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Level 24

International Banking Regulation

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Separation issue
Should web allow universal banks to extend into investment banking? After GDeprssn there was a separation, rejoining with de-regulation-->part of today's problems.
Bailout Concept
goes against "golden rule," pub opin problems-->opaque means: AIG-gov't gave $, got shares; intermediary institutions--gov't guarantees bonds, public injects money directly w/o gov't spndg
Exchange Risk
speculate on the future value of a curcy's xchg rate, but if everyone has same info, & does same, xchg rate's affected. Make a bet evolu. of rate will be favorable--high risk!, but hug…
Med/Long-term Invests. Bond issuing
Bank B doesn't directly borrow from A. Loans can be …
Liberal approach, wants perfect competition: only bank with who you trust. Many small competitors.
Diamond and Dybvig (2)
'83. 2 equilib. exist: 1. business as usual, 2. crisis. Indep. states. Imposs. to predict shift b/w the 2. Sometimes bandwagon effect/irrat. behav./self-ful. proph. So, bnkg should provide safeguards b/c even if everything's okay, you're not immune.
Psychology of Banking
Predicting finan. problems could make it worse; if you have reasons to believe it's unsound, prob. ^. Lots of secrecy, but also opens way for rumors. Crisis can happen anytime/place-shifts unpredict.
Constructive Ambiguities
Duel BIS/IMF system. Private borrow from-->Cent bank-->gov't-->IMF.
Bank collapses
Banks collapse when gov't decides they should. Ex: Lehman Brothers--Treasury/Fed. couldn't afford to pay that way forever, used as an example
Bank Lobbies
finance is a dangerous game, lobbies often block changes--US gov't, David Cameron, etc.
BIS (Bank for Int'l Settlements)
Pub, int'l clearing body, checks rules are applied. Meets resistance from countries: antagonistic interests. Mostly nat'l supervision, but who watches int'l (tax haven) transactions?
Basel I
Group of experts who dis…
Basel II
McDonough Ratio. Addressed risk by saying things should be weighted to give clearer pict, but hard to know real value/easy to cheat
Basel III
Flexible capital ratios, increased tier 1, macro prudential countercyclical buffer, short term and long term capital requirements
Tobin Tax
Debated for 20+yrs. Taxes on finan. mkt mvmts of hot $-very sm amt, but 10-15% of EU Budget. Hard for UK/US b/c of 10% GDP/lobbies.
an institution of 188 members as of late 2013, providing extensive technical assistance and short-term flows of stabilization finance to any of those members experiencing temporarily distressed finances
State/Big Bank parallel
Some banks are too big to fail, just like some states are. Others, like Greece..
80s=excellent, optimism->, speculation.
Japanese Crisis Causes
Japanese Trick
unorthodox stuff; get loans to buy stocks, use stocks as guarantee to get more loans. Explosion of credit: borrow @ 0%, make 20% profit from any speculation = huge incentives to play.
Japanese Crisis Start and Consequences
2 Jan '90, 1 sentence from Gov of Bank of Jap. REsult: TSE v 1/2, real estate froze; ALL banks had assets which didn't even cover 50-60% of their debs--net neg. assets = bankrupt. Took 20 yrs to solve.
Japanese Crisis Solutions
Gov. of Fin. decided to inject taxpayer $, transformed, but saved banks. If it was really bad, bank nat'lzd; others got liquidity in xchg for lots of gov't direction. Exponent. increase from '93-03, 50bil-25…
Troubled banks' paradox
Reveal too much about your needs, and you an cause a run, but if you don't show you're in need, you won't the the $ at all. Banks don't want to be the 1st to fall.
If you appear weak, you risk a run. This is why Japanese banks went 2-3 yrs until they couldn't face regular w/ds before getting help. (Gov't passed a law obliging banks to take pub $.)
Lessons from the Japanese Crisis (5)
General: 1. Importance of image in seeking help, 2. Timeline for recovery, 3. Methods to cure the crisis. Japan: 4. Crisis can happen in developed countries too. 5. Haven-speculation forbidden, close supervision, not very profita…
Banking Crisis of 08
Started in the US with CDS(Credit Default Swaps)/Sub-Prime Credit. Spread when foreign banks bought CDSs.
Sub-Prime Credit
Loaning to less-than-perfect creditors, ^ risk. Extend as much as you want w/o risk?! Careful banks check monthly ability to pay and loan's signif. less than house value; but if no one else checks, why should you?
CDSs/Structured Loans (3 Steps)
Abstract idea. Statistical risks supposedly negated by bundling loans in consol. group. 1. 5% won't perform, …
Crisis 08 American Consequences
Gov't injected tax payer money into some ins. cos and banks (let Lehman Bros collapse), Cos were nat'lzd, layoffs, some $ went to foreign loan holders. Officially now: about to be solved, pub $'s b…
Merger Trend vs Anti-Trust/Competit.
Can't have 1 firm so big it acts monopolistically, but sector tends towards mergers-v compet., but detrim. to consumer. Compet. laws aren't enforced-leads to fin. mkt instab.
Restricted Competition Paradox
Bank mergers as national interest: you don't let your banks, and others do, yours end up weaker. Need to sustain competition, but very dangerous to let them get so big.
The move to stronger banks
Mergers w/i last 40yrs. Economies of scale benefits. Just 200 banks in EU, top 20 = 75% of total, shares in each other--even indep? Bankruptcy of 1 implies systemic risk.
Reform possible?
No supranat'l auth. who can enforce; sep. issue tough sell; ^ own capital & liquidity v profit.; Polit. issues: 10% GPD in UK, pwrful lobbies in US; oligopoly bal breaks if 1 refor…
Interlinkages/Money Market
Banking networks which allows them to borrow from each other--raises the "loanable" percentage; ensures liquidity
The richer a bank appeared, the more business grew b/c of confidence
Insurance Cos/Merchant Bankers
Developed in Eng. and the Neths--extended credit to int'l sea merchants (E & W Indies)
Ex: extent to which a bank can extend loans. Meant to prevent bank risks. If not well devised, you'll have almost continual crisis.
Regs won't work unless they're enforced; ex: sending auditors to examine the books. Meant to prevent bank risks.
Universal banks
general public, loans
Investment banks
These help corporations raise money, usually through issuing
Short-term liabilities
deposits which the bank uses to extend loans; they can be withdrawn at any time
Long-term assets
economic resource which generates value; ex: loans which draw interest
Liquidity Troubles/Asset-Liability Mismatch/Disequilib. of Maturities
deposits can be withdrawn at any time, troubles happen when bank has a hard time getting cash to meet its liabilities. Can still be financially sound.
Central Bank
lender of last resort if the money market fails to extend liquidity to banks in difficulty
Golden Rule of banking
Cent Banks should only extend loans for lack of liquidity, *not* solvency. Must be financially sound. Let solvency crisis banks fail.
Solvency Crisis
bank made errors in extending credit, bad loans, assets < liabilities, even own assets! ethically, should go bankrupt
Moral Hazard
Banks are in "very safe and irrespon. positions." Huge risks: could make a lot, but if you lose, bailed out w/o paying-not their $. Asym. benefs. No incentive to correct. More gov't gives, greedier they get. (orig. insurance-^ins.=v careful.)
Efficiency Frontier
banks always pick the riskiest operation, (@ the limits it pays best). Where should gov'ts put the limits? Too constraining-banks freak, too loose-more disasters poss.
International Interbank Mkt
Came w/ dereg. World-wide lendg/borrwg. Open to lrgst bnks-full compet/integ. Gave birth to rating sys.; 3 days = world GDP; uses multiple currencies
Rating sys.
Helps banks lendg outside of the country know if borrower's finan. sound. Fitch, Moody's, S&P
Fully-integrated Mkt
Means short-term liquidities have an equilib. rate b/c of compet.
Hot money
Banks speculate with liquidities in certain currencies w/ short-term trades: $, £, €, ¥, Swiss Fr.; more profit. for French bank to borrow $, then xchg. for €, etc.?--int. rates are all diff.
Forward Markets
xchg today, but negot. future interest rate. diff from spot xchg rate.
Spot Exchange rate
supply/demand (current mkt) value of a currency xchg
Bi-lateral exchange
Short term: Bank A loans to Bank B,
Rotten Bonds
big risk to loan, high interest (risk premium); but risk may ultim. be passed on to investors in banks
Sovereign Bankruptcy
Doesn't exist! If loan risk is realized, and gov't doesn't repay, there's no way to liquidate and sell their assets-->default, lenders lose everything
The London Club
syndicate which insures private finan. instits holding gov't bonds get treated equally.
Glass-Steagal Act
1933. New Deal saw crash as caused by speculation. Separated universal (safe) deposit bnkg from invstmt bnkg. people buy knowing they're risky--checked bank expansion/made spec. more complicated
Bank runs
Sometimes no rat'l foundation, just rumor's enough (Mary Poppins). Band-wagon effect/self-fulfilling prophecy
information asymmetry
Parties do not have equal access to information
Pub. Interest Reg.
Own capital/solvency requirements; capital adequacy rations. Flip side: should already open banks who don't meet condits. be closed?
Flight to Quality
investors looking for safer investments--gov't bonds shown to be risky now
Rating Agency Paradox
If they announce weaknesses, they can be accused of provoking a crisis, but if they don't announce they fail to foresee one;
EU Gov't Credit Rating Agency?
Same problems as indep, plus, ex: would Italians rate It's gov't badly?