Financial Regulation and Supervision: A post-crisis analysis

The Regulation and Supervision of Banks: The Post Crisis Regulatory Responses of the EU
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Consolidated supervision has also helped reduce the leverage of some nonbank financial institutions, but it has not been fully implemented in many jurisdictions, thereby facilitating regulatory arbitrage within financial groups. Nonetheless, measurement of leverage in asset managers is difficult and information is limited, with some evidence pointing to its increase see Chapter 1 of the April GFSR.

Book Review - Financial Regulation and Supervision, a Post-Crisis Analysis

Two new regulatory liquidity ratios for banks emerged from the crisis. The first to be implemented, beginning in , was the liquidity coverage ratio LCR , based on the concept of holding a stock of liquid assets to withstand a high degree of stress for a day period.

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It is therefore important that regulation and supervision of CCPs ensure that their capital and liquidity buffers are solid, and adequate resolution frameworks are in place that consider the cross-country nature of these entities. After 10 years, an evaluation of the effectiveness and efficacy of the reforms is appropriate. A brief cost-benefit analysis 3. Ferrarini, G. Unfortunately, supervisors often lack dedicated units and skills shortages are widespread. This aspect of reputational risk is, of course, a visible risk for all central banks with statutory competence on micro-prudential supervision over credit institutions, and it is one of the main concerns as to the assignment of such competences to them. Since the global financial crisis, most countries have instituted systemic oversight authorities.

The other, the net stable funding ratio NSFR , implemented beginning in , is based on managing the potential mismatch between asset and liability maturities up to a one-year horizon. All Basel member countries have already implemented the LCR and undergone Regulatory Consistency Assessment Program assessments, which indicate that they have achieved consistency with the agreed-on Basel framework Figure 2.

In contrast, implementation of the NSFR has proved to be more demanding because of the discretion needed to ensure its effectiveness in local markets. FSAP assessments show that wholesale funding is still important in various jurisdictions and that a broad review of liquidity risks will always be necessary. A clear objective of the liquidity reforms was to reduce reliance on volatile short-term funding. However, FSAP observations between and indicate that banking systems in major jurisdictions still rely significantly on wholesale funding.

Although some jurisdictions have introduced liquidity stress testing using horizons beyond the day LCR horizon and highly granular supervisory data, the FSAP risk analysis findings also identified instances in which stress-testing techniques for assessing the scale and nature of liquidity risks warranted further development.

In addition, the FSAP has also identified instances in which the banking community, shielded by benign market conditions, has been slow to develop risk management skills Figure 2. Nonetheless, liquidity buffers have, on average, grown since the global financial crisis, and reliance on wholesale funding is trending downward. Holdings of government securities have risen in many countries Figure 2.

However, inter-nationally active banks domiciled outside the United States continue to rely on U. Note: Panels 1 and 3 correspond to the global median across medians at the country level for all countries in the sample. In panel 4, the first three sets of bars represent the difference in means in the GFC, the —16 period, and , all relative to the precrisis period —07 , for all banks, BCBS countries, and G-SIBs.

The fourth set of bars represents the estimated annual trend during the postcrisis period.

New valuation guidelines for money market mutual funds have reduced run risks. Boards of money market funds can also take measures, such as liquidity charges and suspended redemptions, to address potential run risks. In Europe, most money market funds have also moved toward floating valuation, with exceptions for those investing in government debt, or those that can, like Chinese money market funds, show that they closely track advertised values.

To reduce run risks, European regulations have also included potential redemption gates and liquidity charges. In the United States, reforms to the triparty repo market, including greater transparency about haircuts, rules aimed at reducing the riskiness of collateral, and new clearance procedures aimed at reducing intraday credit, have reduced potential run risks.

Many countries have also applied measures to contain foreign exchange risk. Foreign exchange risk is covered within the Basel capital framework, although the framework does not explicitly cover credit risk related to unhedged counterparties with foreign exchange exposures. Countries with elevated levels of foreign exchange exposures have also long used measures now classified as macroprudential—such as reserve requirements differentiated by currency or higher risk weights for foreign exchange loans—to lean against foreign exchange risk. In Central and Eastern Europe, a wide range of tools were deployed to contain risks for foreign exchange—denominated mortgages.

Measures to address risks associated with large, interconnected, and complex institutions have largely focused on identifying systemic firms and imposing stricter regulatory and supervisory requirements on them. G-SIBs are identified using indicators of size, interconnectedness, lack of readily available substitutes, global cross-jurisdictional activity, and complexity. Supervisory judgment, as an overlay, permits authorities to nominate banks to be included on the publicly disclosed list.

G-SIBs have been subject to a systemic capital surcharge since Supervisory colleges and crisis management groups have been deployed. All G-SIB host jurisdictions should have both supervisory colleges and crisis management groups, where supervisors and other relevant authorities from home and host countries exchange information and views on supervisory issues and crisis preparedness and management.

Successive FSAPs have been able to trace the increasing confidence and sophistication of the supervisory exchanges. Cooperation across borders and among supervisors has improved, with more open exchange. Systemic institutions have increased their capital buffers and banking systems appear to be slightly less concentrated today, but competition measures have not improved. Consistent with the introduction of additional regulatory capital surcharges, the postcrisis increase in capital buffers has been particularly substantial for G-SIBs, which have increased their regulatory capital ratios by 5 percentage points or more, compared with 1 percentage point for other institutions Figure 2.

On average, the moderate but sustained decline in the three-bank concentration ratio observed since continued Figure 2. Note: In panel 1, each bar represents the coefficient of the post—global financial crisis GFC dummy variable, that is, the difference in means in the postcrisis period —17 relative to the precrisis period. Solid bars indicate that the coefficients are statistically significant at the 10 percent level.

Panel 2 shows the medians across all countries in the sample.

Eddy Wymeersch, Klaus J. Hopt, and Guido Ferrarini

The Lerner index is a measure of bank markups, the difference between output prices and marginal costs estimated from a translog cost function. A higher value is associated with lower competition. To express it in percentage points, the Lerner index was multiplied by The Boone indicator is a competition measure based on the elasticity of bank profits to marginal cost. A more negative value is consistent with greater competition because inefficient banks are punished more harshly through lower profits.

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The shaded area refers to the GFC. Important progress has been made in addressing key data gaps for systemic institutions, though the task is yet to be completed. Two key areas for further progress stand out: increasing the granularity of data accessible to international financial institutions and increasing access to aggregate data by national macroprudential authorities.

One of the earliest postcrisis messages from the IMF was that supervisors needed to impose intense scrutiny on banks, coupled with the will and the ability to act. The revised sectoral standards also embodied this approach, with an emphasis on timely and effective supervision rather than regulations alone. These standards require greater attention to be focused on systemic institutions and risks. Many supervisory authorities have refreshed their approaches to examine systemic institutions more rigorously.

For example, the United States launched the Comprehensive Capital Analysis and Review to examine the resilience of its major institutions more rigorously. Some jurisdictions, such as Brazil, have segmented, or tiered, their institutions. In the euro area, supervision is predicated on the systemic significance of institutions.

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Russia has centralized the supervision of its systemic banks. FSAPs have investigated how supervisory intensity has been interpreted and have considered its adequacy, often noting insufficient resources for supervisors, for example, in China, the Netherlands, Sweden, Switzerland, and the United Kingdom.

Factors have also been identified in a number of jurisdictions that could compromise the independence of the supervisory authorities, a key weakness in ensuring financial stability. Incentives to move bank activities to off-balance-sheet vehicles to benefit from regulatory arbitrage have been curtailed. The loopholes used by banks to game the Basel I and II capital frameworks by moving items of the balance sheet and setting aside only moderate resources for potential liquidity support have been closed in Basel III FSB a.

New rules on the treatment of special purpose vehicles reduced the profitability of using them as conduits for capital arbitrage and made them less attractive.

Regulators of Financial Markets - FPC, PRA & FCA

Off-balance-sheet exposures are now captured on a more rigorous basis by the capital framework. Establishing a liquidity framework that considers the volatility of different funding sources has thrown a spotlight on bank use of nonbank financing, bringing this previously largely unmonitored risk within the perimeter. In the United States, the movement of investment banks toward traditional banking licenses after the global financial crisis also brought more institutions within the more tightly regulated part of the regulatory perimeter.

Systemic risk monitoring has been expanded to include shadow banking and market-based finance. The international community has made considerable progress in measuring the size and growth of the shadow banking sector and identifying its main risks, which provide a basis for regulation to contain those risks.

Financial regulation and supervision: a post-crisis analysis

The FSB has established a typology and a broad framework for such regulation, and IOSCO has also published recommendations on issues such as liquidity mismatch between fund investments and redemption terms, leverage within investment funds, operational risk, and securities lending. IOSCO has also been working to transform its recommendations into operational guidance.

The proposed remedies are reporting, monitoring, risk management, stress testing, and deeper liquidity buffers. Some jurisdictions have implemented measures to address some of these risks, but regulatory advances remain limited to date. The regulatory framework for securitization has been overhauled.

The direction of regulation was clear: institutions participating in the securitization market needed to take greater responsibility for their business decisions, show greater transparency, reduce complexity, and engage in less mechanistic reliance on outside agents—such as the ratings from credit agencies. Under the new standards, banks originating securitizations must also retain part of the original structure.