Global Financial Crisis and Basel Standards

Transcription

1 Global Financial Crisis and Basel Standards

2 Lax fiscal policy Hyperinflation Public debt crisis Economic crisis Depression BOP/currency crisis Banking crisis Fixed exchange Rate regime Unstable capital movement account opening Poor financialsector regulation Blue boxes indicate root causes of crises.

3 The 2007/2009 Global Financial Crisis Most (though not all) large developed countries adopt floating exchange rates. Their governments rarely borrow in foreign currencies. Even in developed countries, however, it is difficult to regulate the financial sector properly. Failing to do so causes excessive lending, over-leveraging, and asset price bubbles, all of which render the economy vulnerable to negative economic/financial shocks. The recent global financial crisis originated in US subprime mortgage loans bundled into mortgage-backed securities (MBS).

4 Banking Crises Involve a chain of bank runs and failures Banks are socially important institutions as provider of a payment system but are inherently fragile because they engage in maturity transformation Banking crises hinder normal economic activity and can quickly develop into an economy-wide crisis This is why banking crises are often resolved by mergers, closures, or government takeovers of banking institutions However, this may deteriorate the government s fiscal condition and breed resentment among people Kenneth A. Reinert, Cambridge University Press 2012

5 Company A goods services Company B Company A s account Bank X Company B s account Bank Y Bank X s account Bank Y s account Central bank

6 Why financial firms are inherently fragile Low leverage, low risk High leverage, high risk Loan Other financial assets Deposit Loan Deposit Banks have incentive to increase their assets and liabilities. But doing so makes them more vulnerable to negative shocks. BaselⅠ (minimum capital standard) Other financial assets Other liabilities

7 Banks respond to regulations Bank (before securitization) Bank (after securitization) Loan Deposit New assets Deposit Other financial assets Other financial assets Special Purpose Vehicles (Structured Investment Vehicles) Loan Securities Banks set up SPVs that issue debt and purchase loans from banks. By repeating this securitization procedure, banks can increase leverage without breaching the minimum capital standard.

8 Unbundling loan assets Return Aggregate portfolio Less risk-averse More risk-averse Risk

9 Process of Securitization Source bank Loan portfolio Cash payment Credit rating agency Rating Fee Special purpose vehicle Insurance Fee Credit enhancement agency Securitized instruments Cash proceeds market (Source) Matthews & Thompson (2008)

10 Basel Standards In 1974, the G10 established the Basel Committee on Banking Supervision, whose secretariat was located at the Bank for International Settlements (BIS). In 1988, the Basel Committee introduced a banking capital measurement standard known as the Basel Accord (Basel I) A revised Basel Accord was introduced in 2004 and went into effect in 2007 (Basel II) Prompted by the 2008/9 global financial crisis, a new Accord (Basel III) was put together in 2010 and is being implemented in stages during 2013/2018. Kenneth A. Reinert, Cambridge University Press 2012

11 Bank for International Settlements (BIS) Basel Membership

12 Basel I Basel II Risk weighted credit Tier 1 (min. 4%) + Tier 2 Business firms (100%) Mortgage (50%) Financial firms (20%) Government-related institutions (10%) Governments (0%) Risk weighted credit Tier 1 (min. 4%) + Tier 2 8% 8% Business firms (20~150%) SME/individuals (75%) Mortgage (35%) Financial firms (20%) Government-related institutions (10%) Governments (0%) Non-performing Loans (100%) + amounts of market & operational risks

13 Basel II Minimum capital requirement Basel III Minimum capital requirement 10% SIFI additional Tier 2 1~2.5% Other tier 1 2% Other tier 1 8% 7% Core tier 1 8.5% 2% Core tier 1 Core tier 1 = common equity + retained earnings Leverage ratio (unweight capital ratio that takes off-balance items into account) Liquidity coverage ratio Net stable funding ratio SIFI = Systematically Important Financial Institutions

14 Has Japan learned lessons? Government-sponsored Japan Housing Finance Agency conducting aggressive securitization Mortgage Government-sponsored Credit Guarantee Corporations provide 100% loan guarantees for SMEs; subrogation increasing Corporate loans Deposit While banks are aware of mounting government debt, they can resell government bonds quickly to the Bank of Japan Cross share holding Low interest rate margins encourage banks to invest in riskier assets, such as equities Government bonds Equities Other liabilities Low capital ratio, low ROE

15 Government debt as % of GDP Gross debt Net debt 250 Germany 250 Germany Greece Greece 200 Italy Japan 200 Italy Japan UK UK 150 USA 150 USA