Financial regulation: Difference between revisions

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==Background: financial regulation==
==Background: financial regulation==
===Central bank supervision===
Governments have long been aware of the danger that a loss of confidence following the failure of one bank could lead to the failure of others, and eventually to "systemic failure" of the entire financial system. To limit that danger, they have traditionally  required  banks to limit the extent to which their loans exceed the funds provided by their shareholders  by the imposition of minimum "''reserve ratios''"  and have placed various other restrictions upon their activities.  In the 1980s, however, it was widely considered that those regulations  were imposing  excessive economic penalties, and there was a general move toward "deregulation" <ref>[http://www.bis.org/publ/econ43.pdf?noframes=1 Claudio Borio and Renato Filosa: ''The Changing Borders of Banking'', BIS Economic Paper No 43, Bank for International Settlements December 1994]</ref>. Restrictions that had prevented  investment banks from broadening  their activities to include  branch banking, insurance or mortgage lending were dropped, and reserve requirements were relaxed.
The Glass-Steagall Act -- which was repealed by the Gramm-Leach-Bliley Act in 1999 <ref>[http://banking.senate.gov/conf/grmleach.htm Financial Services Modernization Act (Gramm-Leach-Bliley) Summary of Provisions, 1999]</ref> -- was designed as a method by which to protect depositors from risks associated with securities transactions. It did this by prohibiting commercial banks from participating in investment banking activities and from collaborating with full-service brokerage firms
===International recommendations===
In 1974  the governors of the central banks of the Group of Ten leading industrial countries had set up [[The Basel Committee for Banking Supervision]] <ref>[http://www.bis.org/bcbs/ The Basel Committee for Banking Supervision]</ref> to coordinate precautionary banking regulations <ref> See paragraph 5 of the article on [[Financial economics]]</ref>, and in 1988, concern about the increased danger of  systemic failure led that committee to publish a set of regulatory recommendations that related a bank's required reserve ratio to the riskiness of its loans <ref>[http://www.bis.org/publ/bcbsc111.pdf?noframes=1, ''The Basel Capital Accord'' (Basel I) Basel Committee for Banking Supervision 1988]</ref>. In 1999 further  concern about the danger of instability led to the creation of the [[Financial Stability Forum]] <ref>[http://www.fsforum.org/index.htm The Financial Stability Forum]</ref>  to promote information exchange and international co-operation in financial supervision and surveillance. In 2004, the Basel Committee published revised recommendations known as Basel II <ref>[http://www.bis.org/publ/bcbsca.htm Revised International Capital Framework, (Basel II) Basel Committee on Banking Supervision 2006]</ref> intended to require banks to take more detailed account of the riskiness of their loans.
Responsibility for assessing risk was placed upon the banks and the credit agencies.
During the eighteen-month period between the middle of 2007 and the end of 2008 the "''[[crash of 2008]]''" resulted in  the failure or enforced rescue of fifteen major banks, three of the world's largest mortgage-lenders and one of the world's largest insurance companies <ref> For a list of the affected companies see the timelines subpage of the article on the crash of 2008  [http://en.citizendium.org/wiki/Crash_of_2008/Timelines]</ref>, a disaster that has been attributed to risk-management errors on the part of the banks and the principal credit-rating agencies <ref> For an account  of some  possible sources of  risk-management errors, see the tutorials subpage of the article on the crash of 2008 [http://en.citizendium.org/wiki/Crash_of_2008/Tutorials]</ref> and to inaction on the part of the regulatory authorities. The investments whose riskiness had been wrongly assessed were derivatives based upon mortgages in the United States housing market <ref> See the article on the [[subprime mortgage crisis]]</ref>. In 2007, an international banking panic was triggered by the revelation of serious problems at a major United States bank stemming from its holdings of such derivatives, and in 2008 an international "credit crunch" was generally attributed to a loss of mutual confidence among banks that was prompted by the unexpected failure of the United States authorities to save the Lehman Brothers bank from bankruptcy.
According to the Bank of England "The global banking system experienced its most severe instability since the outbreak of World War I" <ref>[http://www.bankofengland.co.uk/publications/inflationreport/infrep.htm ''Overview of the November Inflation Report'', Bank of England 2008]</ref>.
''(The article on [[bank failures and rescues]] lists the major bank failures and banking crises from the end of the first world war and the [[crash of 2008]])''
==Post-crash proposals==
==Post-crash proposals==


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Background: financial regulation

Central bank supervision

Governments have long been aware of the danger that a loss of confidence following the failure of one bank could lead to the failure of others, and eventually to "systemic failure" of the entire financial system. To limit that danger, they have traditionally required banks to limit the extent to which their loans exceed the funds provided by their shareholders by the imposition of minimum "reserve ratios" and have placed various other restrictions upon their activities. In the 1980s, however, it was widely considered that those regulations were imposing excessive economic penalties, and there was a general move toward "deregulation" [1]. Restrictions that had prevented investment banks from broadening their activities to include branch banking, insurance or mortgage lending were dropped, and reserve requirements were relaxed.

The Glass-Steagall Act -- which was repealed by the Gramm-Leach-Bliley Act in 1999 [2] -- was designed as a method by which to protect depositors from risks associated with securities transactions. It did this by prohibiting commercial banks from participating in investment banking activities and from collaborating with full-service brokerage firms

International recommendations

In 1974 the governors of the central banks of the Group of Ten leading industrial countries had set up The Basel Committee for Banking Supervision [3] to coordinate precautionary banking regulations [4], and in 1988, concern about the increased danger of systemic failure led that committee to publish a set of regulatory recommendations that related a bank's required reserve ratio to the riskiness of its loans [5]. In 1999 further concern about the danger of instability led to the creation of the Financial Stability Forum [6] to promote information exchange and international co-operation in financial supervision and surveillance. In 2004, the Basel Committee published revised recommendations known as Basel II [7] intended to require banks to take more detailed account of the riskiness of their loans. Responsibility for assessing risk was placed upon the banks and the credit agencies.

During the eighteen-month period between the middle of 2007 and the end of 2008 the "crash of 2008" resulted in the failure or enforced rescue of fifteen major banks, three of the world's largest mortgage-lenders and one of the world's largest insurance companies [8], a disaster that has been attributed to risk-management errors on the part of the banks and the principal credit-rating agencies [9] and to inaction on the part of the regulatory authorities. The investments whose riskiness had been wrongly assessed were derivatives based upon mortgages in the United States housing market [10]. In 2007, an international banking panic was triggered by the revelation of serious problems at a major United States bank stemming from its holdings of such derivatives, and in 2008 an international "credit crunch" was generally attributed to a loss of mutual confidence among banks that was prompted by the unexpected failure of the United States authorities to save the Lehman Brothers bank from bankruptcy. According to the Bank of England "The global banking system experienced its most severe instability since the outbreak of World War I" [11].

(The article on bank failures and rescues lists the major bank failures and banking crises from the end of the first world war and the crash of 2008)

Post-crash proposals

[12].

[13].

[14].

[15]

The authorities' reactions

[16]; and in a 2005 lecture, Jean-Claude Trichet, the President of the European Central Bank, argued that not all bubbles threaten financial stability, and that if policy-makers attempted to eliminate all risk from the financial system, they either fail or they would "hamper the appropriate functioning of a market economy"[17]. [18], and by Federal Reserve Board Governor Frederic Mishkin [19]

Policy decisions

References

  1. ↑ Claudio Borio and Renato Filosa: The Changing Borders of Banking, BIS Economic Paper No 43, Bank for International Settlements December 1994
  2. ↑ Financial Services Modernization Act (Gramm-Leach-Bliley) Summary of Provisions, 1999
  3. ↑ The Basel Committee for Banking Supervision
  4. ↑ See paragraph 5 of the article on Financial economics
  5. ↑ The Basel Capital Accord (Basel I) Basel Committee for Banking Supervision 1988
  6. ↑ The Financial Stability Forum
  7. ↑ Revised International Capital Framework, (Basel II) Basel Committee on Banking Supervision 2006
  8. ↑ For a list of the affected companies see the timelines subpage of the article on the crash of 2008 [1]
  9. ↑ For an account of some possible sources of risk-management errors, see the tutorials subpage of the article on the crash of 2008 [2]
  10. ↑ See the article on the subprime mortgage crisis
  11. ↑ Overview of the November Inflation Report, Bank of England 2008
  12. ↑ Asset Prices and the Business Cycle, World Economic Outlook, Chapter 3, International Monetary Fund, May 2000
  13. ↑ Lessons for Monetary Problems from Asset Price Fluctuations, (World Economic Outlook October 2009 Chapter 3) International Monetary Fund 2009
  14. ↑ The Warwick Commission on International Financial Reform: In Praise of Unlevel Playing Fields, (The report of the second Warwick Commission) University of Warwick, November 2009
  15. ↑ The Role of Macroprudential Policy, a discussion paper, Bank of England, November 2009
  16. ↑ Ben Bernanke: Asset-Price "Bubbles" and Monetary Policy (Speech to the New York Chapter of the National Association for Business Economics, New York, New York, October 15 2002) Federal Reserve Board 2002
  17. ↑ Jean-Claude Trichet: Asset price bubbles and monetary policy,(Mas lecture, 8 June 2005) European Central Bank, 2005
  18. ↑ Mark Carney, Governor of the Bank of Canada: Some Considerations on Using Monetary Policy to Stabilize Economic Activity, (Speech to the Foreign Policy Association, New York, 19 November 2009)Bank for International Settlements, 2009
  19. ↑ Frederic Mishkin: How Should We Respond to Asset Price Bubbles, Board of Governors of the Federal Reserve System, October 2008
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