This paper examines the policy issues associated with resolving the possible failure of Fannie Mae or Freddie Mac (housing enterprises). It compares and contrasts these issues with those raised in the context of large bank failures and also identifies important differences in the extant supervisory authorities. Based on these discussions, a number of policy suggestions are offered to minimize the cost of resolution and protect taxpayers from loss should a large bank or housing enterprise fail.
Possible explanations are provided for two basic results in Kräussl's paper. First, rating effect may be stronger in emerging markets because they are less transparent. Transparency is interpreted in the context of Knightian uncertainty and institutional quality. Emerging markets have lower institutional quality ratings and present greater uncertainty than mature markets, therefore, they are more susceptible to rating agencies’ evaluations. Some empirical evidence on the correlations between institutional quality rankings and portfolio investment is presented. Second, sovereign credit downgrades generate a stronger market reaction than upgrades because decision makers value losses more than gains, as posited by cumulative prospect theory.
Basel II attempts to eliminate incentives for regulatory capital arbitrage and align capital regulation with best practices in credit risk management. Despite the imposition of very heavy compliance costs, it is unlikely to succeed in achieving either goal. This paper describes an alternative approach, based on mandatory issues of subordinated debt, which makes use of market discipline to achieve these goals at much lower cost.
Although the world of banking and finance is becoming more integrated every day, in most aspects the world of financial regulation continues to be narrowly defined by national boundaries. The main players here are still national governments and governmental agencies. And until recently, they tended to follow a policy of shielding their activities from scrutiny by their peers and members of the academic community rather than inviting critical assessments and an exchange of ideas. The turbulence in international financial markets in the 1980s, and its impact on US banks, gave rise to the notion that academics working in the field of banking and financial regulation might be in a position to make a contribution to the improvement of regulation in the United States, and thus ultimately to the stability of the entire financial sector. This provided the impetus for the creation of the “US Shadow Financial Regulatory Committee”. In the meantime, similar shadow committees have been founded in Europe, Japan and Latin America. The specific problems associated with financial regulation in Europe, as well as the specific features which distinguish the European Shadow Financial Regulatory Committee (ESFRC) from its counterparts in the US and Japan, derive from the fact that while Europe has already made substantial progress towards economic and political integration, it is still primarily a collection of distinct nation–states with differing institutional set-ups and political and economic traditions. Therefore, any attempt to work towards a European approach to financial regulation must include an effort to promote the development of a European culture of co-operation in this area, and this is precisely what the European Shadow Financial Regulatory Committee seeks to do. In this paper, Harald Benink, chairman of the ESFRC, and Reinhard H. Schmidt, one of the two German members, discuss the origin, the objectives and the functioning of the committee and the thrust of its recommendations.
This paper seeks to explain how policy actions undertaken at the outset of recent crises—particularly the issuance of extensive liquidity support and government guarantees—absorb off-budget fiscal resources and inappropriately constrain officials’ subsequent options for restructuring their country’s troubled financial and corporate sectors. Empirical evidence supports the commonsense view that the damage a crisis works on a country’s financial sector and on its real economy is lessened by taking market-mimicking actions that promptly estimate and allocate losses during the early stages of a crisis. The most important steps are to plan to call a timeout to separate hopelessly insolvent institutions from potentially viable ones and to provide haircuts, guarantees, and liquidity support in ways that protect taxpayers and avoid subsidizing insolvent institutions’ longshot gambles for resurrection.
This study examines which financial stability responsibilities have been delegated to central banks (CBs), how these responsibilities are executed, and whether democratic accountability arrangements are in place. The results of our survey among all CBs in the OECD area suggest that there is no unambiguous definition of financial stability or systemic risk, and that, generally, the responsibility for financial stability is not explicitly formulated in laws. Moreover, there is considerable heterogeneity in the way CBs pursue the financial stability objective. Our results also suggest that the democratic accountability of the financial stability function of central banks is often poorly arranged.
We build a simple model of banking in the presence of macroeconomic shocks where the comparative roles of private and public monitors can be analyzed. This model provides endogenous justifications for prudential regulation (capital requirements) and emergency liquidity assistance by the Central Bank (lender of last resort). We show that market discipline can be helpful, but does not solve the fundamental problem of regulatory forbearance. We propose some directions of reform of the regulatory system that could improve the management of banking crises.
Drawing on a unique dataset of flow-of funds and balance sheet data, this paper analyzes the impact of financial crises on aggregate corporate financing and expenditure in a range of countries. Investment and inventory contractions are the main contributors to lower GDP growth after crises, with a much greater effect in emerging market countries. The debt–equity ratio is correlated with investment and inventory declines following crises. Econometric analysis suggests that financial crises have a greater impact on expenditure and the financing of corporate sectors in emerging markets than in industrial countries. Industrial countries appear to benefit from a pick-up in bond issuance in the wake of banking crises. Although companies in emerging market countries hold more precautionary liquidity, this is evidently not sufficient to prevent a greater amplitude of response of expenditure to shocks.