Stephany Griffith Jones - Does new international regulation help crisis prevention. Presentation given at conference on 17/18 November in honour of Sir Richard Jolly

1. Does new international regulation
help crisis prevention?
Keynote Speech
FEPS TASC Annual
Conference 2011
Stephany Griffith-Jones,
sgj2108@columbia.edu

2. Overall context
Aims of the financial system
-Managing risk and avoiding crisis
-Allocating capital to the real economy efficiently
-Financial system did neither
Do we need a completely different financial
system?
-Restricting or isolating speculation
-private banks to lend to real economy
-Role of public banks to fund real economy

3. Some key problems
- One major problem: increased leverage and
maturity mismatches which increase
systemic risk
- Crisis revealed too low core capital, leverage
too high and
- Both accounting and regulation was pro-
cyclical, reinforcing procyclicality of finance

4. Basel 3
 Size and quality of core capital improved (but
is it enough?)
 Simple leverage ratio 1:30 (too generous)
 Counter-cyclical regulation
 Liquidity coverage ratio positive

6. Higher capital requirements – cost
benefit analysis
 Benefits:
– Stronger Financial System => Lower probability of
banking crises => Lower crisis-induced output
losses
– Reduction of amplitude of output fluctuations
 Costs:
– Higher lending rates => lower output level (but
trend growth rate unaffected)

7. Impact of increasing capital
 Increasing capital by 1%:
– Increases lending spreads by 0.13%
– Decreases output by 0.09%
 Therefore, even if temporary crisis-generated
output losses are assumed:
Net benefits of increasing capital from 7% to 8% =
= Benefits – Costs
= 0.30% - 0.09%
= 0.21% > 0
Source: BIS estimates

8. Countercyclical regulation
 Need for countercyclical regulation to
compensate for pro-cyclical finance
 History; dynamic provisioning
 Rules preferable to discretion
 The gap between credit-to-GDP ratio from its
long-term trend is the benchmark guide for
Basle
 International coordination

9. Implications for national
implementation
 Several elements of Basel 3 positive, such
as countercyclical buffers and liquidity ratios;
increasing quantity and quality of core capital
if needed
 Too slow and gradual introduction of
reforms desirable to accelerate ?

10. Shadow Banking system definition
 Buiter definition (2008) :
 “The shadow banking sector consists of the many highly
leveraged non-deposit-taking institutions that lend
long and illiquid and borrow short in markets that are
liquid during normal or orderly times but can become
very illiquid when markets become disorderly.
 They are functionally very similar to banks but :
 -are barely supervised or regulated.
 -hold very little capital,
 -are not subject to any meaningful prudential
requirements as regards liquidity, leverage or any other
feature of their assets and liabilities.”

12. Challenges of regulating shadow
banking
- Regulate all financial activity in
comprehensive and equivalent manner, for
capital adequacy, leverage and liquidity
(D’Arista and Griffith-Jones, 2010)
- What quacks like a duck should be regulated
like a duck!
- Put all banking activity on banks balance
sheet
- Aim: reduce shadow banking scale

13. Dodd-Frank Act
 More rigorous than initially expected, but
weakened by lobbying, e.g. Volcker rule and
derivatives, further diluted in implementation
 Positive institutional developments:
consumer protection agency (prevents
abuse) and systemic risk regulator also in EU
(prevents silo-thinking about systemic risk)

14. Policy suggestions for consideration
 Key: link financial sector to its main aim, financing
the real economy
 Counter-cyclical regulations
 Increase of quantity and quality of core capital;
increase liquidity requirements
 Regulate all shadow banking system in equivalent
way
 Putting all transactions on the balance sheet
 Forcing derivatives on exchanges