Presentation to
Regulatory Policy Institute
Merton College Oxford
14 September 2010
Cause 1: Monetary policy
Asset bubble inflates
Asset bubble bursts
Real
Rates
Above trend
Rate of growth
Negative real
interest rates
Fed funds rate 2001 - 2008
7
Nov. 05 to Dec. 07
6
percent
5
4
3
2
1
0
Dec. 01 to Nov. 04
Cause 2: Shadow Banking
Rating
Agency
Borrowers
Originating/
Sponsor
Bank
ABS
SPV
Brokers
SIV/
Conduit
stub
stub
Financial
Guarantee
Insurance
Monolines
CDS
Collateralised loan
Credit
Protection
sellers
Hedge
funds
Rating
agency
ABCP
Investors
Cause 3: Shift in US resolution policy
3 month USD LIBOR-OIS spread in percent,
June 2007 – November 2009
3m $ Libor-OIS spread
4
3.5
3
2.5
2
1.5
1
0.5
0
Jul07
A ug07
Sep07
Oct07
N o v07
D ec07
Jan08
F eb08
M ar08
A pr08
M ay08
Conditional Containment
Jun08
Jul08
A ug08
Sep08
Oct08
Meltdown
Jun07
N o v08
D ec08
Jan09
F eb09
M ar09
A pr09
M ay09
Jun09
Jul09
Unconditional
Containment
A ug09
Sep09
Oct09
N o v09
Probability of bail out determines risk
Likely to be rescued
Likely to be abandoned
Probability of default
20%
20%
Loss given default
25%
25%
Loss given bail out
0%
0%
95%
5%
25 bp
475 bp
Probability of bail out
Expected loss
Moving toward Meltdown
3 month $ LIBOR – OIS spread in percent
15 September 2008 to 15 October 2008
7.10 Iceland
4
3.5
3
17.9
AIG
2.5
19.9
Gtee
MMMF
22.9
Goldmans
Morgan
Stanley
29.9 TARP
rejected
30.9
Ireland
2
1.5
1
3.10TARP
enacted
0.5
0
15-Sep-08
30-Sep-08
19.9 TARP
proposed
15.9
Lehmans
18.9
Lloyds/
HBOS
Source: Huertas, Crisis
25.9 WaMu
26.9 – 29.9 Wachovia
15-Oct-08
3.10 – 6.10 Wachovia
26.9 – 29.9
Bradford & Bingley
26.9 – 29.9 Fortis/Dexia
3.10 – 6.10 Fortis
26.9 – 29.9 HRE
3.10 – 6.10 HRE
The world economy goes into free fall
Quarterly GDP Volume Growth
Percentage change on the previous quarter
1%
0%
-1%
-2%
Q4 2009
Q3 2009
Q2 2009
Q1 2009
Q4 2008
Q3 2008
Q2 2008
Q1 2008
Q4 2007
-3%
Source: OECD
A cure for crises
requires a comprehensive and consistent framework
Macroeconomic
policy
Resolution
Regulation
Deposit guarantee
scheme
Supervision
Regulation
ü Capital
ü
ü
ü
ü
Correct trading book regime
Improve quality of capital
Increase quantity of capital
Introduce leverage ratio as back-up
ü Liquidity
ü Introduce global liquidity standard
ü Remuneration
ü Introduce regulation to assure that remuneration promotes
effective risk management
Supervision
ü Change approach
ü Pro-active
ü Forward looking
ü Stress testing
ü Recovery plans
ü Intrusive
? Change organisation
? In UK
? In EU
? In US
Deposit guarantee schemes
ü Co-insurance eliminated
ü Limits raised
? Operations improved to enable prompt pay out
ü In US
ü In UK
? In EU
? Funding
? Backstop from government
? Pre-funded
? If so, risk-based?
Resolution
ü Special resolution regimes for banks
ü In US
ü In UK
? In EU
ü
?
?
?
Recovery and resolution plans
Resolution funds
Bank taxes
Restructuring
? Make banks smaller
? Make banks simpler
Recovery and resolution plans (‘living wills’)
Recovery plan
Recovery
Capital
Plan
Resolution Plan
Recovery
Liquidity
Plan
Plan to sell businesses/subsidiaries
OPTIONS
1.
D
A
T
A
2.
3.
4.
Plan to wind down/liquidate trading book
Early equity
Injection
Share transfer
(TPO)
Deposit
transfer/
Bridge bank
Liquidation/
Deposit
pay-off
Overview of Resolution Methods
Taxpayer
support
Immediate
impact/cost
Long-term
impact/cost
(moral hazard)
Going/gone
concern
None
Very high
Eliminates
moral hazard
Gone
Limited
High
Improves
market
discipline and
reduces cost
Gone
TBD
TBD
TBD
Going
Very high
Limited
High (increases
moral hazard)
Going
Options under SRR
1. Liquidation/
deposit payoff
2. Deposit transfer/
bridge bank
3. Share transfer/TPO
Option outside SRR
Early equity injection
From bail-out to bail-in
intervention
Solvent wind down
Execute
Bail-in
Recovery
Sale
Deposit transfer/
Bridge bank
COB Friday
Monday
Asia open
Subsequent “month”
Macro-policy
ü Introduce macro-prudential policy
ü Create counter-cyclical buffer in banks
? Develop other macro-prudential tools
? Limits on loan to value ratios
? Direct transactions to central counterparties
? Others?
ü Introduce systemic risk boards
ü In US
ü In UK
ü In EU
? Have systemic risk boards identify and mitigate systemic risks
in a timely fashion, including those risks that emanate from
policymakers themselves