Presentazione di PowerPoint€¦ · Basilea III: nuovo paradigma, vecchi errori. Conferenza di...

Opening:Basilea III: nuovo paradigma, vecchi errori.Conferenza di Giovanni Barone Adesi, Direttore del Swiss Finance Institute di LuganoFirenze, Palazzo Pucci 1, Venerdì 18 Febbraio 2011 ore 15.00

Secondo Evento:Condizioni attuali e prospettive dei mercati globali del credito e del debito sovranoConferenza di Edward Altman, Professor of Finance at the Stern School of Business, New York University Firenze, Lunedì 28 marzo 2011 (ore 15.00)

Terzo Evento:"Intellectual Hazard: una minaccia sistemica alla stabilità del sistema finanziario mondiale" Conferenza di Geoffrey Parsons Miller, Stuyvesant Comfort Professor of Law, New York University Law SchoolFirenze, lunedì 2 maggio 2011 ore 15.00

Quarto Evento: To be announced

Basel III: New Perspectives and Old Mistakes

Giovanni Barone-AdesiSwiss Finance Institute, University of Lugano

Florence, February 18 2011

baroneg@usi.ch

Beautiful Minds in FinanceGiovanni Barone Adesi – Basilea 3: Nuovo Paradigma Vecchi Errori - Firenze Venerdì 18 Febbraio 2011

Why a new agreement?

• The 2007 financial crisis erupted while banks were getting ready to implement the Basel II agreements.

• The experience of the crisis brought forward the need to regulate some dimensions of risk that were neglected under Basel II: macro, model, liquidity risk.

• The emphasys has moved from the ‘efficient’use of capital to greater safety.

What is new in Basel III

• Tighter capital standards: common equity at 4.5% in 2015, 7% later.

• Leverage Ratio (also to control model risk)

• Macroprudential protection from excessive credit growth.

• Counter‐cyclical capital buffers.

• Measures to limit counterparty credit risk

• Short and medium term quantitative liquidity ratios.

Capital Standards

• Most of the required capital will be equity, to ensure that stockholders have substantial interest in the survival of banks, not only on their profitability.

• Much of the remaining capital will be contingent convertible bonds, providing some tax advantages.

• Tier II capital will be harmonized.

• Tier III (subordinated bonds, undisclosed reserves) will be eliminated.

Leverage

• There will be limits on leverage, also related to gross exposure.

• Limiting leverage limits risk, if assets do not change.

• Also may protect in some measure from model risk.

• Leverage in US and Europe banks is still measured differently (derivatives).

Counterciclicality

• Basel II capital requirements force banks to reduce their portfolios after recording losses, worsening the downturn.

• Capital requirements will be supplemented now by additional capital buffers, built in good times to face future crises.

Macroprudential Regulation

• New bodies will monitor credit markets to detect credit bubbles. It is not clear yet how this information may lead to corrective action.

• Systemically important institutions may be subject to further capital requirements.

Counterparty Risk Concentration

• Counterparty credit risk concentration will be subject to new limitations.

• This should go beyond credit risk, to catch large unmonitored exposures such as AIG’s in the credit default swap market.

Liquidity Ratios

• Liquidity ratios, short and medium term, will be introduced.

• Maturity intermediation will be limited by these constraints, that apply to all assets.

• Moving derivatives from OTC to clearing houses may increase greatly liquidity needs, because of marking to market. That has not been considered yet.

Some glaring omissions

• Who is subject to the agreement?

• Self‐dealing

• Hiding losses

• The commodity bubble

• The government debt bubble

Who is subject to the agreement?

• Banks, of course. Regulatory arbitrage has moved most of the financial intermediation in USA outside the banking system.

• Europeans like to regulate banks, because banks dominate European financial intermediation.

• American prefer to regulate products, to prevent further migrations of intermediaries away from their banking charters.

Self‐Dealing

• No agreement has been reached on self‐dealing. SIV’s are still possible. Risk and return refer only to what banks choose to disclose.

• Investors’ confidence is undermined by the ongoing opacity. That is most evident in the interbank market.

• Some countries have better rules (Spain had them already before 2007).

Hiding Losses

• Banks still hide plenty of unrealized losses.

• SIV’s, asset transfers from the trading to the investment book, defeasances are the vehicles for this obfuscation.

• Politicians and regulators are happy to keep their heads in the sand.

• However credit markets do not work because of bank hidden losses, that undermine lenders’ confidence.

The Commodity Bubble

• Central bankers are focusing monetary policy on the stability of consumers’ prices.

• Consumers’ prices are stable because labor costs are down and commodity prices are up.

• Price stability means that the deflationary pressure from Asian imports is offset by increases in commodity prices.

• Pursuing stability for consumer prices means supporting the commodity bubble. Sweden only is attempting to address this problem.

The Government Bond Bubble

• A more dangerous bubble stems from the political axiom that all the governments deserve the same consideration.

• The corollary is that all the government bonds are risk‐free for regulatory purposes.

• The combination of zero risk weighting and high promised returns pushes the weaker banks towards the riskiest sovereign bonds, inflating their prices in a dangerous bubble.

The Crisis and Regulation

• After a vigorous expansion, the financial system came close to collapse in 2007‐2008.

• Financial fragility derived from credit and liquidity risks being underestimated through a combination of complacency, political opportunism and greed.

• Regulation contributed to the crisis by herding firms into making similar choices. Surprisingly, its role is not under more scrutiny.

What do we expect from regulation?

• To design ‘good’ regulation it is necessary to specify what we expect to achieve.

• According to regulators, a regulatory system should reduce risk from failing financial institutions to depositors and taxpayers.

• Ideally it should also not aggravate economic crises or stunt economic growth.

The Basic Flaw

• The Basel Agreements were meant to regulate banks, creating a level playing field in the new global markets.

• They set minimum standards, that often do not reflect well underlying risks. One size does not fit all banks at all times.

• Competitive pressures make banks cluster near minimum standards in good times, enhancing systemic risk.

The Three Pillars

• Regulation under the Basel Agreements is based on three pillars:

• Capital requirement

• Supervisory review

• Market discipline

The recent crisis illustrates shortcomings in all of them. We’ll see how.

Capital Requirements

• A portion of risk‐weighted assets should be financed by banks’ own capital. 15‐20%, not 7%, would be more realistic for most banks.

• Risk weights are inadequate. Risk changes.

• Capital is meaningless if not fully marked to market.

• Old‐fashioned reserves with central banks were more meaningful.

Supervisory Review

• Bank supervisors should endorse risk management process and verify that results are in line with expectations.

• Capital requirements are doubled or trebled if results are much worse than predicted. That is very questionable. If a bad model gives you zero capital requirement, multiply zero times three to account for its poor performance!

• Good corporate governance should be the first line of defense.

Market Discipline

• Information must flow to markets for MD to work. Incomplete information about SIV and structured products before the crisis has been followed by the suspension of disclosure rules during crisis, leading to market seizures, solved by massive public intervention.

• Resolution of failing institutions through aquisitions leads to even larger institutions, that markets deem ‘too big to fail’, destroying market discipline.

What is wrong with capital req.

• Way too small to cover potential losses.

• Impossible to enforce in crisis.

• Economic capital hard to measure, regulatory capital not meaningful.

• Minimum requirements do not allow for graduate regulatory response.

• Linked to VAR, rather than expected shortfall.

• Capital is not expensive (M&M), unless it dilutes value of public guarantee.

What is wrong with supervision

• The supervisory review process is subject to substantial conflicts of interests.

• Supervisors are always behind the curve of financial innovation. They are captive of industry know‐how.

• Forebearance and the pretense of stability are the easy way out when crisis strikes.

• Supervision by boards and regulators is constantly eroded in good times. Supervisory arbitrage reinforces that.

What is wrong with market discipline

• ‘Too big to fail’ destroys market discipline.

• Managers are forced to maximize risk to increase the value of implicit private guarantee, that they can monetize and share with stockholders.

• Maximizing risk subject to formal constraints reinforces herding, leading to systemic risk.

• Opacity is encouraged through oligopolies:

Rating agencies, OTC markets, auditing.

To junk Basel Agr. or to shore it up?

• It is necessary to decide whether we try to repair current regulation or throw it away and take a different approach (Glass‐Steagall?)

• If we attempt to repair it we may introduce some new measures to shore it up.

• The resulting architecture may be too complicated. However it evidences some flaws of current design that must be addressed.

I: Risk Reserves

• Reserves on deposit with central banks provide liquidity and risk coverage. To fulfill the latter function, reserves should be related to risk.

• Economic capital is at risk and hard to measure. Regulatory capital is easier to measure, but meaningless. Reserves are meaningful, easy to measure,can be riskless.

• Reserves cannot resolve risk ambiguity.

II: Risk Fee

• The residual risk on the public should be covered by a risk fee, updated frequently.

• It is not easy to price, though we may improve on its current pricing (zero).

• Precommitment may help, if supplemented by ex‐post penalty. Banks then bear model risk.

• Excessive fees increase regulatory burden and discourage growth. Overall burden should not be much increased.

III: Deferred Compensation

• Deferring compensation discourages managers and traders from short‐termism.

• It reduces conflicts between managers and shareholders. It does not resolve the conflict with the ‘lender of last resort’. The managers of several of the big banks that failed had very large stakes.

• G‐20 measures in this direction are marginally useful, though confusion prevails.

IV:Separation of Finance and Commerce

• A postulate of our analysis is that banks are value maximizers. That is false if stockholders have other priorities (private benefits).

• To limit private benefits, boards should not be client‐dominated. Loans to stockholders should be forbidden, as in UK.

• Icelandic banks collapsed when shareholders’loans were no longer covered by share value.

Why all the measures are necessary

• All the measures we discussed seem to be necessary to plug current regulatory holes and achieve our target of protecting public interest.

• The multiplicity of proposed measures should allow for the design of regulatory systems that discourage herding, reducing systemic risk.

• To do so, we should move from a system based on minimum requirements to a system offering trade‐offs. That is more stable.

What has been done to date• More attention to liquidity and deferred compensation since the crisis, in line with measures I and III.

• Measures II and IV are largely ignored. Measure II was actually roughly implemented for ring‐fenced assets in UK, not for entire banks, that show increased risk appetite. The recent watering down of Pillar I reflects that.

• Measure IV is enforced in some jurisdiction, denied elsewhere.

Return to Glass‐Steagall?

• The separation of commercial from investment banking has been advocated by many economists. It is a solution that provided 60 years of stability.

• At this point it is difficult:activities are intertwined (swaps, MBS, FX). Moreover large investment banks survived only because they access central bank liquidity.

• In US many non‐bank institutions would escape G‐S.

Toward next crisis

• The warning of emergency weakens appetite for reform.

• Token measures leave a weakened financial system ready for next crisis.

• The precariousness of liquidity supplied by Central Banks discourages weak institutions from lending activity. Short‐term trading in financial markets provides chance for quick recovery. Lack of volume points to risk of sudden reversal.

Too much liquidity?

• Many observers are relieved by the return of the TED spread to pre‐crisis level. The TED spread has been very low (0.2‐0.3%)for most of the noughties. Before it was moving between 0.5 and 1.5%.

• Perhaps that was a more prudent outlook for credit risk. A low premium may be necessary for recovery, but it has encouraged past reckless behavior.

Volker’s proposals

• Elimination of proprietary trading, hedge funds and private equity funds from bank activities.

• The difference between proprietary trading and market making is not clear cut. Reducing diversification may increase bank risk.

• Creditors are not protected, except depositors. Bank runs and asset substitution are open issues.

• These measures reduce some conflicts of interest. They are unlikely to reduce systemic risk.

Asset fees

• Banks may be willing to consider fees based on assets. That is a poor proxy for risk fees.

• Asset fees may be structured to discourage very large institutions, reigning in systemic risk. But within each class each bank has still the incentive to take more risk than its competitors.

• International consensus is lacking.

Conclusions

• The debate on financial reform is not reaching a consensus. That may undermine the principle of global regulation, possibly a good outcome.

• Lacking a level playing field, eventually it may become necessary to attribute clear powers and responsibilities to individual states and firewall their borders.

• A possibility would be to have separate banks with distinct capital in each country, owned by global bank holding companies. The insurance industry works this way.

• This approach will improve stability, but requires greater capital, reducing economic growth. In any case, any good architecture implies a trade‐off between growth and stability. We have paid too much attention to short‐term growth.

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