranche to third party
Race between hare and turtle continued?
MMMF and repo
The US experience
Reserve Primary Fund (CNAV-fund) breaks the buck, i.e. values
shares below par, due to massive write-offs on Lehman CP
Run on MMMF within and outside of the group (redemption of
>$300 billion/week)
Fed and Treasury provide ad hoc back stop (AMLF)
Amendment of Investment Company Act rule 2a-7 that inter alia
reclassifies >7-day repo transactions as illiquid instruments of
which MMMF may hold only smaller amounts
But: banks set up SPEs that issue CP to MMMFs and
use proceeds in reverse repo with broker dealer (CCP)
Regulatory arbitrage via CCP
Bank
(synthetic)
security
(synthetic)
security
MMMF
repo
Available liquidity
Demand for liquidity
Bank
repo
Conduit
CCP
MMMF
Normative approach to applying prudential rules
Arbitrage facilitated by quasi-literalist stance of supervisors in
the face of financial and/or legal innovation (legalistic approach)
Normative approach can prevent this type of regulatory
arbitrage more vigorously and thus limits need to permanently
update and amend regulatory framework
recall: policy goals constant over time despite dramatic change in
financial landscape (spirit of the law)
does not require knowledge of ultimate perils for the financial
system or society at large (cf. E.Posner & Weyl, 2013)
demands an assessment of financial innovation’s risk-structure
if (tail-)risk is ultimately borne by an entity regulated
precisely for this reason, the pertinent rule applies
Normative approach to applying prudential rules
costs of compliance with prudential regulation hinge on whether
there is a “traditional” equivalent to the transaction
if such an equivalent with regard to risk-structure exists, existing
prudential regulation applies
the costs of compliance ultimate risk-bearer incurs are identical
as a consequence, a change in transactions’ legal structure
cannot yield private profits without creating additional social value
innovating parties have quasi-natural burden of proof to show that
transaction is not only driven by regulatory arbitrage opportunities
Does not hamper innovation per se (and even if it did at
the margin, would that be such a catastrophe?)
Limits and drawbacks of the approach
Concerns about captured supervisor not intrinsically related to
normative approach
more leeway for agency personnel increases scope and
momentum of decisions favoring certain constituents
but: normative approach only gives one-way option to expand the
reach of existing regulation, i.e. does not provide additional
opportunities to camouflage forbearance
Approach requires engaging skilled and courageous personnel
points only to variations in the allocation of resources within the
system of prudential regulation (zero-sum game)
what may be saved in enforcement has to be spent on
rule-making or vice versa (front- vs. end-loaded)
Limits and drawbacks of the approach
Reduces transactional certainty for private sector, i.e.
precognition which transactions can be conducted outside of
existing prudential regulation
yet, what vanishes is only certainty that designing transactions in
a way that they fall outside narrowly-read wording of prudential
rules will suffice to avoid regulation (positive ambiguity)
parties have information on drivers of transactional structure and
can thus predict its treatment by an alert supervisor
Does not necessarily cover/help deal with all occurrences of
alternative credit intermediation (efficient ones in particular)
where idiosyncratic market failures trigger specific regulation, general stance of the normative approach applies
(e.g. MMMFs)