New Policy Briefs on Financial System Reform from Re-Define

This policy paper sketches out what a good bank and a good banking system should like. It then reflects on policy options can can help us get from the banking systems we have to the ones we need

What should the banking system look like

This recent policy brief from Re-Define is a very important contribution to the curent policy discussions on financial sector reform. It lists, discusses and critiques the proposals put forward by governments in the US and Europe.

A stock-take of the ongoing financial reform discussions

This policy brief written in April 2009 discusses what financial sector reforms are needed in order to bring about a system that is more stable, more competitive, fairer and that better serves the need of the real economy

What financial reforms are needed

Revisiting the Tobin Tax - Financial Transaction Taxes for Burden Sharing and as Regulatory Tools

Tobin taxes are back in circulation again. The financial crisis has highlighted the fundamental problems of financial stability as well as the costs associated with bailouts of the financial sector.

Interestingly the family of tobin taxes, better known as financial transaction taxes ot security transaction taxes are good tools which can help tackle both of these problems. Their potential and role in helping provide solutions to the challenges confronting us are discussed briefly in this policy note here. This note which was written a while back will be followed by a Re-Define Policy Paper out next week. 

Exponentially expanded financial markets
 
It is widely known that turnover in financial markets (the total value of financial instruments traded every year) has grown exponentially. This has been the case for almost all financial markets both on-exchange such as stock markets and off-exchange such as OTC derivate markets.
 
Currency market turnover for example rose from about $4 trillion in the 70s to $40 trillion in the 80s to more than $500 trillion now. Turnover in equity markets registered a seven fold increase between 1993 and 2005 to about $51 trillion and the wealth held in the global bond market is more than $60 trillion now with turnover substantially higher. The notional value of OTC credit default swaps, just a single kind of derivate, rose to more than $60 trillion from almost nothing a decade ago.
 

Interveiw with Rob Johnson and Sony Kapoor on 'Too Complex to Fail'

Too complex to regulate? by Andrea Orr, Economic Policy Institute
 

http://www.epi.org/analysis_and_opinion/entry/too_complex_to_regulate/

Lawmakers seeking to prevent a repeat of the greatest financial meltdown since the Great Depression are considering ways to impose tighter regulations on big investment banks, where trading of credit default swaps and other derivatives reached unsustainable levels, helping bring the economy to the brink of disaster in 2008. Although they are commonly described as a form of insurance against defaults on home mortgages, the credit default swaps sold by A.I.G. and other firms became so widespread and complex over the past decade that it became almost impossible for the banks themselves, let alone outside regulators, to sort out the real value of these popular investments or assess the risk.

The rise in trading of derivatives — sophisticated financial instruments whose value is derived from something else such as home mortgages — also underscores how far so many banks have strayed from what should be their main mission of providing lending to individuals and small businesses to help support growth in the general economy. Critics note that derivatives trading escalated to a rapid back-and-forth exchange of paper certificates where the value often had little connection to real economic activity.

If “Too Big to Fail” and “Too Connected to Fail” have become the slogans justifying the repeated government bailouts of some major banks and insurers such as A.I.G., these firms’ continued resistance to tighter government restrictions might be summed up as “Too Complex to Regulate.”

That complexity is neither necessary nor useful, argue Robert Johnson, an EPI board member who previously served as managing director of Soros Fund Management as well as chief economist for the Senate Banking and Budget Committees; and Sony Kapoor, a former investment banker who now heads the international think tank Re-Define (Rethinking Development, Finance, and Environment). In recent interviews, Johnson and Kapoor discuss how Wall Street uses extreme complexity as a shield to pad its profits and keep regulators guessing, and why banks need to return to the sort of activities that serve people on Main Street.

 

Re-Define Managing Director Sony Kapoor delivering the Key Note Address at the DGB Kongress on the Future of Capitalism

 

 

Redefining Regulation Part III - Strengthen Financial Institutions and Make the Financial System More Resilient

Risk taking is central to the functioning of any financial system but the current crisis was brought on by excessive risk taking and a simultaneous decline in the risk absorption capacity of the financial system. Financial institutions have needed of billions of dollars of taxpayer funded public support because they did not have sufficient capital of their own.

 

Regulators allowed Capital, which acts as a shock absorber by absorbing losses, has been allowed to deteriorate over time both in quantity and quality. Even the discredited credit rating agencies have been using a more conservative definition of capital than lax regulators.

 

Under the current capital adequacy regime, regulatory capital requirements have been designed to converge towards the financial institutors’ own definition of capital adequacy based on dubious assumptions of institution self interest and market discipline. Since capital is costly, this regulatory complacence has driven a race to the bottom in capital holding by financial institutions.

 

Almost by definition, it is impossible to use market mechanisms to guard against market failure. Regulators need to make banks do something different to what they would do anyway; otherwise why regulate.

 

This erosion of capital is the other side of excessive leverage in the financial system which has the effect of amplifying both profits and losses and is responsible for the current fragility of the financial system and the speed of its collapse.

 

A parallel development has been the steady chipping away of mandatory liquidity requirements such as Statutory Liquidity ratios, which are still an integral part of the regulations in emerging markets such as India and have helped them withstand the worst impact of the crisis.

 

Because banks borrow short term and lend long term they are particularly susceptible to liquidity drying up. In this crisis, which arose out of excess liquidity in the financial system, liquidity disappeared both on the funding side as well as the asset side. That is why liquidity funding cushions and more conservative asset liquidity assumptions are part of the solution.

 

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