Register, Issue, Cap and Trade: a proposal for ending current and future financial crises Alistair Milne Loughborough University LSE Financial Regulation Seminar, Oct 1 st, 2012

Economics eJournal Published article But only in draft form –Any comments today can be incorporated Please read and comment online ! ejournal.org/economics/discussionpapers/

Summary of the proposal Register of short term liabilities –across the financial system, not just banks A cap on total volume Issue of corresponding tradable licences, with penalty for registered liabilities that do not have matching license Institutions trade licenses, so they are held where gains from short funding are largest Closely related to proposals of Jeremy Stein/ Anil Kashyap and Javier Suarez/ Enrico Perotti

Background/ motivation Liquidity risk central to the financial crisis Policy response –Liquidity Coverage Ratio (LCR) Enough high quality liquidity assets to cope with a one- month stressed runoff Binding by January 2015 Major impact on business models –Net Stable Funding Requirement (NCFR) Enough stable (long term) funding to cover long term assets Minimum standard by January 2018 Major regulatory changes –Much more fundamental than higher capital

Why liquidity regulation? In order to control a (systemic) risk externality –“Firesales” In particular to allow orderly resolution –limit credit booms and asset price instability Stein (2010), Kashyap and Stein (2011) –Formal model of firesales and maturity mismatch Alternative view (Gorton) –maturity mismatch good –Not enough “informationally insensitive assets

How? Quantity controls on individual institutions –Proving highly controversial Major impact on business models Affects some banks much more than others –Fierce ongoing battle over LCR Tax on liquidity eg on maturity mismatch –Limited tax already in place –But what level of tax is appropriate? If we can determine acceptable degree of maturity mismatch –Then “cap and trade” is sensible approach MUST extend to shadow banking

More detail A central register of financial assets and liabilities, updated in real time. –Only registered liabilities legally enforceable Upper limit on short term liabilities of financial intermediaries. (t/365 weighting) –Increased gradually to target e.g. ratio of short term liabilities to GDP Licenses for this amount are distributed to financial institutions (e.g. based on usage) –In advance of each quarter auction of licenses. –Daily monitoring of usage, fines for excess.

Criticisms 1 Easily evaded –Not a system of credit control, credit financed with long term debt unaffected –Shadow banking included Better in this respect than LCFR –Also deals with unregistered maturity mismatch Offshore exposures not covered Yes this is possible, but only evades if assets are offshore as well, so limits credit boom/ externality

Criticism 2 Profound change of business model –End of pricing off LIBOR –Yes, but this is also true of LCR Will greatly reduced transmission of monetary policy –Yes, but this is also true of LCR Will limit leveraged trading and price discovery in security markets –Yes, but as well as this being true of LCR may be a benefit not a cost

Helicopter money? Separate issue Curtailing of “conventional” money transmission (via short term interest rates) –May need us take helicopter money proposals more seriously Register can regarded as a neutral distribution mechanism –But many other possibilities

Current thinking on redraft More link to LCR and other current liquidity policies Less on helicopter money, except in relation to change in monetary transmission Emphasise: liquidity regulation is the BIG issue in Basel III, far more important than capital changes