GLOBAL CRISIS : TOWARDS A NEW
MACRO-PRUDENTIAL FRAMEWORK
IN INDIA
IDEAS CONFERENCE
MUTTUKADU, TAMIL NADU
25-27 JAN 2010
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• DILIP NACHANE
• DIRECTOR
• IGIDR
• MUMBAI , INDIA
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PLAN OF THE PAPER
• A. CHALLENGES POSED FOR EMEs BY GLOBAL
CRISIS
• B. COPING WITH THE CHALLENGES
• C. LIKELY OFFICIAL ROADMAP FOR FINANCIAL
SECTOR REFORMS IN INDIA – TARAPORE, PERCY
MISTRY & CFSR REPORTS
• D. CFSR REPORT : A MIXED RECIPE ?
• E. SUGGESTED ALTERNATIVE AGENDA FOR
REFORMS
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CHALLENGES BROUGHT TO THE
FORE BY CURRENT CRISIS
1.
2.
3.
HIGH SOCIAL COSTS OF FINANCIAL
FAILURES
SYTEMIC RISKS
PRO-CYCLICALITY OF BANK CAPITAL
REGULATION
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CHALLENGES BROUGHT TO THE FORE
BY CURRENT CRISIS (CONTD.)
4. HOW MUCH RELIANCE CAN WE PUT
ON MARKET INCENTIVES FOR
PRUDENT BEHAVIOUR ?
5. ANY ROLE FOR INTERNATIONAL
BODIES LIKE THE IMF, FSB, G20
ETC. ?
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I. REDUCING COSTS OF FINANCIAL
FAILURES - PROBLEMS
• 1.LARGE FISCAL COSTS AND MORAL HAZARD
PROBLEMS POSED BY FINANCIAL BAIL-OUTS
• 2. ASYMMETRIC INFORMATION ABOUT
THE INCIDENCE OF MACRO-ECONOMIC SHOCKS
ON THE FINANCIAL SYSTEM
3. CONTAGION ACROSS COUNTRIES IN
SECURITIES & ASSET MARKETS
4. CONFLICTS BETWEEN MONETARY STABILITY &
FINANCIAL STABILITY OBJECTIVES OF CENTRAL
BANKS
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I. REDUCING COST OF FINANCIAL FAILURES MEASURES
• 1. IMPLEMENT A PROMPT CORRECTIVE ACTION
CODE (INDIA ALREADY HAS ONE IN PLACE)
• 2. ORDERLY CLOSURE RULES FOR IMPORTANT
FINANCIAL INSTITUTIONS
(AS PREVALENT IN THE US FOR BANKS UNDER
THE FDIC IMPROVEMENT ACT & COMPETITIVE
EQUALITY BANKING ACT)
3. RECOGNIZE THE PRINCIPLE THAT USE OF CREDIT
RATINGS BY PRIVATE AGENCIES COULD BE
TEMPORARILY SUSPENDED IN FAVOUR OF
REGULATORS’ RATINGS.
4. ESTABLISH CLEARING HOUSES IN OTC
DERIVATIVES MARKETS
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II. SYSTEMIC RISK
:DEFINITION
• No Single Definition Of Systemic Risk
• G-10 DEF (2001) : “ The Risk That An
Event Will Trigger A Loss Of Economic
Value Or Confidence In, And Attendant
Increases In Uncertainty About, A
Substantial Portion Of The Financial
System That Is Serious Enough To
Quite Probably Have Adverse Effects
On The Real Economy”
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THREE BASIC CONCEPTS
UNDERPINNING SYSTEMIC RISK
• 1. Interlinkages across institutions
• 2. Changes in the returns distributions
of FI’s assets during periods of stress
especially additional risks in the “tails”
of the distribution.
• 3. General “market conditions” relevant
for the existence & propagation of risks
through the financial system.
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MEASURES TO CONTAIN SYSTEMIC
RISK : TRADITIONAL
(INDICATOR)APPROACH
• 1. Capital adequacy : (i) total capital /total
assets (ii) common equity/total assets (iii)
Tier 1 capital/risk-weighted assets (RWA)
(iv) Tier 1 +Tier 2 capital/RWA
• 2. Asset Quality : (i) non-performing
loans/assets (ii) provisioning for loan
losses/total loans
• 3. Leverage : (i) Debt/Common equity (ii)
short-term debt (< 1 year maturity) /total
debt
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MEASURES TO CONTAIN SYSTEMIC
RISK : TRADITIONAL
(INDICATOR)APPROACH
• 4. Liquidity : (i) Loans/Deposits (ii)
Loans/assets
• 5. Earning & Profit (%) : (i)Return on
Assets (ROA) (ii) return on equity (ROE)
• 6. Stock Market Performance : (i) P/E
ratio (ii) earnings per share (iii) book
value per share
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LIMITATIONS OF TRADITIONAL
MEASURES
• 1. “Backward looking” rather than “forward
looking”
• 2. Institution specific and ignore linkages
among FIs
• 3. Often perform poorly in practice
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SUGGESTED NEW MEASURES
OF FINANCIAL INDICATORS
• IMF Occ.Paper No. 212 (Sunderarajan et
al. 2002)
• (i) Core Set
• (ii) Encouraged Set
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CONTAINING SYSTEMIC RISK
• 1. EARLY WARNING SYSTEM
• 2. HIGHER CAPITAL RATIOS
ESPECIALLY FOR LARGE FIs
• 3. CORE LIQUIDITY RATIOS (CORE
FUNDING/TOTAL LIABILITIES). CORE
FUNDING =TIME DEPOSITS +OTHER
SOURCES OF LONG-TERM FUNDING
• 4 CENTRAL COUNTER-PARTY FOR
INTERBANK LENDING
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CONTAINING SYSTEMIC
RISK- CONTD.
• 5. RISK-BASED DEPOSIT INSURANCE
• 6. REGULATORY CODE OF CONDUCT
FOR CREDIT RATING AGENCIES
• 7. BASEL II NEEDS TO LAY GREATER
STRESS ON MODELLING SYSTEMIC
RISKS.
• 8. EXCESSIVE RELIANCE ON MARKET
DISCIPLINE MAY PROVE COUNTERPRODUCTIVE
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III. COUNTERING PRO-CYCLICALITY OF
CAPITAL REQUIREMENTS
• 1. RELATE CAPITAL REQUIREMENTS
TO THE STATE OF THE MACROECONOMY (A RANGE OR BAND TO BE
SPECIFIED)
• 2. HIGHER CAPITAL REQUIREMENTS
ON SYSTEMICALLY IMPORTANT
FINANCIAL INSTITUTIONS
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IV. SUGGESTED MARKET INCENTIVES FOR
PRUDENT BEHAVIOUR
• 1. REPLACE PRACTICE OF PAYING BONUS TO TOP
MANAGEMENT UP-FRONT BY A DEFERRED
COMPENSATION PLAN
• 2. IMPROVING DISCLOSURE REQUIREMENTS FOR
BANKS WITH RESPECT TO CAPITAL,COMPLEX
STRUCTURED PRODUCTS, CREDIT ISK, MARKET
RISK, OPERATIONAL RISK ETC. (BASEL II PILLAR
III)
• 3. REQUIRING ORIGINATORS OF SECURITIZED
PRODUCTS TO TAKE AN EQUITY SLICE IN THE IN
PRODUCTS THAT THEY SELL/DISTRIBUTE
• 4. BETTER SEPARATION OF RATINGS AND
CONSULTANCY ACTIVITIES OF CREDIT RATING
AGENCIES
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IV. SUGGESTED MARKET INCENTIVES FOR
PRUDENT BEHAVIOUR (CONTD.)
• 5. CHICAGO FED PLAN (SEE KEEHN 1989).
INCLUSION OF A MANDATORY
SUBORDINATED DEBT COMPONENT IN
BANK CAPITAL REQUIREMENTS TO
STRENGTHEN MARKET DISCIPLINE (SEE
ALSO CALOMIRIS & POWELL (2000),
EVANOFF & WALL (2000) ETC.).
• IN INDIA THERE IS NO MANDATORY
REQUIREMENT FOR SUBORDINATE DEBT,
BUT THERE IS A CEILING ( < 50% OF TIER I
CAPITAL). SUCH DEBT IS PART OF TIER II
CAPITAL
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IS MARKET DISCIPLINE EFFECTIVE?
• MANY EMPIRICAL STUDIES INDICATE
THAT MARKET DISCIPLINE FROM
STOCK & BOND HOLDERS NOT VERY
EFFECTIVE (e.g. Borio et al (2004) :
Market Discipline Across Countries
Industries ). INSTEAD EFFECTIVE
DISCIPLINING COMES FROM
COUNTERPARTIES (DEPOSITORS,
CREDITORS & REGULATORS)
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V. STRENGTHENING IMF ROLE IN
ENSURING FINANCIAL STABILITY
• 1. VIGOROUS ENFORCEMENT OF IMF
GUIDELINES ON EXCHANGE RATE
SURVEILLANCE (WITH SPECIAL
REFERENCE TO GLOBAL IMBALANCES,
PROTRACTED CURRENCY UNDERVALUATION, CURRENCY MIS-MATCHES
ETC.)
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STRENGTHENING IMF ROLE IN ENSURING
FINANCIAL STABILITY (CONTD.)
• 2. LENDER OF LAST RESORT FUNCTION. IMF
SHOULD LEND FREELY DURING CRISES ON GOOD
COLLATERAL AT A PENALTY RATE AND FOR
SHORT PERIODS ( SAY LESS THAN 90 DAYS) WITH
LIMITED ROLLOVER POSSIBILITIES.
• 25% OF THE COLLATERAL COULD BE IN THE FORM
OF FOREIGN GOVT. SECURITIES AND THE PENAL
RATE COULD BE 2% ABOVE THE VALUEWEIGHTED YIELD ON THE BUNDLE OF SECURITIES
OFFERED AS COLLATERAL (SEE CALOMIRIS
(1999), GOLDSTEIN (2008), BRUNNERMEIER ET AL
(2009) ETC.)
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PROPOSED IMF REFORMS –
MAR. 09
• GENERAL DIS-SATISFACTION AMONG LDCs AND
EMEs ABOUT INADEQUATE REPRESENTATION OF
THEIR POINT OF VIEW
• IMF GOVERNANCE REFORM COMMITTEE – 24 MAR.
09:
• (i) RADICAL CHANGES IN ACCESS, PRICING &
CONDITIONALITY FOR IMF BORROWERS (FCLFLEXIBLE CREDIT LINES)
• (ii) BY RECOMMENDING THE LOWERING OF
THRESHOLD ON CRITICAL DECISIONS FROM 85%
TO 70-75%, THE US VETO IS PROPOSED TO BE
ANNULLED (AS THE US HAS 17% VOTING POWER)
• (III) ON THE FUNDAMENTAL ISSUE OF RAISING
QUOTAS/VOTES OF CERTAIN EMEs THE REPORT IS
SILENT
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IMF REFORMS DO NOT GO FAR
ENOUGH
• NEED TO LEND A “GREATER
VOICE AND MORE EFFECTIVE
REPRESENTATION” TO
DEVELOPING AND TRANSITIONAL
ECONOMIES (DOMINIQUE
STRAUSS-KAHN – WALL ST.
JOURNAL SEPT . 07).
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TWO ALTERNATE SCHEMES
• 1. A PROPOSED TRIPLING OF BASIC VOTES
(NUMBER OF VOTES EVERY COUNTRY HAS QUA
MEMBER) WOULD INCREASE DEVELOPING
COUNTRY VOTES FROM 32.3% TO 34.4% (THE
CORRESPONDING WORLD BANK FIGURE IS 42.6%
PROPOSED TO BE RAISED TO 43.8%)
• 2. DOUBLE MAJORITY VOTING ON SELECTED
ISSUES– A MAJORITY OF WEIGHTED VOTES (AS
CURRENTLY) + A MAJORITY OF COUNTRIES. THE
SYSTEM PREVAILS AT THE INTER-AMERICAN DEV.
BANK, ADB, AFRICAN DEV. BANK FOR ELECTION
OF A NEW PRESIDENT/HEAD (SEE BIRDSALL-2009)
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V. ROLE OF FSF & INTERNATIONAL
STANDARD-SETTING BODIES
• 1. FSF SHOULD ALERT STANDARD SETTING
BODIES ABOUT LOOPHOLES IN EXISTING
REGULATORY STRUCTURES. THE BODIES LIKE
BCBS, IOSCO ETC. CAN THEN DEVISE SPECIFIC
OPERATIONAL GUIDELINES FOR INCORPORATION
INTO NATIONAL REGULATORY AND
SURVEILLANCE FRAMEWORKS.
• 2. FSF CAN ISSUE PUBLIC WARNING ON
EMERGING SYSTEMIC RISKS WHEN THE
SITUATION SO WARRANTS IT (BRUNNERMEIER ET
AL 2009)
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G20 INSURANCE SOLUTION
•
•
•
•
E. PRASAD (MAY 09)
INSURANCE POOL FOR G20 MEMBERS
ENTRY FEE BETWEEN $10BN TO $20
PREMIUM TO DEPEND ON THE LEVEL OF
INSURANCE DESIRED—1% OF THE FACE
VALUE OF POLICY
• COUNTRIES FOLLOWING POLICIES THAT
ENHANCE GLOBAL RISK (SUCH AS LARGE
BUDGET OR CURRENT A/C DEFICITS)
WOULD FACE HIGHER PREMIA
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G20 INSURANCE SOLUTION–
CONTD.
• VERY SIMILAR TO THE CMI SCHEME
DISCUSSED ABOVE.
• PARTICIPANTS OFFERED A SHORT-TERM
CREDIT LINE IN THE EVENT OF A CRISIS.
• PREMIA TO BE INVESTED IN US, EURO
AREA AND JAPANESE GOVT. BONDS. IN
RETURN THE CENTRAL BANKS OF THESE
COUNTRIES WOULD TOP UP THE LINES OF
CREDIT IN THE EVENT OF A GLOBAL CRISIS
• THE SCHEME TO BE ADMINISTERED BY
THE FSF RATHER THAN THE IMF –
REASONS FOR THIS NOT VERY CLEAR
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MAIN OBJECTIVES FOR
REFORMS IN INDIA
• 1. REVIVAL SANS STAGFLATION
• 2. FIREWALLS AROUND THE
FINANCIAL SECTOR
• 3. SAFETY NETS
• 4. LONG TERM CREDIT NEEDS OF
MICRO-SECTOR & INFORMAL SECTOR
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Likely Future Course of Financial
Sector Reforms : India
•
•
•
•
Four Committees
1. Tarapore I & II
2. Percy Mistry
3. Raghuram Rajan
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CFSR –MAIN RECOMMENDATIONS :
GREEN BOX
1. BROADENING ACCESS TO FINANCE( LIBERALIZING THE
BANKING CORRESPONDENT REGULATION )
2. STRONGER BOARDS FOR LARGE PUBLIC SECTOR BANKS
3. BRING ALL REGULATION OF TRADING UNDER SEBI
4. ENCOURAGE INNOVATIVATION TO ADDRESS CONCERNS
BEARING ON SYSTEMIC RISK, FRAUD, TRANSPARENCY,
CONTRACT ENFORCEMENT ETC.
5. SUPERVISION OF ALL DEPOSIT-TAKING INSTITUTIONS TO BE
BROUGHT UNDER RBI
6. MINISTRY OF CORPORATE AFFAIRS SHOULD REVIEW
ACCOUNTS OF UNLISTED COMPANIES , WHILE SEBI
SHOULD REVIEW ACCOUNTS OF LISTED COMPANIES
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CFSR –MAIN RECOMMENDATIONS :
GREEN BOX (CONTD.)
• 7. SPECIAL LEGISLATION FOR
SUPERVISION OF FINANCIAL
CONGLOMERATES
• 8. RISK-BASED DEPOSIT INSURANCE
• 9. SETTING UP OF A FINANCIAL
OMBUDSMAN TO SERVE AS AN
INTERFACE BETWEEN THE
HOUSEHOLD AND FINANCIAL
INDUSTRY.
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CFSR –MAIN RECOMMENDATIONS :
BLUE BOX
• 1. PRIORITY SECTOR LOAN CERTIFICATES TO ALL BANKS
LENDING TO ELIGIBLE ENTITIES IN THE PRIORITY SECTOR
• 2. ENCOURGAE SETTING UP OF MISSING MARKETS SUCH AS
EXCHANGE TRADED INTEREST RTAE AND EXCHANGE RATE
DERIVATIVES
• 3. REGULATORY ACTION TO BE SUBJECT TO APPEAL TO A
FINANCIAL SECTOR APPELLATE TRIBUNAL.
• 4. ALLOWING A HOLDING COMPANY STRUCTURE WITH A
PARENT HOLDING COMPANY OWNING REGULATED
SUBSIDIARIES.
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CFSR –MAIN RECOMMENDATIONS :
RED BOX
• 1. INFLATION TARGETING
• 2. OPENING UP OF RUPEE CORPRATE & GOVT. BOND
MARKET TO FOREIGN INVESTORS
• 3. REMOVE INTEREST RATE RESTRICTIONS ON PRIORITY
SECTOR LENDING
• 4. FREE BANKS FROM OVERSIGHT BY CENTRAL VIGILANCE
COMMISSION
• 5. TOATLLY SCRAP BANK BRANCH LICENSING POLICY
• 6. ALLOW TAKEOVERS BY AND MERGERS WITH FOREIGN
BANKS
• 7. SWITCH-OVER TO A PRINCIPLES BASED (AS OPPSED TO
THE CURRENT RULES-BASED) REGULATORY SYSTEM.
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AN AGENDA FOR REFORMS
• 1. CREDIT DELIVERY TO MSMEs
• 2. SPECIAL TREATMENT OF MSMEs (LOWER RISK
WEIGHTS ON BANK LOANS TO THIS SECTOR)
• 3. RISK-BASED DEPOSIT INSURANCE SYSTEM
• 4. RAISING DEPOSIT INSURANCE LIMIT TO RS. 4
LAKHS FROM THE CURRENT RS. 1 LAKH
• 5. CODE OF CONDUCT FOR CREDIT RATING
AGENCIES
• 6. STRICT MONITORING OF OBSAS AND SPVs
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AN AGENDA FOR REFORMS–
(CONTD.)
• 7. ADMISSION OF POSSIBILITY OF
CAPITAL CONTROLS AT LEAST OVER
LIMITED PERIODS. TW-SB APPROACH
MAY BE CONSIDERED SERIOUSLY
• 8. IMPORTANCE OF CENTRAL BANK
INDEPENDENCE & CREDIBILITY
• 9. REGULATORY & SUPERVISORY
INDEPENDENCE
•
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•THANK YOU
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