1. Hsien-hsing Liao Department of Finance National Taiwan University
Risk Management of Financial Institutions after the Financial Tsunami---Current Reactions
Hsien-hsing Liao
Department of Finance
National Taiwan University

2. Contents The financial failure 2007-? Basel III
Some points from “NYU Stern Working Group on Financial Reform”

3. Understanding financial failure (G20, June 2010, Toronto )
Originate-to-distribute model: complex derivatives, but simple maturity mismatches
Leverage and deleveraging cycle (Minsky-moment)
Contagion cycle: financial  real  political
Contagion: liquidity  solvency
Amplifiers
Endogenous risk (behavioural)
Counterparty risks
Off-balance sheet, contingent lines - paradox of trust
Excess reliance on ‘wholesale’ finance

4. Broad principles underlying reform and regulatory change (G20, June 2010, Toronto )
Undercapitalized financial system
Limits of micro-prudential (individual) rationality in regulation, supervision
Limit size, complexity, in some cases interconnectivity of financial institutions.
Risk allocation
Ex-ante incentives (bail-in) vs. ex-post (bail-out, levy, taxes)
Continuous markets (risk pricing, market clearing, basic transformation functions – ‘market-maker of last resort’)

5. Summary: status of core issues
High conceptual clarity
High/reasonable prospect (with modifications)
High level consensus
Capital adequacy; capital standards ; trading book changes; leverage ratios; liquidity ratios; countercyclical buffers
Reasonable conceptual clarity
Reasonable prospect (in some jurisdictions more than others)
Some consensus
Charges on SIFI; other macro-prudential systemic risk measures – FAT, FSC (IMF); Financial Crisis Responsibility (FCR) fee (Obama-TARP levy 0.15% of LFI liabilities); market stabilization fund (Germany, US); bonus/payroll taxes (UK, France)
Resolution plans –living wills;
Volcker-rule
Basic concept, low clarity
Uncertain prospects
No consensus
Cross-border resolution regime- its link with national measures (punitive charges, stability funds); bank-tax/levy; FTT/CTT

6. Basel III
The Basel Committee on Banking Supervision reached board “Basel III” agreement on 12 Sep. 2010
“Basel III” tightens the definition of regulatory capital;
increases the min. requirement of Tier 1 Capital;
establishes conservation / countercyclical capital buffers;
introduces a leverage ratio;
a new liquidity coverage ratio and a net stable funding ratio
To be phased-in between 1 Jan and 1 Jan. 2019

7. Basel III Proposed Capital Reforms
Quality, consistency & transparency of the capital base.
Enhance risk coverage.
Introduce a leverage ratio.
Deal with Pro-cyclicality.
Address systemic risk & interconnectedness.

8. NYU Stern Working Group on Financial Reform
Financial Architecture
If the financial system continues to be dominated by institutions with high levels of systemic risk:
The creation of a new systemic risk regulator is necessary
This new regulator would supervise the growing cohort of financial conglomerates
institutions are encouraged to follow more specialized business strategies.

9. Systematic Risk Measuring Systemic Risk Managing Systemic Risk
Taxing Too-Big-to-Fail Institutions
Capital and Liquidity Requirements
Is Breaking Up the Big Financial Companies a Good Idea? Size or activities
Contingent Capital
Financial Institutions Subject to the Bankruptcy Code

10. Markets and Institutions
Securtization reforms
Securitization created serious systemic problems that played a major role in the financial crisis.
Transparency
More Regulations vs. Cost Efficiency
Credit Agencies
central players in the subprime residential mortgage crisis