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Preparing for the Next Financial Crisis

Name: Preparing for the Next Financial Crisis
ISBN: 9780429949555

by Olivier de Bandt, Francoise Drumetz, Christian Pfister

December 2020

Intermediate to advanced

386 pages

14h 43m

English

Routledge

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Cover
Half Title
Series Page
Title Page
Copyright Page
Table of Contents (1/2)
Table of Contents (2/2)
Preface
Introduction
1 Notions
1.1 Financial Stability

1.2 Financial Fragility, Liquidity, and Leverage
1.2.1 Definitions
1.2.2 Theoretical Underpinnings
1.2.1.1 The Diamond and Dybvig Model1.2.1.2 Subsequent Developments
1.3 Safe Assets
1.4 Bubbles and Contagion
1.4.1 What is a Bubble?
1.4.2 Contagion or Financial Integration?
1.5 Moral Hazard and too Big to Fail
1.5.1 Moral Hazard and Time Consistency
1.5.1.1 Origin of Moral Hazard
1.5.1.2 Consequences of Moral Hazard for Financial Stability
1.5.2 Concentration of the Financial Industry and TBTF1.5.2.1 Financial Concentration1.5.2.2 TBTF
1.6 Systemic Risk
1.6.1 Definition of Systemic Risk
1.6.2 Sources of Systemic Risk (1/3)
1.6.2.1 Banking Activities1.6.2.2 Financial Markets
1.6.2 Sources of Systemic Risk (2/3)
1.6.2.3 Payment Systems
1.6.2 Sources of Systemic Risk (3/3)
2 Financial Cycles and Crises
2.1 Finance and Growth2.1.1 Finance Matters for Growth
2.1.2 Too Much Finance Harms Growth
2.2 Financial Cycles
2.2.1 Measuring Financial Cycles
2.2.2 Drivers of Financial Cycles (1/2)
2.2.2.1 Securitization2.2.2.2 Shadow Banking
2.2.2 Drivers of Financial Cycles (2/2)
2.2.2.3 Run-Prone Funding Patterns
2.2.3 Predicting Financial Cycles
2.3 Crises
2.3.1 Empirical Approaches
2.3.2 Theoretical Approaches
2.3.3 Recent Developments (1/2)
2.3.3 Recent Developments (2/2)
3 International Dimensions of Financial Stability
3.1 A Global Financial Cycle?
3.1.1 Definition of Global Financial Cycles
3.1.2 Do Global Financial Cycles Exist?
3.2 The Euro Area Crisis and Financial Fragmentation
3.2.1 A Competitiveness Crisis, a Sovereign Debt Crisis, a Banking Crisis
3.2.2 Financial Fragmentation
3.3 International Capital Flows and Financial Stability in Emerging Countries
3.3.1 Benefits and Challenges of Financial Globalization
3.3.2 Policy Options to Absorb the Impact of International Capital Flows
4 Incentives
4.1 Motives and Modalities of a Public Intervention4.1.1 Why Intervene?4.1.1.1 Normative Approach4.1.1.2 Positive Approach
4.1.2 How to Intervene?
4.1.2.1 Setting of Constraints4.1.2.2 Acting on Incentive Schemes4.1.2.3 What Works Best?
4.2 Market Discipline and Transparency
4.2.1 Credit Rating Agencies
4.2.2 Accounting Standards (1/2)
4.2.2.1 Valuation at Historical Cost or at Fair Value4.2.2.2 Perverse Incentives?
4.2.2 Accounting Standards (2/2)
4.2.3 Corporate Governance in Financial Institutions
4.2.3.1 Specificity of Financial Corporate Governance4.2.3.2 Importance of Governance
4.3 Taxation
4.3.1 Financial Transactions Tax4.3.1.1 Motives4.3.1.2 Empirical Studies and Measures Recently Adopted
4.3.2 Financial Activities Tax
4.3.2.1 Motives4.3.2.2 Implementation
4.4 Compensation
4.4.1 Level and Structure of Compensation
4.4.1.1 Data4.4.1.2 Interpretation
4.4.2 Suggested Intervention
4.4.3 Measures Adopted (1/2)
4.4.3 Measures Adopted (2/2)
5 Constraints
5.1 Institutions5.1.1 Deposit Insurance5.1.1.1 Benefits and Costs of Deposit Insurance5.1.1.2 Developments in Deposit Insurance Systems Since the GFC
5.1.2 Limitations of the Scope of Financial Activities (1/3)
5.1.2.1 Benefits and Drawbacks of Universal Banking5.1.2.2 Segmentation and Limitation of Banking Activities
5.1.2 Limitations of the Scope of Financial Activities (2/3)
5.1.2.3 Measures Taken or Proposed Since 2008
5.1.2 Limitations of the Scope of Financial Activities (3/3)
5.1.2.4 Issues Related to Regulation of the Shadow Banking System
5.2 Practices in Financial Markets
5.2.1 Short Selling5.2.1.1 Theory5.2.1.2 Empirical Evidence5.2.1.3 Regulation
5.2.2 High-Frequency Trading
5.2.2.1 Presentation5.2.2.2 Concerns
5.2.3 Exchange-Traded Funds
5.2.4 Reuse and Rehypothecation of Collateral
5.3 Financial Market Infrastructures
5.3.1 Role5.3.1.1 Benefits and Costs5.3.1.2 Risk Management
5.3.2 Concerns
5.3.2.1 Risk Concentration and Interconnectedness5.3.2.2 Risk Transmission
5.3.3 Regulation (1/2)
5.3.3.1 Supervision and Definition of Standards5.3.3.2 Other Measures Proposed
5.3.3 Regulation (2/2)
6 Capital and Liquidity Standards
6.1 Costs and Benefits of Capital and Liquidity Requirements
6.1.1 Main Issues6.1.1.1 Impact on Financial Intermediation6.1.1.2 Impact on Output and Credit Supply6.1.1.3 Reduction in the Cost of Crisis
6.1.2 Expected Impact of Regulatory Changes
6.1.2.1 Differences in Approach
6.1.2.2 Differences in Assessment
6.2 Basel I, Basel II, and Procyclicality
6.2.1 Basel I
6.2.2 Basel II
6.2.2.1 Main Features of Basel II6.2.2.2 Criticisms Addressed to Basel II
6.3 Basel III
6.3.1 Risk-Weighted Capital Ratios6.3.1.1 The Strengthening of Qualitative Requirements for Capital6.3.1.2 The Strengthening of Quantitative Requirements for Capital6.3.1.3 Credit Risk6.3.1.4 Market and Counterparty Risk
6.3.2 Leverage Ratio
6.3.2.1 Arguments in Favour of the Return to a Simple Measure6.3.2.2 Implementation and Impact
6.3.3 Liquidity Ratios
6.3.3.1 Liquidity Coverage Ratio to Regulate Liquidity at a One-Month Horizon6.3.3.2 Net Stable Funding Ratio to Regulate Maturity Transformation6.3.3.3 Implementation and Further Impact
6.3.4 Interactions Across Regulatory Requirements
6.4 Objectives and Constraints of Banking Supervision
6.4.1 Role of Banking Supervision6.4.2 Forms of Intervention of Banking Supervision Authorities6.4.2.1 Off-Site Supervision6.4.2.2 On-Site Inspections6.4.2.3 Assessment of Pillar II Requirements
6.4.3 Financial Stability Depends on Effective Prudential Supervision
6.5 The Solvency II Directive for Insurance in Europe
6.5.1 New Quantitative Prudential Rules
6.5.1.1 A New Accounting Framework to Assess the Solvency of Insurance and Reinsurance Companies6.5.1.2 New Prudential Requirements
6.5.2 Qualitative Requirements have been Strengthened
6.5.3 Implementation and Preliminary Assessment of Impact6.5.3.1 Implementation of Solvency II Regulation6.5.3.2 Preliminary Assessment of the Impact of Solvency II Regulation
6.5.4 The Review of Solvency II (1/2)
6.5.4 The Review of Solvency II (2/2)
7 Crisis Management and Resolution of Financial Institutions
7.1 Definition of Financial Contracts
7.1.1 Bailout
7.1.2 Voluntary Exchange
7.1.3 Contingent Capital7.1.3.1 Threshold7.1.3.2 Conversion Rate
7.2 Internal Bail-in
7.2.1 Objectives
7.2.2 Implementation
7.2.2.1 Scope
7.2.2.2 Trigger
7.2.3 Impact on Financing Costs
7.2.4 Limitations
7.2.4.1 Contagion Risk from Bail-in and the Need to Exclude Retail Deposits7.2.4.2 Higher Legal Costs7.2.4.3 Spill over Risk
7.3 Resolution of Financial Institutions
7.3.1 New Objectives7.3.1.1 Respond to Crisis Situations by Giving Powers to a Resolution Authority7.3.1.2 Generate Financial Resources While Protecting Public Finance by Involving the Private Sector
7.3.2 Differences Between EU and the US
7.3.3 Assessment of Resolution Reforms7.3.3.1 Effectiveness7.3.3.2 Impact
7.3.4 Cross-Border Resolution
7.4 Calibration of TLAC
7.4.1 Objectives of TLAC
7.4.2 Requirements
7.4.3 Impact
7.4.4 Transposition in EU: MREL
8 Macroprudential Policy
8.1 Objectives
8.1.1 The Role of Macroprudential Policy
8.1.1.1 The Need for a Macroprudential Approach8.1.1.2 The Complementary Role Between Micro and Macroprudential Policy
8.1.2 The Definition of the Final Objective
8.2 Indicators8.2.1 Indicators of the Financial Cycle8.2.1.1 Types of Indicators8.2.1.2 Relevance of Indicators
8.2.2 Measurement of Systemic Risk (1/2)
8.2.2.1 Measures Available
8.2.2 Measurement of Systemic Risk (2/2)
8.2.2.2 Assessment
8.2.3 Role of Stress Tests
8.2.3.1 Main Principles of Stress Tests8.2.3.2 Strengths and Weaknesses of Stress Tests
8.3 Intermediate Objectives and Instruments
8.3.1 A Plurality of Intermediate Objectives and Instruments8.3.1.1 Intermediate Objectives8.3.1.2 Macroprudential Instruments
8.3.2 Effectiveness and Limits
8.3.2.1 Principles of Evaluation of Instruments8.3.2.2 Applications
8.4 Questions Related to the Implementation of Macroprudential Policies
8.4.1 Communication and Responsibility
8.4.2 International Coordination
8.4.3 Statistical Information Needs (1/2)
8.4.3 Statistical Information Needs (2/2)
9 Economic Policies and Financial Stability
9.1 Monetary Policy9.1.1 Levers and Constraints in Crisis Situations9.1.1.1 Lender of Last Resort9.1.1.2 Relationship with Fiscal Policy
9.1.2 Interactions Between Monetary Policy and Financial Stability (1/2)
9.1.2.1 Has Monetary Policy Been a Source of Financial Instability?9.1.2.2 Interactions Between Monetary Policy and Macroprudential Policies9.1.2.3 Which Consequences for the Strategy and the Conduct of Monetary Policy?
9.1.2 Interactions Between Monetary Policy and Financial Stability (2/2)
9.2 Fiscal Policy
9.2.1 A Two-Way Link Between Fiscal Policy and Financial Stability
9.2.2 How Can the Loop be Loosened?
9.3 Structural Policies
9.3.1 Tax Policy9.3.1.1 Tax Policy and Housing9.3.1.2 Tax Policy and Debt Finance
9.3.2 Housing Policy
9.3.3 Competition Policy in the Financial Sector (1/2)
9.3.3 Competition Policy in the Financial Sector (2/2)
10 Institutions
10.1 General Issues
10.1.1 Architecture (1/2)
10.1.1.1 Do we Need One Or More Supervisors?10.1.1.2 What Role for the Central Bank?
10.1.1 Architecture (2/2)
10.1.2 Governance
10.1.2.1 Capture and the Revolving Door10.1.2.2 Independence and Accountability
10.2 International Aspects
10.2.1 Institutions (1/2)
10.2.1.1 Groups of Countries10.2.1.2 International Monetary Fund
10.2.1 Institutions (2/2)
10.2.1.3 Bank for International Settlements and Associated Institutions
10.2.2 Extensive Reforms or Improvements to The Existing Framework? (1/2)
10.2.2.1 Comprehensive Reforms10.2.2.2 Improvements to the Existing Framework
10.2.2 Extensive Reforms or Improvements to The Existing Framework? (2/2)
10.3 European Aspects
10.3.1 Economic Aspects10.3.1.1 Risk Pooling
10.3.1.2 Enactment of Rules
10.3.2 Financial System Aspects (1/3)
10.3.2.1 The European System of Financial Supervision10.3.2.2 Banking Union
10.3.2 Financial System Aspects (2/3)
10.3.2 Financial System Aspects (3/3)
11 Emerging Risks and New Challenges
11.1 The Global Covid-19 Crisis Of 2020
11.1.1 The Second Global Crisis of the Twenty-First Century?
11.1.1.1 The Sanitary Crisis11.1.1.2 The Liquidity Crisis (March/April 2020)11.1.1.3 Consequences for Financial Institutions
11.1.1.4 Potential Long-Term Financial Stability Consequences of the Crisis
11.1.2 Policy Responses11.1.2.1 Fiscal and Monetary Policies11.1.2.2 Prudential Regulation11.1.2.3 Responses by Market Authorities11.1.2.4 Responses by International and European Institutions
11.2 New Risks
11.2.1 Cyber Risk11.2.1.1 Definition11.2.1.2 Costs11.2.1.3 Policies
11.2.2 Crypto Assets
11.2.2.1 Definition11.2.2.2 Risks and Responses
11.2.3 Climate Change Related Risks
11.2.3.1 Definition
11.2.3.2 Policy Responses
11.3 New Challenges
11.3.1 The Feedback Loop Between Inequality, Financial Stability, and Populism11.3.1.1 Inequality and Financial Stability11.3.1.2 Inequality and Macroprudential Policies
11.3.2 Population Ageing, Sovereign Debt and Financial Stability
11.3.3 Complexity in Banking and Finance (1/2)
11.3.3.1 Definition11.3.3.2 Implication of Complexity for Financial Stability11.3.3.3 Evolution Over Time and Policy Responses
11.3.3 Complexity in Banking and Finance (2/2)
Index (1/2)
Index (2/2)

Content preview from Preparing for the Next Financial Crisis

Emerging risks and new challenges 341

Of the total amount, €672.5 billion is divided into two main categories:

loans (€360 billion) and grants (€312.5 billion). In addition, there are var-

ious lines of the Commission’s multiannual budget for an amount of €77.5

billion, giving a total of €390 billion in grants. Yet, such borrowing will

have to be reimbursed through an increase in the contributions of Member

States. This could sow the seeds of a future European debt crisis. Moreover,

the distribution of grants instead of loans creates a strong moral hazard: as

each Member State contributes to a limited extent to the EU Commission

budget, it is incentivized to spend ineciently. In response, the so- called

“frugal” Member States (Austria, Den ...

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The Financial Crisis in Perspective (Collection)

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Preparing for the Next Financial Crisis

by Olivier de Bandt, Francoise Drumetz, Christian Pfister

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