SHIFTING FINANCIAL POWERS SHADOW BANKING: RELEVANCE, REGULATION AND RISK

aPrIl 2011 18 th vo lum e ed It I o n 3

SHIFTING FINANCIAL POWERS SHADOW BANKING: RELEVANCE, REGULATION AND RISK

MARK THOMA LEX HOOGDUIN ENRICO PEROT TI NOMI PRINS ELLEN BROWN HERMAN MULDER DIRK SCHOENMAKER

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Inhoudsopgave | colofon

Index Preface e dI tor f I ducI e

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C a s p er Fr a n sz

colofon Uitgever Financiële Studievereniging Amsterdam Redactie Casper Fransz (hoofdredacteur) Gabor Ruigrok Druk Grafiplan Nederland B.V. Opmaak Hetgasbedrijf B.V. Advertenties Fiducie verschijnt vier keer per jaar. Voor Advertenties kan contact worden opgenomen met de Financiele Studievereniging Amsterdam © 2010 FSA

IntervIews: the shadow bankIng system: regulatIon and bank runs 6 Ma r k T h om a het s hadow bankI ng sy t eem I n n ederl and

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L ex H oog d u i n ArtIcles: how to control rIsk creatIon In the fInancIal sector

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En r i co Per ott i Sh adow Banki ng –

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r eforms PendI ng I n cong res s woul d not touch t he abuses of hedg e funds and P r I vat e equI t y Nomi Pr i n s t h e sh adow bankI ng syst em ,

22

t h e credI t melt dow n, and bas el I I I El l en Br own columns:

Hoewel deze uitgave de uiterste zorg is nagestreefd kan voor de aanwezigheid van eventuele (druk)fouten en andersoortige onvolledigheden niet worden ingestaan en aanvaarden de auteur(s), redacteur(en) en uitgever in deze geen aansprakelijkheid. Alle rechten voorbehouden. Niets uit deze uitgave mag worden verveelvoudigd, opgeslagen in een geautomatiseerd gegevensbestand, of openbaar worden gemaakt, in enige vorm of op enige wijze, hetzij elektronisch, mechanisch, door fotokopieën, opnamen, of enig andere manier, zonder vooraf gaande schriftelijke toestemming van de uitgever.

shadows of the Past: atlas shrugged?!

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Her m a n M u l d er dui SenB erg S ch ool of f i nance – aSk an ex pert Di r k S ch oen ma ker

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ACCOUNTANTS EN BELASTINGADVISEURS

Preface editor fiducie

The Shadow Banking System Two years after the crisis our understanding of the

the Duisenberg School of Finance column where

factors that lead to the crisis has grown. One of the

professor Schoenmaker explains some of the basics

most important causes was a banking run in the

of the shadow banking system. Our first interview of

unregulated shadow banking system. This system of

this Fiducie is with professor Thoma of the Oregon

institutions that provide credit and perform maturity

University. He offers his views on bank runs in the

transformations experienced bank runs as a result

shadow banking systems. Then, our interview with

of falling asset prices. As some of these institutions

professor Hoogduin of the Dutch Central Bank

were systemic and all were untransparant and

highlights some of the possible focus points of

interconnected the crisis escalated into the whole

regulation in the Netherlands. Professor Perotti has

financial system.

contributed an article on risk creation in the financial sector. While Nomi Prins argues for regulations to

Each year Fiducie has an issue dedicated to the

cover hedge-funds and private equity and Ellen

FSA Conference. This year’s Conference will

Brown analyses to which extent state-owned banks

allow professionals, academics and policy makers

would help remedy the problems we saw during the

to express and share their views on the shadow

crisis. Finally, Herman Mulder argues that many of

banking system with each other and students.

the non-regulated financial services are contributing

Clearly, legislation will be necessary to regulate and

to a healthy financial system in his column.

decrease future risks. The first steps have already been taken with the Basel III standards and the Dodd-

Fiducie, the academic journal of the Financial Study

Frank bill. However, there exist different opinions

Association Amsterdam is published each quarter

on the best way to proceed forward. Moreover, the

presenting relevant developments related to business

topic itself lacks the kind of theoretical and empirical

and economics. I would like to thank you as reader

literature that other parts of the financial system

for your interest and hope you enjoy reading the

have. Even defining which institutions are players

Fiducie.

in the shadow banking system and which are not is still under debate as it remains to be seen whether hedge-funds and equity funds are to be regulated or not. For all these reasons the following months will be crucial in determining the future of institutions that are part of the shadow banking system. The FSA Conference on the shadow banking system could

Casper Fransz

therefore not come at a better time.

Head Editor Fiducie

This Fiducie shows some of the different opinions on new regulations. If unfamiliar with the shadow banking system, I suggest readers to start reading

5

the shadow banking system: regulation and bank runs

Mark Thoma

Mark Thoma is a professor of economics at the University of Oregon. He specializes in macroeconomics and time-series econometrics, and his research is focused on how Federal Reserve policy impacts the economy. He blogs daily at Economist’s View, and his undergraduate lectures in monetary theory and policy, econometrics, and the Interview by Casper Fransz and Sander Elting

history of economic thought are posted at YouTube.

What is the most problematic aspect of shadow banking

crisis hit this collateral did not hold its value. Asset

unlimited maturity transformation and none

which requires regulation?

prices fell, including the price of collateral, and that

at all. What Morgan Ricks would do would be

In my view the biggest problem is bank runs in the

induced the fear of losses that caused the run on the

to give government insurance to anyone doing

shadow banking sector. If you look at the Dodd-

shadow system.

maturity transformation, much like in the

Frank bill that we passed here in the US, there are a

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traditional banking system, and then couple that

lot of useful regulations in the bill, but the problem

So the first way to fix this is by improving the quality

with heavy ex-ante regulation on behavior. The

of bank runs in the shadow banking system is left

of the collateral that is held against deposits. This

ex-ante restrictions on behavior, i.e. regulation, is

unresolved. These runs are much like the runs in

is what Gary Gorton and Andrew Metrick (Yale

necessary because giving insurance creates moral

the traditional banking system, and a bank run of

University) are proposing. If regulators do, in fact,

hazard. Thus, under this proposal it is impossible

this type was a major factor in the collapse of the

go this route – and there are indications that they

to be involved in maturity transformation without

financial sector.

will -- I would like to see the collateral restricted to

having the ex-ante regulations and the insurance,

something akin to government bonds because that

and hence it is relatively restrictive. I like this

In the traditional banking sector these runs were

type of collateral generally increases in value in a

proposal in terms of its safety – it mimics the

resolved through deposit guarantee funds. How would

crisis. But no collateral is perfect, especially when it

system in the traditional banking system as best

you propose this issue can be solved within the shadow

involves financial assets.

it can – but am worried that it would shut down

banking sector?

the shadow banking system to the extent that it

There are two major proposals out there. In the

The second proposal focuses on maturity

traditional banking sector, the problem of bank runs

transformation; i.e. borrowing short and lending

was solved by deposit guarantees, which currently

long. The problem here is that during a crisis short-

There have been estimations that up to 60% of all

ensure deposits in a single bank up to $250,000.

term funding dries up leading to liquidity problems

credit is routed through the shadow banking system.

Once these gurantees were put in place in the

for banks engaged in maturity transformation.

Does regulating it too strictly impair economic growth?

1930s, bank runs – which had been a big problem

A proposal from Morgan Ricks (Harvard Law

This is a real concern. It is why although the second

up to that point -- stopped in the traditional

School) attempts to solve the problem by restricting

approach is appealing since it worked for the

system. Presently, , the way it works in the shadow

who can engage in maturity transformation.

traditional banking sector, I am more inclined to

banking system is that you receive collateral for

would hurt economic growth.

go for improving the quality of the collateral held

making deposits in shadow bank institutions and

If you can get rid of maturity transformation in

against deposits. But when looking at the actual

this collateral is supposed to ensure deposits and

the banking system, of course you would solve the

proposals for improving collateral, I am worried that

prevent runs. However, the quality of the collateral

problems with bank runs. However, eliminating

the kinds of collateral they are proposing – basically

held against deposits became an issue during the

all maturity transformation is not possible since

any AAA rated asset -- will not hold its value in a

crisis. Essentially, everyone thought their deposits

this increases the efficiency of the banking system.

crisis. So I am in favor of the collateral option, but

were backed by AAA-rated collateral, but as the

Thus, there needs to be a compromise between

as it stands it is not perfect.

“We just do not have enough experience with the shadow banking system to adjust those fees and get the regulations perfect.” You have recently written an article on moral hazard

system but it is unclear as to whether they

financial intermediation has to be included in our

within the shadow banking system. The proposals

contributed negatively to the crisis.

models. That will allow us to analyze how a collapse

discussed above, especially the second, seem to have

affects the real sector, and give us a better model to use

moral hazard problems. It seems improbable that

My understanding is that hedge-funds had very little

to evaluate policy responses. Currently we are flying

the right balance between ex-ante regulation and

to with the crisis, in fact some of them did quite

blind estimating the effects of policy using models

insurance will be immediately found. What is your

well during that time period. That’s the problem

that do not connect the real and financial sectors, and

view on this?

with imposing sweeping, wide regulation, it affects

I do not really trust the multipliers that are coming

I agree. You can only hope that the ex-ante fees and

and limits firms that do not need to be regulated.

out of these exercises if they do not have the right

regulations are sufficient to take that moral hazard

Therefore, targeted legislations is required. My

transmission mechanism. Getting heterogeneous

away. In the traditional banking sector, the deposit

understanding is that the first proposal discussed

agents into these models is, in my view, the real

insurance creates moral hazard and then insurance

above – improving collateral requirements -- does

stumbling block. There are difficult aggregation

fees are used to offset the moral hazard incentive.

try to target only those institutions that were

problems that are swept under the rug in our single-

We just do not have enough experience with the

negative factors influencing the crisis. However, the

agent current models. In the shadow banking system,

shadow banking system to adjust those fees and get

second proposal to limit maturity transformation

this will require us to isolate the important features

the regulations perfect. The regulations will have

does affect hedge funds and that is one of the reasons

of the system in order to effectively model them

to be tight enough to stop moral hazard without

why I am less in favor of that proposal. The second

and connect financial intermediation to economic

unduly shutting down the system itself.

proposal cannot target legislation as effectively as the

activity. However, I am confident we will manage to

first, and credit could become unnecessary expensive.

extend our knowledge and model the complexity of

To what respect does having strong regulations work

the financial sector and the shadow banking system

when shadow banking institutions can relocate to

To what extent did the models in finance and macro-

in particular. The real question is whether existing

countries with less strict regulations in in order to

economics contribute to the financial models?

models can be fixed, or whether we need a brand new

avoid the new legislation?

The major element missing in macro-economic

theoretical paradigm. More and more, I am becoming

This is an important aspect of the problem to

models is the connection between the collapse in

pessimistic that standard DSGE models are up to the

consider. There is a real danger that these institutions

the financial sector and real economic activity. In the

task, but this is something we won’t know for sure

find a way to route the funds outside of US regulation

single agent representative models that are used in

until the research has been completed.

and get the same thing done through the backdoor.

mainstream models today, the kind of heterogeneity that is required to understand the financial sector is

We would also like your opinion on proposed legislation

How would proposed legislation impact the asset

lacking; a single agent cannot trade with itself. Thus,

in the Netherlands. For example, a popular idea

management industry for institutions such as

the macroeconomic models in use prior to the crisis

is to separate the shadow banking system from the

equity funds and hedge-funds? These could be

downplay the financial sector and that turned out

traditional banking system and thereby eliminating

characterized as players in the shadow banking

to be a huge mistake. It is clear that the collapse of

any moral hazard as there will be no insurance for

7

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“Als belegger kun je wel een risico aangaan dat je inmiddels niet of zelden terug kunt vinden in Westerse markten“ “When the time comes and regulators are given a choice between using new untried methods or the old way that is imperfect but will work they will choose the last.“ anyone with deposits/investments in the shadow

bail-outs and not require tax money. Do you think

banking system. What is your opinion on such

that would be a good idea?

legislation?

That would be equivalent to an insurance fee. It

If it is convincing a-priori that regulators are serious

can help with moral hazard and I think it would

about letting these institutions fail, it would be a

be a good idea. But if you look at what happened

credible way to proceed. But there is an important

historically, whenever these funds get large people

condition. That condition is to insure that the

tend to think the fund is getting too big and does

institutions in the shadow banking system are not

not require the large amount of credit it holds. Why

systemically important, something that requires

have so much idle cash sitting around waiting for

diminished size and lower interconnectedness.

a crisis? However, as the crisis showed, you really

Once this is accomplished, the issue is whether the

need a large rescue fund, if the fund is too small

threat to let shadow banks fail in a crisis is credible.

then the question of whether the government

However, if I take as an example the threats issued

should intervene and bail banks out returns. Thus,

in the Dodd-Frank bill – the resolution authority in

this option is one of the ways to lower moral

the bill is supposed to cure moral hazard by having

hazard, but it will not fully offset it.

preset procedures to dismantle these banks then I am not convinced these threats are that credible. The

How would you summarize the lessons we can learn

institutions remain systemic, and I think that when

from the crisis in respect to the shadow banking

the time comes and regulators are given a choice

system?

between using new untried methods to resolve

The traditional banking system did fairly well in the

troubled institutions or the old way – bailouts -- that

crisis, and that indicates that the type of regulation

is imperfect but will work, they will choose bailouts.

used in the tradional banking sector works well.

But perhaps the Netherlands can do a better job

Therefore, I would like to see the shadow banking

than we have done in the US of using regulations to

system to be brought under the same kind of

reduce the systemic danger from these institutions.

regulatory umbrella as the traditional banking

If so, then I think the threat to let them fail is more

sector. We are know what is needed to stop bank

credible.

runs, and we need to do something similar in the shadow banking system.

Another proposal is to, in a way, tax the banking sector and create a fund which would rescue banks in the future. In this manner, banks would fund their own

For reactions, please mail to [email protected]

9

het shadow banking syteem in nederland Lex Hoogduin

Prof. dr. L.H. Hoogduin is sinds 1 januari 2009 directeur bij de Nederlandsche Bank. Hoogduin is verantwoordelijk voor economisch beleid en onderzoek, financiële stabiliteit en financiële markten, betalingsverkeer en statistiek. Daarnaast is Hoogduin parttime hoogleraar Monetaire Economie en Financiële Instellingen aan Interview door Casper Fransz en Sander Elting

de Universiteit van Amsterdam.

Instellingen binnen het Shadow Banking systeem

zin vind ik de term Goodheart’s Law hierbij ook

van het shadow banking systeem. Het probleem

hebben een grote invloed op de stabiliteit van financiële

relevant; op het moment dat je het gaat meten dat

is dat er risico’s zijn binnen het financiële

markten. Ze kunnen echter niet rekenen op steun van

er weer nieuwe type partijen ontstaan die buiten de

systeem waar geen toezicht op is. Financiële

de centrale bank als “lender of last resort”. In hoeverre

meetcriteria vallen. Dat maakt toezicht natuurlijk

instabiliteit kan gegenereerd worden doordat

bemoeit DNB zich met instellingen binnen het shadow

ook lastiger.

wholesale financiering wegloopt zoals bij veel

banking systeem?

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van de structured investment vehicles (SIV). Die

Als reactie op de crisis is er op verschillende terreinen

Veel van het werk wat betreft reguleringen wordt

SIVs waren vaak als het ware verzekerd door de

wetgeving op gang gezet. Dat komt samen in Basel

gedaan onder leiding van het Financial Stability

traditionele banken. Dus je kunt niet negeren wat

III, dat betrekking heeft op traditionele banken.

Board, de FSB, waar zowel het Ministerie

er buiten het traditionele banksysteem gebeurt

Daarnaast is er de kapitaal regulering voor de

van

Bank

omdat het traditionele systeem er wel door wordt

verzekeringssector in Solvency II dat er binnenkort

vertegenwoordigd bij zijn. Klaas Knot, die ook zal

beïnvloed. Regulering kan er dan voor zorgen dat

aan komt. Daarbovenop hebben we in Nederland

spreken op het FSA Congres, zit in de werkgroep van

de mogelijke negatieve invloed van het shadow

ook aparte regulering voor pensioenfondsen. In

het FSB op dit gebied. Wat betreft de Nederlandse

banking systeem op het traditionele systeem

de algemene zin zijn kapitaal vereisten verhoogd

Bank bemoeien wij ons met het shadow banking

wordt verlaagd. Ik zie dat niet zo zeer als direct

en liquiditeit eisen ingevoerd met het idee om de

system daarom vanuit de toezichtskant en daar zit

gerelateerd aan het too big to fail probleem.

buffers groter te maken en het financiele stelsel

zowel een micro- als macro-economische kant aan.

stabieler, weerbaarder, te maken. Er zijn twee

Wat betreft de macro-economisch toezicht kijken

Moet je als toezichts instantie regulering opzetten

terreinen waar de regulering nog niet af is. Ten eerste

wij naar het gehele financiële stelsel en hoe het

zodanig dat de problemen die worden veroorzaakt als

zijn dat de zogenaamde SiFi’s, oftewel systemically

gedrag van de één de ander beïnvloedt. Dat is bij

wholesale financiering wegloopt, een bank run in het

important financial institutions. Het “too big to

het shadow banking systeem heel belangrijk omdat

shadow banking systeem, worden verminderd? Met

fail” probleem. Het andere probleem is het shadow

de regulering net weer ander gedrag en instellingen

andere woorden, moet je investeerders verzekeren zoals

banking systeem.

kan uitlokken en daar moet je wel attent op zijn.

deposito houders verzekerd zijn binnen het traditionele

Tot slot is het belangrijk om duidelijk te stellen dat

banksysteem?

Het idee van een shadow banking systeem is op

de instellingen in het shadow banking systeem geen

Er zijn in een aantal mogelijkheden. Ten eerste kun

zichzelf natuurlijk niet nieuw. In een gereguleerde

toegang tot Centrale Bank geld hebben.

je een deel van de activiteiten binnen het shadow

Financien

als

de

Nederlandse

sector zijn er nu eenmaal vaak prikkels om bepaalde

banking systeem binnen de bestaande regulering

zaken buiten de regulering om op te zetten. De vraag

Lehman Brothers wordt ook vaak genoemd als deel

trekken. Daarnaast kun je ook het toezicht vergroten

of het shadow banking systeem gereguleerd moet

van het shdaow banking systeem ten tijde van de crisis.

op die partijen die deze instellingen binnen het

worden en zo ja hoe wordt op dit moment hard aan

In hoeverre kun je het SiFi probleem en het shadow

shadow banking systeem financieren. Dan spreek

gewerkt. De eerste stap daarbij is een definiëring van

banking probleem compleet scheiden?

je over het algemeen over banken en andere grote

welke instellingen nu binnen het shadow banking

Daar kom je op de vraag wat precies de definitie van

spelers. In het voetbal kun je de sterspeler van de

system vallen. Denk daarbij aan kredietverleners die

een shadow bank is en dan zie je dat het per land

tegenstander ook uitschakelen door te zorgen dat

geen geld aantrekken bij het publiek zoals special

verschillend is. Zo was het toezicht op Lehman

hij de bal nooit krijgt.

purpose vehicles (SPV), hedge fondsen. Maar ook

Brothers in de VS anders dan bijvoorbeeld het

fondsen die wel geld aantrekken bij het publiek maar

toezicht op Citibank. Tegelijkertijd heeft Citibank

Voor de crisis was het idee vaak om indirect te

niet direct omschreven worden als banken. In die

ook weer SPV’s opgezet die weer deel uitmaken

reguleren. De crisis heeft uitgewezen dat die

“Binnen voetbal kun je de sterspeler van de tegenstander ook uitschakelen door te zorgen dat hij de bal nooit krijgt … de crisis heeft uitgewezen dat die aanpak niet erg succesvol is“ aanpak niet erg succesvol is en daarom dat we nu

men probeert systeem relevante banken zodanig te

zien dat er weer aandacht is voor direct reguleren.

structuren dat mochten ze in de problemen komen

Daarnaast is er ook nog de optie, en dat zie je

ze gemakkelijk afgewikkeld kunnen worden. Op

bijvoorbeeld in de Dodd-Frank bill in de VS,

die manier gaan de gezonde delen van de instelling

dat een instelling zodra deze systeemrelevant is

niet verloren in een faillissement. Technisch,

volgens de toezichthouder binnen het toezicht

maar ook juridisch is een faillissement vaak heel

komt te vallen van de toezichthouder. Dat is op

ingewikkeld bij systeem instellingen omdat ze

dit moment nog niet mogelijk in Nederland.

zich in zo veel verschillende jurisdicties bevinden.

Tot slot kun je bepaalde activiteiten reguleren,

De vraag is natuurlijk in hoeverre de toekomstige

bijvoorbeeld securitisatie.

reguleringen de schaalvoordelen van grote banken zullen teniet doen.

De keuze is wat dat betreft nog niet gemaakt. Maar er wordt wel naar gestreefd om dat wereldwijd te

In hoeverre zal de implementatie in Nederland

coördineren. We hebben per slot van rekening een

verschillen van andere landen?

wereldwijd financieel systeem. Daarom dat het

Het Nederlandse bankwezen is geconcentreerd.

beleid eerst op FSB niveau wordt uitgezet, dan

Nederland heeft wat men noemt een retail funding

Europees het beleid wordt bepaald en tot slot in

gap. Dat betekent dat de activiteiten van Nederlandse

Nederland wordt geïmplementeerd.

banken binnen de Nederlandse markt niet geheel gefinancierd kunnen worden door het Nederlandse

Het SiFi probleem wordt via andere manieren

spaargeld wat op de rekening bij een bank staat. De

aangepakt. Ten eerste door middel van extra hoge

reden daarvoor is tweeledig. Ten eerste staat de activa

kapitaal eisen voor systemische instellingen bovenop

kant van de balans van Nederlandse banken voor een

de Basel III standaarden. Dat is bijvoorbeeld in

relatief groot deel in het teken van het financieren

Zwitserland al het geval. Ten tweede kunnen dit

van de woningmarkt. Dat komt natuurlijk ook door

soort instellingen worden gevraagd zogenoemmde

het belasting regime, de hypotheekrenteaftrek.

Coco’s, contingent capital, uit te geven. Dat is geen

Daarnaast sparen Nederlanders voornamelijk via

kapitaal maar wordt wel als zodanig omgezet als

pensioenfondsen, wat in Nederland verplicht is.

het bestaande kapitaal beneden bepaalde waarden

Deze pensioenfondsen diversificeren en daardoor

komt. Daarnaast heb je bail-in clausules. In

wordt een relatief klein gedeelte in Nederland

tegenstelling tot Coco’s, die beginnen te werken

geïnvesteerd. Nederlandse banken moeten daarom

als je nog niet echt in de problemen zit, zal in het

financiering aantrekken vanuit het buitenland. De

geval van bail-in clausules een deel van het vreemd

structuur van het Nederlandse bankwezen wordt

vermogen in eigen vermogen worden omgezet in

hierdoor in grote mate bepaald.

geval van zeer problematische ontwikkelingen zoals bijvoorbeeld een faillissement. Tot slot bestaan er

Dat heeft wel consequenties binnen de SiFi

ook recovery en resolution plans. Dat betekent dat

problematiek op het moment dat er wordt

11

gekozen voor een oplossing waarbij systeem

In hoeverre vallen de Nederlandse pensioenfondsen

relevante banken “schotten” moeten gaan

binnen dit soort regulering?

zetten tussen de operaties in individuele

In eerste instantie zou ik daarop antwoorden dat die

landen. Dan is namelijk de vraag in hoeverre

daar niet onder vallen. Er is geen risico van een bank-

Nederlandse banken nog steeds spaargeld

run bijvoorbeeld want Nederlandse spaarders kunnen

kunnen aantrekken uit het buitenland om de

hun geld daar niet weghalen. In zoverre is er geen

Nederlandse activiteiten te financieren. De

sprake van een risicovolle looptijds transformatie. In

vraag is dan ook of ons financiële stelsel daar

het Nederlandse geval is er bovendien regulering en

stabieler van wordt. De retail funding gap is dan

toezicht op pensioen fondsen.

ook een relatieve zwakte van het Nederlandse financiële systeem.

We moeten echter ook verder kijken. Wereldwijd zijn we banken aan het insnoeren. Extra kapitaal

12

In hoeverre is het Nederlandse financiële systeem

buffers, grote banken nog extra buffers. De vraag

afhankelijk van partijen binnen het shadow banking

is waar de risico’s heen gaan? Verdwijnen ze of

systeem?

verplaatsen zij zich buiten de nieuwe regulering?

Doordat het buiten de regulering valt is dat het

In het geval van bankregulering betekenen de

lastig daar precies in te kunnen zijn. Bovendien

strengere maatregelen dat je in eerste instantie een

is er tot nu toe veel gemeten is op basis van

impuls geeft om activiteiten te verplaatsen buiten

verschillende definities. De cijfers zijn daarom

de regulering; een stimulering van wat we op dit

nog niet duidelijk en vergelijken is lastig. Neem

moment het shadow banking systeem noemen.

bijvoorbeeld geldmarkt fondsen, in zekere zin ook

Dat betekent dat de regulering flexibele definities

deel van het shadow banking systeem. Deze zijn

moet hebben.

in Nederland relatief onbelangrijk terwijl ze in Frankrijk en de VS erg belangrijk zijn. Echter,

In

deze fondsen werken wel verschillend in de VS

dat pensioenfondsen meer gaan lijken op

Nederland

wordt

erover

gesproken

dan in Franksrijk en dat is in de financiële crisis

beleggingsfondsen. Beleggingsfondsen zijn wel

wel een significant verschil gebleken. In de VS

enigszins gereguleerd, maar in mindere mate dan

heb je een garantie als inlegger in het geldmarkt

banken. Daarboven is er de neiging om richtlijnen

fonds, terwijl die garantie er niet is in Frankrijk.

op te stellen die pensioenfondsen ertoe dwingen

Daardoor waren er grotere problemen in de VS

in grotere mate te investeren in de Nederlandse

omdat de balans van zo’n fonds dan problematisch

economie.

wordt als de activa sterk in waarde dalen. Dit is relevant voor de regulering want het betekent

Pensioenfondsen in Nederland zijn daarmee nog niet

dat instellingen die dezelfde naam hebben, een

meteen deel van het shadow banking systeem. Maar

geldmarkt fonds, verschillen tussen landen en dat

ze nemen wel een plek in het financiële systeem in

heeft invloed op de ideale regulering.

die in vergelijking tot het verleden minder veilig kan

“Als belegger kun je wel een risico aangaan dat je inmiddels niet of zelden terug kunt vinden in Westerse “De retailmarkten“ funding gap is dan ook een relatieve zwakte van het Nederlandse financiële systeem.“ worden. Daarboven zullen dit soort institutionele

zijn en voortdurend oplettend toezicht houden. Tot

beleggers uiteindelijk naar grote waarschijnlijkheid

slot moet niet alleen de individuele instelling worden

de kopers zijn van de eerder genoemde Coco’s. De

geobserveerd, maar vooral ook de naar de stabiliteit

tail risk van banken die eerst bij de belastingbetaler

van het stelsel als geheel.

lag ligt daarmee in de toekomst wellicht meer bij de pensioenfondsen, maar dat zijn uiteindelijk de

Uiteindelijk moet je niet die partijen straffen die

belastingbetalers “met een andere pet op”.

niet zorgen voor extra risico’s in het stelsel. Daarom hoeven niet noodzakelijk alle private equity

Brengen hedge-fondsen en andere private equity

fondsen individueel gereguleerd te worden. Echter,

fondsen systeemrisico met zich mee?

misschien zijn er systeemrelevante fondsen waarbij

Het is in te denken dat individuele fondsen systeem

dat wel noodzakelijk is. Dan zou je ze dus binnen de

risico met zich mee zouden kunnen brengen. Het

regulering kunnen trekken bij systeemrelevantie en

zijn instellingen die deel kunnen zijn van het shadow

in de VS is dat nu mogelijk met de Dodd-Frank bill.

banking systeem. Maar zelfs als ze dat niet waren, is het van belang dat de systeem relevantie van dit soort instellingen in de gaten wordt gehouden. Hedge fondsen zijn een niet te verwaarlozen onderdeel van het financieel systeem. Hun aandeel is niet alleen negatief voor de stabiliteit van het stelsel. Ze spelen vaak ook een stabiliserende rol. Dit zijn de soort partijen die koersrisico’s durven te nemen die andere partijen niet aandurven. Kijk naar de Europese schulden crisis. De meeste institutionele partijen zijn niet de partijen die blijven vasthouden aan Grieks schuldpapier. Diversiteit is belangrijk voor de stabiliteit. Verschillende partijen in het stelsel zorgen voor verschillende exposure en verschillend gedrag. Private equity fondsen zijn een ander voorbeeld waarom het uitermate belangrijk dat grondig wordt geanalyseerd wat voor een soort gedrag wordt uitgelokt met voorgestelde regulering. Bovendien moeten we ons niet vastpinnen op definities, flexibel


13

how to control risk creation in the financial sector Enrico Perotti

Enrico Perotti holds a PhD from MIT and is Professor of International Finance at the University of Amsterdam where he holds the Chair of the Finance Group. His research interests include: Corporate governance and intermediation; political

Enrico Perotti

economy of finance; innovation theory; privatization; leadership and strategic investment timing. Prof Perotti is Director of Research at Duisenberg school of

Professor of International Finance at the

finance as well as Programme Director for the MSc in Corporate Finance and Banking. He is also an

University of Amsterdam

advisor on MacroPrudential Policy at the Dutch National Bank and the Bank of England.

Two major scientific challenges have arisen for

funding. There are serious risk that these ratios will

controlling credit risk accumulation and its possible

economists since the crisis. The first is how to

not be adopted, or seriously weakened, leaving the

consequences. Assessing risk creation in a timely

manage better systemic crises in developed markets,

system at the mercy of future liquidity runs.

fashion is necessary to enable timely prudential

which had been believed to be above such fragility.

action, such as increasing preventive risk charges to

The second, and more complex question, is to avoid

This article reviews ideas related to crisis prevention

excess risk creation, so as to avoid major crises

by the introduction of regulatory charges.

altogether.

14

deflate the accumulation of excess risk taking. Systemic risk is defined commonly as the risk of

Using charges to contain the creation of systemic

financial shocks undermining the functioning of

Regulatory tools

risk

the financial system (payment, intermediation) and

The most basic tools of regulation are quantity limits

In the popular press, risk charges on financial

leading to disruptive consequences for the economy.

or charges. Quantity limits can include outright

intermediaries have been associated to the idea of

This clearly defines the task: SR indicators should

prohibition of certain activities, such as the Volcker

a special bank tax on unstable funding, introduced

have some predictive power on the chance and extent

proposal to eliminate proprietary trading for retail

already in 10 EU countries and narrowly defeated

of general disruption. Second, they should not just

banks, or the prohibition of holding naked derivative

in the US congress last year. These taxes are not

measure potential losses within the financial sector.

positions without an economic need to hedge the

harmonized, and a task force at the EU is considering

When financial intermediaries fail to absorb them, the

underlying risk.

a general framework.

risk is shifted elsewhere, producing spillover effects

More generally, quantity limits include minimum

After the crisis there has been a general call for

essence of systemic risk, and distinguishes it from

capital requirements for banks and insurers, to

greater taxation of the financial sector, mostly to

aggregate risk, namely the risk of correlated shocks

ensure financial intermediaries have enough reserves

recoup some of the fiscal costs of the measures taken

to asset prices which should be in principle smoothed

to absorb asset losses. This approach follows the logic

to contain the crisis.

by financial intermediation and risk management.

distorted by inadequate regulatory attention to

When the G20 asked last year the IMF to consider

There is broad consensus that spillover effects,

financial innovation.

alternative choices, the Fund’s advice was to avoid

across financial intermediaries and into the general

on the economy. This propagation externality is the

of the previous Basel II approach, which was widely

taxing financial transactions, as trading can easily

economy, are a negative externality, since they reflect

Minimum ratios have also been proposed in Basel

move abroad, and to focus on balance sheet taxes.

costs shifted to third parties, just as pollution. This

III to close the gap on the regulation of liquidity risk,

Echoing the views of top economists, the IMF

calls for regulatory remedies, either in the form of

which was a massive gap in Basel II. The last crisis

also adviced to design bank taxation not (just) to

constraining rules limiting choices, or taxes and

was originated by credit losses, but became massive

punish past behavior, but to discourage future risk

levies on risky activities. We focus here on the notion

by propagation via unstable funding. The new Basel

accumulation. So the bank tax should be preventive

of systemic risk taxation, aimed at penalizing choices

proposals, opposed very vigorously by the industry,

and not punitive.

creating risk externalities.

limits to unstable short term funding (essentially,

Measuring systemic risk

Current academic analysis

uninsured wholesale funding) which is used by

Measuring systemic risk is a critical step in the

A few early attempts at SR measurement, the

banks to expand credit faster than stable deposit

determination of a macro prudential policy aimed at

basis for a SR tax, have been proposed. A first

would create minimum buffers of liquid assets, and

classification can distinguish between price and

in a systemic crisis the financial system cannot

The key idea is to discourage bank funding choices

exposure measures (for instance, the fraction of

absorb some major shock. Given the essential role

which create “propagation risk”. These include

unstable funding in bank liabilities). In the first

of financial confidence to sustaining the payment

excessive bank size and unstable funding, namely

category belong the CoVar methodology proposed

system, saving and investment, this forces public

short term wholesale funding, which is uninsured

by Adria Brunnermeier (2009) and the Expected

intervention, for instance by deposit insurance funds

and thus quick to escape risk. The recent crisis

Shortfall suggested by Acharya et al (2010). These

or by public guarantees. The result is that losses end

started with a US housing bubble, but became

measures are based on market prices, in particular

up being socialized. But since private intermediaries

globally devastating because a general credit boom

bank share prices or credit risk derivatives. Novel

do not bear these losses, private securities will not

had been built on unstable funding, not on deposit

work has also focused on risk measures targeting

reflect adequately the underlying risk. For instance,

savings. Lenders expanded their balance sheet

capital requirements for individual intermediaries,

ban share prices may not reflect risky choices if

rapidly by attracting very short term wholesale

as proposed by Flannery (2007), Hart and

shareholders stand to gain from gains while deposit

funding, drawing from abundant international

Zingales (2010) and Flannery and Perotti (2011).

insurance stand to bear the losses. Losses may not be

liquidity. This capital asked no questions on bank

The second category includes proposals to target

absorbed by financial sector when they are too large

credit quality because it was designed to escape

risk exposures with aggregate consequences, such

for the risk absorption capacity. This will occur either

rapidly. Easy to obtain because investors did not

as credit growth (Borio 2009), refinancing risk

when the affected asset class is too large for capita

need to assess the risk taken by the borrowing

exposure (Perotti Suarez 2009, 2010; Shin, 2010),

buffers, or when prices are too correlated because

bank, this type of very short term capital abetted

and contingent liquidity risk (Perotti 2010). My

of unstable funding forces disruptive sales. This

disastrous choices. Just before its default, Lehman

view is that relying on exposures is much better

novel notion leads to the endogenous correlation by

Brothers’ funding maturity was almost entirely

than relying on market prices.

general exposure to unstable funding (Perotti and

made up of repo, or overnight credit. To maximize

Suarez, 2009; Shin, 2010). Massive liquidity risk

its profits, banks were holding massive amount of

Measures based on asset prices allow more

was indeed the core of shock propagation in the last

mortgage debt, up to thirty year maturity, funding

sophisticated econometric measurements, thanks

crisis. This can explain the vastly different impact

it with twelve hours money.

to abundant data. However, to the extent that the

on the economy of the internet bubble. The 2001

critical measure need to reflect risk correlation

shock led to losses ten times as large as subprime,

So when this funding escaped en mass, it forced

conditional on a shock, the relevant time series may

yet as it was funded with equity held by households,

massive asset sales and price crashes, until central

be fewer.

losses could not ne shifted and be propagated across

banks rushed to plug the hole with super cheap

the economy.

emergency credit. A short term maturity of funding

One first objection is that market prices may be

minimize its cost (as well as market discipline on

imprecise or even distorted risk measures, because

Unstable funding in the crisis

bank lending). Short term funding thus lead to very

of irrationality, leading to cyclical over and under

It is important that the public understands what is

poor credit choices as it allows for trivially simple

confidence.

at stake, as so far the open debate has been rather

bank profits at cost of creating massive liquidity

shallow. While the top priority remains to increase

risk for the system as a whole.. The worse losses at

A distinct view is that even in the case of rational

bank capital, a well designed bank tax must target

ABN AMRO, Fortis, Royal Bank of Scotland and

market investors, this approach is flawed by the

unstable debt funding, an issue not so complex to

ING came from massive trading positions built on

very nature of systemic risk. Almost by definition,

be above public scrutiny.

unstable funding, and the Dutch, Belgian and UK

15

16

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“Systemic risk is defined commonly as the risk of financial shocks undermining the functioning of the financial system (payment, intermediation) and leading to disruptive consequences for the economy.” taxpayers will keep paying for years the resulting

which would remain in the hand of national

costs. The excess credit growth at DSB was also

central banks.

built on massive use of this veritable financial steroid. Most critically, some incentive for stable funding Unstable cheap funding is a classic negative

is sorely needed at present to enable a stable exit

externality, where private cost saving comes at the

strategy from massive central bank funding of banks,

cost of a public risk, just as pollution. The classic

which will otherwise fuel high inflation. The task

economic solution is to tax risk pollution via liquidity

should pass to private investors, but not on the

risk charges, as proposed by Javier Suarex and me in

hysterically short term basis of 2005-2007. Never

the Financial Times in early 2009. Since then, the

again should the entire economy be held hostage to

German and UK bank tax have targeted uninsured

bank recklessness.

bank liabilities, excluding insured deposits. For stable funding (with maturity longer than one year) the tax rate is either half, or zero. There has been no exodus of banks. Conclusion To summarize, an intelligently designed bank tax offers some opportunities. First, it is needed for a general shift to stable funding, because no intermediary will move alone, as the gain will be in general stability but will raise its funding costs. Second, wholesale short term credit pays no deposit insurance fees, yet it is able to force a bail out when it runs. Surely, this massive loophole is to be plugged, forcing them to think twice about building massive risky bets. Third, bank risk levies may become a primary tool for macroprudential policy, to slow down excess credit growth without raising interest rates for everyone. The European Systemic Risk Board may play an useful role by coordinating them,


17

shadow banking – reforms pending in congress would not touch the abuses of hedge funds and private equity Nomi Prins

Nomi Prins is a journalist and Senior Fellow at Demos. Her latest book is: It Takes a Pillage: Behind the Bonuses, Bailouts, and Backroom Deals from Washington to Wall Street (Wiley, September, 2009). She is the author of Other People’s Money: The Corporate Mugging of America (The New Press, October 2004), a devastating exposé into corporate corruption, political collusion and Wall Street deception. Other People’s Money was chosen as a Best Book of 2004 by The Economist, Barron’s and The Library

Nomi Prins

Journal. Her book Jacked: How “Conservatives” are Picking your Pocket (whether you voted for them or not) (Polipoint Press, Sept. 2006) catalogs her travels around the USA; talking to people about their

Journalist and Senior Fellow at Demos

economic lives.

This article is a republication of The American

Before becoming a journalist, Nomi worked on Wall Street as a managing director at Goldman Sachs,

Prospect, May 4, 2010.

and running the international analytics group at Bear Stearns in London.

Despite all the noise about financial reform,

Exchange Commission as investment advisers. But

necessitate use of a resolution fund -- into which

the shadow banking system that helped create

private-equity and venture-capital funds would not.

shadow bankers have made no payment. They pile

the financial crisis would remain fundamentally

Dodd’s bill leaves it up to the SEC to construct a

on the risk but don’t pay for the fallout.

unaltered by the legislation now pending in

definition for private-equity and venture-capital

Congress. Indeed, leveraged entities such as private-

funds as differentiated from hedge funds. (There’s

The Volcker Rule Minus Teeth.

equity, venture-capital, and hedge funds get only

no standardized definition of hedge fund yet.) Cue

The latest Senate bill ostensibly adopts the so-called

minor regulatory attention.

industry lawyers.

Volcker Rule restrictions prohibiting depository

These barely regulated, nontransparent bastions

Loophole No. 1: Private-equity funds are financial-

sponsoring or investing in a hedge or private-equity

of speculation propagated systemic risks beyond

pyramid bottom-feeders; they buy distressed

fund (it makes no explicit mention of venture-capital

any that could be created by the banks themselves.

companies or assets, load them up with debt, extract

funds). A new Financial Stability Oversight Council

Whether housed at banks, created by banks, or

near-term profit, and are gone before any collapse

would decide how to implement and interpret this

freestanding, they exist to enable speculative risk-

occurs. And since private-equity funds can both

regulation. Additionally, the comptroller general is

taking hidden from either regulatory or market

invest in hedge funds and do anything a hedge fund

required to conduct a feasibility study regarding a

scrutiny while camouflaging layers of debt and

does (it’s all a matter of how they pitch what they

self--regulatory private-equity and venture-capital

enabling the complex-securitization deals that

do to their investors), hedge funds could just change

fund oversight and submit a report to the House

caused the financial collapse.

their name to avoid registration or information

Financial Services and Senate Banking committees

institutions and bank-holding companies from

18

sharing. Dodd’s bill would charge banks and any

within a year after enactment. Of course, a year

Yet, neither the House bill passed last December nor

non-bank financial company supervised by the Fed

gives lobbyists plenty of time to figure out ways to

the most recent Senate bill submitted by Sen. Chris

holding $50 billion or more in assets to pay into

circumvent any form of regulation.

Dodd does more than impose marginal adjustments

an “orderly liquidation fund.” But hedge, private-

on the shadow banking system. Even those measures

equity, and venture-capital funds wouldn’t have to

Loophole No. 3: Under the Senate bill, foreign-based

contain loopholes so inviting that JPMorgan Chase,

contribute.

firms that aren’t directly or indirectly controlled by

the largest hedge-fund manager by assets worldwide, scoffs at the notion it will be adversely affected. Leaving Shadow Banks Intact.

a firm organized under U.S. laws are exempted. Loophole No. 2: Neither the Senate nor the House

European banks could thus expand their private-

bill alters the way in which hedge and private-equity

equity and hedge-fund game on our soil, thereby

funds do business. They only minimally alter where

spreading globalized risk.

Under the most recent Senate bill, hedge funds

a fraction of the funds’ business can’t be done. A

managing more than $100 million worth of assets

collapse of all or part of the banking system due

Loophole No. 4: Though large banks like

would have to register with the Securities and

to hedge-fund or private-equity abuses would

JPMorgan Chase and Goldman Sachs run hedge

funds, the language in Dodd’s bill doesn’t prohibit

Bear Stearns’ infamous credit hedge funds were

a bank from managing the portfolio of a client

designed to leverage structured credit securities by

who chooses to invest in hedge funds. Since banks

as much as 35 to 1, enticing “hot money” investors

aren’t required to delineate or disclose exactly

who ultimately ran for the hills when they smelled

what’s proprietary and what’s client-oriented (a

potential losses, creating chaos in their wake. Current

major deficiency of the Volcker Rule itself ), there’s

proposals might prohibit banks from outright owning

nothing to keep them from calling nearly every

such funds (and only if they aren’t “client oriented”),

hedge-fund activity client--oriented, thereby

but they don’t constrain how the funds operate.

getting around this rule. Private-Equity

Firms

Weren’t

Innocent

Missing the Problem

Bystanders.

Hedge Funds. Despite lobbyist claims to the

Private-equity funds financed both mortgage-

contrary, the hedge-fund industry played a key role

lending and real-estate-development companies,

in the run-up to the banking crisis. It was an eager

both directly and by purchasing equity in

buyer and trader of the equity in toxic collateralized-

commercial CDOs. Now, they are picking up the

debt obligations (CDOs) and other complex high-

broken pieces of those endeavors by buying failed

risk securities while heavily leveraging the higher-

banks and lenders on the cheap (as hedge funds go

rated pieces of these securities. In other words, the

about buying cheap bank stocks in bulk).

industry provided the seed money to create these securities and a market for them while excessively

Major private-equity firms like Fortress and the

borrowing money from the banks creating them. By

Carlyle Group are busy raising capital to buy chunks

doing so, the industry inflated the perceived value

of more than $1 trillion of distressed commercial

and demand for these securities, as well as systemic

real-estate debt that lies underwater on the books

risk and leverage.

of banks, insurance companies, and other lenders. Much of that original debt had been securitized

Indeed, the hedge-fund industry tripled to an

in complex assets with high leverage, just like sub-

estimated $1.8 trillion business between 2002 and

prime loans were -- and could ignite another crisis

2008, just as the sub-prime loan and complex-

when defaults cumulate.

-securitization market was expanding. Not a coincidence.

Between 2002 and early 2008, roughly $1.4 trillion

19

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“As long as leveraged funds bolster these markets (whether inside or outside of banks), the true value of complex securities will be unknowable and subject to extreme cycles of bubble and collapse.” worth of sub-prime loans were originated by now-

size, should be required to register with the SEC

fallen lenders like New Century Financial. If such

and be subject to stringent reporting requirements

loans were our only problem, the theoretical solution

and limits on leverage.

would have involved the government subsidizing these mortgages for the maximum cost of $1.4

Private-equity firms should have to confer with

trillion. However, according to Thomson Reuters,

regulators and make public all steps of their actions

nearly $14 trillion worth of complex-securitized

when buying and operating failed banks whose

products were created, predominantly on top of

deposits are government-insured; otherwise we will

them, precisely because leveraged funds abetted

maintain this unbalanced situation where banks can’t

every step of their production and dispersion. Thus,

own private-equity funds, but private-equity funds

at the height of federal payouts in July 2009, the

can manage banks.

government had put up $17.5 trillion to support Wall Street’s pyramid Ponzi system, not $1.4 trillion.

Hedge funds should have restrictions on the

The destruction in the commercial lending market

percentage of securitized assets they can buy and

could spur the next implosion.

the percentage of federally backed banks or financial firms they can own. Hedge funds currently own 6

As long as leveraged funds bolster these markets

percent of Citigroup, for example; if they dump

(whether inside or outside of banks), the true value

their stock, the ripple effect could generate a need

of complex securities will be unknowable and subject

for more federal aid.

to extreme cycles of bubble and collapse. This time it was sub-prime; next time it could be commercial

Without addressing these structural issues, shining

real estate, oil, or food.

a high-beam of transparency, and dramatically restraining the leverage and risk that these funds

The Reforms We Need.

can take or enable, we are doomed to crash again.

Current reforms won’t deter the reckless financial engineering, investing, and inflation of values upon

-

which leveraged funds thrive. Right now, Wall Street funds are inhaling a host of new distressed security

Nomi Prins is a journalist and a senior fellow at

concoctions (a k a toxic assets part II) that scoop up

Demos. Her books include It Takes a Pillage: Behind

all the junk out there and regift it to the markets. This

the Bailouts, Bonuses, and Backroom Deals from

all operates under the radar screen.

Washington to Wall Street and Other People’s Money.

Thus it is imperative that banks with any form of leveraged fund, even if it belongs to a client, must provide detailed information to the SEC, no exceptions. Every hedge fund, private-equity firm, and venture-capital company, no matter what its


21

the shadow banking system, the credit meltdown, and basel III Ellen Brown

Ellen Brown is an attorney and the author of eleven books. In Web of Debt: The Shocking Truth About Our Money System and How We Can Break Free, she shows how the Federal Reserve and “the money trust” have usurped the power to create

Ellen Brown

money from the people themselves, and how we the people can get it back. Her

Attorney and Author

22

websites are webofdebt.com, ellenbrown.com, and publicbankinginstitute.org.

While local banks are held in check by the new banking

How the Shadow Banking System Evolved

spooked for some reason and all pull their money

regulators in Basel, Wall Street’s “shadow banking

Bank runs don’t generally occur in the traditional

out at once, the banks can no longer make loans,

system” has hardly been curbed at all; and it is here that

banking system anymore, because (a) depositors are

and credit freezes.

the 2008 credit crisis was actually precipitated. The

now protected by FDIC insurance, and (b) banks

banking system’s credit machine is systemically flawed

that run out of reserves can borrow from the Federal

In September 2008, investors were spooked when

and needs a radical overhaul.

Reserve, which is empowered to create money ex

the mortgage-backed securities backing their repo

nihilo (out of nothing). But FDIC insurance

“deposits” proved not to be “triple A” as represented.

In September 2010, the Bank for International

covers only $250,000 in deposits, and there is a

They pulled their money out all at once, drying up

Settlements issued heightened capital requirements

massive and growing demand for banking by large

the pool where banks go to get cheap liquidity for

that will make lending even more difficult for local

institutional investors – pension funds, mutual funds,

their loans. The LIBOR rate – the primary rate that

banks, which do most of the consumer and small

hedge funds, sovereign wealth funds – which have

major banks charge each other for loans of maturities

business lending today. The new rules are ostensibly

millions of dollars to park somewhere between

not greater than 1 year – shot up from under 3%

designed to prevent a repeat of the 2008 credit

investments. They want an investment that is secure,

to nearly 5%, too high to make lending profitable.

collapse, but they fail to address its real cause, which

that provides them with a little interest, and that

Credit then froze, precipitating the banking crisis

involves a “shadow” banking system that has largely

is liquid like a traditional deposit account, allowing

that followed.

escaped regulation.

quick withdrawal. Basel III: Why It Misses the Mark

What went wrong in September 2008 was not that

The shadow banking system evolved in response

The new banking regulations called Basel III

the existing Basel II capital requirements were too

to this need, operating largely through the repo

were announced by the Basel Committee on

low. It was that banks found a way around the rules.

market. “Repos” are sales and repurchases of

Banking Supervision (BCBS), part of the Bank

The Basel II rules base a bank’s capital requirement

highly liquid collateral, typically Treasury debt

for International Settlements (BIS), “the central

on how risky its loan book is, and banks can make

or mortgage-backed securities. The collateral

bankers’ central bank” in Basel, Switzerland. Under

their books look less risky by buying unregulated

is bought by a “special purpose vehicle” (SPV ),

the new rules, the mandatory reserve known as Tier

“insurance contracts” known as credit default

which acts as the shadow bank. The investors

1 capital will be raised from 4 percent to 4.5 percent

swaps (CDS). This insurance, however, proved

put their money in the SPV and keep the

by 2013 and will reach 6 percent in 2019. Banks

to be a fraud, when insurer AIG went bankrupt

securities, which substitute for FDIC insurance

will also be required to keep an emergency reserve

on September 15, 2008. The credit collapse that

in a traditional bank. (If the SPV fails to pay up,

of 2.5 percent.

followed has normally been blamed on the collapse

the investors can foreclose on the securities.) To

of the subprime housing market. But according to

satisfy the demand for liquidity, the repos are

The stock market shot up after the new rules were

Yale economist Gary Gorton (whose views were

one-day or short-term deals, continually rolled

announced, as Wall Street breathed a sigh of relief.

recently acknowledged by Fed Chairman Ben

over until the money is withdrawn. This money

The megabanks, propped up by generous taxpayer

Bernanke), the subprime problem was not itself

is used by the banks for other lending, investing

bailouts, would have no trouble meeting the new

sufficient to trigger a global credit freeze. What

or speculating. But that puts the banks in the

capital requirements, which were lower than

it did trigger was an old-fashioned bank run, in

perilous position of Jimmy Stewart in “It’s a

expected and would not be fully implemented until

the not-so-familiar market known as the shadow

Wonderful Life,” funding long-term loans with

2019. Only the local commercial banks, the ones

banking system.

short-term borrowings. When the investors get

already struggling to meet capital requirements,

would be seriously challenged by the new rules.

For smaller commercial banks and public sector

We are still trapped in that spiral today, despite

Unfortunately, these are the banks that make most

banks (government-owned banks popular in

massive “quantitative easing” (essentially money-

of the loans to local businesses, which do most of the

Europe), the credit-constraining effects of

printing) by the Federal Reserve. In an article

hiring and producing in the real economy.

Basel III are a serious problem. But larger

in The Financial Times titled “US Money Supply

banks, said Keller and Jordans, “were quick to

Plunges at 1930s Pace as Obama Eyes Fresh

The smaller local banks neither triggered the crisis

praise the agreement and insisted they would

Stimulus,” Ambrose Evans-Pritchard quoted

nor got the bailout money. Yet it is they that will

meet the required reserves in time.” The larger

Professor Tim Congdon from International

be affected by the new regulations, and that effect

banks were not worried, because “The largest

Monetary Research, who warned:

could cripple local lending. Concerns about the

U.S. banks are already in compliance with the

.

credit-tightening effects of Basel III were reported

higher capital standards demanded by Basel III,

money supply] has no precedent since the Great

in a September 13 Huffington Post article by Greg

meaning their customers won’t be directly affected.”

Depression. The dominant reason for this is that

Keller and Frank Jordans, who wrote:

Their customers, of course, are mainly large

regulators across the world are pressing banks

.

“Bankers and analysts said new global rules could

corporations. “Small businesses that rely on

to raise capital asset ratios and to shrink their

mean less money available to lend to businesses

borrowing from community banks,” on the other

risk assets. This is why the US is not recovering

and consumers. . . .

hand, “may be more affected . . . . They will try to

properly.”

“European savings banks warned that the new

make up for the higher capital requirements by

capital requirements could affect their lending

lending at higher rates and stiffer terms.”

.

by unfairly penalizing small, part-publicly owned .

.

Monetary Policies: An Appraisal”, the Bank If the big banks that brought you the current credit

for

“‘We see the danger that German banks’ ability

crisis can already meet the new requirements,

with Professor Congdon. The authors said,

to give credit could be significantly curtailed,’

what exactly does Basel III achieve, beyond

“The main exogenous [external] constraint

said Karl-Heinz Boos, head of the Association

shaking down their smaller competitors? As David

on the expansion of credit is minimum capital

of German Public Sector Banks.

Daven remarked in a September 13 article called

requirements.” (“Capital” means a bank’s own

“Insisting that French banks were ‘among

“Biggest Banks Already Qualify Under Basel III

assets minus its liabilities, as distinguished

those with the greatest capacity to adapt to the

Reforms”:

from its “reserves,” which apply to deposits and

new rules,’ the country’s banking federation

.

“Indeed, on the day Lehman Brothers collapsed,

can be borrowed from the Federal Reserve or

THEY would have been in compliance with the

from other banks.)

that will inevitably weigh on the financing of the

.

In a working paper called “Unconventional

institutions.

nevertheless said they were ‘a strong constraint

.

“The plunge in M3 [the largest measure of the

International

Settlements concurred

Basel III standards.”

economy, especially the volume and cost of credit.’

Meanwhile, 2-1/2 years after the 2008 bailout,

Toward a Better Solution

Juan Jose Toribio, former executive director

the economy continues to struggle with a lack of

Basel III will not fix the systemic weakness

at the IMF and now dean of IESE Business

credit, the hallmark of recessions and depressions.

in the shadow banking system. Arguably, the

School in Madrid, said the rules could hamper

Credit (or debt) is issued by banks and is the source

weakness cannot be fixed under the current scheme

the fragile recovery.

of virtually all money today. When credit is not

of private banking and credit. As noted in an article

“‘These are regulations and burdens on bank

available, there is insufficient money to buy goods

on Seeking Alpha by The Business Insider:

results that only make sense in times of monetary

or pay salaries, so workers get laid off and businesses

.

and credit expansion,’ he said.”

shut down, in a vicious spiral of debt and depression.

“Our financial system remains vulnerable to another credit crunch, with many of the same

23

FSA CONGRES 2011 THURSDAY 28 APRIL CONCERTGEBOUW AMSTERDAM

F I NANC I ËLE S T U D I EV ERENI GI N NG G Amsterdam

FINANCI ËLE ST U DI EV ERENI GI N NG G Amsterdam

Jan Kees de Jager

Shifting Financial Powers

Shadow Banking: relevance, risk, regulation

Minister of Finance

Ad Scheepbouwer CEO KPN

Doug Shaw

COO EMEA BlackRock

Lex Hoogduin

Executive Director DNB

Jan de Ruiter

Country Executive RBS

Florencio Lopez-de-Silanes

Professor in Finance and Law EDHEC Business School and DSF

Wim Boonstra

Chief Economist Rabobank Nederland

Yasushi Shiina

Member of the Secretariat FSB

Angelique Pieterse

Sr Investment Manager at PGGM Investments

Herman Mulder World Connectors

Dirk Schoenmaker

Dean of Duisenberg school of ﬁnance

Klaas Knot

r Onde ers em er n l e e de d en scoot te word erloot! v

Director Financial Markets Ministry of Finance

Dirk Meerburg

Partner De Brauw Blackstone Westbroek

Sweder van Wijnbergen Professor in Economics, UvA

Jan Maarten Slagter Chairman VEB

Enrico Perotti

Department Head, Finance Group, University of Amsterdam

“Only a complete overhaul of the banking system can eliminate these systemic flaws, flaws that ultimately stem from a misconception about what money is.” exact features as the last. All it needs is someone

credit and scramble to cover it with short-term loans,

Dakota escape the credit crisis that crippled other

to strike the match of panic.”

exposing them to the systemic risk of sudden and

states. In 2009, when other states were floundering,

unpredictable withdrawals.

North Dakota had the largest budget surplus it had

The question is how to eliminate this systemic risk: .

ever had.

“Regulate shadow banking more tightly, and

That is the old model, but today money and credit

you probably have to also provide government

are something else. No gold or other commodity

We need to set up some banks that serve the needs

backstops. Shudder. Try to shut the thing down

backs our money today. Nothing backs the U.S.

of the real economy rather than those of Wall Street

or restrict it and you suck credit out of the

dollar but “the full faith and credit of the United

bankers, brokers and their super-rich clients for yet

system, credit which much of the non-financial

States.” Money and credit are creatures merely of

more bonuses, bailouts and paper profits. State-

‘real’ economy uses and needs.”

legal agreement, a tally of accounts keeping track

owned banks could fill the role the Wall Street

of who owes what to whom. Two or more parties

banks have declined to fill, providing an effective

The real economy needs credit, and choking it off by

can enter into a legal agreement without having

credit engine for state and local economies.

over-regulating the banks will kill the real economy.

any money at all. They can advance credit against

Indeed, according to Gary Gorton, the shadow

goods or services and engage in productive trade.

banking system evolved because banks were already

The tribute exacted by a private banking monopoly

so over-regulated that they could not turn a profit.

actually hampers this productive flow.

He writes: .

“Holding loans on the balance sheets of banks

The “full faith and credit of the United States” could

is not profitable. . . . This is why the parallel or

and should be overseen by a branch of the U.S.

shadow banking system developed. If an industry

government, just as legal agreements are overseen by

is not profitable, the owners exit the industry by

the judiciary. Publicly-owned banks could issue the

not investing; they invest elsewhere. Regulators

full faith and credit of the nation without worrying

can make banks do things, like hold more

about capital or reserves. After all, if you are the

capital, but they cannot prevent exit if banking

nation, why do you need “reserves” of your own

is not profitable. ‘Exit’ means that the regulated

credit?

banking sector shrinks, as bank equity holders refuse to invest more equity.”

While we’re waiting for change at the national level -- something that could take a while -- we

Only a complete overhaul of the banking system can

might consider setting up some state-owned banks.

eliminate these systemic flaws, flaws that ultimately

The Bank of North Dakota (BND), currently the

stem from a misconception about what money is. We

only U.S. state-owned bank, is very stable and

think of money as a “thing,” something that must be

very profitable, with an average return on equity

dug out of the ground or borrowed from someone

of 25-26%, most of which is rebated to the state

who already has it. Since banks don’t have enough

treasury. The BND does not compete with local

of this thing to cover their loans and investments,

banks but partners with them, participating in loans

they engage in a shell game in which they advance

and guaranteeing them. The BND helped North


25

shadows of the Past: atlas shrugged?! Herman Mulder

Independent ESEG Advisor & Board Member Former Director-General, lastly Head Group Risk Management & Sustainability ABN AMRO Bank. Initiator of the Equator Principles. Knight in the Royal Order of Oranje Nassau. Since mid 2006 self-employed and independent Advisor and Board Member in the areas of Sustainable Business and Development Finance (inter alia) Worldconnectors, GRI, NCDO, NCP/OECD-NL, Global Compact, TEEB (Bonn/London), Tomorrow’s Company (London), BiD Network, UTZ Certified, CBI (Boston). Member jury FT/IFC Sustainable Bank of the Year Award.

We need to tack

is in sailing to keep the ultimately right course, is

Prudent risk & opportunity management is

always challenging and a bit chaotic, particularly if

conditioned upon taking informed decisions about

your crew is inexperienced and you are entering in

alternative investment and/or lending options in

uncharted waters as we are now doing.

very dynamic contexts ,with more “unknowns”

26

(and “ought to knowns”) than “knowns”. It is very

In general, strong institutions are typically more

much a balancing act, taking into account your own

capable and ambitious than weaker ones, which

resources and strengths, and the risks, opportunities

are more risk-averse. Unfortunately, (almost) the

and rewards at stake.

whole banking sector is currently clearly in the second category: strategic reorientation, operational

We are living in an era of transformation (“the Big

streamlining,

recapitalization,

redefining

its

Tack”) with major geo-political and societal shifts,

sustainable business model, all are high priorities

with new interdependencies, with us (notably the

exacerbated by political and societal pressures

elites) living beyond our means and the planetary

following the recent financial and economic crises.

boundaries (i.e. unsustainable resource depletion, ecosystem degradation, biodiversity loss), with social,

As a result hereof regulatory and supervisory micro-

cultural and religious “discontent” , with intensified

prudential requirements are tightened to prevent the

information networks able to initiate instant, major

recent systemic crisis to occur again. Basel III and

changes (ref. Egypt). These all require urgent,

Solvency 2 are in advanced development stages, and

effective responses which governments are unable

2011 will be the year that “shadow banking”, as it

to provide by themselves, hence requiring society to

evolved in the last 6-7 years (becoming larger in size

act collectively, including the business and financial

than the regulated banking sector) and significantly

sectors. Business cannot thrive in failed societies or

contributing to the meltdown, will be addressed, and

economies.

rightfully so.

It has become an imperative to redefine the essence

Although every crisis requires its own solutions to

of the economy itself , recognizing the cost of, and

prevent it to re-occur, but is also providing seeds

returns on natural capital and social/human capital

for the next one (which inevitably will come). The

to be considered as key drivers next to financial

history of crises is showing this phenomenon. In

capital. WE must recognize that the markets are

my article in Fiducie “ There is no alternative…

not perfect, full of asymmetries, and the price is not

.”(November 2010) I did some “imagineering”

always right. Change or “tacking” as essential as it

myself in this context: beware of Monday 12

October 2015: Malthus (planetary boundaries),

But are they able, do they have the ambition to create

Marx (state in hands of the elites), with a wrap of

a green, inclusive and responsible economy? And if

Murphy; the “pricing power” is moving “south”, to

would be, will its regulators and supervisors allow it

the beginning of our supply chains.

to play the catalytic role to be an agent for “positive systemic change”? The signs on the wall are not

We are all supervisors

hopeful: neither the ambition, nor the facilitating

The risk for any risk manager, which includes

environment seem to be in place.

regulators and supervisors, is to become too micro-prudentially oriented, even to the extent

It has always been my view that the order (and

that it believes it may effectively sit on the seat

implicit hierarchy) of the Basel Accord was wrong:

of the clients-facing business-colleagues whose

it starts with minimum risk capital requirements

responsibility is “oiling the wheels” for the P&L of

(Pillar 1), then supervisory review (Pillar 2), followed

itself, its clients, the economy-at-large. Excessive

by market discipline (Pillar 3). In my view, Pillar 3

micro-prudential risk-regulation/oversight

and

was always the more critical after self-discipline in

“marked to market” accounting rules, are posing a

Pillar 1: the challenge must come from society-

significant macro-prudential risk and even a moral

at-large , which includes shareholders and all

hazard. What happened in the period of the last

other stakeholders such as clients, counterparties,

10 years during which we discussed Basel II is

academics, rating agencies, NGO’s.

precisely that, causing the eventual implosion of the unregulated part of financial markets: off-loading

But markets, stakeholders must all rely on

the bank’s capital/balance-sheet and regulatory

frequent, material, correct disclosure of financial

arbitrage became key drivers for doing business.

and (GRI-type) non-financial performance , risks, opportunities, dependencies, impacts. It also fits the

Is there a déjà vu?! In an era that economic

imperative of more public accountability, beyond

revitalization in the real economy is key (and

shareholders. Emphasizing the importance of

definitely green and inclusive!), and lower income

(advanced) public disclosure , allowing the markets

and unemployment are affecting social cohesion,

to engage and challenge, will then become an

banks should be even more able to play a key role

important additional instrument for supervisors to

therein; it is part of their license to operate, and

perform their regulatory role. It reduces the risk for

crucially important for regaining trust (its core

supervisors of being “Atlas shrugged”. Advanced

capital factor) of its stakeholders.

disclosure would also enable sector- resp. system-

27

Towers Watson. Een helder perspectief voor concrete oplossingen.

Towers Perrin en Watson Wyatt zijn nu samen Towers Watson. Een wereldwijde onderneming met een eenduidige focus op klanten en hun succes. U kunt vertrouwen op 14.000 ervaren professionals die over zowel lokale als internationale expertise beschikken. Onze aanpak is gebaseerd op samenwerking en betrouwbare analyses. Wij bieden een helder perspectief dat uw specifieke situatie koppelt aan het grotere geheel. Zo leiden wij u naar betere bedrijfsresultaten. Towers Watson. Duidelijk resultaat.

towerswatson.nl

Benefits | Risk and Financial Services | Talent and Rewards ©2010 Towers Watson. Alle rechten voorbehouden.

“In my view, Pillar 3 was always the more critical after self-discipline in Pillar 1: the challenge must come from society-at-large , which includes shareholders and all other stakeholders such as clients, counterparties, academics, rating agencies, NGO’s.” analyses by expert-observers to address macroprudential risks. Good, long shadows in the morning (after the night before) “Shadow banking” during recent years has made non-regulatory financial services a pariah. And the way it developed must clearly be reined in. But not all non-regulated financial services are a health-risk; on the contrary, they are an essential contributor to create a healthy and sustainable real (!) economy and society. They are a source of innovation, dynamics , inspiration for the banking system to do better. They will serve to make “markets” better fit for such purpose. Prudent risk managing is a balancing act between risking too much and risking too little: doing the latter is becoming a real danger. Informed decisiontaking is key to reduce risk. All stakeholders have duty to provide input. The financial services sector, whether regulated or unregulated, whether real or “shadow”, is too important to leave it to the regulator and the supervisor. The unfortunate shadows of the past should not become the shadows of the future. Herman Mulder , Amsterdam 12 March 2011 For reactions, please mail to [email protected]

29

duisenberg school of ﬁnance - ask an expert shadow banking: unregulated and unknown Dirk Schoenmaker

Dean of the Duisenberg school of finance. He is an expert in the areas of central banking, financial supervision and stability, and European financial integration. Before his appointment at the Duisenberg school in 2009, he served at the Ministry of Finance and the Ministry of Economic Affairs in the Netherlands. Dirk Schoenmaker was a member of the European Banking Committee as well as the Financial Services Committee of the European Union. In the 1990s, he served at the Bank of England and was a Visiting Scholar at the International Monetary Fund. Dirk Schoenmaker is a professor of Finance, Banking and Insurance at the VU University Amsterdam since 2004. He studied business economics and law at Erasmus University Rotterdam and earned his PhD in economics at the London School of Economics. He received the Barclays Global Investors Award for best paper at the European Finance Association Meetings in 2001. Dirk Schoenmaker has published widely in his area of expertise and is co-author of the textbook ‘European Financial Markets and Institutions’ published by Cambridge University Press.

30

The vast amounts of credit supplied by the shadow

an interdisciplinary approach when studying the

banking system contributed to the global financial

financial system at the Duisenberg school of finance.

crisis. While authorities were monitoring the

In this case, we apply the “law of communicating

credit supplied by the official banking system,

vessels” from physics. If you fill one vessel with water

the “invisible” shadow banks financed largely the

and keep the other empty, pressure will be building

housing and equity market bubble. The current

up and the water will drip to the other vessel until

reregulation of banks may again lead to a resurgence

the two vessels are levelled. A popular interpretation

of shadow banking.

is the figure below. If regulators squeeze the banking system, shadow banking will emerge. It is basically a

What is shadow banking? By “shadow banking”,

cat (regulators) and mice (industry) game, in which

we refer to credit intermediation and maturity

the mice seem to be moving fast and ahead of the

transformation that takes place outside of the banks

game.

that have access to central bank liquidity and whose deposits are guaranteed. Examples of shadow banks

Figure: Regulatory squeeze on banking

are mutual funds, special purpose vehicles and credit hedge funds. These shadow banks also supply credit, but are not officially regulated as banks. That is why they are called shadow banks. Why is it unregulated? Financial innovation is constantly changing the financial landscape. Regulatory and tax arbitrage are main drivers of

Why is it unknown? Shadow banks are doing

this process of financial innovation. So when the

their business in the “shadow” of the official banks.

official banks are suffering from new cumbersome

Shadow banks, such as hedge funds, are happy to

rules, the financial industry will look for new ways

keep a low profile and thus to escape regulatory

to do their business in unregulated vehicles, the

scrutiny. After the crisis, hedge funds and private

shadow banks. To understand this process, we take

equity are getting a light touch of regulation. It is

not difficult to predict that if and when regulators

Rather than focusing on individual banks or

further tighten the regulatory screws on hedge funds

insurance companies from a micro perspective, we

and private equity, business will move on to a new,

take a macro perspective and look at the financial

yet unknown, financial vehicle. That shadow banks

system as a whole. In this so-called macro prudential

are relatively unknown is part of our culture. We

approach, we develop new tools to monitor and, if

all focus on things that are visible and well known.

needed, to stop the development of asset price

So regulators are primarily looking at banks and

bubbles in an early stage. If you want to learn more

insurers. Also academics have a bias towards research

about this, I can recommend you to attend the FSA

on banks. They have developed various models to

Congress ‘Shifting Financial Powers - Shadow

explain the behaviour of banks. Insurance is already

Banking: Relevance, Regulation and Risk’ at 28 April

less popular.

2011 and to visit the Duisenberg school of finance.

Similarly, when you as a student are studying finance,

Prof Dirk Schoenmaker

banks have a prominent place in your textbooks. It

Dean Duisenberg school of finance

is explained that banks are really important as they can create money. An advanced textbook will also explain the whole process of monetary policy and


31

duIsenberg school of

the working of central banks. To square the circle,

f Inance stands for

the textbook explains that only (commercial) banks

toP educatI on and

have access to the liquidity of the central bank. In practice, it works differently. At the height of

research In fI nance and

the crisis, the investment banks, who were lightly

law. a PremIer PrI vate

regulated and had no official access to the Federal

f Inance school located

Reserve, got liquidity when needed. The investment banks subsequently applied for a banking licence

I n amsterdam wIth

at the Fed. So we have all been fooling ourselves

world-claSS faculty and

by focusing on (commercial) banks, while a lot of

d Irec t lI nks to I ndustry

unregulated business was going on contributing to the build up of the credit financed housing and

leaders I n the world of

equity market bubble.

f Inance.

What to do about it? In the research and teaching programmes at the Duisenberg school of finance, we take a system approach to financial regulation.

for more InformatI on, go to www.dsf.nl.

www.werkenbijpwc.nl

Of heb jij een beter idee om alle facetten van de financiële wereld te ontdekken? Financial Traineeship

Informatiemiddag 19 april 2011 Judith Verschoor 088 792 53 79 [email protected]

Sta je op het punt een financiële master af te ronden, dan ligt de wereld aan je voeten. Het bedrijfsleven staat te springen om talent met een financieel fundament. Wil je meer weten over dit tweejarig coachings- en opleidingstraject, neem dan contact op met Judith. Of meld je aan voor de informatiemiddag op 19 april via www.werkenbijpwc.nl/financialtraineeship

© 2011 PricewaterhouseCoopers B.V. (KvK 3412089) Alle rechten voorbehouden.

SHIFTING FINANCIAL POWERS SHADOW BANKING: RELEVANCE, REGULATION AND RISK

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