One Approach to Financial Re-Regulation

At Vox, Avinash Persaud serves up a regulatory finance model I think might work:

The inappropriateness of financial regulation, Avinash Persaud, May 1, 2008: … [The] model we have today, I venture [to say] is a highly dangerous model. It is expropriation of gains by bankers and socialization of costs by taxpayers. Paying for a decade of bank bonuses can be very expensive for the taxpayer and the opportunities for moral hazard are enormous. …

The alternative model rests on three pillars. The first recognises that the biggest source of market and systemic failure is the economic cycle and so regulation cannot be blind and deaf to the cycle — it must put it close to the centre. Charles Goodhart and I have proposed contra-cyclical charges — capital charges that rise as the market price of risk falls as measured by financial market prices — and a good starting point for implementation of such charges is the Spanish system of dynamic provisioning (Goodhart and Persaud 2008).

The second pillar focuses regulation on systemically important distinctions, such as maturity mismatches and leverage, and not on out-dated distinctions between banks and non-banks. Institutions without leverage or mismatch should be lightly regulated — if at all — and in particular would not be required to adhere to short term rules such as mark-to-market accounting or market-price risk sensitivity that contribute to market dislocation. Bankers will argue against this, saying that it creates an unlevel playing field, but financial markets are based on diversity, not homogeneity. Incentivising long-term investors to behave long-term will mean that there will be more buyers when banks are forced to sell.

The third pillar is requiring banks to pay an insurance premium to tax payers against the risk that the tax payer will be required to bail them out. If such a market could be created, it would not only incentivise good banking and push the focus of regulation away from process to outcomes, but it would provide an incentive for banks to be less systemic. Today, banks have an incentive to be more systemic as a bail out is then guaranteed. The right response to Citibank's routine failure to anticipate its credit risks is not for it to keep on getting bigger so that it can remain too big to fail, but for it to whither away under rising insurance premiums paid to tax payers. …

Comments

[Per Kurowski]

Does prudence in banking really have to mean purposelessness?

What is more prudent for the bank regulators, to work exclusively at avoiding the default of banks and the occurrence of a bank crisis, or to ascertain that the banking system serves a purpose for the society?

These days when it has been demonstrated that the bank regulators are failing in their self imposed limited scope of functions; and indeed through the creation of the current structure of minimum capital requirements for the banks and the appointment of the credit rating agencies as risk commissars have themselves contributed to create new systemic risks, is it not time for us to take a big step back and, before digging us deeper in our regulatory hole, ask ourselves what is the purpose of our banks?

Aren’t you as fed up as me having a purposeless banking sector? If we absolutely have to live with risk avoidance based regulatory system, can’t we at least start measuring units of default risk in terms of decent jobs created, youngsters educated or environmental threats avoided?

Risk is the oxygen of development and so please let us not kill risk taking!

[Mark]

Persaud doesn't solve the problem; he shifts the problem. How are risk-based premiums to be set for institutions with portfolios bursting with exotic, opaque financial instruments with no track record? The Glass-Steagall model simply said if you want a lifeguard to come save you when you get in trouble, then stay inside the well marked, bright red buoys. If you stray beyond, you swim in the deep waters at your own risk. Now the extreme sports daredevils know that the Baywatch crew will spare no expense to come to their rescue.

[John Bill]

Dear friend,

Realy it is very useful post , Accept my sincere thanks and appreciation

John Bill

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