The Regulatory Response to the Financial Crisis

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The Regulatory Response to the Financial
Crisis by C.A.E. Goodhart Financial Markets
Group There are, at least, seven fields where
the recent turmoil has thrown up issues for
discussion. These are- 1. Deposit
Insurance 2. Bank Insolvency Regimes, a.k.a.
prompt corrective action 3. Money market
operations by Central Banks 4. Liquidity Risk
Management 5. Procyclicality in CARs, i.e. Basel
II, and general lack of counter-cyclical
instruments 6. Boundaries of regulation,
Conduits, SIVs and reputational risk 7. Crisis
management- (a) within countries, Tripartite
Committee (b) cross-border
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(1) Deposit Insurance (a) UK system, 100 up to
2000, 90 up to 35,000 it was never intended
to prevent runs. To allow banks to be closed
with less political fuss. (b) Only 100, and
speedy provision, will prevent runs, but (i)
Coverage (ii) Cap, (35,000 would cover more
than 95 of depositors) (iii) Allows bad
bankers to continue, so long as they can
persuade auditors to attest to solvency (c) Leads
to urgent need for p.c.a. Not generally
available in Europe.
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(2) Bank Insolvency Regimes (a) Over-rides
property rights (i) Need to allow
CEO/Chairman to rectify. (ii) What is trigger?
(leverage ratio in USA, but might need to be
different in Europe?) (iii) Need for both
independent assessment, and political
assent. (iv) Consistent with Human Rights?
Judicial Review. (b) Operational issues (i)
Alternative management (ii) Bridge
bank (c) Procedural issues (i) Separate
institution? (ii) If not, where situated (CB or
FSA)?
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(3) Money Market Operations Five
problems- (a) Stigma (b) Maturity (c)
Collateral (d) Incentives to hold liquidity
(e) Need for adjustable instrument
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(4) Procyclicality in CARs (a) Procyclicality
worsened by- (i) Risk sensitive
CARs (ii) Mark to market (iii) Ratings
agencies (?) (b) What is purpose of
regulation? (i) Externalities, not individual
behaviour (ii) Herding, endogenous
risk (c) Relate CARs more to rates of growth,
not to risk-weighted levels. (d) But what are
boundaries?
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(5) Boundaries Contingent Commitments- (a) lega
l status? (b) Reputational Risk (c) Calls on
contingency will be systematic (d) Information (e)
What to do.
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(6) Crisis Management UK experience- (a) Nothing
to do with CB independence. (b) Concern about
who is in charge. Were HMT and FSA unable to
force BoE to act? (c) Use of Coyne
approach? (d) FSA failed to assess liquidity
risk. Generic to culture of FSAs? Need for
over-lap as in USA/Japan? Cross-border (a) Not
(yet) needed, thankfully. (b) Problem understood,
but not resolved (i) ex ante burden
sharing (ii) Federal euro funding (iii) ?