Académique Documents
Professionnel Documents
Culture Documents
North Asia
Economists’ hubris informed the financial tsunami of 2008 Shahin Shojai & George Feiger
Global financial crisis and the European Monetary Union Christian Fahrholz & Cezary Wójcik
Lehman Bros and Repo 105: a powerful case of addiction Jennifer S. Taub
Regulating the rating agencies: Quick fix or political expedient? Lawrence White
Did we tame the beast: views on the US Financial Reform Bill Lawrence Baxter
The regulators strike back: Basel and new liquidity rules Thomas Dietz
Basel Committee’s enhanced framework for liquidity Michael Wong & Fai Y. Lam
In Financial Risk Management,
Experience Counts For Everything.
In Asia Pacific, We’ve Got Plenty Of It.
Standard & Poor’s Fixed Income Risk Management Services group is analytically and editorially independent
from any other analytical group at Standard & Poor’s, including Standard & Poor’s Ratings. This material is
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Copyright © 2009 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
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Publisher & Editor-in-Chief
Christopher Rogers
Editor Emeritus
Dr. John C. Pattison
Editor
Ian Watson
Sub Editor
Fiona Pani
Editorial Contributors
Prof. Lawrence Baxter, Toby Baxendale, Eleanor Beamond-Pepler, Prof. Lucian
Bebchuk, Prof. Thorsten Beck, Claas Becker, Dr. Sergey Chernenko, Satyajit Das,
Thomas Dietz, Charles L. Evans, Dr. Christian Fahrholz, Dr. George Feiger, Dr.
Fritz Foley, Dr. Robin Greenwood, Andrew G Haldane, Fai Y. Lam, William M.
Isaac, Prof. Laurence Kotlikoff, David Millar, Michael Mussa, Prof. Enrico Per-
otti, Jonathan Pickworth, Prof. Carmen M. Reinhart, Christopher Rogers, Shahin
Shojai, Dr. V. Shunmugam, Gavin Sudhakar, Kavaljit Singh, Prof. Jennifer S.
Taub, Steve Randy Waldman, Peter J. Wallison, Prof. Lawrence White,
Prof.Cezary Wójcik Dr. Michael Wong, Prof. Charles Wyplosz
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ISSN No: 2071-5455
Journal of Regulation and Risk – North Asia
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cannot accept responsibility for any errors, omissions or those opinions expressed by contributors.
Articles
Perspectives on regulatory reform after the 2008 crash 91
Charles L. Evans
Regulation or prohibition: the $100 billion question 101
Andrew G. Haldane
Economists’ hubris informed the financial tsunami of 2008 123
Shahin Shojai & George Feiger
‘Walker Review’ heralds new dawn in risk management 133
David Millar
Ideas have consequences: the importance of ‘narrative’ 139
Peter J. Wallison
Minority shareholders blind to threat of expropriation 149
Dr Fritz Foley et al
TM
Creating a culture of risk awareness.
© 2010 Global Association of Risk Professionals.
All rights reserved.
Foreword
First and foremost, may we offer our readers an apology for the lateness of this
Journal appearing – the delay has been caused by a change of ownership and man-
agement structure which we trust will contribute greatly to our future efforts in
raising issues of importance within the governance, risk management and compli-
ance space here in Northeast Asia, together with the Asia region in general. These
changes will be finalised by year’s end, at which juncture the Journal will become
a standalone entity with a revised publication calendar and enhanced local cover-
age, supplementing our already extensive international coverage.
This double issue of the Journal should provide readers with considerable food for
thought on current and future financial management and financial sector policy. This
edition of the Journal also appears exactly two years after events at Lehman Brothers
in August and early September 2008 precipitated the largest financial crisis since the
Great Depression of the 1930s, one which threatened to spill over into the general global
economy unless massive and co-ordinated action was undertaken by the G-20 group of
nations to mitigate against the worst effects of the crisis – the implosion of the banking
system, large-scale economic dislocation and huge unemployment.
Having stabilised the global banking system, many nations are now threatened by
a sovereign debt tsunami as they adjust economic policy to the post-crisis environment
in an effort to contain spiralling debt levels caused, in part, by bailing out the banking
sector and issuing unlimited public guarantees over much of the debt many of the global
“too-big-to-fail” banks hold on their balance sheets – the Greek crisis epitomising this
current problem.
Further, as a result of the trillions of dollars lost from the global GDP, hope was
unleashed that stringent regulatory reforms would be embraced the world over to pre-
vent a repeat of the 2008 crisis by reining in the worst excesses of the financial services
sector. As promised, the US has been the first to enact legislation to regulate more effec-
tively its banking sector, the outcome of which, the Dodd-Frank Act, informs much of the
content of this current Journal.
Suffice to say, many of our renowned contributors have mixed feelings over
Dodd-Frank and are now focusing their attention on discussions within the Basel
Committee, as it too tries to implement an international framework in an effort
to make banking more robust and less of a threat to the global economy – more
about which we shall hear in our next edition of the Journal towards the end of
November.
Christopher Rogers
Publisher & Editor-in-Chief
A full list of those who kindly assisted with the publication of this issue is not
possible, but the Publisher and the Editor would like to thank the following or-
ganisations for their generous assistance and support: The Federal Reserve Bank
of Chicago; the Bank of England; the Bundesbank; the Financial Services Author-
ity, the Peterson Institute for International Economics, the American Enterprise
Institute, the Roosevelt Institute, Harvard Legal Blog; the Pareto Commons; Vox-
eu; Interfluidity and DLA Piper for their kind permission to reproduce material
from their respective publications and websites.
Detailed comments and advice on the text and scope of contents from Wil-
liam Isaac, Prof William Black, Dr John C. Pattison, Prof Lawrence Baxter Prof
Laurence Kotlikoff and Prof Jennifer Taub were invaluable; we are also grateful
to Ian Watson and Fiona Plani of Edit24.com for their due diligence in setting out,
editing and correcting the text.
Further thanks must also go to the China Banking Regulatory Commission,
Beijing & Shanghai Chapters of the Professional Risk Managers International
Association and the Hong Kong Chapter of the Global Association of Risk Pro-
fessionals for their kind assistance in helping to distribute this journal to their
respective memberships in Greater China, Japan and Korea.
AFTER a career spanning almost three the Brookings Institute as a research fellow.
decades with Wall Street leviathan This at a time of rising political tensions and
Morgan Stanley, and three years of that economic problems within the US as a result
time most recently spent heading up of the country’s involvement in Vietnam and
Morgan’s operations in Asia Pacific as huge costs associated with funding both
chairman, Stephen Roach announced the US military-industrial complex and
recently that he would be hanging up his President Lyndon B. Johnson’s push for a
spurs in the region. He said he would be “Great Society”.
heading back to the US for a well-earned The pull of public service being great,
rest and teaching assignments at Yale Roach joined the staff of the economics divi-
University’s Jackson Institute for Global sion of the Federal Reserve Board in 1972
Affairs. Roach will, however, remain a and remained there until 1979 before mov-
thought leader with Morgan Stanley in ing on to his first position within the pres-
the guise of non-executive chairman, a tigious confines of Wall Street at Morgan
position that will allow him to keep tabs Guaranty Trust Company – better known
on Asia on a monthly basis. today as JP Morgan Chase.
One of Wall Street’s most respected and oft Days at the Fed
quoted economists, Roach has had a long Roach’s time at the Fed coincided with one
and distinguished career since graduating of the more interesting periods of politics
from the University of Wisconsin – Madison and monetary policy within DC spanning
with a bachelor’s degree in economics; this two Fed chairmen and three US presidents
followed by a period of research undertaken – Arthur Frank Burns and George William
at New York University for which he was Miller, and Richard Nixon, Gerald Ford and
awarded his doctorate. Jimmy Carter respectively. Notwithstanding
With Ph.D in hand, Roach journeyed to the politicisation of the Fed under Nixon, his
Washington, DC, where he joined the staff of tenure also occasioned that of the“oil shock”
The financial reform bill that had preoc- US in what was promised as the most wide-
cupied numerous parties in Washington ranging reform undertaken since the days of
since November last year finally gar- Roosevelt and the Great Depression.
nered enough support to become law
this month once President Obama gives Asian concerns
it his official seal of office. Following Should our readers, many of whom work for
much intense and often bitter debate in the US and European-based too-big-too-
Congress between proponents of the bill, fail financial institutions in question – with
its opponents, and those that sought more many others working for more regional and
far reaching reform, the US becomes the local financial services businesses – actually
first leading economy to honour its G-20 care what legislation and reforms have been
obligations and overhaul its financial ser- passed in Washington this summer?
vices sector in the wake of the 2008 bank- The answer must be an unequivocal
ing meltdown. “yes”. Yes, not only should we care, but we
need to take stock of the Dodd-Frank Act
As the dust settles and the bill’s two lead- and ask ourselves whether US lawmakers
ing sponsors, Senator Chris Dodd (pictured have enabled legislation which will make the
above) and Representative Barney Frank global financial system safer or whether, to
prepare for Washington’s long summer the contrary, have they enacted a bill which,
recess, a plethora of bankers, lawyers, aca- for all its fine words and original intent, has
demics and industry specialists now begin failed in its stated ambition of reining in
the onerous task of reviewing what has been the worst aspects of Wall Street and casino
officially termed the Wall Street Reform capitalism.
and Consumer Protection Act – otherwise It is our view that each of us who reads
referred to as the Dodd-Frank Act – to this Journal should be highly concerned at
determine the full extent of the legislation’s what has transpired in Congress, particu-
impact on the financial services sector in the larly in the light of events from March to
IN the new financial order being put in vehicles to maintain portfolios of assets that
place by regulators around the world, have received sufficiently high grades from
reform of credit rating agencies should the recognised agencies.
be a key element. Credit rating agencies, Disappointment about the raters’ per-
which play an important role in modern formance, and scepticism about the effec-
capital markets, completely failed in the tiveness of regulation, has led to calls to
years preceding the financial crisis. What eliminate any regulatory reliance on ratings.
is needed is an effective mechanism for If ratings are not backed by the force of law,
rating the raters. so the argument goes, regulators need not
worry about rating quality and can leave the
There is widespread recognition that rat- monitoring of raters to the market.
ing agencies have let down investors. Many
financial products related to real estate lend- Failure to perform
ing that Standard & Poor, Moody’s, and Fitch Proponents of this course of action such
rated as safe in the boom years turned out as Senators George LeMieux and Maria
to be lethally dangerous. And the problem Cantwell, would remove references to the
isn’t limited to such financial products: with credit agencies in all major financial services
issuers of other debt securities choosing and laws. LeMieux stated: “We know that one
compensating the firms that rate them, the of the main reasons why we had our finan-
agencies still have strong incentives to recip- cial debacle in 2008 was that credit agencies
rocate with good ratings. failed to do their jobs, they put AAA stamps
What should be done? One proposed of approval on products that deserve no such
approach would reduce the significance stamp, and the investing world relied upon
of the raters’ opinions. In many cases, the the fact that these rating agencies were sup-
importance of ratings comes partly from posed to do their job and they failed.”
legal requirements that oblige or encour- Even if ratings were no longer required
age institutional investors and investment or encouraged by law, however, demand for
THE Obama Administration as well as issue liar mortgages, rate triple-C assets as
Congress continue to ignore the primary triple A, insure the uninsurable, pay yourself
cause of our financial debacle and to pro- massive and fully undeserved bonuses, shop
pose reforms that badly miss the mark. for compliant regulators, and bribe politi-
cians to change rules – that’s theft, plain and
The cause was first and foremost finan- simple.
cial fraud, of which the US Securities and
Exchange Commission’s fraud-based law- Proprietary info key
suit of Goldman Sachs is just the latest Proprietary information, not proprietary
evidence. The financial industry, aided and trading, was the key to the crime.
abetted by credit rating companies on the “We’ll make you a mint. But no ques-
take, politicians on the make, and regula- tions. If we disclose, others will learn and
tors on a break, systematically manufactured we’ll no longer beat the market.”
trillions of dollars of securities, which we Would that everyone could beat the mar-
now call toxic. And we call them toxic, not ket. And would that Wall Street’s wizards, as
because they were risky, but because they a group, actually had proprietary information
were, phony. of social value. But the information they were
keeping private was their sale of snake oil.
Fraud in vogue When the fraud surfaced, so did the
The fraud didn’t arise because banks were questions. Was every asset toxic? Was every
too large, too leveraged, and too intercon- loan overvalued? Were any financial state-
nected, although these factors greatly exac- ments to be trusted? These questions were
erbated the financial fallout and need to be asked about every bank, no matter its pedi-
fixed. gree, the tenure of its“top”management, or
The fraud arose because large parts of its regulator. And this new information, that
the industry decided to make money the old there was no information, laid waste to one
fashioned way – by stealing it. When you financial company after another. Today, two
THE financial panic of 2008 and the ensu- trying to deflect blame to “greedy bankers,”
ing deep recession did not have to hap- and offering slogans rather than solutions to
pen and I am appalled by the enormous real and present dangers.
financial, human and political cost of it Among other things, they are telling us
all. Taxpayers, rightly so, are extremely the Troubled Asset Relief Program (TARP)
angry about the events of 2008 and 2009 was essential to calming the markets when,
– they know instinctively that something in fact, the TARP did far more harm than
does not smell right. good. This book exposes the TARP for what
it was – an ill-conceived programme hastily
I wrote this book – Senseless Panic: How slapped together by a panicked government
Washington Failed America – to get out the working too close for my comfort with a
truth about what happened and why and handful of Wall Street firms. It set off an eco-
how we can prevent future crises. We, and I nomic and political firestorm from which we
mean all of us and our great country, are in have yet to recover.
enormous trouble! If we do not take the time
to learn what went wrong and how to fix it, Carter appointee
we, our children, and their children, will pay I had the privilege of leading the Federal
a big price. Deposit Insurance Corporation (FDIC) dur-
If we let them, our political leaders will ing the bank and thrift crises of the 1980s,
do everything in their power to hide their having been appointed to the FDIC board of
culpability for the mess in which our nation directors by President Carter in 1978 at the
finds itself, and they will enact “politically age of 34. Little did I know when I took the
easy” legislation that will not address the post that the country was about to experi-
fundamental causes of the crisis and will ence the worst economic and banking crisis
in fact make things worse. Our leaders are since the Great Depression – a crisis that
already covering up their role in creating would result in larger and more severe bank
what I call the senseless panic of 2008, are failures than in the 1930s.
SENSELESS
PANIC
H O W WA S H I N G T O N FA I L E D A M E R I C A
W I L L I A M M . I S A AC
with P H I L I P C . M E Y E R
Book review
JIMMY Stewart plays George Bailey salvation called Limited Purpose Banking
who is cast as the “honest” and trust- (LPB). He also proposes a reduction of the
worthy banker in the classic Hollywood financial service sector regulators in the US
film, ‘It’s a Wonderful Life’. Laurence from its current 115 down to one: the Federal
Kotlikoff’s book laments that in the real Financial Authority (FFA).
world of modern banking, such charac- In his opening remarks he discusses the
ters no longer exist. Modigliani-Miller Theorem, written in 1958,
showing in elegant math how in the absence
Laurence Kotlikoff himself is a Professor of of bankruptcy costs, leverage does not mat-
Economics at Boston. Several Nobel Prize ter. If a company takes on more risk by bor-
winners have endorsed the book: George rowing more, its owners will offset that risk
Akerlof, Robert Lucas, Robert Fogel, Edward by borrowing less, leaving total debt in the
Prescott, and Edmund Phelps. I count 36 economy unchanged.
endorsements from the great and the good
of the academic world on the back cover and Leverage can be good
front pages. I do not recall ever seeing this Kotlikoff makes no mention of the fact that
in a book. leverage in itself is not a bad thing if it is
The book is written for the layman. It is made up of people forgoing their consump-
light on economic theory, but does reference tion today, i.e. saving and committing it to
some other-worldly models. It is also good projects that will deliver up goods in the
at explaining what on the face of it appear future.
to be complex financial phenomena, but are This glaring omission does not impede
in fact con tricks that in any other industry him from telling the story of our financial
would earn you a prison sentence. Kotlikoff meltdown and making a solid policy recom-
shows his readers how the financial sys- mendation for this crisis. It does, however,
tem has failed in its fiduciary duty, and pre- prevent him from seeing the elephant in the
sents a simple and elegant solution for its room: that the credit creation process itself
NOT content with reviewing one book • Robert Pozen (2010) Too Big To Save:
at a time, popular commentator, risk spe- How to Fix the U.S. Financial System; John
cialist and acclaimed author, Satyajit Das, Wiley, New Jersey;
scrutinises several of the latest bestsellers • Yves Smith (2010) ECONned: How
from international authorities concern- Unenlightened Self Interest Undermined
ing the financial crisis, its origins and its Democracy and Corrupted Capitalism;
consequences. MacMillan.
Thomas Carlyle, the Scottish Victorian-
Among the books reviewed by Das are the era historian, christened economics the“dis-
following recently published titles: mal science”. In Eat The Rich, P.J. O’Rourke
• Carmen M. Reinhart & Kenneth Rogoff described economics as “an entire scientific
(2009) This Time is Different: Eight Centuries discipline of not knowing what you’re talk-
of Financial Folly; Princeton University Press, ing about.” One can only quibble with the
London; word“scientific”.
• Raghuram G. Rajan (2010) Fault Lines:
How Hidden Fractures Still Threaten the New, more dangerous phase
World Economy; Princeton University Press; The publisher-led recovery – “crash literature”
• Simon Johnson and James Kwak (2010) as it could be termed – in the global econ-
13 Bankers: The Wall Street Takeover and the omy has entered a new and more dangerous
Next Financial Meltdown; Pantheon Books, stage. Economists have begun to hold forth
NewYork; on the problems. Keynesians, Monetarists,
• Nouriel Roubini and Stephen Mihm Cavaliers, Roundheads and Vegetarians are
(2010) Crisis Economics: A Crash Course in stirring to give their own views of reality and
the Future of Finance; Penguin; putative solutions. Worryingly, at least two of
• Joseph Stiglitz (2010) Freefall: Free the books are now in the Best Seller lists for
Markets and the Sinking of the Global Business Books.
Economy; Allen Lane, London; A key characteristic of the emerging tidal
OTC markets for derivatives have been Traditionally, trading in securities had
much in the news recently and subject been executed in pits at a central location
to great criticism, not only for their anti- (Gorham and Singh, 2009), with traders
competitive and secret nature, but also exchanging buy and sell orders on their own
for contributing to the financial crisis or on behalf of their clients. In that system,
of September and October 2008. In this personal interactions bred collusion among
paper, the author argues that the rising unscrupulous traders to front-run their
opacity and barriers to entry in the deriv- competitors (Schlegel, 1993). Front-running
atives and over-the-counter markets have refers to an illegal practice of executing orders
been sorely overlooked – particularly by on a security early with the advance knowl-
legislators and regulators – leading to edge of pending orders from customers/
dark pools, flash trading and front-run- competitors.
ning. These unfair practises can, at any Computerisation helped to eliminate
time, cripple markets. They undermine front-running, and was better able to handle
the premise of free market trade and rising volumes, reduce transaction costs, and
should be abolished. improve speed and accuracy. Naturally, the
bulk of trade shifted to the online platform.
While over-the-counter (OTC) markets for
collateralised debt obligations (CDO) and Technology the key
credit default swaps (CDS) are blamed for To attract volumes amid increasing com-
the financial crisis of 2007-2009, what has petition, increased technology support
been overlooked is the menace of rising and reduced delays became the fashion for
opacity in the exchange-traded market. online exchanges the world over.
This raises questions about the funda- Online trading threw markets wide
mentals of this market’s very existence, i.e. open to all armed with a desktop computer
transparency and equal access to one and all and access to a public network. It brought in
in the price discovery process. the much-desired transparency, as trading
DOES the recently passed Financial reforming the framework governing finan-
Reform Bill help mitigate against the cial institutions and regulators. Critically, it
next financial crisis or at least reduce its does little to change the incentives for banks
probability? Professor Thorsten Beck in and regulators.
this paper argues the case for a firm “no”. Financial sector regulation has differ-
His verdict is reached not because the ent objectives that might imply a trade-off.
reform steps themselves are damaging While stability is at the top of policymakers’
or wrong, but simply because they only agendas right now, they also aim for regula-
provide for a framework that does little tion that fosters competitiveness and“useful”
to change incentives for either banks or innovation.
regulators.
Balkanisation
At the end of May, the US Senate passed its The reform efforts have been driven by the
version of the Financial Reform Bill. While large amount of taxpayers’ resources that
it still has to be reconciled with the House have been put at the financial system’s dis-
of Representatives’version, the outline of the posal to avoid a meltdown. But political
regulatory reform in the US is slowly becom- considerations, including the re-election
ing clear. A thorough assessment of the Bill, opportunities of individual senators, have
however, is made difficult by its sheer size also had a major impact.
and bulk, some 2,300 pages, when com- While the balkanisation of the institu-
pared to the tiny Glass-Steagall Act of 1933. tional structure of financial sector supervi-
Do the important changes to US regu- sion has often been criticised, so has the
latory structure and oversight improve sta- lack of certain institutions. Both the House
bility? Beck argues that the Reform Bill is and the Senate versions foresee the creation
neither the silver bullet to ensure a safer of a new bureau of consumer financial pro-
financial system nor a complete flop. It is tection (BCFP), with the purpose of provid-
but one small step in the long march of ing consumers with better information and
This column, first posted on April 19, debt and banking crises, inflation, currency
2008 and regularly updated, argues that crashes and debasements.3 The database
sovereign debt crises have historically covers 66 countries across all regions. The
followed financial crises. Although data range of variables encompasses external
covering only the past 30 years might and domestic debt, trade, GNP, inflation,
have given few hints about Greece’s cur- exchange rates, interest rates and commod-
rent problems, the Reinhart-Rogoff data- ity prices. The coverage spans eight centu-
base spanning eight centuries reveals ries, going back to the date of independence
that today’s events are very much in line or well into the colonial period for some
with historical experience. countries.
enormously. Weaker growth in the US and banking crises, as shown in Figure 2. Periods
other advanced economies softens growth of high international capital mobility have
prospects for export-dependent emerging repeatedly produced international bank-
markets in Asia and elsewhere; inflation is ing crises, not only famously as they did in
on the rise. Is this cycle different? the 1990s, but historically. The figure plots a
three-year moving average of the share of
Financial liberalisation all countries experiencing banking crises on
Another regularity found in the literature the right scale. On the left scale, we employ
on modern financial crises is that countries our favoured index of capital mobility, due
experiencing large capital inflows are at high to Obstfeld and Taylor (2004),5 updated and
risk of having a debt crisis. Default is likely to backcast using their same design principle,
be accompanied by a currency crash and a to cover our full sample period; while the
spurt of inflation.The evidence here suggests index may have its limitations, it neverthe-
the same to be true over a much broader less provides a summary of de facto capital
sweep of history, with surges in capital mobility based on actual flows.
inflows often preceding external debt cri- As noted, our database includes long
ses at the country, regional, and global level time series on domestic public debt.6
since 1800, if not before. Because historical data on domestic debt is
Also consonant with the modern theory so difficult to come by, it has been ignored
of crises is the striking correlation between in many empirical studies on debt and infla-
freer capital mobility and the incidence of tion. Indeed, many generally knowledgeable
observers have argued that the recent shift over 30 per cent and has been at times more
by many emerging market governments than 50 per cent. Furthermore, contrary to
from external to domestic bond issues is the received wisdom, these data reveal that
revolutionary and unprecedented.7 Nothing a very important share of domestic debt –
could be further from the truth, which has even in emerging markets – was long-term
implications for today’s markets and for his- maturity.
torical analyses of debt and inflation.
The topic of domestic debt is so impor- The inflation-default cycles
tant, and the implications for existing empir- Figure 4 on inflation and external default
ical studies on inflation and external default (1900 to 2006) illustrates the striking cor-
are so profound, that we have broken out relation between the share of countries in
our data analysis into an independent com- default on debt at one point and the num-
panion piece.8 Here, we focus on a few major ber of countries experiencing high inflation
points. The first is that contrary to much (which we define to be inflation over 20 per
contemporary opinion, domestic debt con- cent per annum). Thus, there is a tight corre-
stituted an important part of government lation between the expropriation of residents
debt in most countries, including emerging and foreigners.
markets, over most of their existence. As noted, investment banks and official
Figure 3 plots domestic debt as a share bodies, such as the International Monetary
of total public debt over 1900 to 2006. For Fund, alike have argued that even though
our entire sample, domestically issued debt total public debt remains quite high today in
averages more than 50 per cent of total many emerging markets, the risk of default
debt for most of the period. Even for Latin on external debt has dropped dramatically
America, the domestic debt share is typically because the share of external debt has fallen.
www.edit24.com
Asia, Australia, Africa
Hong Kong: +852 9144 5549 Australia: +61 (41) 271 8715 South Africa: +27 (82) 449 6333
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AS well as dealing with local anti-cor- its failure to prevent bribery by a member
ruption laws and the long reach of the of staff. The Act signals a complete reform
US Foreign Corrupt Practices Act, inter- of UK bribery law to provide a modern and
national businesses based in Asia now comprehensive scheme of offences that will
have a further compliance challenge in enable courts and prosecutors to respond
the form of new UK legislation. more effectively to bribery at home or abroad.
A question of sovereignty:
capital controls gain credence
Does the move by Jakarta and Seoul to
impose capital controls breach IMF protocols,
asks PIRC economist Kavaljit Singh.
IN June, South Korea and Indonesia forwards. Also, new ceilings have been
announced several policy measures to imposed on domestic banks and branches of
regulate potentially de-stabilising capital foreign banks dealing with FX forwards and
flows which could pose a threat to their derivatives. For Korean banks, there will be
economies and financial systems. a limit on currency forwards and derivatives
positions at 50 per cent of their equity capi-
Seoul kicked off the process on June 13 tal. For foreign banks, the ceilings will be set
when it announced a series of currency con- at 250 per cent of their equity capital, against
trols to protect the South Korean economy the current level of around 300 per cent.
from external shocks. The new currency
controls are much wider in scope than for- No-limit contracts
eign exchange liquidity controls announced Under the existing trading rules in Korea,
earlier in 2009. Jakarta quickly followed suit banks can buy FX derivatives contracts with-
on June 16 when Indonesia’s central bank out any limits. Many banks also rely heav-
deployed measures to control short-term ily on borrowings from overseas to cover
capital inflows. potential losses arising from forward trading.
The policy measures introduced by As a result of this lax policy regime, the FX
South Korea’s central bank have three major derivatives trading substantially contributed
components: restrictions on currency deriv- to the rise in short-term overseas borrow-
atives trades; enhanced existing restrictions ings and external debt during 2006-2007.
on the use of bank loans in foreign currency; Officials state that almost half of the
and, further tightening of existing regula- increase in their country’s total external debt
tions on the foreign currency liquidity ratio of US$195 billion during this year was due
of domestic banks. to the increase in FX forward purchases by
The new restrictions on currency deriva- banks. In addition to new curbs on banks,
tives trades, include non-deliverable cur- the Korean authorities have also tight-
rency forwards, cross-currency swaps and ened the ceilings on companies’ currency
derivatives trades to 100 per cent of under- establish liquidity risk management mecha-
lying transactions from the current 125 per nisms as they are a major source of FX liquid-
cent. The currency controls will come into ity. According to the Bank for International
effect from July 2010. But these will be imple- Settlements (BIS), foreign banks account for
mented in a flexible manner. A grace period the bulk – some 60 per cent – of short-term
of three months has been allowed to avoid external liabilities of all banks operating in
any sudden disruptions in derivatives trad- South Korea. Further, foreign banks are also
ing markets and banks can cover their exist- the dominant players in inter-bank borrow-
ing forward positions for up to two years if ing from abroad.
they exceed the ceilings. In addition to these policy measures,
the Korean authorities also announced the
A cause of systemic risk establishment of a headquarters inside the
With regards the enhanced restrictions on Korea Centre for International Finance to
the use of bank loans in FX, this has been regularly monitor capital flows as part of
done primarily to make sure that FX bank developing an early warning system.
loans are for overseas use only. At present, The authorities have also supported the
bank loans in foreign currency are allowed need to establish global financial safety nets
for purchase of raw materials, foreign direct through international co-operation. The
investment and repayment of debts. Only agenda of global financial safety nets will be
in certain cases can such loans be used for pursued as part of the ‘Korea Initiative’ at the
domestic use. Seoul G-20 summit to be held in November
Under the new rules, such loans will be 2010. Meanwhile, the Korean authorities
restricted to overseas use only. As an excep- have explicitly ruled out imposition of any
tion, only the small- and medium-sized financial transactions taxes, such as in Brazil,
enterprises have been allowed to use FX or unremunerated reserve requirements,
financing for domestic use, to the extent that such as in Chile.
total foreign currency loans remain within
the current levels. Fear of capital exodus
This policy measure is hugely significant The imposition of currency controls by
since excessive foreign currency bank loans the Korean authorities has to be analysed
are considered to be major sources of sys- against the backdrop of the global financial
temic risks in many emerging markets. And crisis. Despite its strong economic funda-
finally, the Korean authorities have further mentals, South Korea witnessed sudden
tightened the existing regulations on foreign and large capital outflows due to de-lever-
currency liquidity ratio of domestic banks. aging during the global financial crisis. It has
The domestic banks will monitor the sound- been reported that almost $65 billion left the
ness of FX liquidity on a daily basis and country in the five months after the collapse
report it to authorities every month. of Lehman Brothers in September 2008.
The authorities have also recommended South Korea’s export-oriented economy
that foreign banks operating in Korea also suffered badly due to contraction in
TM
Creating a culture of risk awareness.
© 2010 Global Association of Risk Professionals.
All rights reserved.
Central banking
Perspectives on regulatory
reform after the 2008 crash
Chicago Fed President Charles L. Evans is
sceptical that monetary policy alone can
deal with financial ‘over-exuberance’ .
WE are slowly emerging from the worst Federal Open Market Committee or the
financial crisis since the 1930s. The Federal Reserve System.
hardships created by these exceptional To highlight some of the changes that are
circumstances for households and busi- being considered, there are proposals that
nesses are well known. Governments would assign monetary policy a more active
and regulators around the world have role in fighting asset bubbles; proposals that
responded to the crisis with a variety of would strengthen current microprudential
aggressive and innovative policy actions, regulations; proposals that would introduce
including giving special assistance to a systemic regulator and macroprudential
specific institutions. regulations; and proposals that would create
resolution authority – particularly for sys-
Now, as we slowly emerge from the crisis, temically important financial institutions.
we are engaged in a vigorous debate on
how best to address the major weaknesses Implementation challenges
in our financial regulatory framework that Time does not permit me to discuss the spe-
were revealed by the crisis. Our goal, clearly, cifics of each of these proposals. Instead, I
is to avoid another crisis of this magnitude. would like to offer my thoughts on some of
Financial reform will not be easy. We face the challenges we are likely to face in imple-
complex problems that will require a com- menting even the most well-thought-out
prehensive, multi-pronged approach. But policies.
reform is critical for ensuring our long-term Let me be clear. I don’t bring up these
economic stability. potential challenges as roadblocks to the
Today, I would like to offer my thoughts healthy debate that is underway. Rather, I
on some of the reform proposals that are offer them as issues we need to consider as
being discussed. I should note that my we build a better financial infrastructure.
remarks reflect my own views and are not One pre-emptive action that is being
those of the Chicago Federal Reserve Bank, debated concerns the role of monetary
impacts
is subject to the l change
Who exactly financia iance and risk
t Practices Act
? Global compl
Foreign Corrup t–
managem
en
Yuet-Ming, DLA Risk manag products ails a potent
In this paper, Tham t, examines the
ement s head of det
EastNet’ David Dekker, cial markets.
consultan
Piper Hong Kong ts of the FCPA in Asia.
Of ‘Black ce, in finan
Swans’, str complian reaction
pernicious effec ess mi cal
optimise che
d risk man tests & t oth-
companies
amongs
of companies –
many of which agement will just
be one of to offer these serv ut
ices.
es by hundreds Stand signs be able k abo
nies. The US legis- rather spea moni-
n Corrupt Practic
The US Foreig beginnings in the were
Fortune 500 compa ls by even- outlines the ard & Poor’s Da we saw
the first
a year ago the financial wor is These days
ld ers
that will
we should ks, or
its ded to these scanda positive ben vid Samuel About itutions
than ban name that
Act (FCPA), has gate Specia l lature respon in 1977. efits s mat ion in
cred it cris ncia l inst ider s, a
testing on of bank stress
when the Water the FCPA sfor the at fina prov
Watergate era, tually enacting to the of a tran months l world l service re activities ed
.
volun tary disclo- two main provisions in the last ncia tore d financia and futu
Prosecutor called
for
made There are
ibery provisions,
and the It is a big the bottom and
sformed
the fina
nge that
is
rs their curr
ent
dly we
have mov
nies that had FCPA – the anti-br Both the SEC and the challenge line. has tran the cha than cove k at how rapi banks
sures from compa to Richard a robust for banks ve pace. in scope Loo on the
contributions accounting provisi
ons. app
of worst-ca roach to managin
to build an explosi much broader e interaction ration) to
questionable of Justice (DOJ)
have juris-
g the risk downturn capital g is that wer physical rs of ope
ential campaign. US Department se
by definitio stress scenarios that occurrin expected. banks fall from (location and hou Internet banking
.
Nixon’s 1972 presid the FCPA. Generally,
the SEC
n, ,
uncover risk adequacy
prog inal ly big to fail or term s ts then but
over are alm conc ram rge,
d diction provisions and unlikely trigg ost
or unprece ered by apparently encies, and; applying
entrations
and risk depe to
s orig to be too g taken over by electronic paymen were still in cha
ver, these disclosures reveale prosec utes the accounting t issuers den nd- con sidered or bein fina n- ban ks shif ting to a
payments to thes ing re is
Howe
nable domestic provisions as agains dings ted events. drive busi
ness selec e improvements are either
fail are mo Again the digm cor-
not just questio elled the anti-bribery istrative procee How thro ugh tion inst itut ions that hug e para- tion ed the para l persons and
chann ever – for exam l a men sica ks
that had been h civil and admin ,
fying the risk solving the problem
perf
adjusted prici ormance analysis ple, financia lting in by as re we (phy r without the ban
but illicit funds business. throug utes companies
and nd, resu regarded world whe such as
ments to obtain as the DOJ prosec concentration of identi- ng that take and cially sou banks are s) pay each
othe
to foreign govern investi- where ibery provisions cies that give s and depe into account. s stress test risk- t in how poration new tech
nologies
led to subsequent uals for the anti-br rise to wor nden- results digm shif er banks. ent with
The information Exchange individ dings. vital if the st-case outc lic and oth involvem
US Securities and h criminal procee indu
vidual bank stry is to thrive –
omes is the pub around payments.
gations by the reveale d that throug s and Top-level
oversight ely revo lves mob ile
Commission (SEC)
which
to past two year are to turn the lesso if indi- Building king larg omers, los-
kept “slush funds” l The anti-bribery provision s to competit ns of a more robu Since ban ity to service cust viders nisations
many US issuers ibery provision
makes it Banks that ive advantag the process for st and com the abil the impact work pro ks and orga r pay-
officials and politica The FCPA’s anti-br tackle the e. uncoverin prehensive trust and determining oing risk Net future the ban
pay bribes to foreign money or anythi
ng be lauded
by investors issue head-on will prise is clearly, in part threats to the ente
g omer and A and othe iders
offer or provide ing a cust of the ong well as In the SWIFT, NACH ork prov B
parties. ary illegal to officials (“foreign”
mean- coming year and ance challeng , a corporat r- uld be partOpiniotion n , as as me netw
up with a volunt s of industry regulators in the e.The boar e govern- of it, sho t of the organisa new such orks beco money from A to
The SEC later came of value to foreign or most imp
mme under which any cor- S”) with the intent to obtain ortantly, will recuperation
and,
must have
the mot
d and top
exec utive man age men
ines s of existing and ying ment netw to sen d ork traf-
“non-U ss to ivation and you
disclosure progra payments ing directing busine tained profi be able to
deliv scrutinise s ng the risk rs using/bu s that allow for the netw ilari-
self-reported illicit business, or for tability gain
s. Meanwh er sus- able activ
and call a
halt to appa
the clout
to monitori custome nge charge you This brings sim
poration which was given retain that are well
rently profi and the more cha and will erate. , energy
with the SEC placed to ile, banks ities if thes products there are
-regulation
. ld that are fic that you gen such as telecom
and co-operated likely any person of value can include sponsor- consolida take adva
ntage of the term interests of
e are not t- ucts. But
Deregulation, non
nce that it would tion in
the enterpris the longer- these prod king wor s ncial
an informal assura Anything of a holi- can understa process need to be the intended in the ban
have kno
wn it. industrie ies. The fina
action. The result education, use e or do not challenges ties with e compan an important
and ‘desupervision’
ement for travel and , nd the risks sure they risk profi fit and as we be the cabl
enforc yment portfolios ing banking the future, not and
be safe from USD$300 ship of future emplo of potential embedde But contrary le of the orga suppliers rly undergo
ing
the disclosure that more than mas- day home, promise There is no To acqu isitio
d in the
ing corp
to popular
opin
nisation. threaten
ks will , in e our funds, ld is clea
was (a meals. improve ns. orate The ban ch to mov wor
nable payments nts, drinks and and strengthe enterprise risk man tion of putt governance is not
ion, improv-
icles by whi and folios; they 135
million in questio been made discou just veh ines the port
the 1970s) had n investor confi agem ent boar ing a ques- Black exam
defa ult nces
Professor William maintainepide
the ‘right’
sive amount in bank
147 s can take the lead dence, we d members executives our bala
Better boar in three relat think appropri in plac
ate incentive e and giving them
and
age fraud mic that North Asia
causes of the mortg
Asia d and seni ed areas: & Risk
ation & Risk North s. ulation .
l of Regd States
sight and or executive For the bank
Journal of Regul agement;
control of
ente over- sion to make has sweptJou the rnaUnite
re-invigorated rprise risk man s when
they the right
deci-
- business are
stress testi
ng and growth look difficult, e.g. whe
or when s n
Journal of risk managemgood in the upturn, demonstrate three
criti-
Regulation
& Risk Nor ent looks and they implicitly wholesale
expensive paper is a leading regulation and a
th Asia THE author of this g cal failures of e of fraud
and former bankin of private market disciplin Financial
academic, lawyer ‘white collar’ failure
r specialising in credit risk. The
and other forms of
163regulato one of the unsung heroes of the Enforcement Networ
k (FinCEN)
crime. As 1980s, Crimes us
debacle of the week on Suspicio
Savings & Loans released a study this
ys spends much that federally regu-
Professor Black nowada why financial Activity Reports (SARs) (sometimes) file
ing ns
of his time research lated financial institutio of Investigation
y to become dys- Bureau
markets have a tendenc his theory on with the Federal mortgag e
ned for evidence of
functional. Renow (FBI) when they find
Black lectures at the
‘control fraud’, Prof. fraud.
ri and Kansas City.
University of Missou Rob
‘The Best Way to
He is the author of Epidem ic warning
One: How Corpora
te of an “epidem of ic”
a Bank is to Own The FBI began warning
ans Looted the in their congressional
testi-
Executives and Politici nta- mortgage fraud years
S&L Industry.’ A
prominent comme ber 2004 – over five
l mony in Septem if the epidemic were
of the current financia It also warned that
tor on the causes of the ago. l cri-
crisis, Prof. Black
is a vocal critic it would cause a financia
has handled the not dealt with e was done to
Contact
ent remotely adequat
way the US governm ions sis. Nothing
g crisis and rewarded institut to the epidemi c by regulators, law
bankin y respond sector “market dis-
failed in their fiduciar enforcement, or private
that have clearly d and
epidemic produce
duties to investors. cipline.” Instead, the
in US housing prices
hyper-inflated a bubble
tary does not nec- a crisis so severe that
it nearly
Christopher Rogers
The following commen of that produced l
view of the Journal of the global financia
essarily represent the caused the collapse bailouts of
– North Asia. dented
Regulation and Risk system and led to unprece
s on criminal refer- largest banks.
“The new number many of the world’s
in the US are just in
rals for mortgage fraud
Editor in chief
33
Asia
ion & Risk North
Journal of Regulat
christopher.rogers@irrna.org
Regulation or prohibition:
the $100 billion question
Andrew G. Haldane,Executive Director,
Financial Stability, Bank of England,
examines the social costs of systemic risk.
The car industry is a pollutant. Exhaust Public policy has long-recognised the
fumes are a noxious by-product. costs of systemic risk. They have been tack-
Motoring benefits those producing and led through a combination of regulation and,
consuming car travel services – the pri- at times, prohibition. Recently, a debate has
vate benefits of motoring. But it also begun on direct restrictions on some bank-
endangers innocent bystanders within ing activities – in other words, prohibition.
the wider community – the social costs of This is recognition of the social costs of sys-
exhaust pollution. temic risk. Bankers are in uproar.
This paper examines the costs of bank-
Public policy has increasingly recognised the ing pollution and the role of regulation and
risks from car pollution. Historically, they restrictions in tackling it. In light of the crisis,
have been tackled through a combination this is the US$100 billion question. The last
of taxation and, at times, prohibition. During time such a debate was had in earnest fol-
this century, restrictions have been placed on lowed the Great Depression. Evidence from
poisonous emissions from cars – in others then, from past crises and from other indus-
words, prohibition. This is recognition of the tries helps define the contours of today’s
social costs of exhaust pollution. Initially, car debate.This debate is still in its infancy. While
producers were in uproar. it would be premature to be reaching policy
The banking industry is also a pollut- conclusions, it is not too early to begin sifting
ant. Systemic risk is a noxious by-product. the evidence. What does it suggest?
Banking benefits those producing and
consuming financial services – the private Systemic costs
benefits for bank employees, depositors, One important dimension of the debate
borrowers and investors. But it also risks concerns the social costs of systemic risk.
endangering innocent bystanders within the Determining the scale of these social costs
wider economy – the social costs to the gen- provides a measure of the task ahead. It
eral public from banking crises. helps calibrate the intervention necessary to
Table 2. Average ratings difference for a sample of banks and building societies
2007 2008 2009 Average (2007–09)
that a crisis occurs every two decades, the than measure. But one particularly simple
systemic levy needed to recoup these crisis proxy is provided by the rating agencies, a
costs would be in excess of $1.5 trillion per number of whom provide both “support”
year. The total market capitalisation of the and“standalone”credit ratings for the banks.
largest global banks is currently only around The difference in these ratings encompasses
$1.2 trillion. Fully internalising the output the agencies’ judgment of the expected gov-
costs of financial crises would risk putting ernment support to banks.
banks on the same trajectory as the dino-
saurs, with the levy playing the role of the Hidden government support
meteorite. Table 2 looks at this average ratings differ-
It could plausibly be argued that these ence for a sample of banks and building
output costs are a significant over-statement societies in the UK, and among a sample of
of the damage inflicted on the wider econ- global banks, between 2007 and 2009. Two
omy by the banks. Others are certainly not features are striking. First, standalone rat-
blameless for the crisis. For every reckless ings are materially below support ratings, by
lender there is likely to be a feckless bor- between 1.5 and four notches over the sam-
rower. If a systemic tax is to be levied, a more ple for UK and global banks. In other words,
precise measure may be needed of banks’ rating agencies explicitly factor in material
distinctive contribution to systemic risk. government support to banks.
One such measure is provided by the Second, this ratings difference has
(often implicit) fiscal subsidy provided to increased over the sample, averaging over
banks by the state to safeguard stability. one notch in 2007 but over three notches by
Those implicit subsidies are easier to describe 2009. In other words, actions by government
2007
Large banks 2.67 12 1
Small banks 0.14 1 0
2008
Large banks 2.78 10 1
Small banks 0.86 2 0
2009
Large banks 4.67 7 3
Small banks 3.43 6 0
Average (2007–2009)
Large banks 3.37 10 2
Small banks 1.48 3 0
(a) The ‘Large’ category includes HSBC, Barclays, RBS, Lloyds TSB, Alliance & Leicester and Bradford & Bingley (up to 2008), and Nationwide. The
‘Small’ category includes building societies: Chelsea, Coventry, Leeds, Principality, Skipton, West Bromwich and Yorkshire.
The ratings are year-end.
Source: Moody’s and Bank calculations.
during the crisis have increased the value into a monetary measure of the implied fis-
of government support to the banks. This cal subsidy to banks. This is done by map-
should come as no surprise, given the scale ping from ratings to the yields paid on banks’
of intervention. Indeed, there is evidence bonds;6 and by then scaling the yield dif-
of an up-only escalator of state support to ference by the value of each banks’ ratings-
banks dating back over the past century.5 sensitive liabilities.7 The resulting money
amount is an estimate of the reduction in
‘Too big to fail’ problem banks’ funding costs which arises from the
Table 3 takes the same data and divides perceived government subsidy.
the sample of UK banks and building soci- Table 4 shows the estimated value of
eties into “large” and “small” institutions. that subsidy for the same sample of UK
Unsurprisingly, the average rating difference and global banks, again between 2007 and
is consistently higher for large than for small 2009. For UK banks, the average annual
banks. The average ratings difference for subsidy for the top five banks over these
large banks is up to five notches, for small years was over £50 billion – roughly equal to
banks up to three notches. This is pretty UK banks’ annual profits prior to the crisis.
tangible evidence of a second recurring phe- At the height of the crisis, the subsidy was
nomenon in the financial system – the “too larger still. For the sample of global banks,
big to fail”problem. the average annual subsidy for the top five
It is possible to go one step further and banks was just less than $60 billion per year.
translate these average ratings differences These are not small sums.
Sample
Global 37 220 250 169
Total
Total 18 83 71 57
Big 5
Average 4 0 17 1 14 1 12 1
See footnotes for tables 2 and 3 for details on sample.
Source: Moody’s, Bank of America Merrill Lynch, Bankscope published by Bureau van Dijk Electronic Publishing and Bank calculations
Table 4 also splits UK banks and building has widened during the crisis. They calcu-
societies into “Big 5”, “medium” and “small” late an annual subsidy for the 18 largest US
buckets. As might be expected, the large banks of over $34 billion per year. Applying
banks account for more than 90 per cent of the same method in the UK would give an
the total implied subsidy. On these metrics, annual subsidy for the five largest banks of
the too-big-to-fail problem results in a real around £30 billion.
and ongoing cost to the taxpayer and a real
and ongoing windfall for the banks. If it were Banking pollution
ever possible to mint a coin big enough, This evidence can provide only a rough
these would be the two sides of it. guide to systemic scale and cost. But the
These results are no more than illus- qualitative picture it paints is clear and con-
trative – for example, they make no allow- sistent. First, measures of the costs of crisis,
ance for subsidies arising on retail deposits. or the implicit subsidy from the state, suggest
Nonetheless, studies using different meth- banking pollution is a real and large social
ods have found similarly sized subsidies. For problem. Second, those entities perceived to
example, Baker and McArthur ask whether be “too big to fail” appear to account for the
there is a difference in funding costs for US lion’s share of this risk pollution. The public
banks either side of the $100 billion asset policy question, then, is how best to tackle
threshold – another $100 billion question.8 these twin evils.
They find a significant wedge in costs, which To date, the public policy response has
(a)
Chart 1. Average assets relative to GDP of US commercial banks
0.014
0.012
Average Assets per Commercial Bank as a a
percentage of Nominal GDP
0.010
0.008
0.006
0.004
0.002
0.000
34
38
42
46
50
54
58
62
66
70
74
78
82
86
90
94
98
02
06
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
Year
(a) Blue vertical line represents the 1982 Garn-St Germain Act, green vertical line represents the 1994 Riegle-Neal
(a) Blue vertical line represents the 1982 Garn-St Germain Act, green vertical line represents the 1994 Riegle-Neal Act,red vertical line
represents the Riegle-Neal Act coming into effect in 1997.
Act,
red vertical
Source: FDIC andline represents the Riegle-Neal Act coming into effect in 1997.
www.measuringworth.org
Source: FDIC and www.measuringworth.org
costs at the time. Kennedy (1973) describes Glass and Steagall made just such a distinc-
how“Stock dealings which had made bank- tion. They underpinned it with legislation,
ers rich and respected in the era of afflu- signed by President Roosevelt in June 1933.
ence now glared as scarlet sins in the age of As with McFadden, Glass-Steagall
depression. appears to have been effective from the
1930s right up until the latter part of the
Embittered public 1980s. Measures of concentration in the
Disillusionment with speculators and secu- US banking system remained broadly flat
rities merchants carried over from invest- between the 1930s and the late 1980s (Chart
ment bankers to commercial bankers; the 2). But competitive pressures were build-
two were often the same, and an embittered ing from the late 1970s onwards. Strains
public did not care to make fine distinctions”. on US commercial banks intensified from
45.00
Total assets of top 3 US banks (as % of total com m ercial
40.00
35.00
banking sector assets)
30.00
25.00
20.00
15.00
10.00
5.00
0.00
1935 1939 1943 1947 1951 1955 1959 1963 1967 1971 1975 1979 1983 1987 1991 1995 1999 2003 2007
(a)
(a) Red line
Red represents
line the Gramm-Leach-Bliley
represents Act (1999) which
the Gramm-Leach-Bliley revoked
Act restrictions
(1999) which of Glass-Steagall
revoked restrictions of Glass-Steagall
(b)
Top 3 banks by total assets as a % of total banking sector assets
(b) Top
(c)
3 banks by total assets as a % of total banking sector assets
Data includes only the insured depository subsidiaries of banks to ensure consistency over time — for example, non-deposit subsidiaries
(c) Data
are notincludes
included. only the insured depository subsidiaries of banks to ensure consistency over time - for example,
non-deposit subsidiaries are not included.
Source: FDIC
alternative
Source: FDIClending vehicles (such as mutual and dramatic. The share of the top three
funds and commercial paper markets) and largest US banks in total assets rose fourfold,
Chart 3. Largest
from overseas UKThe
banks. company’s
private costsassets
of in each
from sector
10 per cent torelative to between
40 per cent GDP 1990
restrictions were rising. and 2007 (Chart 2). A similar trend is dis-
Legislators responded. After 1988, secu- cernible internationally: the share of the top
Per cent
rities affiliates within BHCs were permitted, five largest global banks in the assets of160
the
though were still subject to strict limits. In largest 1,000 banks has risen from around
1999, the Gramm-Leach-Bliley Act revoked 140
eight per cent in 1998 to double that in 2009.
the restrictions of Glass-Steagall, allowing 2007 120
co-mingling of investment and commercial Massive growth of banks
2000
banking. This came as a specific response to This degree of concentration, combined with
100
the perceived high private costs of restric- the large size of the banking industry rela-
tions relative to the perceived social benefits tive to GDP, has produced a pattern which80is
– again, in a reversal of the Weitzman calcu- not mirrored in other industries. The largest
lus from the early 1930s. 60
banking firms are far larger, and have grown
As with size, the effects of liberalisation far faster, than the largest firms in other
40
on banking concentration were immediate industries (Chart 3). With the repeal of the
20
Journal of Regulation & Risk North Asia
0 109
ng
ce
gy
s.
ng
es
ail
gy
ia
non-deposit subsidiaries are not included.
Source: FDIC
Per cent
160
140
2007 120
2000
100
80
60
40
20
0
Banking
Insurance
Oil/Energy
Telecomms.
Mining
Utilities
Pharm.
Retail
Technology
Media
Source: Bureau van Dijk Electronic Publishing, International Monetary Fund and Bank calculations.
Source: Bureau van Dijk Electronic Publishing, International Monetary Fund and Bank calculations.
McFadden and Glass-Steagall Acts, the too- robustness and incentives. Each has a
big-to-fail problem has not just returned but potentially important bearing on systemic
flourished. resilience and hence on the social benefits of
In the light of the Great Recession, and restrictions.
the large apparent costs of too-big-to-fail,
does Weitzman’s cost-benefit calculus sug- (a) Modularity
gest there is a case for winding back the clock In 1973, Nobel-prizing winning economist
to the reforms of the Great Depression? Robert Merton showed that the value of a
Determining that requires an assessment of portfolio of options is at least as great as the
the benefits and costs of restrictions. value of an option on the portfolio.15 On the
face of it, this seems to fly in the face of mod-
Benefits of prohibition ern portfolio theory, of which Merton him-
The potential benefits of restricting activity self was of course one of the key architects.
in any complex adaptive system, whether Whatever happened to the benefits of port-
financial or non-financial, can roughly be folio diversification?
grouped under three headings: modularity, The answer can be found in an unlikely
Source: FDIC
Per cent
160
140
2007 120
2000
100
80
60
40
20
0
Banking
Insurance
Oil/Energy
Telecomms.
Mining
Utilities
Pharm.
Retail
Technology
Media
Source: Bureau van Dijk Electronic Publishing, International Monetary Fund and Bank calculations.
Source: Bureau van Dijk Electronic Publishing, International Monetary Fund and Bank calculations.
source – Al’Qaeda. Although the precise undermining the operations of other cells is
organisational form of Al’Qaeda is not severely reduced. That, of course, is precisely
known with certainty, two structural char- why Al’Qaeda has chosen this organisa-
acteristics are clear. First, it operates not as tional form. Al’Qaeda is a prime example of
a centralised, integrated organisation but modularity and its effects in strengthening
rather as a highly decentralised and loose systemic resilience.
network of small terrorist cells. Second, as There are many examples from other
events have shown, Al’Qaeda has exhibited industries where modularity in organi-
considerable systemic resilience in the face sational structure has been deployed to
of repeated and ongoing attempts to bring enhance systemic resilience. Computer
about its collapse. manufacture is one. During the late 1960s,
These two characteristics are closely con- computers were highly integrated systems.
nected. A series of decentralised cells, loosely Gradually, they evolved into the quintes-
bonded, make infiltration of the entire sential modular system of today, with dis-
Al’Qaeda network extremely unlikely. If any tinct modules (CPU, hard disk, keyboard)
one cell is incapacitated, the likelihood of this which were replaceable if they failed without
2.0% 2.0%
R2 = 0.013
R = 0.0857
2
1.5% 1.5%
1.0% 1.0%
0.5% 0.5%
0.0% 0.0%
0 1,000 2,000 3,000 4,000 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7
Average assets ($m) Diversification
Notes: Average assets are calculated for 24 banks between 2006 and 2008. Income Notes: Pre-crisis diversification and income volatility for a sample of 25 banks.
volatility is measured as the standard deviation of operating income (per asset) over Diversification index based on revenue concentration, as described in the main text.
the period 1997-2008. Source: Bankscope, published accounts and Bank calculations.
Source: Bankscope, published accounts and Bank calculations.
Chart 6. Bank size and write downs Chart 7. Bank diversification and write downs
Write 7% Write 7%
downs per downs per
asset 6% asset 6%
5% 5%
4% 4%
R2 = 0.0009 R2 = 0.0919
3% 3%
2% 2%
1% 1%
0% 0%
0 1,000 2,000 3,000 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7
T otal Assets ($bn) Diversification
Notes: Total assets for a sample of 21 banks for 2007. Cumulative write downs over Notes: Sample of 21 banks. Cumulative write downs over the course of the crisis are
the course of the crisis are shown (from 2007 Q4 to 2009 Q3). shown (from 2007 Q4 to 2009 Q3).
Source: Bankscope, published accounts and Bank calculations. Source: Bankscope, published accounts and Bank calculations.
This can be seen in the relationship between ought to make banks less prone to idiosyn-
diversification on the one hand and diversity cratic risk to their asset portfolio. In the limit,
on the other.18 The two have quite different banks can completely eradicate idiosyncratic
implications for resilience. risk by holding the market portfolio. The
In principle, size and scope increase the “only” risk they would face is aggregate or
diversification benefits. Larger portfolios systematic risk.
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IN this paper, the authors look at the participant in the financial system, from the
shortcomings of academic thinking on individual investor through banks and bro-
financial risk management – a very topi- kers up to central banks, needs to think of a
cal subject. Economists have drifted into three-level analysis of risk:
realms of sterile, quasi-mathematical and 1. At the level of the individual financial
a priori theorising instead of coming to instrument;
grips with the realities of their subject. In 2. at the level of a financial institution hold-
this sense, they have stood conventional ing diverse instruments;
scientific methodology, which develops 3. at the level of the system of financial
theories to explain facts and tests them institutions.
by their ability to predict, on its head. A financial instrument might be a credit
card or a residential mortgage or a small
Not surprisingly this behaviour has carried business loan. In the US, risks in many such
over to the field of risk management, with instruments have been intensively studied
an added twist. Like the joke about the man and have proven moderately predictable
who looks for his dropped keys under the in large pools. For example, a useful rule
street light because that is where the light of thumb is to equate the default rate on
is rather than where he dropped the keys, national pools of seasoned credit card bal-
financial economists have focused on things ances to the national unemployment rate.
that they can ‘quantify’ rather than on things A financial institution holding a diverse
that actually matter. portfolio of such instruments might be a
The latter include the structure of the bank that originates them and retains all or
financial system, the behaviour of its par- some, or an investing institution like a pen-
ticipants, and its actual ability to capture and sion fund or a hedge fund or an insurance
aggregate information. company (or, indeed, an individual investor
The recent (and indeed on-going) with a personal portfolio).
financial crisis has made it clear that every The system of financial institutions is the
RISK management has been the topic on the messages and are acting accordingly to
everyone’s lips since late 2007. Why did minimise any risky practices?
risk management practices not prevent
the “credit crunch”? What could have The ‘Walker Review’
been done better? In July last year the UK Treasury released
the ‘Walker Review’. This went for prelimi-
The simple answer is that, whilst risk man- nary public response and was re-released
agement was being applied at the lower in November. In January the FSA (the UK
levels of financial institutions, it was being regulator), released a discussion paper
largely ignored at the top level. Tools and based on the Walker Review. Comments
techniques could have been better, and are were closed on April 28 and Prudential
being improved, but there is no point install- Handbook rule changes are expected in Q3
ing an expensive security alarm system, then 2010. The UK’s Financial Reporting Council
switching off the bell because it keeps going (FRC) consulted on whether to include the
off; that makes too much noise and spoils Walker recommendations in the Combined
your partying! Code on Corporate Governance (Combined
Regulators and governments are now Code) for all UK listed companies. Feedback
realising this and, worldwide, are formulat- closed in March and recommendations are
ing rules, restrictions and regulations which expected in Q3.
are forcing senior individuals in banks, i.e. I have approached this article from the
executive and non-executive board mem- point of view of risk in financial institutions.
bers, to understand the risk messages. However, the relevant responsibilities of
Does the current generation of board non-executive directors in all organisations
members have the knowledge, the capacity, – financial or non-financial, commercial or
the training to both manage the alarm sys- not-for-profit, can be said to revolve around
tem and to assure the regulator, the visiting two issues, these being: the risks involved in
policeman that, yes, they fully understand carrying out their necessary activities; and
THERE is substantial evidence that the the rationale for the rescue of Bear Stearns,
cause of the financial crisis was noth- evolved into the narrative for explaining the
ing more complicated than a buildup of chaos that followed Lehman’s collapse.
weak and high–risk mortgages in the US With this narrative generally accepted,
financial system – mostly the result of US the Obama administration’s regulatory plan
government policy to expand home own- inevitably followed.
ership.[1] Too little regulation was not a In his bestselling book, The Big Short,
major factor. Under these circumstances, Michael Lewis begins his description of
substantial changes in US government the derivatives market with this quote
housing policy – particularly with respect from Leo Tolstoy: “The most difficult sub-
to Fannie Mae and Freddie Mac – would jects can be explained to the most slow–
have been the most effective way to pre- witted man if he has not formed any idea
vent a recurrence of financial crisis. of them already; but the simplest thing
cannot be made clear to the most intelli-
Yet the debate over financial regulation in gent man if he is firmly persuaded that he
Congress became a contest between those knows already, without a shadow of doubt,
who want the government to have more what is laid before him.”[2]
control of the financial system and those
who want it to have less. Considering the Power of narrative
legislation that came out of both houses, Although Lewis did not cite it for this pur-
the United States is well on its way to tak- pose, Tolstoy’s remark is a perfect descrip-
ing down the most innovative and successful tion of the power of narrative in the modern
financial system the world has ever known. day. Once a narrative about a public issue
This happened because an erroneous idea becomes accepted, it is virtually impos-
– that large, non–bank financial institu- sible to change; facts that support it are
tions are too “interconnected” to fail – ini- reported by the media, but contrary facts
tially adopted by the Bush administration as are ignored. So it has been with the notion
Issues in resolving
systemically important
impacts
financial institution
s
l change
Resecuritisation Dr Eric S. Rosengren
in banking: major
Global
funding liquidity Dr Fang Du
in times of financial
comp Housing, monetary crisis
and fiscal policies: Dr Ulrich Bindseil
– ent from bad to worst
managem
Derivatives: from
disaster to re-regulat Stephan Schoess,
products ails a potent ion
head of det
Black swans, market Professor Lynn A. Stout
EastNet’s David Dekker,
crises and risk: the
rkets. human perspectiv
ncial ma Measuring & managing e
nce,
complia al reaction in fina
risk for innovative Joseph Rizzi
financial instrumen
Red star spangled ts
chemic banner: root causes Dr Stuart M. Turnbull
of the financial crisis
oth-
The ‘family’ risk: Andreas Kern & Christian
es amongst ces. a cause for concern Fahrholz
compani among Asian investors
be one of to offer these servi Global t financial change impacts complianc
will just David Smith
signs be able speak abou e and risk
we saw
the first ld ers
that will ld rather Thei-scramble is on
mon Opinion
we shou banks, or that to tackle bribery David Dekker
a year ago the financial wor s These days ns than
and corruption
About mation in it crisi institutio , a nameWho exactly is subject to the Penelope Tham & Gerald
of a tran
sfor
months
the cred
world at
finan cial
financial
service prov iders
e activities.
Foreign Corrupt Practices
Act? Deregulatio Li
and in
the last
the financial that is tored curre
Financial
nt and futur have moved markets remuneration reform: one Tham Yuet-Ming n, non-regu
and ‘desup lation
sformed ge rs their ly we s step forward
has tran . the chan than cove how rapid n on the Ofbank ‘Black Swans’, stress tests Umesh Kumar & Kevin
osive pace in scope Look at interactio ) to & optimised risk Marr
an expl
is much
broader
occurring expected. banks
that were from physical hours of
operation
Challenging the
ing. value of enterprise
management
David Samuels ervision’
fail or fall s (location and Inter net bank risk management
Professor
causes of the William Black exam
ly to ents then
original too big by term Rocky but
charge, road ahead for global accountancy convergen Tim Pagett & Ranjit
ed to be being taken over - electronic paym s were still in
Jaswal
consider ng or ing to aregulatory ce
mortgage frau ines the
n the bank paradigm is shift Asian
The
either faili more finan Rubik’s Cube Dr Philip Goeth
are that are
ns - Agai
para the d and cor-
ons d epidemic
institutio a huge mentione sical pers s has swept that
financial d, resulting in by as
Alan Ewins and Angus
regarded re we (phy r without the bank Ross the Uni
cially soun how banks are world whe othe such as THE autho ted States.
t in ) pay each nologies r of this
digm shif r banks. porations new tech academic, paper is a
lic and othe ent with lawyer and leading
the pub involvem ents. regulator former bank and they implic
around speci itly demonstrat
ly revolves mobile paym crime. As one alising in ‘white
ing cal
failures of e three criti-
e bank ing large custo mers, los- of the unsu collar’ failure regulation
and a whole
Contact
Sinc ce s ions Savings & ng of private mark
y to servi ct ider nisat Loans debac heroes of the and sale
the abilit ing the impa ork prov s and orga r pay- et discipline
trust and determin risk Netw future the bank and othe
Professor
Black nowa le of the 1980s, Crime
other forms of fraud
mer and ongoing the NACHA
of credit risk.
ing a custo be part of the as In SWIFT, providers of his time days spend s Enforceme The Financial
ld ion, as well such as become
network
A to B
researchin s much
released nt Network
of it, shou of the organisat markets have g why finan
cial Activi a study this week on
(FinCEN)
ent ing and new ment networks send money from traf- a tendency
managem ess of exist ying to ork functional
. Renowned to become dys- lated Reports (SARs) that
ty Suspicious
g the riskin using/bu allow you you for the netw
monitorin customers ges that ge s similari- ‘control fraud for his theor financial institu federally regu-
and the more chan will char This bring energy ’, Prof. Black y on with tions (some
products But there are d that are and you generate. telecom, University
of Missouri lectures at
the (FBI)
the Federal
Bureau of
times) file
ucts. worl fic that as
these prod s in the banking stries such financial He is the autho and Kansas when they Investigatio
enge known it. with indu panies. The r of ‘The Best City. find evidence n
chall we have ties com important a Bank is Way to Rob fraud. of mortgage
Christopher Rogers
and as the cable
g banking e, not be liers and rgoing an to Own One:
threatenin s will, in the futur our funds, supp is clearly unde Executives
and Polit
How Corpo
The bank by which to mov
e
; they
world S&L Indus icians Loote rate Epidemic warn
cles portfolios 135 try.’ A prom d the The ing
default vehi balances and tor on the
causes of
inent comm FBI
enta- mortg began warning of an
our the current
maintain crisis, Prof.
Black is a financial age fraud in “epidemic”
of
Nor th Asia way the US vocal mony in September
their congr
ession
Risk critic of the al testi-
lation & governmen ago. It also 2004 – over
of Regu banking crisis t has hand five years
Journal and rewar led the
not dealt with
warned that
if the epide
that have ded institution it would cause mic were
clearl
duties to inves y failed in their fiduc s sis. Nothing remot a financial
Editor in Chief
tors. iary respo ely cri-
nd to the epide adequate was done to
enforcemen mic by regula
The following t, or tors, law
essarily repres commentary
does cipline.” Instea private sector “mark
ent the view not nec- hyper d, the epidemic produ et dis-
Regulation of the Journa -inflated a ced and
and Risk – l of that bubble in US
“The new North Asia. produced a housing prices
numbers on crisis so severe
rals for mortg criminal refer- caused the collapse that it nearly
age fraud in system of the global financ
the US are
just in many and led to unpreceden ial
of the world ted bailouts
christopher.rogers@irrna.org
Journal of ’s largest banks of
Regulation .
& Risk North
Asia
33
ON July 30, 1998, Alan Greenspan, in relation to derivatives from being debated
then chairman of the Federal Reserve, and dealt with.
argued that: “Regulation of derivatives Based on surveys conducted by the Bank
transactions that are privately negoti- of International Settlements (BIS), the global
ated by professionals is unnecessary.” In derivative market as at June 2009 totalled
October 2008, the now former chairman US$605 trillion in notional amount – in June
grudgingly acknowledged that he was this year it is guesstimated that the figure is
“partially” wrong to oppose regulation between $650 billion to $700 billion depend-
of credit default swaps (CDS). “Credit ing on which source is utilised, but still below
default swaps, I think, have serious prob- its 2008 high.
lems associated with them,” he admitted
to a Congressional hearing. His current OTC v. exchange trades
views on wider derivative regulation This is a large increase in size from less than
remain unknown. $10 trillion 20 years ago. The bulk of the
activity takes place in the over-the-counter
Politicians and regulators globally are cur- (OTC) market where derivatives are traded
rently busy drafting laws to regulate deriva- privately and on a bilateral basis between
tives. A common theme underlying the banks and clients. The OTC market should
activity is an absence of knowledge of the be contrasted with the exchange-traded
true operation of the industry and the mat- market where relatively standardised prod-
ters that need to be addressed. As Goethe ucts are traded on formalised, regulated
observed: “There is nothing more frighten- exchanges.
ing than ignorance in action.” The outstanding amount compares
The author Thomas Pynchon warned:“If to global gross domestic product (GDP)
they can get you to ask the wrong questions of around $60 billion. As author Richard
then the answers don’t matter.” Simplistic Duncan points out in his 2009 book, The
causes and solutions may prevent real issues Corruption of Capitalism, the outstandings in
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Asia, Australia, Africa
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email: ian@edit24.com email: fiona@edit24.com email: remo@edit24.com
Sources: Bank of England, Bank of Japan, European Central Bank, US Federal Reserve
Source: Bloomberg
created too many inflationary forces due to that Greece’s current woes could result in the
the fact that a large proportion of the funds implosion of the Euro and the collapse of the
have been utilised to restore commercial EMU which poses a significant risk not only
banks balance sheets in order to prevent a to Europe, but to the global economy itself
deflationary rout – although it remains to be as highlighted by Fahrholz and Kern in 2009
seen if such actions will result in inflationary and Fell in 2010.
pressures. However, fiscal problems have The current Euro and Greek crisis thus
already surfaced in some economies, with begs four important questions, namely:
many of these adopting austerity measures What are the roots of the current Greek
to prevent a sovereign debt run in the mar- problems within EMU? What is the short-
kets and as such, now threaten the nascent term response of EMU countries to such a
global recovery as countries cut back on Greek-type crisis? What does the Greek
expenditure. crisis tell us about the construction of the
Nowhere is this currently better illus- EMU? What should be done to safeguard
trated than in the European Union, specifi- the EMU and the euro in the long-run?
cally the Euro bloc of nations, with one of its With regard to the first question, it is
own members, Greece, verging on the brink important to note that while the global crisis
of a sovereign debt default – this despite mas- has been a trigger, the Greek problems are
sive European Central Bank interventions. primarily home-grown. Accor ding to the
Many commentators have even suggested latest European Statistical Office estimates,
TO the uninitiated, ‘Repo 105’ evokes the A repurchase agreement or “repo” is a two-
name of a basic finance course or perhaps part arrangement. The seller (borrower of
an expensive perfume. However, the cash) agrees to sell securities at a slight dis-
broader implication of Lehman’s corrupt count to a buyer (lender of cash). Under that
accounting strategy is neither simple nor same agreement, the borrower agrees to buy
does it pass the smell test. The term Repo them back at a future date at a higher price[4].
105, floated through financial circles in The securities are known as “collateral.”The
March 2010, with the release of the exam- discount is known as the margin or“haircut”
iner’s report in the Lehman bankruptcy.[1] and the ratio between the increased price
Volume three of a 2,200 page document, and original price is known as the rate.
claimed that management used account-
ing tricks to mask US$50 billion in debt. Oiling Wall St’s wheels
Repos have been called the“oil in the indus-
While hiding $50 billion off balance sheet is try of Wall Street”[5] because investment
nothing to sneeze at, ‘Repo 105’ may be an banks financed up to 50 per cent of their
unfortunate distraction. Instead, we should assets in the repo markets.[.6] One analyst
focus on the perfectly legal, yet dangerous noted that“repo markets are only one chan-
use of repos backed by securitised bonds to nel linking the “shadow banking” sector to
grow balance sheets. the broader economy”.[7] Given its size and
This practice, expanded by a 2005 legal importance, the repo market is surprisingly
change, destabilised the financial sector and obscure.
led to the ultimate credit crisis of 2008. In At its peak, the US market was estimated
other words, this enabled what Gary Gorton to be between $7- $10 trillion.[.8] Outstanding
and Andrew Metrick deemed the “run on US repos today are approximately $4.3 tril-
repo”[2] and what Jane D’Arista described as lion.[9] Lenders in the repo market can be
a“run on the financial sector by the financial institutional investors like pension funds and
sector.”[3] mutual funds seeking a liquid but relatively
J ournal of reg
ulation & risk
north asia
Subscribe
Issues in resolving
systemically importan
t financial institution
Resecuritisation s Dr Eric S. Rosengren
in banking: major
challenges ahead
A framework for
funding liquidity DuDr Fang
in times of financial
Housing, monetary crisis
and fiscal policies: Dr Ulrich Bindseil
from bad to worst
Derivatives: from
disaster to re-regulat Stephan Schoess,
ion
Black swans, market Professor Lynn A. Stout
crises and risk: the
human perspectiv
Measuring & managing e
risk for innovativ Joseph Rizzi
e financial instrumen
Red star spangled ts Dr Stuart M. Turnbull
banner: root causes
of the financial crisis
The ‘family’ risk: Andreas Kern & Christian
a cause for concern Fahrholz
among Asian investors
Global financial
change impacts David Smith
compliance and
risk
The scramble is on
to tackle bribery David Dekker
today
and corruption
nce Who exactly is subject
Complia
Penelope Tham & Gerald
to the Foreign Corrupt
Legal &
Li
Practices Act?
Financial markets
remuneration reform: Tham Yuet-Ming
one step forward
Of ‘Black Swans’, Umesh Kumar & Kevin
stress tests & optimised
to the
Marr
risk management
subject
Challenging the
value of enterprise David Samuels
actly is
risk management
Act?
Who ex
Rocky road ahead
Practices
for global accountan Tim Pagett & Ranjit
Jaswal
cy convergence
Corrupt
The Asian regulator Dr Philip Goeth
y Rubik’s Cube
Foreign Yuet-Ming
, DLA Alan Ewins and Angus
Ross
er, Tham mines the
In this pap consultant, exa Asia.
ng Kong FCPA in
Piper Ho ious effects of the
pernic
which
many of
panies – legis-
s of com es. The US
by hundred compani even-
Practices were Fortune 500 these scandals by
Corrupt in the onded to
Foreign nnings lature resp 1977.
The US its begi FCPA in to the
A), has te Special tually enacting the main provisions
Act (FCP n the Waterga lo- two s, and the
te era, whe ntary disc There are bribery provision and the
Waterga calle d for volu had made – the anti- the SEC
or that FCPA s. Both -
Prosecut compan
ies ard g provision J) have juris
s to Rich accountin ent of Justice (DO y, the SEC
sures from contribution n. erall
question
able
idential
campaig US Departm the FCPA. Gen s and
n’s 1972 pres diction over untin g provision rs
Nixo aled acco nst issue
es reve ecutes the s as agai
, thes e disclosur payments pros bribe ry provision rative proceedings
However estic anti- inist
ble dom d the and adm es and
questiona had been channelle . through civil es compani isions
not just prosecut prov
funds that business the DOJ bribery
but illicit to obtain whereas the anti-
gn gove rnments eque nt investi- individuals for eedi ngs.
to forei to subs Exchange through criminal
proc
mation led rities and
The infor that
the US Secu h revealed ision
gations by ) whic to ery prov makes it Risk managem
ion (SEC h funds” anti-brib bribery provision
Commiss issuers kept “slus ical The ’s anti- ey or anyt
hing ent
and polit The FCPA ide mon n-
many US gn officials offer or prov ials (“foreign”mea or
s to forei illegal to Of ‘Black
pay bribe ntary foreign offic
with a volu cor- of value to ”) with the inten
t to obta
in
ness to
Swans’, stre
parties. e up
optimised ss tes
risk manag ts &
later cam r which any ing “non
-US ting busi
The SEC for direc
prog ramme unde illicit payments n busi ness, or
disclosur
e
which self-
reported
SEC was
given
retai
any pers
on. can inclu
de sponsor- ement
poration with the likely of value of a holi- Standard &
perated it would Anything ation, use
and co-o rance that lt l and educ employm
ent, outlines the Poor’s
an infor
mal assu
enforcem
ent actio
n. The resu for trave
$300 ship home, promise
of future e is no positive ben David Samuels
than USD meals. Ther efits of ban
be safe from osure that more - day ks and k stress
discl ents (a mas e discounts, drin testing on
was the
questiona
ble paym
been mad 147 the bottom
million in in the 1970s) had
It is a big
challenge line.
unt a robust appro for bank
sive amo Asia ach to mana s to build downturn
Nor th of worst-case ging the risk capital adequ
ion & Risk by definition,
stress scena
rios that, almo uncover risk acy programs
nal of Regulat are triggered by st concentrati
ons and to
Jour unlikely or encies, and;
unprecede apparently applying these risk depend-
nted event to drive busin improveme
s. ess selection nts
through perfo –
However, solvin
g the probl rmance analy for example,
fying the risk em of identi adjusted pricin sis and risk-
concentrati - into accou g that takes
Contact
cies that give ons and depen nt. stress test result
rise to worst den- s
vital if the -case outco
indus mes is Top-l
vidual banks try is to thrive – and evel overs
are if indi- Buildi ight
past two years to turn the lessons ng
to competitive of the proce a more robust and
Banks that advantage. ss for uncov comprehen
tackle the issue ering threat sive
be lauded by head-on will prise is clearly, in part, s to the enter-
Christopher Rogers
investors and ance challe a corporate
coming years regulators nge.The board govern-
of industry in the must and top execu
most impo recuperatio have the motiv tives
rtantly, will n
tained profit be able to delive and, scrutinise and ation and
the clout to
ability gains r sus- able call a halt to
that are well . Meanwhile activities if appar
placed to take , banks term these are not ently profit-
consolidatio advantage interests of in the longe
n process need of the the the enterprise r-
can understand to be intended risk or do not fit
Editor in Chief
portfolios of the risks embe sure they But contrary
profile of the
organisatio
potential acqui dded in the to popular n.
To improve sition ing corpo rate governance opinio n, improv-
s.
and strengthen enterprise risk manageme tion of puttin
g the ‘right
is not just a
ques-
investor confid nt
banks can take ence, we think board members in ’ executives
and
the lead in appropriate place and
Better board three relate incentives. giving them
and senior d areas:
christopher.rogers@irrna.org
sight and executive over- For the bank
contro to make the
agement; re-inv l of enterprise risk sions when
they are difficu right deci-
igorated stress man- busin
testing and ess growth lt, e.g. when
or when risk looks good
manageme in the uptur
Journal of
Regulation nt looks expen n,
& Risk Nort sive
h Asia
163
The three large US-based credit rating But while the urge for expanded regulation
agencies – Moody’s, Standard & Poor’s, is well-intentioned, its results are potentially
and Fitch – provided excessively opti- quite harmful. Expanded regulation of the
mistic ratings of subprime residential rating agencies is likely to:
mortgage-backed securities (RMBS) in • Raise barriers to entry into the bond infor-
the middle years of this decade – actions mation business;
that played a central role in the financial • rigidify a regulation-specified set of struc-
debacle of the past two years. tures and procedures for bond rating;
• discourage innovation in new ways of gath-
The strong political sentiment for height- ering and assessing bond information, new
ened regulation of the rating agencies – as technologies, new methodologies, and new
expressed in legislative proposals by the models (including new business models). As
Obama Administration in July 2009, specific a result, ironically, the incumbent credit rat-
provisions in the financial regulatory reform ing agencies will be even more central to the
legislation (H.R. 4173) that was passed by bond markets, but are unlikely to produce
the House of Representatives in December, better ratings.
and epitomised by further debate, amend-
ments and resolutions this May and June A better path to stride
in the Senate, together with recent regula- There is a better policy route, which starts
tions that have been promulgated by the with an understanding of the basic purpose
Securities and Exchange Commission (SEC) of the rating agencies: to provide informa-
– is understandable, given this context and tion (in the form of judgments, or“ratings”)
history. The hope, of course, is to forestall about the creditworthiness of bonds and
such debacles in future. their issuers. If the information is accurate,
The advocates of such regulation want it helps bond investors – primarily financial
to grab the rating agencies by the lapels, institutions, such as banks, insurance com-
shake them, and shout, “Do a better job!” panies, pension funds, mutual funds, etc.
Macro-prudential councils:
how to avoid future crises
Amsterdam University’s Prof Enrico Perotti
calls for G-20-wide forward looking bank
levies to address systemic risk creation.
DURING 2010, European insurers will to provide an efficient way of setting legisla-
be participating in the European Com- tion in the context of the complex and fast-
mission’s 5th Quantitative Impact Study moving European financial markets.
(QIS5). The exercise will feed in to the
Commission’s further development Level One
of the new regulations and so help to Level 1 consists of the Solvency II Directive
shape the final Solvency II landscape. It text, which was finalised and adopted by the
will also form a vital part of the prepara- European Parliament in 2009. This forms
tions by both firms and regulators for the the “skeleton” of Solvency II, setting out the
introduction of Solvency II. QIS5 repre- high-level framework. Level 1 includes the
sents the last opportunity for field testing two key principles of Solvency II: market-
of the current thinking on quantitative consistency for the balance sheet, coupled
aspects of Solvency II. with capital requirements at the one-year
99.5 per cent VaR level.
The first four QIS exercises were carried Other fundamentals outlined in the
out between 2005 and 2008, and have Level 1 text include the high-level structure
been instrumental in shaping the direc- of the standard formula for the calcula-
tion of Solvency II. These pan-European tion of the Solvency Capital Requirement
studies have enabled the Commission to (SCR), considerations for the internal model
understand the likely impact of the current approach to the SCR, and governance and
thinking on Solvency II. QIS5 will be the disclosure requirements.
most important field study yet, coming at a
critical point in the development of the final Level Two
Solvency II framework. The Level 2 implementing measures put
Solvency II is being developed accord- flesh on the bones of the high-level Directive
ing to the Lamfalussy model. This model is text. At this stage, more detail is prescribed
structured according to four levels, designed as to the calculations that underlie the
Market consistent valuation of New focus for supervisor More pressure from capital
assets and liabilities Level of harmonisation markets, investors and
Economic capital validation of Group supervision shareholders
internal models
be appropriate for the undertaking: a robust from firms, will be of central importance for
starting point is needed in order to provide ensuring the Commission has the best pos-
the elements needed for the calculation of sible basis for decision-making.
the SCR and MCR. This applies to“standard The Technical Specification for QIS5
formula”and“internal model”firms alike. is owned by the European Commission.
All undertakings in scope of the Solvency A draft of the specification was published
II Directive will have the opportunity to on April 15, 2010 and is open for feedback
take part in QIS5, including solo firms as from a specified, limited number of stake-
well as groups and EEA sub-groups. The holders for five weeks. Many aspects of
Commission is keen to encourage large-scale the draft Technical Specification are based
participation, with a spectrum of participants on the corresponding sections of CEIOPS’
that captures all aspects of the insurance advice on the Level 2 implementing
industry.This includes a focus on the involve- measures.
ment of smaller and specialist firms: it is However, there are also several areas
important that the proposed measures are where the Commission has made revisions,
tested against small firms as well as large and some of these are fairly significant. This
firms and international groups in order to highlights the importance of QIS5 in inform-
achieve a regime that is suitable for the diver- ing the remaining“moving parts”of Level 2.
sity of the European insurance sector.
The balance sheet
Draft technical specification The Commission has maintained the
Widespread and representative participation, fundamental Level 1 principle of market
combined with high-quality submissions consistency for the valuation of assets,
THIS paper was written in anticipation then approve the legislation by a likely mar-
of the US Financial Reform Bill’s final gin of about 59 votes to 40. Only then can
passage through Congress prior to being the Bill go to the President for signature.
signed into law by President Obama on These final votes are scheduled for next
July 5 – obviously this is now not the week when Congress returns from the July
case. The Bill currently before Congress Fourth recess. So we will not know until next
was devised to address problems associ- week whether 12 months of intense effort in
ated with the global financial crisis (GFC) Congress and two years of aftershocks from
of 2007-2009. the GFC will actually lead to financial reform
in the United States. If, however, Dodd-
The Dodd-Frank Wall Street Reform and Frank is signed into law, the United States
Consumer Protection Act, which by its very will become the first major nation to hon-
title indicates the complicated nature of the our its commitment to the G20 to reform its
reforms, is actually not yet law. The Bill, which financial system.
I will refer to as“Dodd-Frank”for the rest of
this paper, now hangs in limbo, having been Dodd-Frank in general
passed by the House of Representatives and This legislation is neither uncontroversial
the Senate, subsequently reported out of nor sure to be effective. The Bill has engen-
Conference Committee and finally approved dered a range of reactions, ranging from sav-
by the House, but not quite yet enacted by age criticism to effusive self-promotion by
Congress. Congressional leaders and the President. At
Two more votes remain in the Senate. the conservative end of the spectrum, a pro-
The first will be whether to stop with a fessor at Stanford writes that Dodd-Frank
cloture vote an attempted filibuster by the is a “financial fiasco.” The ubiquitous Judge
Republican minority, which would prevent Richard Posner, having recently turned his
the bill from coming to a floor vote. If the attention to the subject of banking regula-
Senate votes for cloture a second vote will tion and become a Keynesian after years in
In view of the passage, finally, of the lowballs valuation estimates will inevita-
Dodd-Frank Act and the huge discre- bly face angry push-back from the regu-
tionary powers it has handed over to the lated bank. Moreover, the examiner will be
majority of the US’s existing supervisory “proven wrong” again and again, until she
bodies, it is well worth revisiting an loses her job. Her fuddy-duddy theories
essay hosted by Steve Randy Waldman about cash-flow and credit analysis will
on his website – Interfluidity – during not withstand empirical scrutiny, as shoddy
the height of the Congressional skir- credits continually perform while asset
mishes concerning consolidation within prices rise. Valuations can remain irrational
America’s multiplicity of regulatory bod- much longer than a regulator can remain
ies. This is an issue Dodd-Frank failed to employed.
carry as evidenced in the new regulatory
environment contained within the Bill’s Asset overvaluation
2,319 pages. Bad times, unfortunately, follow good times,
and regulatory incentives are to do the wrong
An enduring truth about financial regulation thing yet again. When bad times come, over-
is this: Given the discretion to do so, financial optimistic valuations have been widely tol-
regulators will always do the wrong thing. erated. In fact, they will have become very
It’s easy to explain why. In good times, common. Over-valuation of assets leads to
regulators have every incentive to take banks overstatement of capital. Overstatement of
at their optimistic word on asset valuations, capital permits banks to increase the scale
and therefore on bank capitalisation. It is of their lending, which directly increases
almost impossible for bank regulators to reported profitability.
be “tough” in good times, for the same rea- Banks that overvalue wildly thrive in
son it is almost impossible for mutual fund good times. Fuddy-duddy banks lag and
managers to be bearish through a bub- their CEOs are ousted and The Economist
ble. A “conservative” bank examiner who runs uncomplimentary stories about what
Is an outdated anti-trust policy hindering products. It was also the intent to“stimulate
economic growth, innovation and entre- businesses to find new, innovative and more
preneurial spirit in the current financial efficient methods of production.”2 Enacted
crisis? Competition policy works effec- in 1890, anti-trust law consists of three
tively provided free and open markets main regulations against international car-
prevail as an underlining legislative tel activity; namely, the Sherman Anti-trust
intent. When it comes to global compe- Act, the Clayton Act and the Federal Trade
tition, the main focus of anti-trust regu- Commission Act (FTCA). Recently, in 2004,
lation is targeted towards global firms President Geroge W. Bush amended this
which are considered “too big to fail”. by empowering anti-trust laws to increase
criminal fines and penalties up to US$1 mil-
The US Congress enacted anti-trust laws as lion and 10 years‘ jail for violators.
a pro-competition tool in promoting free and
open trade markets. Applying this 28-year- Consumer prophylatic
old anti-trust paradigm, this article argues An anti-trust law protects consumers by
its effectiveness and US agencies’ aggressive regulating competitors in setting product
enforcement initiatives in the new digital age prices honestly and independently. When
and 21st-first century standards. Although international competitors cheat customers
the primary focus here is on US anti-trust by price fixing, bid rigging, market division or
laws, this is comparable to the anti-trust laws allocation schemes and other forms of collu-
in economically developed countries around sion, such competitors are subject to crimi-
the globe.1 nal prosecution enforced by the Antitrust
Congress enacted anti-trust laws to pro- Division of the US Department of Justice
tect competition and bring about regulatory (DOJ). International cartel activity is a form
reform in order to preserve free and open of co-operation among competitors to the
markets and ensure that consumers had material terms of agreement in which com-
access to lower prices and innovative quality petitors enter by price fixing, defining market
a single entity when granting the company H. Ginsburg, hoping to clarify its anti-trust
an exclusive headwear licence and therefore regulatory process and identify potential
could not violate Section 1 of the Sherman gaps within the guidelines.19 However, the
Act, 15 U.S.C. 1, which requires proof of col- outcome of these public comments has yet
lective action involving separate entities.”18 to be reflected in its guidelines.
The Anti-trust Division’s guidelines pro-
vide a very broad brush for its grounds to Recent trends
enforce anti-trust regulation against viola- Recent trends have shown that due to the
tors. These guidelines were publicly critiqued bureaucratic and time-consuming Anti-
by well-known economic pundits, reason- trust Division’s Business Review process,
ing that the guidelines language is vague limited corporations and individuals have
and out-of-touch with modern economics, taken full advantage of such review requests.
and does not provide any meaningful guid- In addition, in 2009 only two such business
ance to the judicial review process. review requests were addressed by anti-trust
In response to this sharp criticism, dur- division.20
ing December 2009, enforcement agencies Similarly, trends have shown that lim-
solicited public comments along with the ited corporations and individuals have taken
support of Supreme Court Judge, Douglas full advantage of the Anti-trust Division’s
20
18
Average jail sentence in months
15
12
10
6.9
5 4.5 4.6
3 3 3.3 3
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
Fiscal Year
*Includes defendants charged with with USC§1 and/or obstruction offenses
Source: DOJ Antitrust Division
Corporate Leniency Program against crimi- the anti-trust violators in a true competitive
nal convictions. The division has used this business world.
leniency programme for many years as In today’s economic market conditions,
an “investigative tool for detecting cartel delivering innovation isn’t an option, it’s a
activity against corporations and individu- business necessity. In a competitive global
als.”21 Even though the division claims that market, businesses understand cutting costs
its modern leniency programme has dra- might keep them operational in the short
matically increased amnesty applications in term.
recent years – due to negative publicity and
reputation issues – corporations and indi- Lack of consistency
viduals have considered these programmes However, increasing revenue with an entre-
as quick-and-dirty operational solutions. preneurial model should be the ultimate goal.
Such programmes aid agencies merely as an Based on recent trends observed, US legisla-
investigative tool in resolving complicated tive intent seems to be out-of-line, outdated
and sophisticated anti-competitive issues; and counter-productive to promoting pro-
however they fail to remedy the intent of competitive markets. Anti-trust regulation
J ournal
of regu
lation &
north a risk
sia
Available
Issues in res
olv ing system
ically imp
Resecuriti ortant fina
sation in ban ncial institu
king: major tions
A framewo challenges Dr Eric S. Rose
rk for fun ahead ngren
ding liquidit
Housing, y in times
monetary of financi Dr Fang Du
and fiscal al crisis
Derivative pol icies: from
s: from dis bad to wo Dr Ulrich Bind
aster to re- rst seil
Black swa regulation
ns, marke Stephan Scho
t crises and ess,
Measurin risk: the hum Professor Lynn
g & manag an perspectiv A. Stout
ing risk for e
Red star spa innovative
ngled ban financial ins Joseph Rizzi
ner: root cau truments
The ‘family’ ses of the Dr Stuart M.
risk: a cau financial cris Turnbull
se for con is
cern among Andreas Kern
Global fina Asian inv & Christian
ncial change estors Fahrholz
impacts com
The scram pliance and
ble is on to risk David Smith
tackle bri
Who exactly bery and
corruption David Dekker
is subject
to the For
Financial eign Corru Penelope Tha
markets rem pt Practic m & Gerald
uneration es Act? Li
Of ‘Black reform: one
Swans’, stre step forwa Tham Yuet-Mi
ss tests & rd ng
Challengi opt imi sed risk ma Um esh Kumar & Kev
ng the val nagement in Marr
ue of enterp
Rocky roa rise risk ma
d ahead for nagement David Sam
global acc uels
The Asian ountancy Tim Pagett
regulator convergen & Ranjit Jasw
y Rubik’s ce al
Cube
Dr Philip Goe
th
Alan Ewins
and Angus
Contact
Ross
Christopher Rogers
Editor in Chief
christopher.rogers@irrna.org
Asset securitisation can serve vari- root cause of the current financial crisis. The
ous purposes: generation of funding, author believes that such a view is signifi-
economic risk transfer and associated cantly too simplistic. In general, securitisa-
capital release, market arbitrage, regula- tion deals perform similar to the underlying
tory arbitrage (mainly limited to Basel assets. As an example, the CLOs referencing
I regulation), or a combination of these. bank loans exhibit a fairly good performance,
Assets to be securitised include corporate similar to the performance of bank loans.1
loans (unsecured and secured), consumer Put differently, performance was within
loans, credit card claims, mortgage loans, investors’expectations.
non-performing loans, and tranches
of existing securitisations (CDO2s). Asset performance
Securitisations can either be done in Another example of an asset class that per-
true-sale form, removing the assets from formed within expectations is the securitisa-
the previous owner’s balance sheet, or in tion of UK prime retail mortgaged-backed
synthetic form involving credit default securities (RMBS).2 The main asset class that
swaps. did not perform according to expectations
was the securitisation of US subprime mort-
Securitisations are fairly complex prod- gages. ‘Subprime’ means that origination
ucts: legal, tax, accounting, and regulatory standards were significantly lower, i.e. loans
issues had to be solved in each jurisdiction. were granted to borrowers that were not
Meanwhile, securitisation has become a fully able to afford a house. As house prices
fairly standard procedure in some markets. fell, the degree of collateralisation of such
For standard securitisations, it is not neces- mortgages declined dramatically, resulting in
sary to obtain regulatory approval for each losses for the CLOs.
deal, thus facilitating the set-up of new Rating agencies have downgraded a lot
deals. of securitisation tranches, often the down-
Securitisation is often regarded as the grade comprised multiple notches. In some
Pilot schemes
The two pilot securitisations were China
Construction Bank MBS 2005-1 and China
Development Bank CLO 2005-1. CCB’s
RMBS transaction was a RMB 3.017 bn deal
involving a trust structure. Ignoring legal
subtleties, this can be regarded as a true-sale
deal, in this case with separate interest and
principal waterfalls. Credit enhancement is
provided through excess spread, a first loss
position of three per cent kept by the origi- securitisation of corporate assets was gov-
nator, and subordination of the notes. CDBs erned by the Specific Asset Management
CLO 2005-1 transaction was a RMB 7.773 Plan (SAMP) that was enacted in May 2005.
Figure 1. Capital structure of CCB MBS 2005-1 An example of a SAMP deal is the China
Network Communications securitisation.
This structure provided significant interest
savings compared to traditional bank financ-
ing and did not require approval from CBRC
or PBOC. The SAMP programme was sus-
pended by the China Security Regulatory
Commission (CSRC) in 2006, and subse-
quent efforts to restart the programme in
2007 failed.
In summary, there are two main securi-
tisation markets in China. Securitisations of
bank assets are regulated by CBRC, and the
tranches are traded in the interbank market.
Securitisations of corporate assets are regu-
lated by CSRC, and the tranches are traded
in the stock exchange market.
J ournal of reg
ulation & risk
north asia
Subscribe
Volume I, Issue III,
Autumn Winter 2009-2010
Articles & Papers
Issues in resolving
systemically important
financial institution
Resecuritisation s Dr Eric S. Rosengren
in banking: major
challenges ahead
A framework for
funding liquidity Dr Fang Du
in times of financial
Housing, monetary crisis
nce
Complia and fiscal policies: Dr Ulrich Bindseil
Legal & Derivatives: from
from bad to worst
disaster to re-regulati Stephan Schoess,
on
Black swans, market Professor
crises and risk: the Lynn A. Stout
to the
human perspectiv
e
subject
Measuring & managing
risk for innovative Joseph Rizzi
actly is
financial instrumen
s Act? Red star spangled ts
Who ex Practice
banner: root causes Dr Stuart M. Turnbull
of the financial crisis
Corrupt
The ‘family’ risk: Andreas Kern & Christian
a cause for concern Fahrholz
Foreign
among Asian investors
, DLA Global financial
Yuet-Ming
today
change impacts David Smith
compliance and
er, Tham mines the
risk
The scramble is on
In this pap consultant, exa
to tackle bribery David Dekker
and corruption
Asia.
g Kong FCPA in
Who exactly is subject Penelope Tham & Gerald
to the Foreign Corrupt
Piper Hon ious effects of the
Li
Practices Act?
Financial markets
remuneration reform: Tham Yuet-Ming
pernic h Of ‘Black Swans’, stress
one step forward
y of whic tests & optimised
Umesh Kumar & Kevin
Marr
anies – man legis-Challengin risk management
reds of comp anies. The US g the value of enterprise David Samuels
by hund comp even- risk management
upt Practices were Fortune 500 these scandals by Rocky road ahead Tim Pagett
Corr in the to for global accountanc & Ranjit Jaswal
Foreign nnings e responded FCPA in 1977. y convergence
The US its begi ial latur ting the
the
isions to The Asian regulatory Rubik’s Cube
A), has rgate Spec tually enac main prov the
Dr Philip Goeth
Act (FCP n the Wate o- two s, and
era, whe ntary discl e There are bribery provision and the Alan Ewins and Angus
Risk manaRoss
Watergate called for volu – the anti- SEC
r had mad Both the gement
Prosecuto companies that ard FCPA nting provisions. J) have juris-
to Rich Justice (DO
sures from contributions aign. accou
rtment of the SEC
. Generally, s and Of ‘Black
ble
questiona presidential camp US Depa the FCPA provision Swans’, stre
1972 diction over accounting against issuers optimised ss tes
risk manag ts &
Nixon’s revealed cutes the s as s
disclosures ents prose bribery provision ative proceeding
However,
these
ble dom
estic
questiona had been channelle
paym
d the
anti-
civil and
administr
companies
and ement
not just through prosecutes ry provisions Stan
funds that n busin ess.
eas the DOJ
anti-bribe
dard & Poor’s
nts to obtai outlines the
but illicit
to foreig
n governme to subsequent inves
ti- wher
individual
s for the edings.
proce positive bene David Samuels
mation led Exchange through criminal fits of bank
The infor rities and that testing on stress
the US Secu h revealed ision the bottom
gations by ) whic to ery prov makes it line.
ion (SEC h funds” anti-brib bribery provision It is aing big challe
Commiss issuers kept “slus cal The ’s anti- robust -appro nge for banks to build
ey oraanyth
and politi The FCPA ide mon
many US n officials offer or prov als (“foreign” mean
of worst ach to mana downturn
s to foreig illegal to n offici or stress scena ging the risk uncov
n -case capital adequ
pay bribe a volun tary to foreig t to
by obtai
definition, rios that, almos er risk concentratio acy programs to
parties. up with cor- of
value the inten ess to are triggered t encies,
later came r which any -US”) with directingunlik businely
or unpreceden by apparently and; applyi ns and risk
depend-
The SEC e unde ents ing “non or for to ng these
programm ess, ted events. drive busine improvemen
illicit paym retain busin
disclosure eported given include sponsor- through perfor ss selection – for examp ts
tion which self-r the SEC was any person. can Howe ver,
holi-solvin mance le,
pora with likely of value of a
, usethe g the proble adjusted pricing analysis
perated it would Anything ationfying riskent,
concentratio m of identi- that takes stress and risk-
and co-o ance that t l and educ cies employm
Contact
The resul ns into account.
mal assur nt action. for trave of future that give no to worst- and dependen- test results
an infor enforceme $300 ship home, promise s. Ther
vital e is rise case outcom
than USD s and meal
if the indust
be safe from sure that more day ry is to thrive es is
– and if indi- Top-level oversight
disclo ents (a mas-e discounts, drink vidual banks
are turn
was the ble paym past two years to Buildin
questiona been mad 147 the lessons
of the proces g a more robust and
million in in the 1970s) had Banks that
to competitive
advantage. s for uncov comprehens
unt ering threat ive
sive amo tackle the issue
h Asia be lauded by head-on will prise is clearly, in part, s to the enter-
Risk Nort investors and ance challe a corporate
lation & coming years regulators
Christopher Rogers
nge.The board govern
Journal
of Regu most impor
of industry
recuperation
in the must
have the motiv and top execut -
tantly, will ives
tained profita be able to delive and, scrutinise and ation and
the clout to
bility gains. r sus- able call a halt to
that are well Meanwhile, activities if apparently
placed to take banks term these are not profit-
consolidatio advantage interests of in the longer
n process need of the the the enterprise -
can understand to be intended risk or do not fit
portfolios of the risks embed sure they But contrary
profile of the
organisation
ded in the
Editor in chief
To improve
potential acquis
itions. ing corporate to popular opinion, impro .
governance v-
and strengthen enterprise risk manag tion of puttin
g the ‘right’
is not just a
ques-
investor confid ement
banks can take ence, we think board members in executives
and
the lead in appropriate place and
Better board three related incentives. giving them
and senior areas:
sight and executive over- For the bank
control of sions to make the
agement; re-inv enterp rise when they right deci-
igorated stress risk man- busine are difficu
christopher.rogers@irrna.org
testing and ss growth lt, e.g. when
or when risk looks good
Journal of managemen in the upturn,
Regulation t looks expen
& Risk North sive
Asia
163
The current debate in the United States the move has achieved durably was to wreck
over China’s exchange rate policy can be the Japanese economy, which has not grown
viewed as a rerun of the 1970s and ‘80s, one iota since. The Japanese used to call this
with China taking Japan’s role. This “the lost decade”; clearly it is now becom-
paper argues that while there is a rela- ing the“lost generation.”As China emulates
tionship between current account defi- Japan’s export-led growth strategy, this story
cits and surpluses, causality is difficult to is likely to figure prominently in its policy-
establish. Politics aside, even if Beijing makers’ minds. And rightly so. For further
does not choose to let the renminbi development of this premise, see Park and
(RMB) appreciate, inflation will eventu- Wyplosz, 2010.
ally finish the job.
Negative correlation
Back in the 1970s and‘80s, a sure vote-getter Figure 2 (see overleaf) illustrates the dangers
in the US and pleasure-getter on Capitol of interpreting co-movements as causality.
Hill was to complain about Japan manipu- The striking feature is the opposite move-
lating its exchange rate. Every argument that ments – or negative correlation – of the
you may hear today about China was made US and Japanese current accounts. Equally
then. In the end, Japan caved in and let its strikingly, despite these wide fluctuations, for
exchange rate appreciate. This is shown in more than 30 years the Japanese account has
Figure 1 (overleaf), which displays real effec- not been into negative territory while the US
tive exchange rates, i.e. rates corrected for the has not seen a surplus.
evolution of the country’s labour costs rela- US legislators interpreted these opposite
tive to those of its trade partners. yo-yo movements as a proof that the US
As can be seen from Figure 2 (overleaf), deficits were caused by the Japanese sur-
the US current account deficit improved, pluses and they saw the continuing Japanese
but only temporarily, and Japan remained surpluses as a proof that the yen was over-
in surplus after a temporary reduction. What valued. They say exactly the same things
Source: IMF. Note: Nominal exchange rates corrected for unit labour
costs. An increase represents a real appreciation Source: IMF.
today, just cut out“Japan”and replace it with the “saving glut” hypothesis originally pro-
“China”. posed by Bernanke (2005). This view argues
But there is a big problem. The negative that excess savings in China – about 40 per
correlation between the US and Japanese cent of GDP – both depresses imports and
current accounts is still very much there. So creates the need for investment opportuni-
if yesterday’s Congress members were right, ties abroad. Thus politicians look at the cur-
then it must still be that the US external defi- rent account and competitiveness, therefore
cit continues to be driven by Japan’s surplus. the exchange rate, while Fed chairman
You do not need to bring China into the pic- Ben Bernanke looks at capital flows – the
ture. Alternatively, if you agree with today’s Chinese savings are transformed into US
Congress, you didn’t need Japan back then, (public sector) borrowing. This removes the
maybe China was already doing the trick exchange rate from centre stage.
(it wasn’t). The other possibility is that both
China and Japan have been colluding all Heart of the matter
along, which would require an incred- Causality lies at the heart of the dispute, as is
ible amount of co-ordination between two often the case. As economists, we know how
countries that are barely on speaking terms. delicate the causality issue is. Theoretically, in
general equilibrium few are the truly causal
China’s reaction – or exogenous – factors. Empirically, causal-
China’s authorities naturally see causality ity is the most vexing issue, which has led
running in the other direction. They blame to countless techniques, none of which are
the US current account deficits for the particularly convincing. The first observa-
Japanese and Chinese surpluses. They fur- tion, which is neither clarifying nor hopeful,
ther blame the US budget deficits for their is that it is impossible to prove which side
external deficits. The US response has been of the debate is guilty. In particular, no one
Deregulation, non-r
egulation
and ‘desupervision’
Global
unlikely or , and; applyi risk depend-
lation &
Risk unpreceden by apparently to
drive busine ng these improvemen
Journal
of Regu
comp ted events.
through perfor ss selecti on – for examp ts
nt – However, solvin
manageme ent
le,
g the proble adjusted pricing mance analysis and
products
fying the risk m of identi- risk-
pot concentratio that takes stress
head of details a cies that give ns and depen into account. test results
EastNet’s David Dekker,
rise to worst- den-
rkets. vital if the
ncial ma
case outcom
nce, industry is es is Top-le
complia al reaction in fina vidual banks to thrive – vel oversight
are to turn and if indi-
the Buildin
chemic past two years to
competitive
lessons of
the proces
g a more robust
and compr
amo ngst oth- Banks that
tackle
advantage. s for uncov
ering ehensive
companies ces. be lauded by the issue head- prise threat s to
be one of to offer these servi t investors and on will ance is clearly, in part, a corpor the enter-
will just coming years regulators challenge.The ate
signs be able speak abou in the must board and top govern-
we saw
the first d ers
that will ld rather moni- most impor
of industry
recuperation have the motiv executives
we shou banks, or that
a year ago the financial worl s These days tantly, will
be able to delive and, scrutinise and ation and
About in utions than , a name
tained profita call a halt to the clout to
formation credit crisi cial instit providers bility gains. r sus- able apparently
of a trans last months the d at finan financial service ities. that are well Meanwhile, activities if
these are not profit-
the cial worl future activ ed
placed to take banks term
and in the finan ge that is tored their current and we have mov consolidatio
n process need
advantage
of the the
interests of
the enterprise
in the longer
-
formed rs ly s
Contact
has trans pace . the chan e than cove at how rapid n on the bank can understand
the
to be sure
they
intended risk
profile
or do not fit
osive in scop Look risks embed of the organisation
an expl broader were ical inter
actio ation) to portfolios of ded in the But contrary
is much s that from phys s of oper potential acquis ing corporate to popular opinion, impro .
occurring expected. bank or fall tion and hour net banking. To improve itions. govern v-
to fail s (loca then Inter and strengthen enterprise risk manag tion of ance is not
originally to be too big by term payments e, but ement board putting the ‘right’ just a ques-
d g taken over - electronic still in charg to a investor confid executives
considere or bein s were ng banks can ence, memb ers in and
r failing more finan n the bank igm is shifti take the lead we
in three related think appropriate incent place and giving them
are eithe ns that are huge para- Agai tioned the parad persons and cor- Better board
Christopher Rogers
institutio a men sical s and senior areas: ives.
cial in as sight For
finan d, resulting regarded
by e we (phy out the bank and contro executive over- the bank
to make the
cially soun how banks are world wher each other with es such as agement; re-inv l of enterprise risk sions when
) pay man- busine they are difficu right deci-
in porations technologi igorated stress
digm shift r banks. nt with new testing and ss growth lt, e.g. when
ic and othe involveme ents. or when risk looks good
the publ around Journal of managemen in the upturn,
ly revolves mobile paym Regulation t looks expen
ing large mers, los- & Risk North sive
Since bank y to service custo impact ns Asia
Editor in chief
the abilit ng the providers organisatio
trust and determini Network e the banks and other pay-
mer and ongo ing risk the futur HA and
a custo of the as In T, NAC iders 163
ing
ld be part n, as well as SWIF ork prov B
me netw
of it, shou of the organisatio
ng and new such t networks beco ey from A to
ent mon
managem ess of existi ng men to send ork traf-
g the riskin using/buyi allow you you for the netw
monitorin customers ges that e s similari-
christopher.rogers@irrna.org
and the more chan will charg bring
products there are are and rate. This energy
ucts. But world that you gene as telecom,
these prod s in the banking fic that stries such financial
enge known it. with indu anies. The
and chall as we have not be the ties cable comp g an important
tenin g banking futur e, supp liers and unde rgoin
threa the s, clearly
s will, in e our fund world is
The bank by which to mov ; they 135
les portfolios
default vehic balances and
our
maintain
h Asia
Risk Nort
lation &
of Regu
Journal
a second step, for each of these eight cat- cross-border comparisons between different
egories a corresponding RSF factor is set credit institutions. The ongoing quantita-
representing the share of stable funding tive impact study previously mentioned will
needed (according to the point of view of the also quantify the impact of the NSFR on the
supervisors) related to total funding needed Basel and the EU credit institutions.
or representing the assumed drawdown of In addition to the LCR and the NSFR the
the currently undrawn portion of off-balance consultation paper introduces four monitor-
sheet categories. ing tools the supervisors are (as a minimum)
supposed to make use of when assessing the
Liquidity drains liquidity profile of banks:
The latter was introduced because many • A contractual maturity mismatch;
off-balance sheet categories need little direct • concentration of funding;
or immediate funding but can lead to sub- • available unencumbered assets;
stantial liquidity drains in times of stress. This • market-related monitoring tools.
could clearly be observed during the finan- Supervisors are supposed to take action
cial crisis when many SPVs used liquidity when potential liquidity difficulties would
facilities granted by financial institutions, be signalled by the metrics. The contractual
bringing serious trouble to some. Finally, the maturity mismatch is supposed to identify
total NSFR is the sum of the weighted sums gaps between contractual on- and off-bal-
in the respective RSF categories. ance cash in- and outflows for pre-defined
All in all the NSFR framework leaves time buckets. Such kind of gap analysis is
much less space for national discretion, already used on a large scale by the cross-
since only the SFRs for other contingent border groups themselves (covering also
funding obligations are subject to the deci- non-contractual cash flows, however, and
sion of the national supervisors. The NSFR under a going-concern perspective) and
could therefore be a rather robust metric for gives insight into the extent up to which the
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