Will Basel III work?

Xavier Vives 22 December 2014

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The recent financial crisis has exposed the failures of regulation. We have witnessed how the three pillars of the Basel II approach – namely capital requirements, supervision, and disclosure and market discipline – have been insufficient to prevent or contain the crisis. Banking has proved much more fragile than expected. Among the problems that have surfaced is the danger of an overexposure to wholesale financing, as demonstrated by the demises of Northern Rock and Bear Stearns.

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Topics:  Financial markets

Tags:  BASEL III, capital requirements, banking, regulation, financial crisis, liquidity requirements, transparency, Competition policy, state aid, fire sales, financial fragility, coordination failure, moral hazard, contagion, solvency, liquidity, balance sheets, Information, public signals

Liquidity-driven foreign direct investment

Ron Alquist, Rahul Mukherjee, Linda Tesar 22 December 2014

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A fundamental question in international economics is why and how firms engage in foreign direct investment (FDI). Two broad motives for undertaking such investments have been identified -- one related to trade frictions and the second one related to the value of exercising corporate control. The trade literature focuses on the importance of economies of scale, trade barriers, and cross-border differences in production costs as the reasons for firms becoming multinational (see, among others, Brainard 1997; and Helpman et al. 2004).

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Topics:  International finance

Tags:  FDI, liquidity, emerging markets

Why is euro inflation so low?

Jean-Pierre Landau 02 December 2014

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Inflation in the Eurozone stood at 0.4% (year on year) in November. It has been persistently declining for almost a year, and constantly undershooting forecasts. The Eurozone is now clearly diverging from many advanced economies, where inflation is either on the rise – albeit at moderate levels – as in the US, or, when falling, still remaining close to target, as the UK.

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Topics:  Macroeconomic policy Monetary policy

Tags:  inflation, eurozone, safe assets, safety trap, risk aversion, disinflation, exchange rates, interest rates, liquidity trap, zero lower bound, monetary policy, public debt, Eurozone crisis, Central Banks, ECB, quantitative easing, long-term refinancing operations, unconventional monetary policy, liquidity, asset-backed securities, securitisation, debt sustainability, fiscal space, fiscal capacity, balance sheets

Where danger lurks

Olivier Blanchard 03 October 2014

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Until the 2008 global financial crisis, mainstream US macroeconomics had taken an increasingly benign view of economic fluctuations in output and employment. The crisis has made it clear that this view was wrong and that there is a need for a deep reassessment.

The benign view reflected both factors internal to economics and an external economic environment that for years seemed indeed increasingly benign.

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Topics:  Macroeconomic policy Monetary policy

Tags:  macroeconomics, global crisis, great moderation, rational expectations, nonlinearities, fluctuations, business cycle, monetary policy, inflation, bank runs, deposit insurance, sudden stops, capital flows, liquidity, maturity mismatch, zero lower bound, liquidity trap, capital requirements, credit constraints, precautionary savings, housing boom, Credit crunch, unconventional monetary policy, fiscal policy, sovereign default, diabolical loop, deflation, debt deflation, financial regulation, regulatory arbitrage, DSGE models

Finance at the speed of light: Is faster trading always better?

Marius Zoican 20 September 2014

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Few activities embraced the computer age so actively as trading. Loud and hectic pits have been progressively replaced by silent computer server rooms. Transactions are no less dynamic for it, however. A London-based trader can buy stocks in Frankfurt within just 2.21 milliseconds.1 Light needs 2.12 milliseconds to travel the same distance. Welcome to the age of algorithmic and high-frequency trading!

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Topics:  Financial markets

Tags:  high-frequency trading, algorithmic trading, technology, liquidity, spreads, price discovery, adverse selection, exchanges, competition-stability trade-off

Shadow banking and the economy

Alan Moreira, Alexi Savov 16 September 2014

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Shadow banking, what is it good for? At the epicentre of the global financial crisis, shadow banking has become the focus of intense regulatory scrutiny. All reform proposals implicitly take a stance on its economic value.

According to the prevailing regulatory arbitrage and neglected risks views, it doesn’t have any – shadow banking is about evading capital requirements, exploiting ‘too big to fail’, and marketing risky securities as safe to unwitting investors. The right response is to bring shadow banking into the regulatory and supervisory regime that covers insured banks.

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Topics:  Financial markets Global crisis Macroeconomic policy

Tags:  shadow banking, banking, financial crisis, global crisis, regulatory arbitrage, liquidity transformation, financial stability, externalities, collateral, business cycle, financial regulation, financial fragility, liquidity, liquidity crunch

Persistent noise, investors’ expectations, and market meltdowns

Giovanni Cespa, Xavier Vives 22 April 2014

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The recent financial crisis has revived interest in the question of what triggers crashes and meltdowns in financial markets. An important reason for abrupt and large price dislocations is the lack or ‘slow motion’ of arbitrage capital (Duffie 2010) that weakens the risk-bearing capacity of liquidity providers.

We suggest that there is an alternative explanation based on expectations dynamics in the presence of persistent market noise.

In the market:

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Topics:  Financial markets

Tags:  liquidity, financial crises, asset prices, noise trading, informational efficiency

Recent studies reinforce the case for the Liquidity Coverage Ratio

Stefan W Schmitz, Heiko Hesse 28 February 2014

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With the underpricing of liquidity risk prior to the crisis, a return to the same pre-crisis liquidity pattern is not expected. There is widespread consensus that banks’ extensive pre-crisis reliance on deep and broad unsecured money markets is to be avoided in the future (see e.g. IMF 2013). Creating substantial liquidity buffers across the board is the explicit aim of a number of regulatory responses to the crisis, such as the CEBS Guidelines on liquidity buffers (CEBS 2009) and the LCR.

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Topics:  EU institutions Financial markets

Tags:  liquidity, banking

A call for liquidity stress testing and why it should not be neglected

Clemens Bonner 06 February 2014

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The recent financial crisis has shown that neglecting liquidity risks comes at substantial costs. In order to reinforce banks’ resilience to liquidity risks, the Basel Committee on Banking Supervision (BCBS) proposed the introduction of two harmonised liquidity standards:

  • The liquidity coverage ratio; and
  • The net stable funding ratio.

While the implementation of harmonised liquidity regulation across the globe is a unique and necessary step for supervision, one single metric cannot provide a complete picture of an institution’s liquidity risk profile.

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Topics:  Financial markets

Tags:  liquidity, banks, stress tests

The determinants of banks’ liquidity buffers and the role of liquidity regulation

Clemens Bonner, Iman van Lelyveld, Robert Zymek 01 November 2013

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Until recently, liquidity risk was not the main focus of banking regulators. However, the 2007–2009 crisis showed how rapidly market conditions can change, exposing severe liquidity risks for some institutions. Although capital buffers were effective in reducing liquidity stress to some extent, they were not always sufficient. In the light of this, efforts are underway internationally as well as in individual countries to establish or reform existing liquidity risk frameworks – most notably the proposals by the Basel Committee on Banking Supervision (BCBS 2013).

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Topics:  Financial markets Microeconomic regulation

Tags:  transparency, liquidity, regulation, banking, Too big to fail, disclosure

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