The impact of financial regulation on developing countries
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Speakers
Alvir Hoffman, Central Bank of Brazil
Mingkang Liu, China Banking Regulatory Commission
Joseph Stiglitz, Columbia University
Moderator: Nancy Birdsall, CGD
Initial Presentations
Alvir Hoffman
- small banks and export firms effected first; central bank took action to provide liquidity
- resilience to the crisis has two reasons: low exposure to toxic products; high liquidity buffer
- we have strong limits, high capital requirements, supervision based on central counterparty clearing agency for derivatives, strong supervisory system
- lessons – EME banks will be effected by global regulatory framework – it should be seen as opportunity to strengthen our regulatory frameworks
- Comments on the existing proposals
- Tier 1 capital changes should not be a big problems; leverage ratio should be designed with new international reporting standards in mind
- We are comfortable with new liquidity measures
- Countercyclical buffers – prefer through capital than provisions
- Compensation –
- Need to regulate/supervise all systemically important institutions
Mingkang Liu
- cause of the crisis? Not trade imbalances, 1997 crisis didn’t have these kind of spillovers, neither did dot-com bust, real causes need to be found
- complexity & interconnectedness – ie end of Glass-Steagall, banks reliance on capital markets
- driving force is distorted incentives, market practitioners were seeking quick profits, not sustainable growth path
- inadequate regulation and supervision, inadequate cross-border cooperation
- Lessons
- corporate governance is key to every institution; leadership must be responsible for institution. Duty to monitor from the head
- market forces are not invincible or universal, we have no globalised standards; our duty is to be prudential – tell practitioners to stick to tested practices
- traditional limits and ratios worked, we still use loan-value, loan-deposit, simple capital adequacy; 80% of capital of Chinese banks are common stocks
Joseph Stiglitz
- purpose of fin market – allocate capital and mitigate risks at low costs – US financial sector failed on all fronts, profitability of fin sector should be signal that something was wrong
- pervasive externalities as costs put on the whole world
- innovation in US fin markets were not creating better markets, they were tax regulatory and accounting arbitrage, they were mostly negative innovations
- developing countries can’t afford these kinds of failures, don’t blame the saver, blame the investor – mistakes happen over and over again in history;
- but regulators failed as well, regulatory capture and financial lobbying was a key reason
- think of positive agenda about directing capital to where we want it to go; with regulatory rules can stop this. We didn’t learn lesson from AFC
- We have bailed out the financial system over and over again – gave perception that markets were working fine; even though we bailed out the lenders in crisis so many times
- We haven’t fixed things, they are worse now – moral hazard problem is larger, concentration, complexity still there
- Financial market and capital market liberalisation are responsible for the mess we are in and helped spread the problem; EMEs had better regulation should be giving TA to the West about policies
- We can’t allow home country regulation any more; Basle II should be dead – risk models were garbage; go back to basic plain-vanilla financial products
Birdsall -Should Basle II be dead? Is it bad for developing economies?
Hoffman – three pillars of Basle II – risk models are optional
- original idea was only for internationally active banks, but it got too overblown
- transparency of complexity does not help
Liu – Basle II has not been tested by any problems before, it is not perfect, but it is progressive, we are gathering lessons and modifying Basle II
- practice makes perfect, we have to modify based on learning
- three balances needed:
- no complacency in EMEs on Basle, but no excessive risk aversion
- international best practices and concrete domestic concrete situation
- balance between domestic homework (safety nets, restructuring etc) and implementation of intl economic standards based on our perspectives
Birdsall – go to US politics on loose monetary policy and regulatory capture
Stiglitz – do a thought experiment, it was global imbalances that brought on the problem
- low interest rates were due to weak aggregate demand, to keep economy going
- financial sector saw large profits and they used large wealth to get loose regulation
- stupid economic ideas: can’t see a bubble in advance, no tools to stop a bubble, cheaper to clean up afterward
Birdsall – is it too big to fail or too complex? They can be different solutions
- insufficient aggregate demand was due to concentration of wealth and inequality
Discussion
Questioner – how can we make sure with global regulation that crisis will not be easily transmittable between countries? How to get responsible parties to pay for those effected?
Questioner – products demanded by pension funds and inst investors driven by need for profit for baby boomer retirements
Questioner – How do you see selection for regulators in EMEs? What are key qualities for a good regulator?
Questioner – regulatory capture more complex than any model, you can’t quantify
- Basle II – not designed to prevent crisis, model came from banks themselves
Questioner – new role of Fed in systemic risk regulator? How should it be done?
Liu – stopping spillovers is still open question, home regulators must control risks from the very beginning
- cross-border cooperation don’t be naive, gaps between national legislations on resolution, accounting standards, etc
- we need new rules for the game – should be simplified, stop people from playing games
- greater leaders are almost always great simplifiers, regulators should give market practitioners simple, basic rules that they must follow
- models are always controversial and complicated, we can not rely on them alone; we need new Basle II or Basle III with some rules-based system but also lots on discretional basis – must balance, be cautious
- crisis management – have to look at commercial banks but also counterparties, look at interconnectedness; building block approach; get things in the right order
- calm your panic, make sure the sequence is correct
Stiglitz – first we need to ask what kind of fin system we want; if we want money to go to SMEs, need to use regional banks, small banks
- we continued to do this after crisis management
- Basle II was simply for big banks to reduce their capital requirements, undertake more risk
Questioner – what about future of reserve currency?
Stiglitz – I think we need a new global reserve system
- investors can’t have free lunch either – a series of agency problems
Liu – far too early to think Chinese currency could be an intl reserve currency
- in reality – “countries with reserve currencies have to be more responsible, we have to be more supportive, in long run working together we can make some difference”
- lets hurry up – time and tide wait for no man
Hoffman – supervisor needs autonomy and authority to do macro-prudential regulation
