Post-crisis Regulatory Reform Research Articles

Глобальные системно значимые банки: все еще угроза для финансовой стабильности?

The global financial crisis of 2007–09, followed by sweeping overhaul of international banking regulation, urged financial regulators to apply a tailored supervisory regime to global systemically important banks (G-SIBs). This approach was caused by exacerbation of the G-SIBs’ systemic risks and their transmission during macro level instability. The size of G-SIBs, the extent of their market power, and the heterogeneity of their operating models resulted in their dual role in systemic stress: being a source of systemic risks for the macro level, G-SIBs are at the same time transmitters of crisis developments to the micro level, hence increasing their own exposure to risks. Under these circumstances, the objectives of the post-crisis recovery required a revision of regulatory priorities by shifting them from G-SIBs’ profitability to G-SIBs’ stress resilience through the application to them of more stringent capital adequacy standards and liquidity requirements, which ultimately contributed to G-SIBs’ insusceptibility to external shocks. At the same time, the G-SIBs’ role in exacerbation of systemic stress remains uncertain due to the unresolved issues of the G-SIBs’ systemic importance. Accordingly, the crisis and liquidity dilemmas remain unresolved. Given the high level of G-SIBs interconnectedness in the international financial area, their dysfunction can provoke a domino effect of insolvency and bankruptcies in the international banking sector. Based on 2011–21 statistics for all G-SIBs included in the annual lists of the Financial Stability Board (FSB), we found certain decline in G-SIBs’ systemic risks, which is attributable to further strengthening of their market discipline. This proves that international regulatory policy is on the right track. We also found that the stress resilience of G-SIBs, a product of the application of Basel III capital surcharge buffers and the total loss-absorbing capacity (TLAC) standard, significantly contributed to financial stability at a level sufficient not only for the integrity of G-SIBs’ performance during the COVID-19 pandemic, but also for minimization of the risk of collapse of the banking systems that prevented the transformation of the related shocks and instability into an economy-wide crisis. Nevertheless, the post-crisis regulatory reform failed to contain the systemic importance of G-SIBs, mostly due to the lack of supervisory tools and techniques in reduction of the negative effects of the G-SIBs’ international interconnectedness.

A bank's optimal capital ratio: A time-varying parameter model to the partial adjustment framework

We extend the existing literature on bank capital structure by applying a time-varying parameter model to the partial adjustment framework. This model allows one to obtain a more timely and on-going assessment of bank behavior in adjusting the capital ratio to its optimal or target level. The estimated time-varying rate of capital adjustment indicates that banks slowly adjusted their capital ratios to their optima or targets before the 2007–2009 global financial crisis, while they more rapidly adjusted their capital ratios upwards after the crisis. This finding suggests that banks make faster capital structure adjustments under more stringent post-crisis regulatory reforms of capital requirements. Moreover, we find convincing evidence on a structural change in bank behavior in adjusting its capital ratio around the global financial crisis.

Take on Me: OTC Derivatives Client Clearing in the European Union

This paper focuses on the EU regime for client clearing, including recent amendments to this regime introduced by 2019 regulatory reforms. It begins by providing the legal and regulatory context to clearing using central counterparties and the authorities’ interest in promoting it in the post-crisis regulatory reforms. It then explains the significance of client clearing for those many entities unable or unwilling to become a member of a central counterparty. Focusing on the EU regulatory regime, and informed by recent empirical work undertaken for the Financial Stability Board, the paper proceeds by exploring the use of client clearing in practice and, in particular, engages with the complexities of these arrangements and the difficulty in accessing clearing reported by some entities. Informed by those fundamental aspects of the clearing regime, the paper then evaluates recent measures intended to promote client clearing which were introduced in 2019 in the course of the so-called ‘EMIR Refit’. It looks in detail at the so-called ‘FRANDT’ requirement, namely that financial intermediaries providing access to clearing services do so on ‘fair, reasonable, non-discriminatory and transparent commercial terms’. By way of contribution to the ongoing policy debates, the paper exposes the difficulty in meeting the desired policy objectives using current means, but also suggests ways in which this area of financial markets regulation may be revised.

The CDS-Bond Basis: Negativity Persistence and Limits to Arbitrage

We reinvestigate the CDS-bond basis negativity puzzle after the financial crisis. This puzzle is defined as the unexpected persistence of the dislocation between bond and derivative credit markets. We show that the first two moments of the basis are described by three distinct Markov regimes identified with periods related to the 2008 financial crisis. We observe that the post-crisis regime differs significantly from the crisis and the pre-crisis regimes. We then explore the cross-sectional variation of the CDS-bond basis in each regime. Using a model with several limit-to-arbitrage factors, we validate that the negative basis can be explained by liquidity risk in both the bond and CDS markets, together with counterparty risk, collateral quality, and funding constraints. Finally, we propose a model to empirically affirm that the basis negativity persistence during the post-crisis period is mainly related to a significant decrease in basis arbitrage activity, which is partly explained by the post-crisis regulatory reforms.

Divergent effects of international regulatory institutions. Regulating global banks and shadow banking after the global financial crisis of 2007–2009

The rules structuring the global economy frequently emerge from informal international regulatory institutions. A set of approaches in International Relations and International Political Economy conceptualize these institutions as negotiation arenas and deem powerful actors to determine rule creation. Others stress the change-inhibiting effects of densely institutionalized environments. Yet variation in policy outcomes of post-crisis financial regulatory reforms cannot be fully explained by either. I argue that conceptualizing institutional asset specificity helps explain international policy processes and outcomes. The institutional assets of regulatory institutions, their rules, prescriptions, and procedures of decision-making, offer divergent transaction cost reducing effects. Specific asset institutions possess narrow institutional scopes and stringently defined mandates. They reduce transaction costs by offering tested approaches and established regulatory instruments, while proving unadaptable to policy issues falling outside their scope. General asset institutions avoid constraints of specialization and can adapt to various purposes. The lower asset specificity in turn increases the ambiguity over regulatory instruments and the commensurate costs of standard development. I assess the argument by analyzing four post-crisis reform initiatives on regulating global banks and shadow banking.

Liquidity, Solvency and Stability (Presentation Slides)

Post crisis regulatory reform has focused on higher capital requirements and the implementation of liquidity requirements of two kinds.Is the post-crisis focus on both liquidity and capital requirements optimal, given the twin objectives of economic growth and financial stability? The answer depends on what you believe caused the financial crisis. Was it an insolvency crisis or a liquidity crisis? It is argued that post-crisis regulatory reform should focus on: Higher capital requirements; Lower or no liquidity requirements; Restricting consumer leverage; Improving financial literacy; Focusing on bank culture.

Improving resolvability: partial property transfers and central counterparties

One of the most significant reforms introduced in the wake of the global financial crisis was the introduction of mandatory clearing for certain standardised ‘over the counter’ (OTC) derivatives. As a result of this policy, central counterparties (CCPs) have assumed a larger role in the global financial system. Designing a harmonised regime for the orderly management of failing CCPs is an integral part of post-crisis regulatory reforms but is challenging. This work remains ongoing at the international, regional and national levels. This article seeks to contribute to the ongoing debates. The article’s focus is on a particularly appealing resolution tool, partial property transfer. It explains how a resolution strategy using partial property transfer interacts with the typical legal structure of systemically significant CCPs. The first thesis developed in this article is that in order for resolution authorities to be able to implement a partial property transfer of a failing clearing service or services while ensuring the continuity of critical service provision, ex ante reforms to the organisational structure of some clearing houses should be considered. The second is that, to be fit for purpose, the creditor safeguard used in a partial property transfer resolution needs to be framed in terms of the losses at the point of transfer to creditors of the affected clearing service. The article offers proposals designed to facilitate effective resolutions in this context. It provides worked examples to illustrate the rationale behind the proposals and to explore how they improve the resolvability of large CCPs.

Accounting for success: The Big Four as allies of finance in post crisis regulatory reform

AbstractThis paper argues that the Big Four accountancy firms—PricewaterhouseCoopers, Deloitte, Ernst & Young, KPMG—operate as key political allies of the financial sector within financial regulatory battles. Leveraging the theoretical notion of “actor plurality” within the policymaking process, I demonstrate how, in the case of the European Union Financial Transaction Tax (FTT) initiative, accountancy professionals offered crucial support for the financial sector. They did so by disseminating key oppositional claims against the FTT proposal, developing tax mitigation and relocation strategies, preparing negative impact assessments, and advising on lobbying tactics. This allied stance of the Big Four is primarily a consequence of the ways in which their commercial priorities have been fundamentally transformed by the provision of consultancy services within the modern global economy. Moreover, the paper shows how accountancy experts are deeply embedded within a network of professional relationships that fosters substantive policy alignment between the Big Four and prominent financial lobbying groups. By highlighting the overlooked role of the major accountancy firms within post crisis regulatory reform, the study illuminates the unequal power relations that permeate financialized societies and contributes to a deeper understanding of how financial preferences continue to prevail within the policymaking process.

Physiology of the Over-The-Counter (OTC) Derivatives Market and Post-Crisis Reform

The recent financial crisis had a strong impact on the worldwide economy, particularly the crisis of 2007 known as the Global Financial Crisis GFC. What started as a US financial market crash resulted in a truly global crisis, impacting both financial and non-financial sectors. One of the markets involved was the derivatives market. As a result, both regulators and regulated firms are aware of the risks and uncertainties manufactured in the derivatives market, in particular in the OTCDM. In order to understand the role of risk and risk-based regulation in the context of the OTCDM and CCPs regime, this paper explores the rationale of derivatives as tools of distribution of risks. Following the notion of ‘manufactured risks’ of the risk society theory, it explains in detail why the OTCDM is a centre of production of risks. It also considers the post-GFC regulatory reforms and the move towards the use of CCPs. It puts forward the argument that the inclusion of CCPs in the OTCDM and the increase in mandatory central clearing adds complexity to the market, and thereby might become a source of new ‘manufactured risks’. This paper provides the framework of the OTC derivatives market. It is devoted to explain the physiology of Financial Derivatives. To this end, the work is divided into two parts. The first part addresses the fundamental questions of how financial derivatives work, with a critical overview of the uses of these transactions, and the traditional process of trading. Then, it highlights the differences between the exchange and the over-the-counter (OTC) markets, and how the post-crisis regulatory reforms have modified the structure and functioning of the OTCDM. Since the focus of this research is the OTCDM, the second part addresses the questions regarding the role that the OTC derivatives market played in the Global Financial Crisis, and the market failures that motivated current changes for more formal regulation and supervision. Such post-crisis regulatory reforms frame the object of study of this research, which is the major transformation of regulation and supervision of the OTC derivatives in the United Kingdom - as the biggest market of the world - and the consequent move towards the regulation of Central Counterparties CCPs, as new intermediaries of the market. The discussion of this paper concerning the decision to regulate CCPs in the OTCDM, as a means to enhance the stability of the market, is central to the analysis of this research. The aim is to explain the decision of UK regulators to regulate CCPs as a means of identifying, assessing and controlling the risks of the OTCDM collectively. This is instead of supervising individual firms that raise high risks.

The Evolution of the Pillar 2 Framework for Banks: Some Thoughts after the Financial Crisis

This paper examines the evolution of the Pillar 2 framework for banks, introduced by the Basel 2 Accord, and discusses the main issues at stake in the current policy debate. The main objective of Pillar 2 was to complement the minimum requirements established by regulators (Pillar 1) with tailored supervisory measures based on a thorough assessment of banks’ risk profiles. However, its implementation coincided in most jurisdictions with the outbreak of the global financial crisis: the main policy objective became to restore the stability of the global financial system. In this context, Pillar 2 contributed significantly to enhance supervisory action, in particular by raising capital requirements. Nevertheless, a number of issues still remain. Today, in the run-up to the completion of the post-crisis regulatory reform, the debate has regained momentum and a sound supervisory framework can be finalized under more favorable conditions, to avoid that Pillar 2 loses its key properties.

Resolution: Ready to Go?

Ending too-big-to-fail is one of the cornerstones of post-crisis regulatory reform. Ten years after the great financial crisis, where do we stand? If a major bank were to reach the point of non-viability, are the authorities ready to resolve it? The answer depends largely on whether authorities are able and willing to cooperate with one another. At the behest of regulators and supervisors, banks are making themselves resolvable. Investors are on notice that they will be at risk if a bank fails, and rating agencies now expect bail-in to be the norm, not bail out. So whether too-big-to-fail ends is now largely up to the authorities. They have the responsibility to form, communicate and execute the resolution plan, not the bank. Here, further progress is needed. Although authorities have mapped out two alternatives (the single point of entry [SPE] and multiple point of entry [MPE]), these alternatives depend upon cooperation among the authorities, both within jurisdictions and across jurisdictions. This is a frail foundation for resolution. Resolution regimes do not necessarily promote cooperation. Within jurisdictions, the central bank generally lacks a formal seat at the table in determining the initiation and execution of the resolution plan, even though its decision with respect to emergency liquidity assistance (ELA) largely determines when resolution will be triggered, and its decision with respect to liquidity provision to the recapitalised bank-in-resolution largely determines whether resolution will succeed or fail. With respect to cooperation across jurisdictions, authorities face a dilemma. They are aware that cooperation will yield the best global solution, but they recognise that cooperation may not yield the best result for their own jurisdiction or be consistent with their own mandates. Indeed, resolution regimes generally instruct authorities to frame their decisions with respect to financial stability within their own jurisdiction rather than global financial stability. Hence, each authority must assume that other authorities will put their own interest first. That in turn has prompted two responses. First, authorities are talking with one another, in so-called crisis management groups, about how they could cooperate to resolve each globally significant bank (G-SIB). But their deliberations largely concern the processes they should employ rather than the decisions they should reach. Moreover, the conclusions of these groups are not binding on the participating authorities. Second, authorities are taking steps to reduce the need for cooperation. These steps are diminishing the effectiveness and efficiency of global banks without necessarily enhancing their resolvability. Instead, authorities should take steps to foster cooperation as well as co-opt the market into promoting such cooperation, both within and across jurisdictions.

Measuring the Implementation of the FSB Key Attributes of Effective Resolution Regimes for Financial Institutions in the European Union

There are lingering concerns about the health of European banks and extensive market commentary about whether post-crisis regulatory reforms in Europe have adequately addressed these concerns. In June 2012, European policymakers released the broad outlines of a proposal for a "European banking union" to strengthen the banking sector and help assuage concerns of investors and depositors, however, uncertainty remains regarding how the new EU bank resolution regime, the Bank Recovery and Resolution Directive (BRRD), will work in practice. This paper addresses whether the BRRD has fulfilled the requirements of the FSB Key Attributes for Resolution Regimes, which many take to be the gold standard bank resolution framework. We find that the BRRD diverges from the FSB Key Attributes or allows variation at the Member State level in multiple areas. The majority of these variations point to slight inconsistencies with the FSB recommendations. That said, some variations may have a larger impact than others.

Post-crisis regulatory reform in banking: Address insolvency risk, not illiquidity!

An extensive review of the evidence related to the 2007–09 crisis reveals that it was an insolvency risk crisis, not a liquidity crisis. The appropriate post-crisis regulatory reform should therefore focus on increasing capital requirements. The Basel III liquidity requirements do not serve a useful economic purpose in dealing with the root causes of the stresses that led to the 2007–09 crisis, and unnecessarily constrain the asset transformation and liquidity creation roles of banks to the detriment of economic growth.

The Demand for Central Clearing: To Clear or Not to Clear, That Is the Question

This paper analyses whether the post-crisis regulatory reforms developed by globalstandard-setting bodies have created appropriate incentives for different types of market participants to centrally clear Over-The-Counter (OTC) derivative contracts. Beyond documenting the observed facts, we analyse four main drivers for the decision to clear: 1) the liquidity and riskiness of the reference entity; 2) the credit risk of the counterparty; 3) the clearing member’s portfolio net exposure with the Central Counterparty Clearing House (CCP) and 4) post trade transparency. We use confidential European trade repository data on single-name Sovereign Credit Derivative Swap (CDS) transactions, and show that for all the transactions reported in 2016 on Italian, German and French Sovereign CDS 48% were centrally cleared, 42% were not cleared despite being eligible for central clearing, while 9% of the contracts were not clearable because they did not satisfy certain CCP clearing criteria. However, there is a large difference between CCP clearing members that clear about 53% of their transactions and non-clearing members, even those that are subject to counterparty risk capital requirements, that almost never clear their trades. Moreover, we find that diverse factors explain clearing members’ decision to clear different CDS contracts: for Italian CDS, counterparty credit risk exposures matter most for the decision to clear, while for French and German CDS, margin costs are the most important factor for the decision. Moreover, clearing members use clearing to reduce their exposures to the CCP and largely clear contracts when at least one of the traders has a high counterparty credit risk.

Post-Crisis Regulatory Reform in Banking: Address Insolvency Risk, Not Illiquidity!

An extensive review of the evidence related to the 2007-09 crisis reveals that it was an insolvency risk crisis, not a liquidity crisis. The appropriate post-crisis regulatory reform should therefore focus on increasing capital requirements. The Basel III liquidity requirements do not serve a useful economic purpose in dealing with the root causes of the stresses that led to the 2007-09 crisis, and unnecessarily constrain the asset transformation and liquidity creation roles of banks to the detriment of economic growth.

Double Whammy: Implicit Subsidies and the Great Financial Crisis

This paper concerns itself with the joint effect of implicit subsidies that are built into the US housing-finance system and financial safety net. These subsidies are implicit because they are channeled through the regulatory, supervisory, and tax systems in hard-to-observe ways. In the last two economic booms, the stealthy way banks have pursued these subsidies allowed hidden leverage and arcane loss exposures to build up to a disastrous degree. When lenders' safety-net support was finally tested by creditor runs, the struggle to reallocate losses and loss exposures away from the banks that had concealed them pushed the world's financial system into open crisis. Post-crisis regulatory reforms seem to have blunted the force of these subsidies, but the instruments assigned to this task are too weak to work for long. With the connivance of regulators, US megabanks are already re-establishing their ability to use dividends and stock buybacks to rebuild their leverage back to dangerous levels. Meantime a number of European megabanks (exemplified by Deutsche Bank) have remained in a zombie or near-zombie condition throughout the last decade. In the coming years, these banks' perilous condition and the possibility of extending safety-net coverage to support subsidized loans for bankrupt students, pension funds, and state and local entities could easily trigger another crisis. Besides trying to avoid future crises and directing bailouts when a crisis occurs, top regulators seem to believe that an important part of their job is to convince taxpayers that the next crash can be contained within the financial sector and won’t be allowed to hurt ordinary citizens in the ways that previous crises have. This paper seeks to convince readers that, until the law begins to hold individual bankers civilly and criminally responsible for using the safety net to enrich themselves by recklessly putting their banks' survival at risk, these rosy claims are bullsh*t.

The Impact of Post-Crisis Regulatory Reforms on Cross-Border Financial Transactions

One of the near casualties of the global financial crisis (Crisis) was the march toward a more principles-based global regulatory structure that simultaneously encouraged cross-border transactions and recognized sovereign authorities over them without the necessity of a one-size-fits-all regulatory framework. The implementation of the G20 reforms for over-the-counter derivatives was far more prescriptive than principled. Post-crisis implementation of the G20 reforms, embodied in the United States in Title 7 of the Dodd Frank Wall Street Reform and Consumer Protection Act, yielded a costly, and in some markets, persistent loss of liquidity and fragmentation as market participants have attempted to sort out complex and sometimes competing regulatory requirements for reporting, trading, clearing, margin, and capital in practice.

The Impact of the Leverage Ratio on Client Clearing

As part of the post-crisis regulatory reform, many interest-rate derivative transactions are required to be centrally cleared. Nevertheless, the treatment of this type of transaction under the leverage ratio (LR) requirement does not allow for the use of initial margin to reduce the exposure, thereby increasing capital costs. As a result, LR affected clearing member banks may be more reluctant to provide central clearing services to clients given this additional cost. This in turn can prevent some real economy firms from hedging their risks. We analyse whether this is the case by exploiting detailed confidential transaction and portfolio level data as well as the introduction and posterior tightening of the LR in the UK in a diff-in-diff framework. Our results suggest that the LR had a disincentivising effect on client clearing, both in terms of daily transactions as well as the number of clients, but this impact seems to be driven by a reduced willingness to take on new clients.

Banks, private money creation, and regulatory reform

PurposeThis paper aims to consider recent arguments that post-crisis regulatory reform has misunderstood the nature of banks’ activities. These arguments suggest that a bank’s role is not that of intermediation between savers and borrowers but the systemically riskier one of private money creation.Design/methodology/approachThe paper assesses whether banks’ activities are best understood as private money creation rather than intermediation. It considers the argument that regulatory reform has not gone far enough to prevent a recurrence of future credit spirals ending in financial crises.FindingsThis paper analyses banks’ activities and finds that it is incorrect to consider that they engage in relatively unfettered money creation. While fractional reserve banking does create flows of money through the economy, these flows are tethered to banks’ funding requirements. Multiple use of that money, rather than representing an ill-understood risk, simply reflects the nature of maturity transformation. This has not been missed in designing the post-crisis regulatory framework. The revised framework contains many features that are not fully recognised by proponents of the money creation critique and goes significantly further than they allow. Once completed, it will address many of the concerns they raise. They are right to call for further consideration of whether the countercyclical features of the new framework are sufficiently developed.Originality/valueThe paper provides an early detailed response to recent criticism of the post-crisis regulatory reform programme coming from a money creation perspective of banks’ role in the economy.

Haircutting Non-Cash Collateral

Haircutting non-cash collateral has become a key element of the post-crisis regulatory reform of the shadow banking system and OTC derivatives markets. This article develops a haircut model by expanding haircut definitions beyond the traditional value-at-risk measure and employing a double-exponential jump-diffusion model for collateral price. Haircuts are solved to target traditional credit risk measurements, such as probability of default, expected loss or unexpected loss given certain internal or external rating criteria. Computational results are presented for main equities, securitization, and corporate bonds.