A good piece – with a lousy conclusion – on VoxEU by Jorge A. Chan-Lau, Marco A. Espinosa-Vega, Kay Giesecke and Juan Sole: Policymakers must prevent financial institutions from becoming too connected to fail:
Some policymakers (e.g., Stern and Feldman 2004) have long recognised this problem and have called for “macro-prudential” oversight and regulation focused on systemic risks, not just individual institutions. However, it is easy to ignore such admonitions when times are good because the probability of an extreme or tail event may appear remote—a phenomenon dubbed “disaster myopia.” Moreover, it is difficult to monitor the linkages that lead to the too-connected-to-fail problem. Yet to make macro-prudential oversight a reality—as G20 nations called for in the communiqué following their April 2 summit – —policymakers must be able to observe information on potentially systemic linkages.
…
Because it is virtually impossible for a country to undertake effective surveillance of potential cross-border systemic linkages alone, the IMF should assume a more prominent global financial surveillance role.
This smells like another IMF power-grab. They nod towards the idea of progressive capital charges – as I have advocated – with credit to Donato Masciandaro, whose VoxEU piece was discussed on January 14, but it’s clear that they want a lot of banks to fill in a lot of forms and send them off to a greatly expanded bureaucracy at the IMF. They’ll have to compete for staff with OSFI, who are expanding with not just one, but two positions in Toronto!
There are simpler ways. Section 3.1.5 of OSFI’s Capital Guidelines states:
Canadian deposit taking institutions (DTIs) include federally and provincially regulated institutions that take deposits and lend money. These include banks, trust or loan companies and co-operative credit societies.
The term bank refers to those institutions that are regarded as banks in the countries in which they are incorporated and supervised by the appropriate banking supervisory or monetary authority. In general, banks will engage in the business of banking and have the power to accept deposits in the regular course of business.
For banks incorporated in countries other than Canada, the definition of bank will be that used in the capital adequacy regulations of the host jurisdiction.
… and Section 3.1.6 states:
Claims on securities firms may be treated as claims on banks provided these firms are subject to supervisory and regulatory arrangements comparable to those under Basel II framework (including, in particular, risk-based capital requirements). Otherwise, such claims would follow the rules for claims on corporates.
Footnote: That is, capital requirements that are comparable to those applied to banks in this Framework. Implicit in the meaning of the word “comparable” is that the securities firm (but not necessarily its parent) is subject to consolidated regulation and supervision with respect to any downstream affiliates.
… and applies credit risk weights according to the credit rating of the sovereign; thus implicitly assuming that there will be a bail-out in times of trouble.
This smacks of bureaucratic bloat. If anything, if the regulators wish to address systemic risk, they must make it harder – requiring more capital – for banks to hold each other’s paper. The risk weight of the assets held should be:
- based on the credit quality of the unsupported institution
- subject to concentration penalties (e.g., holding 1% of assets in a single external bank requires more capital than holding 0.5% of assets in each of two external banks), and
- be more expensive in terms of capital than the paper of a non-regulated, non-financial company
I will not go so far as to state definitely that there is no role for the IMF in bank supervision. I will say, however, that before I support such a role, I want somebody to explain to me, slowly and carefully, why we need a whole new additional set of rules instead of just adjusting the extant system based on experience.