Register, Issue, Cap and Trade:a proposal for ending current and

future financial crises

Alistair MilneLoughborough University

LSE Financial Regulation Seminar, Oct 1st, 2012

Economics eJournal

• Published article

• But only in draft form– Any comments today can be incorporated

• Please read and comment online !

http://www.economics-ejournal.org/economics/discussionpapers/2012-34

Summary of the proposal

• Register of short term liabilities– across the financial system, not just banks

• A cap on total volume• Issue of corresponding tradable licences,

with penalty for registered liabilities that do not have matching license

• Institutions trade licenses, so they are held where gains from short funding are largest

• Closely related to proposals of Jeremy Stein/ Anil Kashyap and Javier Suarez/ Enrico Perotti

Background/ motivation

• Liquidity risk central to the financial crisis• Policy response

– Liquidity Coverage Ratio (LCR)• Enough high quality liquidity assets to cope with a one-

month stressed runoff• Binding by January 2015• Major impact on business models

– Net Stable Funding Requirement (NCFR)• Enough stable (long term) funding to cover long term

assets• Minimum standard by January 2018

• Major regulatory changes– Much more fundamental than higher capital

Why liquidity regulation?

• In order to control a (systemic) risk externality– “Firesales”

• In particular to allow orderly resolution

– limit credit booms and asset price instability

• Stein (2010), Kashyap and Stein (2011)– Formal model of firesales and maturity mismatch

• Alternative view (Gorton)– maturity mismatch good– Not enough “informationally insensitive assets

How?• Quantity controls on individual institutions

– Proving highly controversial• Major impact on business models• Affects some banks much more than others

– Fierce ongoing battle over LCR

• Tax on liquidity eg on maturity mismatch– Limited tax already in place– But what level of tax is appropriate?

• If we can determine acceptable degree of maturity mismatch– Then “cap and trade” is sensible approach

• MUST extend to shadow banking

More detail• A central register of financial assets and liabilities,

updated in real time. – Only registered liabilities legally enforceable

• Upper limit on short term liabilities of financial intermediaries. (t/365 weighting)– Increased gradually to target e.g. ratio of short term

liabilities to GDP

• Licenses for this amount are distributed to financial institutions (e.g. based on usage) – In advance of each quarter auction of licenses. – Daily monitoring of usage, fines for excess.  

Criticisms 1

• Easily evaded– Not a system of credit control, credit financed

with long term debt unaffected– Shadow banking included

• Better in this respect than LCFR

– Also deals with unregistered maturity mismatch

• Offshore exposures not covered• Yes this is possible, but only evades if assets are

offshore as well, so limits credit boom/ externality

Criticism 2

• Profound change of business model– End of pricing off LIBOR– Yes, but this is also true of LCR

• Will greatly reduced transmission of monetary policy– Yes, but this is also true of LCR

• Will limit leveraged trading and price discovery in security markets– Yes, but as well as this being true of LCR may be a

benefit not a cost

Helicopter money?

• Separate issue

• Curtailing of “conventional” money transmission (via short term interest rates)– May need us take helicopter money proposals

more seriously

• Register can regarded as a neutral distribution mechanism– But many other possibilities

Current thinking on redraft

• More link to LCR and other current liquidity policies

• Less on helicopter money, except in relation to change in monetary transmission

• Emphasise: liquidity regulation is the BIG issue in Basel III, far more important than capital changes