Corporate governance of banks and financial stability
Luc Laeven, Lev Ratnovski 21 July 2014
Bank distress during the recent crisis caused significant damage to the real economy. Appropriately, the policy response focused on stronger bank supervision and regulation. This column asks if there is a role for improvements in bank corporate governance. Based on the literature the authors suggest that better risk management, regulation of pay, and enhanced market discipline can help make banks safer. However, corporate governance cannot substitute for strong supervision: it can at best provide a helping hand.
Corporate governance is the practice of shareholders exercising control over managers so that they act in shareholders’ interests. In non-financial firms, this maximises firm efficiency. Such efficiency effects also exist in banks. For example, banks that face more active takeover markets are more cost-efficient (Brook et al. 1998).
Unlike non-financial firms, bank operations have another relevant dimension besides efficiency: risk. Banks are prone to risk-taking, due to:
corporate governance, bank regulation, systemic risk
Are banks too large?
Lev Ratnovski, Luc Laeven, Hui Tong 31 May 2014
Large banks have grown and become more involved in market-based activities since the late 1990s. This column presents evidence that large banks receive too-big-to-fail subsidies and create systemic risk, whereas economies of scale in banking are modest. Hence, some large banks may be ‘too large’ from a social perspective. Since the optimal bank size is unknown, the best policies are capital surcharges and better bank resolution and governance.
Large banks have grown significantly in size and become more involved in market-based activities since the late 1990s. Figure 1 shows how the balance-sheet size of the world’s largest banks increased two- to four-fold in the ten years prior to the crisis. Figure 2 illustrates how banks shifted from traditional lending towards market-oriented activities.
regulation, economies of scale, bank regulation, banking, Too big to fail, systemic risk, BASEL III, bank resolution, bank capital
How to loosen the banks-sovereign nexus
Paolo Angelini, Giuseppe Grande 08 April 2014
The ‘deadly embrace’ between banks and their government has strengthened with the EZ Crisis. This column argues that this has mostly been consequence rather than a cause of the Crisis. Moreover, adverse bank-sovereign negative feedback depends on the economy-wide effects of the sovereign risk, not just the banks’ direct exposure. Loosening the embrace requires sound public finances and well-capitalized, well-supervised banks – including the banking union project.
Sovereign debtors and their national banking systems are closely linked through a range of direct and indirect channels. These include banks’ claims on sovereigns, semi-automatic links between sovereign and bank credit ratings, public backstops, collateral in banks’ operations, and the effects of fiscal distress on the overall economy – and thus the quality of bank loans (CGFS 2011, Bank of Italy 2013a).
EU institutions Financial markets
bank regulation, capital requirements, home bias, bank capital
Estimating the impact of changes in aggregate bank capital requirements during an upswing
Joseph Noss, Priscilla Toffano 06 April 2014
The impact of tighter regulatory capital requirements during an economic upswing is a key question in macroprudential policy. This column discusses research suggesting that an increase of 15 basis points in aggregate capital ratios of banks operating in the UK is associated with a median reduction of around 1.4% in the level of lending after 16 quarters. The impact on quarterly GDP growth is statistically insignificant, a result that is consistent with firms substituting away from bank credit and towards that supplied via bond markets.
The recent financial crisis and economic contraction that followed highlighted the crucial role that banks play in facilitating the extension of credit and enabling economic growth. This underlies the economic rationale for imposing regulations on the banking industry, including minimum capital requirements designed to mitigate risks banks would not otherwise account for in their behaviour.
regulations, bank regulation, banking, capital requirements, banks, BASEL III, credit, Macroprudential policy, bank capital
Have we solved 'too big to fail'?
Andrew G Haldane 17 January 2013
The Subprime Crisis became the Global Crisis when one too-big-to-fail bank was allowed to fail. This column argues that too-big-to-fail is far from gone despite years of reform efforts. It is important that it not be forgotten. Further analytical work, weighing the costs and benefits of different structural reform proposals, would help keep memories fresh and policies on the right track.
That is not my pessimistic verdict; it is the market’s. Prior to the crisis, the 29 largest global banks benefitted from just over one notch of uplift from the ratings agencies due to expectations of state support. Today, those same global leviathans benefit from around three notches of implied support. Expectations of state support have risen threefold since the crisis began.
bank regulation, Too big to fail
Bank governance and regulation
Luc Laeven 25 October 2011
Recent financial regulatory reforms target banks’ risk-taking behaviours without considering their ownership and governance. This chapter argues that bank governance influences how regulations alter bank’s incentives. Banks with more powerful owners tend to take more risks, and greater capital requirements actually increase risk-taking in banks with powerful shareholders. Bank regulation should condition on bank governance.
Regulations for banks are being rewritten in response to the global financial crisis. The Basel III framework is being adopted, capital requirements are being increased, and safety nets have expanded in scope and size, all with the aim of making banks safer. These financial reforms and re-regulations, however, ignore bank governance – the ownership of banks and the incentives and conflicts that arise between bank owners and managers. But what if the governance structure of banks is intrinsically linked to bank risk?
Financial markets International finance
bank regulation, banking, bank governance, principal-agent problem
Do not be detoured by bankers and their friends; our future financial salvation lies in the direction of Basel
Avinash Persaud 23 September 2011
The financial crisis revealed substantive problems that need to be solved, especially in the banking sector. This column argues that Basel III, the new accord on international banking, is an overdue step in the right direction. It should be defended against attempts by bankers and their friends to cut it down, dilute it, and postpone it.
For the past decade I have been a trenchant critic of the international banking rules developed in Basel. Nine years ago, I wrote an editorial in The Financial Times1 highlighting the perverse irony of bankers capturing their regulators and yet fashioning international banking regulation in a way that would lead them to systemic collapse.
Financial markets International finance
bank regulation, global crisis, BASEL III
Tax banks to discourage systemic-risk creation, not to fund bailouts
Enrico Perotti 07 February 2010
Obama’s plans for bank taxation took markets, policymakers, and academics by surprise, leaving all parties now debating its merits. This column suggests an alternative. By raising a Pigouvian tax based on banks’ individual contribution to systemic-risk creation, the policy would target the externality caused by funding fragility while raising the cost of opportunistic risk creation in good times.
The burning issue of funding the bailout has finally led to the first policy action on financial taxation. The good news is that it is not a Tobin tax on all financial transactions, which would be a very crude and distortionary solution. Financial intermediaries have indeed grown too large, but discouraging all financial transactions suppresses activity and fails to target problematic practices.
bank regulation, Pigouvian tax, Obama's bank reforms
Sudden financial arrest
Ricardo Caballero 17 November 2009
How should governments respond to sudden failure of the financial system? This column says that it is neither credible nor desirable to refuse to assist the private sector in financial crises. It makes the case for massive provision of credible public insurance and guarantees to financial transactions and balance sheets – a financial defibrillator to respond to sudden financial arrest.
“Sudden cardiac arrest (SCA) is a condition in which the heart suddenly and unexpectedly stops beating. When this happens, blood stops flowing to the brain and other vital organs…. SCA usually causes death if it’s not treated within minutes….”
– US National Institute of Health
moral hazard, bank regulation, Sudden financial arrest
Liquidity risk charges as a macro-prudential tool
Enrico Perotti, Javier Suarez 07 November 2009
There is a post-crisis consensus on the need to address systemic liquidity risk and its role in propagating turmoil. This column, which accompanies the release of a new CEPR Policy Insight, refines the implementation details of a new macro-prudential tool – liquidity risk charges – to discourage systemic risk creation by banks.
The recent financial crisis was unprecedented in scale and speed of propagation. The original housing shock was severely compounded by banks’ extreme funding fragility (Brunnermeier 2009). Banks’ risk-absorbing capacity had been reduced not just by lower capital buffers but also by extremely short-term funding. The panic withdrawals of wholesale short-term investors propagated and compounded losses as they forced massive distress sales (Gorton 2009). These in turn caused rapid asset price declines, triggered further margin calls and thus more fire sales across markets.
Financial markets Macroeconomic policy
bank regulation, macro-prudential regulation, Liquidity risk charges