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David C. L. NellorInternational Monetary Fund
May 2009
Rethinking Regulation for Financial Stability and
Growth
22
Outline
Financial Stability – why does it matter Regulatory Framework – what went wrong Specific Proposals – is there a solution Policy Choices – confronting the trade offs Conclusions – what does it mean for
Nigeria
33
Financial Stability – why does it matter Estimates of Bank Restructuring Costs
-10
0
10
20
30
40
50
60
Perc
ent o
f GD
P
Indonesia Korea Thailand US S&Ls Sweden
Official Est. Final adj.
44
Financial Stability – why does it matter Index - Ratio of Private Sector Credit to GDP
0
20
40
60
80
100
120
-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11
Indonesia 0=1997 Sweden 0=1990
55
2. Regulatory Framework – what went wrong?
Macro versus Micro Supervision Regulatory and Supervisory
Perimeter Supervisory Capacity Pro-cyclicality Global Architecture
66
Macro versus Micro Supervision
Macroeconomic developments – asset markets, macro imbalances
Regulators are micro focused and not on interlinkages across financial institutions
Basel based on bank’s own risk models Presence of foreign intermediaries in
some countries and cross-border capital flows
77
Regulatory and Supervisory Perimeter
Coverage of supervision and regulationSystemic importance of non-banks Too big to fail – did not mean subject
to prudential supervision & regulation
Reporting requirementsInformation from wider range of
financial institutions & off-balance sheet items
Supervisory insight – “ticking boxes” versus knowledgeable supervision
88
Supervisory Capacity Regulators/supervisors did not keep
pace with developments“Sophisticated financial
engineering” - structured products & off balance sheet entities
Interlinkages across financial institutions and markets (contagion effects) - use of credit risk mitigants and contingent liabilities
Risks of under-resourced supervisory agencies
99
Regulatory System Procyclical
Risk-based capital ratios - capital requirements through the cycle
Loan loss provisions – rules unrelated to expected losses through the cycle
Liquidity risk - liquidity risk management did not require stress tests sensitive to firms’ credit ratings & off-balance sheet obligations
1010
Global Architecture
Coordination: inability to address global imbalances or manage crisis effectively at multilateral level
Crisis framework: shortcomings in legislation dealing with cross-border bank resolution and bankruptcy
Liquidity and Financing: limitations of central bank liquidity support; reputational risk to accessing IMF support
1111
3. Specific Proposals – is there a solution
Turner Review Issing Group G 30 (Volcker) De Larosiere
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Turner Review
Highly regulated broad-based financial sector with central bank and FSA doing macro prudential supervision
Increased capital requirements and avoiding pro-cyclicality through introduction of capital buffers
Limitations on scale of debt/leverage No specific limitations on activities
of banks
1313
Issing Group
Risk map – global financial intermediation (net exposures) and risk factors.
Pre-arranged link between findings and actions such as on capital requirements
Regulation of hedge funds Systematic cooperation of
regulators
1414
G30 (Volcker)
Redesigning the regulatory structure – overlaps, gaps, limit scope for regulatory arbitrage
Central bank take a lead responsibility on financial stability – may need to be given tools and mandate
Limit scope of bank activities – proprietary trading limited, no hedge fund operations
Prevent non-banks from taking deposits
1515
De Larosiere
Macro prudential supervision is essential
Macro supervision must impact the micro supervisors
Macro authority has to be at the regional (global?) level
Consistency of supervision across the region (globally?)
1616
4. Policy Choices – confronting the trade offs
Global versus national The macro prudential regulator Narrow or broad banking Market and regulatory failure Risk and reward preferences
1717
Global versus national
Internationally integrated banking system operating with national level regulatory structure – a mismatch?
Feasibility versus ideal – think globally act nationally
Challenge of building links between surveillance and actions
1818
The Macroprudential Regulator
Is a separate/new agency required? Central bank independence and policy
focus Dealing with the non-bank financial sector Analytic capacity Could vary capital and liquidity
requirements over time – discretion versus automaticity
1919
“Narrow” or “Broad” Banking
Where is the balance?As deposit takers, want banks to
be conservativeAs allocators of capital, want
banks to be flexible risk takers Solution – regulatory overlay
versus regulation plus limiting activities
2020
Market versus Regulatory Failure
Incentives for regulatory arbitrage will persist whatever the structure
Markets are dynamic, can regulators match that change?
Does this favor simplifying the regulatory task by moving to “narrow” banking?
2121
Risk and Reward Preferences
Countries at different stages of development and other reasons mean that preferences might not be the same
Global coordination does not mean that all need to be the same
But, some shared principles otherwise regulatory arbitrage will dominate
2222
Conclusions
Can agreethe regulatory framework failedsome areas where it failed
Can agree some principlesmarkets are not self regulatinginvestors should reap the reward and
incur the losses associated with risks they take
markets are dynamic – regulatory structure must match this
Cannot agree on definitive regulatory solutions
2323
Conclusions
Need to secure international agreement on principles of regulation and supervision.
Countries will need to define their regulatory and supervisory structures within these international principles
Coordination within regions and internationally will be needed.
2424
What does it mean for Nigeria? Develop regional frameworks and
participate in international solutions CBN as financial stability agency;
advisory committee including all regulators
Consider containing scope of banking recognizing supervisory capacity
Accept somewhat greater risk recognizing development needs
A transparent and clear bank resolution framework is essential if take greater risk – bank entry and exit is a sign of a healthy system
2525
Thank you!
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