The financial crisis and regulation reform

Journal of Banking Regulation

Volumn 12, Issue 4, 2011, Pages 277-307

  Miele, Maria Grazia ^a   Sales, Elisa ^b  

^a Specialized Intermediaries Supervision Department of the Bank   (Italy)

^b UNIVERSITY OF ROME TOR VERGATA   (Italy)

Author keywords

Basel III; financial crisis; global imbalances; sectoral disequilibria

Indexed keywords

EID: 84860413265     PISSN: 17456452     EISSN: 17502071     Source Type: Journal    
DOI: 10.1057/jbr.2011.7     Document Type: Article

References (86)

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2. The export-led growth strategy allowed allocation of domestic resources through international trade especially because domestic demand was not sufficient. International reserves served as buffers against financial crisis and as collateral to ensure the continuation of foreign direct investment inflows, that in turn augmented balance of payments surpluses. Reserve gathering increased since 2001, especially in Asian emerging markets, where it was perceived as a core tool to protect their domestic banking sectors and credit markets and to manage currency floating. See Dooley et al1.
3. Source: IMF Data, calculated as the sum of the balances of individual euro area countries.
4. The current account in per cent of GDP in 2006 (IMF data) were: Greece -11.1 per cent; Portugal -10.1 per cent; Spain -8.9 per cent; Ireland -3.6 per cent; Italy-2.6 per cent5.
5. Source: IMF Data.
6. Blanchard, O. and Milesi-Ferretti, G.M. (2009) Global Imbalances: In Midstream? IMF Staff Position Note, SPN 09/29.
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10. According to Macfarlane9: 'The most significant factor in the emergence of Asia's large current account surpluses in recent years (China notwithstanding to the contrary) has been the decline in investment, not the rise in investment. For Asia countries, excluded China and Japan, investment rates fell by 8.7 per cent of GDP between 1996 and 2004'.
11. Rajan, R. (2006) Perspectives on global imbalances, http://www.imf.org.
12. Eichengreen, B. (2006) The Blind Men and the Elephant, Brookings Policy Brief. Washington DC: The Brookings Institution.
13. Caballero, R.J., Farhi, E. and Gourinchas, O.P. (2008) Financial crash, commodity prices and global imbalances. In: D. Elmendorf, G. Mankiw and L. Summers (eds.) Brookings Papers on Economic Activity, Vol. 2. Baltimore: Brooking Institution Press, pp. 1-55.
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19. Acharya, V. and Schnabl, P. (2010) Do global banks spread global imbalances? The case of asset-backed commercial paper during the financial crisis of 2007-09. IMF Economic Review 58: 37-73.
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21. IMF, World Economic Outlook, April 2006, p. 22.
22. IMF, World Economic Outlook, October 2008, p. 16.
23. IMF, World Economic Outlook, April 2008, p. 113.
24. IMF, World Economic Outlook, April 2008, p. 105.
25. IMF, World Economic Outlook, April 2008, p. 114.
26. IMF, World Economic Outlook, April 2006, pp. 16-17.
27. Nickell, S. (2004) Household debt, house price and consumption growth speech to Bloomberg. London, 14 September.
28. OECD Economic Outlook. (2006) Has the rise in debt made household more vulnerable? No. 80 Special Chapter. pp. 135-158.
29. IMF, World Economic Outlook, April 2008, p. 104.
30. Boeri, T. and Guiso, L.31 (2009) Identify the origin of the crisis in Greenspan's low interest rate policy.
31. 'The First Global Financial Crisis of the 21st Century'. A VoxEU.org Publication.
32. Brunnermeier, M.K. (2009) Deciphering the liquidity and credit crunch 2007-2008. Journal of Economic Perspective 23(Winter): 77-100.
33. Kiff, J. and Mills, P. (2007) Money for Nothing and Checks for Free. IMF Working Paper no. 188.
34. IMF, Global Financial Stability Report 2008.
35. IMF, World Economic Outlook, September 2006.
36. IMF, World Economic Outlook, April 2008.
37. The problem of asymmetric information is typical in financial contracting and includes adverse selection regarding borrower quality and moral hazard on the side of the borrower: the adverse selection problem consists of the lender's incapacity to observe the borrower's quality. This can lead to the elimination of the safest borrowers from the market or to credit rationing by lenders (Stiglitz and Weiss, 1981); the moral hazard problem exists when the lender cannot, costlessly, observe the borrower's actions after a loan contract has been signed, and the borrower may take actions that are in his own but not the lender's interest. Problem of moral hazard in the lending relationship can be mitigated by monitoring of the borrower by the lender (Diamond, 1984).
38. See also Boot, A.W.A. (2000) Relationship banking: What Do we know? Journal of Financial Intermediates 9: 7-25.
39. CDOs (collateralized debt obligations) were probably the most complex type of credit risk transfer instruments; a kind of security backed by other types of structured finance securities, by CDSs (Credit default swaps) or other CDOs (so-called CDO square).
40. Source: ESF Securitisation Data Report Q2:2008, European Securitisation Forum, London, Securities Industry and Financial Markets Association (SIFMA), 2008.
41. Adrian, T. and Shin, H.S. (2009) The Shadow Banking System: Implications for Financial Regulation. Federal Reserve Bank of New York Staff Report, no. 382.
42. Price Waterhouse Coopers. (2004) SIC-12 and Fin46R, the substance of control, http://www.pwc.com/gx/en/ifrsreporting/ pdf/sic12-fin46r.pdf.
43. IMF, Global Financial Stability Report, April 2008.
44. Cannata, F. and Quagliariello, M. (2009) The Role of Basel II in The Subprime Financial Crisis, Guilty or Not Guilty? CAREFIN Working Paper.
45. See M.K. Brunnermeier32.
46. Brunnermeier, M.K. and Pedersen, L.H. (2008) Market liquidity and funding liquidity. The Review of Financial Studies 22: 2201-2238.
47. Capital was also insufficient in some financial firms, like AIG and other insurers that offered credit risk protection for several billions of notional credit risk exposure but, as the crisis showed its effects, were not able to repay their creditors.
48. See IMF43.
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52. IMF, Global Financial Stability Report, April 2006.
53. Donnelly, C. and Embrechts, P. (2010) The devil is in the tails: Actuarial mathematics and the subprime mortagages crisis. Risklab.
54. CDOs, on the other hand, are much more concentrated than ABSs and generally contain, or are referenced to, relatively small numbers of non-homogeneous assets. As a result, both idiosyncratic and systematic risks are important.
55. IMF CGFS-Committee on the Global Financial System. (2008) Ratings in Structured Finance: What Went Wrong and What Can Be Done to Address Shortcomings? Report submitted by a Study Group established by the Committee on the Global Financial System.
56. IMF, CGFS - Committee on the Global Financial System. (2005) The Role of Ratings in Structured Finance: Issues and Implications. Report submitted by a Working Group established by the Committee on the Global Financial System.
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58. CGFS55,56.
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61. For example, Merryll Lynch expended 15 billion of dollars in executive compensation in 2008, only 6 per cent less than in 2007, even if it reported 42 billion of losses (Forbes, 23 January 2009)62.
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63. Securities and Exchange Committee. (2008) Summary Report of Issues Identified in the Commission Staff 's Examinations of Select Credit Rating Agencies, http:// www.sec.gov.
64. Apart from subordination, which creates a hierarchy of loss absorption among the tranche securities, a second form of credit enhancement is over-collateralization, which is the amount that the principal balance of the mortgage pool exceeds the principal balance of the tranche securities issued by the vehicle; a third form of credit enhancement is excess spread, that is the amount by which the total interest received on the underlying loans exceeds the total interest payments due to investors in the tranche securities. Over-collateralization and excess spread can absorb losses. See SEC63.
65. Hannoun, H. (2010) Information gaps: What has the crisis taught us? Speech at the Bank of International Settlements, April.
66. De Larosière, J. (2009) 'Report', The High-Level Group on Financial Supervision in the EU.
67. Financial Stability Board. (2009) Progress since the Pittsburgh Summit in implementing the G20 recommendations for strengthening financial stability.
68. G-20. (2009) The Global Plan for Recovery and Reform.
69. See G-20 (2009)68.
70. The new Tier 1 composition includes only the instruments with a higher loss-absorbing capacity on a going-concern basis - such as common equity, retained earnings and reserves - excluding intangible assets - such as goodwill and debt-like instruments and preferring tangible resources. Common equity, representing the highest standing element of a bank's capital, is subordinated to all other funding resources; furthermore, it has no compensation constraints and absorbs losses without exacerbating a bank's condition in a crisis. This set includes other instruments which do not have incentive to redeem and maturity date.
71. See G-2068: 'risk-based capital requirements should be supplemented with a simple, transparent, non-risk based measure which is internationally comparable, properly takes into account off-balance sheet exposures, and can help contain the build-up of leverage in the banking system'.
72. Financial Stability Board56: 'the Basel Committee should supplement the risk-based capital requirement with a simple, non-risk based measure to help contain the buildup of leverage in the banking system and put a floor under the Basel II Framework'.
73. In Italy, during the first period, the two ratios worked together through the Risk-Assets Ratio and the Gearing Ratio.
74. Beltratti, A. and Stulz, R.M. (2009) Why Did Some Banks Perform Better during the Credit Crisis? A Cross-Country Study of the Impact of Governance and Regulation. Fisher College of Business Working Paper no. 12.
75. See Beltratti et al 74: 'The worst-performing banks are larger banks. We see that the best-performing banks had significantly lower leverage at the end of 2006. Interestingly, the difference in capital ratios is higher for the equity capital ratio than for the Tier 1 capital ratio. The best-performing banks have a Tier 1 ratio that is 98 basis points higher than the worst-performing banks. However, they have a ratio of equity to assets that is higher by 176 basis points. A similar result holds for the ratio of tangible equity to liabilities. Consequently, the banks that performed better had more capital but also better capital - in the sense of more equity'.
76. Blum, J.M. (2007) Why 'Basel II' May Need a Leverage Ratio Restriction. Swiss National Banks Working Papers.
77. See Blum76: 'The leverage ratio helps to offset the banks' potential capital savings of understating their risks by (i) reducing banks' put option value of limited liability ex ante, and by (ii) increasing the banks' net worth, which in turn enhances the supervisors' ability to sanction banks ex post'.
78. Angelini, P. and Panetta, F. (2009) Financial Sector Procyclicality: Lessons from the Crisis. Occasional Papers no. 44, Bank of Italy, Economic Research Department.
79. Adrian, T. and Shin, H. (2007) Liquidity and Leverage. Federal Reserve Bank of New York Staff Reports no. 328.
80. In up-phases the asset prices tend to rise, if debt is stable the leverage, defined as the ratio of assets to the equity (asset less liabilities), may decrease. If the leverage is targeted by banks, they may try to bring back the leverage to the initial value increasing their liabilities to acquire more assets. In the reverse situation, during downturn phases, the asset prices decrease, the leverage increases, so banks may reduce the assets. There may be a stronger down pressure on asset prices. So the banks' balance sheets dynamics may emphasize cyclical upturns and downturns. See Adrian and Shin79.
81. The analysed investment banks are: Bear Stearns, Lehman Brothers, Merrill Lynch, Goldman Sachs and Morgan Stanley. Today, there are not standalone investment banks in Wall Street. The former three of them were under distressed conditions or declared bankruptcy. The other two were converted into bank holding companies.
82. The authors point out strong positive relationship between variations in leverage and in balance sheet size; financial institutions adjust their balance sheets actively, allowing the leverage increase in boom periods and its decrease in bust ones.
83. Baglioni, A., Boitani, A. and Monticini, A. (2010) Is the Leverage of European Commercial Banks Pro-Cyclical? ISCE - Quaderni dell'Istituto di Economia e Finanza, Università Cattolica del Sacro Cuore.
84. Gross, D. (2010) Too interconnected to fail = Too big to fail? http://www.voxeu.org.
85. Financial Stability Board. (2010) Framework for strengthening adherence to international standards. Financial Stability Board Publications, 9 January 2010, http://www.financial stabilityboard.org/publications/r-100109a.pdf.
86. IMF, (2009) Canada: Article IV Consultation. Country Report 09/162, Washington, DC.