1. Does new international regulation help crisis prevention?Keynote Speech FEPS TASC Annual Conference 2011 Stephany Griffith-Jones,[email_address]

2. Overall context

Aims of the financial system

Managing risk and avoiding crisis

Allocating capital to the real economy efficiently

Financial system did neither

Do we need a completely different financial system?

Restricting or isolating speculation

private banks to lend to real economy

Role of public banks to fund real economy

3. Some key problems

One major problem: increased leverage and maturity mismatches which increase systemic risk

Crisis revealed too low core capital, leverage too high and

Both accounting and regulation was pro-cyclical, reinforcing procyclicality of finance

4. Basel 3

Size and quality of core capital improved (but is it enough?)

Simple leverage ratio 1:30 (too generous)

Counter-cyclical regulation

Liquidity coverage ratio positive

5. 6. Higher capital requirements cost benefit analysis

Benefits :

• Stronger Financial System => Lower probability of banking crises => Lower crisis-induced output losses

• Reduction of amplitude of output fluctuations

Costs :

• Higher lending rates => lower output level (but trend growth rate unaffected)

7. Impact of increasing capital

Increasing capital by 1%:

• Increases lending spreads by 0.13%

• Decreases output by 0.09%

Therefore, even if temporary crisis-generated output losses are assumed:

Net benefits of increasing capital from 7% to 8% =

= Benefits Costs

= 0.30% - 0.09%

= 0.21% > 0

Source: BIS estimates

8. Countercyclical regulation

Need for countercyclical regulation to compensate for pro-cyclical finance

History; dynamic provisioning

Rules preferable todiscretion

The gap betweencredit-to-GDPratio from its long-term trend is the benchmark guide for Basle

International coordination

9. Implications for national implementation

Several elements of Basel 3 positive, such as countercyclical buffers and liquidity ratios; increasing quantity and quality of core capital if needed

Too slow and gradual introduction of reforms desirable to accelerate ?

10. Shadow Banking system definition

Buiter definition (2008) :

The shadow banking sector consists of themany highly leveraged non-deposit-taking institutions that lend long and illiquid and borrow short in markets that are liquid during normal or orderly times but can become very illiquid when markets become disorderly.

They are functionally very similar to banks but :

-arebarely supervised or regulated .

-holdvery little capital ,

-arenot subject to any meaningful prudential requirementsas regards liquidity, leverage or any other feature of their assets and liabilities.

11. 12. Challenges of regulating shadow banking

- Regulate all financial activity in comprehensive andequivalent manner, for capital adequacy, leverage and liquidity (DArista and Griffith-Jones, 2010)

- What quacks like a duck should be regulated like a duck!

- Put all banking activity on banks balance sheet

- Aim: reduce shadow banking scale

13. Dodd-Frank Act

More rigorous than initially expected, but weakened by lobbying, e.g. Volcker rule and derivatives, further diluted in implementation

Positive institutional developments: consumer protection agency (prevents abuse) and systemic risk regulator also in EU (prevents silo-thinking about systemic risk)

14. Policy suggestions for consideration

Key: link financial sector to its main aim, financing the real economy

Counter-cyclical regulations

Increase of quantity and quality of core capital; increase liquidity requirements

Regulate all shadow banking system in equivalent way

Putting all transactions on the balance sheet

Forcing derivatives on exchanges