Scott E. Harrington
- Published in print:
- 2005
- Published Online:
- January 2007
- ISBN:
- 9780195169713
- eISBN:
- 9780199783717
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780195169713.003.0002
- Subject:
- Economics and Finance, Financial Economics
This chapter considers capital adequacy and capital regulation of insurers and reinsurers. A basic theme is that capital standards should be less stringent for financial sectors characterized by ...
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This chapter considers capital adequacy and capital regulation of insurers and reinsurers. A basic theme is that capital standards should be less stringent for financial sectors characterized by greater market discipline and less systemic risk. Because market discipline is greater and systemic risk is lower for insurance than in banking, capital requirements should be less stringent for insurers than for banks. Similarly, because market discipline is generally greater in reinsurance (wholesale) markets than in direct insurance (retail) markets, capital requirements and related regulation plausibly need not be as stringent for reinsurers as for direct insurers. Current capital requirements and related solvency regulation for US and EU insurers and reinsurers are largely consistent with significant market discipline in the insurance and reinsurance sectors. Any federal regulation of US insurers/reinsurers, harmonized regulation of EU reinsurers, consolidated oversight of financial conglomerates, and increased centralization of regulatory authority to supervise insurance and other financial activities should be designed with full recognition of the limited systemic risk and strong market discipline in insurance/reinsurance and avoid undermining that discipline.Less
This chapter considers capital adequacy and capital regulation of insurers and reinsurers. A basic theme is that capital standards should be less stringent for financial sectors characterized by greater market discipline and less systemic risk. Because market discipline is greater and systemic risk is lower for insurance than in banking, capital requirements should be less stringent for insurers than for banks. Similarly, because market discipline is generally greater in reinsurance (wholesale) markets than in direct insurance (retail) markets, capital requirements and related regulation plausibly need not be as stringent for reinsurers as for direct insurers. Current capital requirements and related solvency regulation for US and EU insurers and reinsurers are largely consistent with significant market discipline in the insurance and reinsurance sectors. Any federal regulation of US insurers/reinsurers, harmonized regulation of EU reinsurers, consolidated oversight of financial conglomerates, and increased centralization of regulatory authority to supervise insurance and other financial activities should be designed with full recognition of the limited systemic risk and strong market discipline in insurance/reinsurance and avoid undermining that discipline.
Kern Alexander, Rahul Dhumale, and John Eatwell
- Published in print:
- 2005
- Published Online:
- September 2007
- ISBN:
- 9780195166989
- eISBN:
- 9780199783861
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780195166989.003.0009
- Subject:
- Economics and Finance, Financial Economics
This chapter examines the extent to which different settlement systems affect the nature of systemic risks and the potential vulnerability of the financial system to such problems. It considers ...
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This chapter examines the extent to which different settlement systems affect the nature of systemic risks and the potential vulnerability of the financial system to such problems. It considers whether externalities can be reduced if individual institutions fully internalize the costs of their actions specifically by creating private submanagement systems as low-cost alternatives. The proposed standards for payments and risk control features, including the length of time during which participants are exposed to credit and liquidity risks, are addressed. The role of public intervention through prudent regulation in the payments system is discussed. The chapter concludes by discussing the establishment of minimum regulatory standards — whether in terms of interest charges, collateralization requirements, or loss-sharing agreements — and the associated tradeoffs between their costs and their ability to reduce risk.Less
This chapter examines the extent to which different settlement systems affect the nature of systemic risks and the potential vulnerability of the financial system to such problems. It considers whether externalities can be reduced if individual institutions fully internalize the costs of their actions specifically by creating private submanagement systems as low-cost alternatives. The proposed standards for payments and risk control features, including the length of time during which participants are exposed to credit and liquidity risks, are addressed. The role of public intervention through prudent regulation in the payments system is discussed. The chapter concludes by discussing the establishment of minimum regulatory standards — whether in terms of interest charges, collateralization requirements, or loss-sharing agreements — and the associated tradeoffs between their costs and their ability to reduce risk.
Donato Masciandaro and Francesco Passarelli
- Published in print:
- 2012
- Published Online:
- May 2012
- ISBN:
- 9780199698165
- eISBN:
- 9780191738630
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199698165.003.0011
- Subject:
- Economics and Finance, Financial Economics
We describe systemic financial risk as a negative externality. Free riding leads to excess risk production. We consider two instruments usually adopted to tackle this problem: financial regulation ...
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We describe systemic financial risk as a negative externality. Free riding leads to excess risk production. We consider two instruments usually adopted to tackle this problem: financial regulation and taxation. From a normative viewpoint, taxation is superior in many respects. We take a positive, political-economy perspective. We show that a majority of low-risk portfolio-owners may have a strategic incentive to use regulation rather than taxation in order to charge the minority a large share of the externality reduction. We also show that, when the majority chooses a tax, the probable level is socially too low. If the majority chooses regulation, the latter will possibly be too harsh. This eventually explains why financial regulation is more frequently adopted, and why incentives to circumvent it are so strong in reality.Less
We describe systemic financial risk as a negative externality. Free riding leads to excess risk production. We consider two instruments usually adopted to tackle this problem: financial regulation and taxation. From a normative viewpoint, taxation is superior in many respects. We take a positive, political-economy perspective. We show that a majority of low-risk portfolio-owners may have a strategic incentive to use regulation rather than taxation in order to charge the minority a large share of the externality reduction. We also show that, when the majority chooses a tax, the probable level is socially too low. If the majority chooses regulation, the latter will possibly be too harsh. This eventually explains why financial regulation is more frequently adopted, and why incentives to circumvent it are so strong in reality.
Roy C. Smith, Ingo Walter, and Gayle Delong
- Published in print:
- 2012
- Published Online:
- May 2012
- ISBN:
- 9780195335934
- eISBN:
- 9780199932146
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780195335934.003.0014
- Subject:
- Economics and Finance, Economic Systems
This chapter discusses essential regulatory principles for controlling systemic risk: Systemic financial intermediaries like large and complex financial institutions (LCFIs), which are thought to be ...
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This chapter discusses essential regulatory principles for controlling systemic risk: Systemic financial intermediaries like large and complex financial institutions (LCFIs), which are thought to be too big to fail, must be charged insurance premiums commensurate with the explicit or implicit government insurance they enjoy on a continuous basis. There should be an additional risk premium tied specifically to the systemic risk of the institutions, for example, if it exceeds a normative level, the institution pays for the additional risk taken on. Some sort of after-the-fact discipline such as “contingent capital” may be necessary; for example, debt that automatically converts into equity when losses seriously deplete equity capital. A form of functional separation or carve-outs needs to be enforced, whether by regulatory fiat or through appropriate capital charges.Less
This chapter discusses essential regulatory principles for controlling systemic risk: Systemic financial intermediaries like large and complex financial institutions (LCFIs), which are thought to be too big to fail, must be charged insurance premiums commensurate with the explicit or implicit government insurance they enjoy on a continuous basis. There should be an additional risk premium tied specifically to the systemic risk of the institutions, for example, if it exceeds a normative level, the institution pays for the additional risk taken on. Some sort of after-the-fact discipline such as “contingent capital” may be necessary; for example, debt that automatically converts into equity when losses seriously deplete equity capital. A form of functional separation or carve-outs needs to be enforced, whether by regulatory fiat or through appropriate capital charges.
E. Philip Davis
- Published in print:
- 1995
- Published Online:
- November 2003
- ISBN:
- 9780198233312
- eISBN:
- 9780191596124
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198233310.003.0006
- Subject:
- Economics and Finance, Financial Economics
Turning from financial fragility to systemic risk, the next two chapters seek to make an initial assessment of the causes, nature, and consequences of financial instability in contemporary financial ...
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Turning from financial fragility to systemic risk, the next two chapters seek to make an initial assessment of the causes, nature, and consequences of financial instability in contemporary financial markets by means of an examination of the features of six recent periods of financial disorder, in the light of the various theoretical approaches to financial crisis that have been proposed in the literature. To what extent did financial instability follow directly from financial fragility in the non‐financial sectors, with defaults by companies or households progressively weakening the balance sheets of financial institutions? Or were risks other than credit risk primarily responsible? Were the periods of financial instability ‘unique events’ or can common features be discerned? How well do the predictions of the theoretical paradigms fit the actual data? This chapter provides the theoretical background, while Ch. 6 offers an empirical assessment. We cover the financial fragility, monetarist, uncertainty, credit rationing/disaster myopia, and asymmetric information strands of the theory of financial instability.Less
Turning from financial fragility to systemic risk, the next two chapters seek to make an initial assessment of the causes, nature, and consequences of financial instability in contemporary financial markets by means of an examination of the features of six recent periods of financial disorder, in the light of the various theoretical approaches to financial crisis that have been proposed in the literature. To what extent did financial instability follow directly from financial fragility in the non‐financial sectors, with defaults by companies or households progressively weakening the balance sheets of financial institutions? Or were risks other than credit risk primarily responsible? Were the periods of financial instability ‘unique events’ or can common features be discerned? How well do the predictions of the theoretical paradigms fit the actual data? This chapter provides the theoretical background, while Ch. 6 offers an empirical assessment. We cover the financial fragility, monetarist, uncertainty, credit rationing/disaster myopia, and asymmetric information strands of the theory of financial instability.
E. Philip Davis
- Published in print:
- 1995
- Published Online:
- November 2003
- ISBN:
- 9780198233312
- eISBN:
- 9780191596124
- Item type:
- book
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198233310.001.0001
- Subject:
- Economics and Finance, Financial Economics
A remarkable feature of the period since 1970 has been the patterns of rapid and turbulent change in financing behaviour and financial structure in many advanced countries. These patterns have, in ...
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A remarkable feature of the period since 1970 has been the patterns of rapid and turbulent change in financing behaviour and financial structure in many advanced countries. These patterns have, in turn, often been marked by rising indebtedness, volatile asset prices, and periods of financial stress, whether in the non‐financial sector, the financial sector, or both. At the same time, the economics profession has seen a notable advance in the scope and depth of the theory of finance, particularly as it relates to the nature and behaviour of financial institutions and markets. In this context, the objective of the book is to explore, in both theoretical and empirical terms, the nature of the relationships in advanced industrial economies between levels and changes in borrowing (debt), vulnerability to default in the non‐financial sector (financial fragility), and widespread instability in the financial sector (systemic risk). The work seeks to provide a survey and critical assessment of the current economic theory relating to debt and financial instability to offer empirical evidence casting light on the validity of the theories, and it suggests a number of policy implications and lines of further research. Unlike most extant texts on these matters, which generally relate to one country's experience, the book focuses on the way similar patterns are observable in several countries—but not in others—as well as in the international capital markets themselves. Particular attention is paid to the importance of the nature and evolution of financial structure to the genesis of instability. Whereas a structural approach is common in analysis of comparative behaviour of financial systems—notably in corporate finance—its application to instability is relatively rare. Given the international scope of the analysis, the work is germane to understanding the behaviour of financial systems in all capitalist economies, as well as in the international capital markets. However, it is of particular relevance to analysis of the US, Japan, Germany, France, the UK, Canada, Sweden, Norway, Italy, and Australia, whose recent experience is analysed in some detail.Less
A remarkable feature of the period since 1970 has been the patterns of rapid and turbulent change in financing behaviour and financial structure in many advanced countries. These patterns have, in turn, often been marked by rising indebtedness, volatile asset prices, and periods of financial stress, whether in the non‐financial sector, the financial sector, or both. At the same time, the economics profession has seen a notable advance in the scope and depth of the theory of finance, particularly as it relates to the nature and behaviour of financial institutions and markets. In this context, the objective of the book is to explore, in both theoretical and empirical terms, the nature of the relationships in advanced industrial economies between levels and changes in borrowing (debt), vulnerability to default in the non‐financial sector (financial fragility), and widespread instability in the financial sector (systemic risk). The work seeks to provide a survey and critical assessment of the current economic theory relating to debt and financial instability to offer empirical evidence casting light on the validity of the theories, and it suggests a number of policy implications and lines of further research. Unlike most extant texts on these matters, which generally relate to one country's experience, the book focuses on the way similar patterns are observable in several countries—but not in others—as well as in the international capital markets themselves. Particular attention is paid to the importance of the nature and evolution of financial structure to the genesis of instability. Whereas a structural approach is common in analysis of comparative behaviour of financial systems—notably in corporate finance—its application to instability is relatively rare. Given the international scope of the analysis, the work is germane to understanding the behaviour of financial systems in all capitalist economies, as well as in the international capital markets. However, it is of particular relevance to analysis of the US, Japan, Germany, France, the UK, Canada, Sweden, Norway, Italy, and Australia, whose recent experience is analysed in some detail.
Ruud de Mooij and Gaëtan Nicodème (eds)
- Published in print:
- 2015
- Published Online:
- May 2015
- ISBN:
- 9780262027977
- eISBN:
- 9780262321099
- Item type:
- book
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262027977.001.0001
- Subject:
- Economics and Finance, Financial Economics
The financial crisis has revealed many problems in the transparency and functioning of the financial sector. New debates on regulation and taxation of the financial sector have emerged as economists ...
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The financial crisis has revealed many problems in the transparency and functioning of the financial sector. New debates on regulation and taxation of the financial sector have emerged as economists and policy makers were challenged to understand the sequence of events and the complex interactions between financial markets and the real economy-often not captured by economic models. This book opens a novel field of research by bringing together insights from public finance and banking, with the aim to better understand what had happened and how policy design of taxation and regulation could prevent a similar occurrence in the future.Less
The financial crisis has revealed many problems in the transparency and functioning of the financial sector. New debates on regulation and taxation of the financial sector have emerged as economists and policy makers were challenged to understand the sequence of events and the complex interactions between financial markets and the real economy-often not captured by economic models. This book opens a novel field of research by bringing together insights from public finance and banking, with the aim to better understand what had happened and how policy design of taxation and regulation could prevent a similar occurrence in the future.
Ruben Lee
- Published in print:
- 2011
- Published Online:
- October 2017
- ISBN:
- 9780691133539
- eISBN:
- 9781400836970
- Item type:
- chapter
- Publisher:
- Princeton University Press
- DOI:
- 10.23943/princeton/9780691133539.003.0011
- Subject:
- Economics and Finance, Macro- and Monetary Economics
This chapter explores what regulatory intervention in the governance of market infrastructure institutions is optimal. Attention is focused on how such intervention can enhance the realization of the ...
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This chapter explores what regulatory intervention in the governance of market infrastructure institutions is optimal. Attention is focused on how such intervention can enhance the realization of the three core objectives of securities markets regulation identified by International Organization of Securities Commissions (IOSCO), namely the protection of investors, ensuring that markets are fair, efficient, and transparent, and the reduction of systemic risk. The chapter is divided into five sections. In the first, some preliminary comments are presented. In the next three sections, the manner in which regulatory intervention in the governance of market infrastructure institutions may promote each of the IOSCO core objectives in turn is examined. The last section encapsulates these discussions and presents key lessons about how best to regulate the governance of market infrastructure institutions. In order to do so, 16 general propositions are articulated.Less
This chapter explores what regulatory intervention in the governance of market infrastructure institutions is optimal. Attention is focused on how such intervention can enhance the realization of the three core objectives of securities markets regulation identified by International Organization of Securities Commissions (IOSCO), namely the protection of investors, ensuring that markets are fair, efficient, and transparent, and the reduction of systemic risk. The chapter is divided into five sections. In the first, some preliminary comments are presented. In the next three sections, the manner in which regulatory intervention in the governance of market infrastructure institutions may promote each of the IOSCO core objectives in turn is examined. The last section encapsulates these discussions and presents key lessons about how best to regulate the governance of market infrastructure institutions. In order to do so, 16 general propositions are articulated.
Xavier Freixas, Luc Laeven, and José-Luis Peydró
- Published in print:
- 2015
- Published Online:
- September 2016
- ISBN:
- 9780262028691
- eISBN:
- 9780262328609
- Item type:
- chapter
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262028691.003.0007
- Subject:
- Economics and Finance, Public and Welfare
This chapter gives an overview of existing methods to measure systemic risk. The objective of this chapter is to provide guidance on how one should measure systemic risk in practice, including in ...
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This chapter gives an overview of existing methods to measure systemic risk. The objective of this chapter is to provide guidance on how one should measure systemic risk in practice, including in environments with data limitations such as emerging markets and the non-regulated financial system. The chapter discusses methods to develop real time early warning signals to measure excessive credit and other aggregate financial imbalances. It also provides measures based on balance sheet data and on market data, both to analyze contagion risks and macro imbalances, including network analysis. Finally, the chapter summarizes how different measures of financial imbalances that are commonly used in policy and academic circles have performed in many financial crises over the twentieth century.Less
This chapter gives an overview of existing methods to measure systemic risk. The objective of this chapter is to provide guidance on how one should measure systemic risk in practice, including in environments with data limitations such as emerging markets and the non-regulated financial system. The chapter discusses methods to develop real time early warning signals to measure excessive credit and other aggregate financial imbalances. It also provides measures based on balance sheet data and on market data, both to analyze contagion risks and macro imbalances, including network analysis. Finally, the chapter summarizes how different measures of financial imbalances that are commonly used in policy and academic circles have performed in many financial crises over the twentieth century.
E. Philip Davis
- Published in print:
- 1995
- Published Online:
- November 2003
- ISBN:
- 9780198233312
- eISBN:
- 9780191596124
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198233310.003.0008
- Subject:
- Economics and Finance, Financial Economics
Chapters 5 and 6 identified a number of features common to most periods of financial instability in recent decades; these observations were felt to validate to some extent the various theories of ...
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Chapters 5 and 6 identified a number of features common to most periods of financial instability in recent decades; these observations were felt to validate to some extent the various theories of financial crisis that have been proposed in the literature. On the other hand, not one theory was able to explain financial instability; features of several had to be jointly present in order for a situation of financial instability to arise. This chapter explores the hypothesis that many of the factors underlying heightened systemic risk can be adequately subsumed in an industrial organization framework, with particular reference to the role of an intensification of competition among financial intermediaries following market developments that reduce entry barriers. The approach seeks both to encompass the mechanisms highlighted by existing theories of financial crisis, particularly those relating to uncertainty and imperfect information, and also to extend them by focusing on certain structural aspects that have hitherto been generally neglected by theorists, and which can be discerned in many, if not all, cases of financial instability. (In other words, it seeks to complement and not substitute for the analysis of Chs. 5 and 6.). It is suggested that the hypothesis could provide additional policy recommendations and also useful leading indicators of financial instability as well as fragility, both for regulators and for market participants themselves.Less
Chapters 5 and 6 identified a number of features common to most periods of financial instability in recent decades; these observations were felt to validate to some extent the various theories of financial crisis that have been proposed in the literature. On the other hand, not one theory was able to explain financial instability; features of several had to be jointly present in order for a situation of financial instability to arise. This chapter explores the hypothesis that many of the factors underlying heightened systemic risk can be adequately subsumed in an industrial organization framework, with particular reference to the role of an intensification of competition among financial intermediaries following market developments that reduce entry barriers. The approach seeks both to encompass the mechanisms highlighted by existing theories of financial crisis, particularly those relating to uncertainty and imperfect information, and also to extend them by focusing on certain structural aspects that have hitherto been generally neglected by theorists, and which can be discerned in many, if not all, cases of financial instability. (In other words, it seeks to complement and not substitute for the analysis of Chs. 5 and 6.). It is suggested that the hypothesis could provide additional policy recommendations and also useful leading indicators of financial instability as well as fragility, both for regulators and for market participants themselves.
Brian Coulter, Colin Mayer, and John Vickers
- Published in print:
- 2015
- Published Online:
- May 2015
- ISBN:
- 9780262027977
- eISBN:
- 9780262321099
- Item type:
- chapter
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262027977.003.0004
- Subject:
- Economics and Finance, Financial Economics
A natural economic response to systemic risk, as a form of negative externality, is to look attaxation to correct it. However, this chapter argues that systemic risk is not a standard externality. ...
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A natural economic response to systemic risk, as a form of negative externality, is to look attaxation to correct it. However, this chapter argues that systemic risk is not a standard externality. First, a ‘polluter pays’ approach is inapplicable because the polluter is insolvent in a systemic crisis and cannot pay. Second, the equivalence between taxation and regulation holds only under a set of very strict assumptions The imposition of a levy increases banks per-loan funding requirements and potentially total amount of debt in the system. The levy may thereby perversely exacerbate potential systemic crises unless paid in capital, in which case it returns full circle to capital regulation.Less
A natural economic response to systemic risk, as a form of negative externality, is to look attaxation to correct it. However, this chapter argues that systemic risk is not a standard externality. First, a ‘polluter pays’ approach is inapplicable because the polluter is insolvent in a systemic crisis and cannot pay. Second, the equivalence between taxation and regulation holds only under a set of very strict assumptions The imposition of a levy increases banks per-loan funding requirements and potentially total amount of debt in the system. The levy may thereby perversely exacerbate potential systemic crises unless paid in capital, in which case it returns full circle to capital regulation.
Jens Hagendorff
- Published in print:
- 2013
- Published Online:
- January 2014
- ISBN:
- 9780199694891
- eISBN:
- 9780191748820
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199694891.003.0005
- Subject:
- Business and Management, Finance, Accounting, and Banking
The purpose of this chapter is to analyse whether a European banking system, which consists of smaller and more specialised banking firms and is regulated with a larger set of prudential rules than ...
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The purpose of this chapter is to analyse whether a European banking system, which consists of smaller and more specialised banking firms and is regulated with a larger set of prudential rules than present, is likely to better withstand systemic shocks. The chapter adopts a novel empirical approach that relates the changes in the risk that a bank fails to changes in the degree of systemic stability. Also, the role of liquidity is examined in protecting banks against these shocks only when the banking system is under stress. While the results show that restrictions on a bank’s leverage ratio and the imposition of liquidity requirements, as in the Basel III Accord, may improve the resilience of a bank to systemic events, they also demonstrate that bank size, the share of non-interest income and asset growth (none of which are at the centre of the new regulatory landscape) are key determinants of a bank’s risk exposure. In particular, the introduction of a cap on bank absolute size appears the most effective tool, ceteris paribus, to reduce the default risk of a bank given systemic events.Less
The purpose of this chapter is to analyse whether a European banking system, which consists of smaller and more specialised banking firms and is regulated with a larger set of prudential rules than present, is likely to better withstand systemic shocks. The chapter adopts a novel empirical approach that relates the changes in the risk that a bank fails to changes in the degree of systemic stability. Also, the role of liquidity is examined in protecting banks against these shocks only when the banking system is under stress. While the results show that restrictions on a bank’s leverage ratio and the imposition of liquidity requirements, as in the Basel III Accord, may improve the resilience of a bank to systemic events, they also demonstrate that bank size, the share of non-interest income and asset growth (none of which are at the centre of the new regulatory landscape) are key determinants of a bank’s risk exposure. In particular, the introduction of a cap on bank absolute size appears the most effective tool, ceteris paribus, to reduce the default risk of a bank given systemic events.
Avinash D. Persaud
- Published in print:
- 2010
- Published Online:
- February 2010
- ISBN:
- 9780199578801
- eISBN:
- 9780191723285
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199578801.003.0008
- Subject:
- Economics and Finance, Macro- and Monetary Economics, Financial Economics
Persaud provides in his chapter complementary analysis on the design of banking regulation and supervision in the light of the credit crisis. In the author's view, two fundamental flaws in financial ...
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Persaud provides in his chapter complementary analysis on the design of banking regulation and supervision in the light of the credit crisis. In the author's view, two fundamental flaws in financial regulation led to the biggest crisis of modern times. The first was to put market evaluations of risk at the heart of financial regulation, through external ratings and risk measures derived from market prices. The essential problem is that market prices may improperly evaluate risk in the presence of market failures. The second flaw was to assume that common standards, such as value‐accounting and risk measures are good and that diversity is bad, thus underestimating the advantages different players have to assume different risks.Less
Persaud provides in his chapter complementary analysis on the design of banking regulation and supervision in the light of the credit crisis. In the author's view, two fundamental flaws in financial regulation led to the biggest crisis of modern times. The first was to put market evaluations of risk at the heart of financial regulation, through external ratings and risk measures derived from market prices. The essential problem is that market prices may improperly evaluate risk in the presence of market failures. The second flaw was to assume that common standards, such as value‐accounting and risk measures are good and that diversity is bad, thus underestimating the advantages different players have to assume different risks.
Viral V. Acharya, Lasse H. Pedersen, Thomas Philippon, and Matthew Richardson
- Published in print:
- 2013
- Published Online:
- September 2013
- ISBN:
- 9780226319285
- eISBN:
- 9780226921969
- Item type:
- chapter
- Publisher:
- University of Chicago Press
- DOI:
- 10.7208/chicago/9780226921969.003.0007
- Subject:
- Economics and Finance, Econometrics
This chapter analyzes a scheme to charge financial firms for their systemic risk contributions, based on the price of their contingent capital insurance. It provides an explicit calculation formula ...
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This chapter analyzes a scheme to charge financial firms for their systemic risk contributions, based on the price of their contingent capital insurance. It provides an explicit calculation formula for contingent capital insurance and illustrates how the systemic risk surcharge varies with institution size, its leverage, risk (equity volatility), and, importantly, its correlation with rest of the economy or with the systemically important part of the financial sector. Calculations of both the tax and the insurance premium for major financial firms prior to the 2007 financial crisis show that the measure accurately chose the systemic firms, consistent with recent statistical-based measures of systemic risk. A commentary is also included at the end of the chapter.Less
This chapter analyzes a scheme to charge financial firms for their systemic risk contributions, based on the price of their contingent capital insurance. It provides an explicit calculation formula for contingent capital insurance and illustrates how the systemic risk surcharge varies with institution size, its leverage, risk (equity volatility), and, importantly, its correlation with rest of the economy or with the systemically important part of the financial sector. Calculations of both the tax and the insurance premium for major financial firms prior to the 2007 financial crisis show that the measure accurately chose the systemic firms, consistent with recent statistical-based measures of systemic risk. A commentary is also included at the end of the chapter.
Xavier Freixas, Luc Laeven, and José-Luis Peydró
- Published in print:
- 2015
- Published Online:
- September 2016
- ISBN:
- 9780262028691
- eISBN:
- 9780262328609
- Item type:
- chapter
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262028691.003.0009
- Subject:
- Economics and Finance, Public and Welfare
This chapter presents the “new” financial regulatory framework that relies on both microprudential and macroprudential policies to manage systemic risk. It gives an overview of macroprudential tools ...
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This chapter presents the “new” financial regulatory framework that relies on both microprudential and macroprudential policies to manage systemic risk. It gives an overview of macroprudential tools and then discusses the tradeoffs involved in choosing an optimal policy mix and the practical considerations when implementing these tools. It also analyses whether macroprudential policy setting should be within the same organization or a different organization than microprudential policy. The chapter also presents a critical review of the Basel III regulatory framework and the EU and US regulations. The analysis of the effectiveness of macroprudential tools is illustrated with case studies. The chapter emphasizes the preventive role of macroprudential policy in limiting the possibility and impact of financial crises, and concludes that the macroprudential policy mix needs to be chosen such that it deals both with the time and cross-sectional dimensions of systemic risk. This requires a multitude of measures and there is a risk that they will conflict with each other even though they share the same objective. Also, macroprudential policy should be combined with strong supervision, with an increased focus on the buildup of systemic risk through correlated risk exposures and risk taking by systemically important financial intermediaries.Less
This chapter presents the “new” financial regulatory framework that relies on both microprudential and macroprudential policies to manage systemic risk. It gives an overview of macroprudential tools and then discusses the tradeoffs involved in choosing an optimal policy mix and the practical considerations when implementing these tools. It also analyses whether macroprudential policy setting should be within the same organization or a different organization than microprudential policy. The chapter also presents a critical review of the Basel III regulatory framework and the EU and US regulations. The analysis of the effectiveness of macroprudential tools is illustrated with case studies. The chapter emphasizes the preventive role of macroprudential policy in limiting the possibility and impact of financial crises, and concludes that the macroprudential policy mix needs to be chosen such that it deals both with the time and cross-sectional dimensions of systemic risk. This requires a multitude of measures and there is a risk that they will conflict with each other even though they share the same objective. Also, macroprudential policy should be combined with strong supervision, with an increased focus on the buildup of systemic risk through correlated risk exposures and risk taking by systemically important financial intermediaries.
Xavier Freixas, Luc Laeven, and José-Luis Peydró
- Published in print:
- 2015
- Published Online:
- September 2016
- ISBN:
- 9780262028691
- eISBN:
- 9780262328609
- Item type:
- chapter
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262028691.003.0002
- Subject:
- Economics and Finance, Public and Welfare
This chapter gives a definition of systemic risk, describes the real consequences of systemic risk, and presents a taxonomy and illustration of systemic financial crises throughout history. It ...
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This chapter gives a definition of systemic risk, describes the real consequences of systemic risk, and presents a taxonomy and illustration of systemic financial crises throughout history. It explains that systemic risk is not limited to financial stability but also implies real effects for the economy at large, arising from an impairment of the financial system that causes substantial negative aggregate output and employment effects.Less
This chapter gives a definition of systemic risk, describes the real consequences of systemic risk, and presents a taxonomy and illustration of systemic financial crises throughout history. It explains that systemic risk is not limited to financial stability but also implies real effects for the economy at large, arising from an impairment of the financial system that causes substantial negative aggregate output and employment effects.
Prasanna Gai
- Published in print:
- 2013
- Published Online:
- May 2013
- ISBN:
- 9780199544493
- eISBN:
- 9780191747175
- Item type:
- book
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/acprof:oso/9780199544493.001.0001
- Subject:
- Economics and Finance, Financial Economics
This book opens new ground in the study of financial crises. It treats the financial system as a complex adaptive system and shows how lessons from network disciplines—such as ecology, epidemiology, ...
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This book opens new ground in the study of financial crises. It treats the financial system as a complex adaptive system and shows how lessons from network disciplines—such as ecology, epidemiology, and statistical mechanics—shed light on our understanding of financial stability. Using tools from network theory and economics, it suggests that financial systems are robust-yet-fragile, with knife-edge properties that are greatly exacerbated by the hoarding of funds and the fire sale of assets by banks. The book studies the damaging network consequences of the failure of large interconnected institutions, explains how key funding markets can seize up across the entire financial system, and shows how the pursuit of secured finance by banks in the wake of the global financial crisis can generate systemic risks. The insights are then used to model banking systems calibrated to data to illustrate how financial sector regulators are beginning to quantify financial system stress.Less
This book opens new ground in the study of financial crises. It treats the financial system as a complex adaptive system and shows how lessons from network disciplines—such as ecology, epidemiology, and statistical mechanics—shed light on our understanding of financial stability. Using tools from network theory and economics, it suggests that financial systems are robust-yet-fragile, with knife-edge properties that are greatly exacerbated by the hoarding of funds and the fire sale of assets by banks. The book studies the damaging network consequences of the failure of large interconnected institutions, explains how key funding markets can seize up across the entire financial system, and shows how the pursuit of secured finance by banks in the wake of the global financial crisis can generate systemic risks. The insights are then used to model banking systems calibrated to data to illustrate how financial sector regulators are beginning to quantify financial system stress.
E. Philip Davis
- Published in print:
- 1995
- Published Online:
- November 2003
- ISBN:
- 9780198233312
- eISBN:
- 9780191596124
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198233310.003.0002
- Subject:
- Economics and Finance, Financial Economics
This section offers an essential background for the analysis of the rest of the book. It outlines the nature of the debt contract; aspects of the economics of debt; theories of credit rationing and ...
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This section offers an essential background for the analysis of the rest of the book. It outlines the nature of the debt contract; aspects of the economics of debt; theories of credit rationing and financial intermediation; key differences between financial systems interpreted in the light of these concepts; and (in the appendix) stylized facts of the overall development of financial systems. To motivate this chapter, it suffices to note that the book suggests that the influence of credit rationing, the nature and locus of intermediation, and the type of financial system, all have a key influence on the genesis of financial fragility and systemic risk; and that these features in turn relate directly to the underlying nature of the debt contract itself. Note that there are three main types of debt: that owed by end users to investors (direct finance), by end users to intermediaries (generally loans), and by intermediaries to investors (generally deposits). Focus is mainly on the first two here and in Chs. 2–4; the third comes to the fore in the second part of the book, relating to financial instability.Less
This section offers an essential background for the analysis of the rest of the book. It outlines the nature of the debt contract; aspects of the economics of debt; theories of credit rationing and financial intermediation; key differences between financial systems interpreted in the light of these concepts; and (in the appendix) stylized facts of the overall development of financial systems. To motivate this chapter, it suffices to note that the book suggests that the influence of credit rationing, the nature and locus of intermediation, and the type of financial system, all have a key influence on the genesis of financial fragility and systemic risk; and that these features in turn relate directly to the underlying nature of the debt contract itself. Note that there are three main types of debt: that owed by end users to investors (direct finance), by end users to intermediaries (generally loans), and by intermediaries to investors (generally deposits). Focus is mainly on the first two here and in Chs. 2–4; the third comes to the fore in the second part of the book, relating to financial instability.
Xavier Freixas, José-Luis Peydró, and Luc Laeven
- Published in print:
- 2015
- Published Online:
- September 2016
- ISBN:
- 9780262028691
- eISBN:
- 9780262328609
- Item type:
- book
- Publisher:
- The MIT Press
- DOI:
- 10.7551/mitpress/9780262028691.001.0001
- Subject:
- Economics and Finance, Public and Welfare
Macroprudential regulation is the latest buzzword in economics but it means different things to different people. This book offers a framework to operationalize macroprudential policy. It defines ...
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Macroprudential regulation is the latest buzzword in economics but it means different things to different people. This book offers a framework to operationalize macroprudential policy. It defines systemic risk and macroprudential regulation, offers a rationale for macroprudential regulation and explains its differences with microprudental policy, discusses its interactions with macroeconomic policies, presents alternative methods to measure systemic risk, reviews country experiences with macroprudential policy, and discusses the strengths and weaknesses of various macroprudential tools and the trade-offs involved in choosing an optimal policy mix. The book emphasizes the preventive role of macroprudential policy in limiting the possibility and impact of financial crises, and concludes that the macroprudential policy mix needs to be chosen such that it deals both with the time dimension (i.e. procyclicality) and cross-sectional dimension (i.e., firm heterogeneity) of systemic risk. At the same time, the powers and effectiveness of macroprudential policy should not be overestimated. Its implementation will require a multitude of measures and there is a risk that these measures will conflict with each other, even though they share the same objective. Also, macroprudential policy needs to be combined with strong supervision, with an increased focus on the buildup of systemic risk through correlated risk exposures and risk taking by systemically important financial intermediaries. Weak supervision and generous too big to fail subsidies hamper the effectiveness of macroprudential policy. And there is a risk of political interference in the design and implementation of macroprudential regulation, limiting its effectiveness.Less
Macroprudential regulation is the latest buzzword in economics but it means different things to different people. This book offers a framework to operationalize macroprudential policy. It defines systemic risk and macroprudential regulation, offers a rationale for macroprudential regulation and explains its differences with microprudental policy, discusses its interactions with macroeconomic policies, presents alternative methods to measure systemic risk, reviews country experiences with macroprudential policy, and discusses the strengths and weaknesses of various macroprudential tools and the trade-offs involved in choosing an optimal policy mix. The book emphasizes the preventive role of macroprudential policy in limiting the possibility and impact of financial crises, and concludes that the macroprudential policy mix needs to be chosen such that it deals both with the time dimension (i.e. procyclicality) and cross-sectional dimension (i.e., firm heterogeneity) of systemic risk. At the same time, the powers and effectiveness of macroprudential policy should not be overestimated. Its implementation will require a multitude of measures and there is a risk that these measures will conflict with each other, even though they share the same objective. Also, macroprudential policy needs to be combined with strong supervision, with an increased focus on the buildup of systemic risk through correlated risk exposures and risk taking by systemically important financial intermediaries. Weak supervision and generous too big to fail subsidies hamper the effectiveness of macroprudential policy. And there is a risk of political interference in the design and implementation of macroprudential regulation, limiting its effectiveness.
E. Philip Davis
- Published in print:
- 1995
- Published Online:
- November 2003
- ISBN:
- 9780198233312
- eISBN:
- 9780191596124
- Item type:
- chapter
- Publisher:
- Oxford University Press
- DOI:
- 10.1093/0198233310.003.0005
- Subject:
- Economics and Finance, Financial Economics
Chapters 2 and 3 focused largely on the direct costs of financial fragility, namely increased business failures, household bankruptcies, and mortgage foreclosures. It was noted (Ch. 2, Sect. 3) that ...
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Chapters 2 and 3 focused largely on the direct costs of financial fragility, namely increased business failures, household bankruptcies, and mortgage foreclosures. It was noted (Ch. 2, Sect. 3) that the key assumption required for such defaults to be of economic relevance is that there should be positive costs of bankruptcy, i.e. that default does not merely involve a smooth transfer of assets from debtor to creditor. Such costs might include not merely legal costs but also difficulties of firms in keeping personnel, obtaining inventory, costs of portfolio reallocation, costs of disposing of collateral, etc. But it was also noted that financial fragility may have broader economic effects. In the extreme, fragility may lead to systemic risk in the financial system; this relationship, as well as other causes and consequences of systemic risk, is explored in Chs. 5–8. Here we assess some of the wider implications of overindebtedness and default for economic performance, short of the generation of financial instability. In general, these are spillovers or externality effects that are not taken into account by companies or households when selecting their level of gearing in the light of their assets and income, nor by lenders choosing their interest rates on loans. They thus constitute possible grounds for policy intervention.Less
Chapters 2 and 3 focused largely on the direct costs of financial fragility, namely increased business failures, household bankruptcies, and mortgage foreclosures. It was noted (Ch. 2, Sect. 3) that the key assumption required for such defaults to be of economic relevance is that there should be positive costs of bankruptcy, i.e. that default does not merely involve a smooth transfer of assets from debtor to creditor. Such costs might include not merely legal costs but also difficulties of firms in keeping personnel, obtaining inventory, costs of portfolio reallocation, costs of disposing of collateral, etc. But it was also noted that financial fragility may have broader economic effects. In the extreme, fragility may lead to systemic risk in the financial system; this relationship, as well as other causes and consequences of systemic risk, is explored in Chs. 5–8. Here we assess some of the wider implications of overindebtedness and default for economic performance, short of the generation of financial instability. In general, these are spillovers or externality effects that are not taken into account by companies or households when selecting their level of gearing in the light of their assets and income, nor by lenders choosing their interest rates on loans. They thus constitute possible grounds for policy intervention.
