International Financial Regulatory Reforms: Are We on the Right Track? Patrick Leblond CERIUM Summer School June 30, 2010

© Patrick Leblond – June 30, Paul Zanetti, Australia

© Patrick Leblond – June 30, Session Plan Introduction Financial regulation: the basics The G20 process: where are we? Conclusion

© Patrick Leblond – June 30, Introduction

© Patrick Leblond – June 30, The value of bank assets was falling quickly… Source: IMF, Canada 2009 Article IV Consultation, Staff Report

© Patrick Leblond – June 30, …while banks had a lot of debt Source: Bank of Canada, Financial Stability Report, December 2008, p. 24.

© Patrick Leblond – June 30, So, banks did not want to lend money to each other anymore Source: Bank of Canada

© Patrick Leblond – June 30, Governments had to intervene

© Patrick Leblond – June 30, Financial Regulation: The Basics

© Patrick Leblond – June 30, Basic Principles Equilibrium between –System stability and security –Risk taking Competition is necessary for risk taking Benefits must be superior to costs International trade in financial services must not be impeded –No discrimination International coordination is a must

© Patrick Leblond – June 30, John Cole -- The Scranton Times, 1 April 2008

© Patrick Leblond – June 30, What are the financial risks that must be regulated? Liquidity risk – Run on the bank Systemic risk –Contagion –Credit freeze Moral hazard –Capitalism for the gains, socialism for the losses

© Patrick Leblond – June 30, What are the solutions? Liquidity risk –Minimum liquidity reserves –Deposit insurance –Central bank credit Systemic risk –Minimum capital ratios –Leverage ceiling for all financial activities –Limits on asset riskiness –Stress tests –Bankuptcy (resolution) regime for banks Moral Hazard –No implicit guaranteed bailouts

© Patrick Leblond – June 30, International Regulation International coordination of rules and standards –Financial Stability Board –Basel Committee on Banking Supervision –IOSCO –IASB –IMF National implementation of those rules and standards

© Patrick Leblond – June 30, Source : Davies and Green (2008, p. 33)

© Patrick Leblond – June 30, The G20 Process: Where Are We?

© Patrick Leblond – June 30, What has been proposed (1) Bank tax –On bankers’ bonuses –On banks’ profits –On financial transactions Higher minimum capital ratios (capital to assets) –Ratio levels? –Risk weights? –Definition of capital? –Countercyclical? Maximum leverage ratio (assets to capital) –On what activities? –No weighting of assets according to risk

© Patrick Leblond – June 30, What has been proposed (2) Separate investment banking activities from commercial banking activities Contingent capital Clearing mechanism for financial derivatives Regulation of hedge funds Regulation of credit-rating agencies Systemic stress-testing with disclosure Harmonized accounting standards

© Patrick Leblond – June 30, What is for sure to be there internationally Minimum liquidity ratios Higher minimum capital ratios Leverage ratio –But to all financial activities? Stress-testing with public disclosure –Large multinational financial institutions –National level Harmonized accounting standards –Fair value everywhere?

© Patrick Leblond – June 30, Example of Capital Ratio Asset Category Risk Weight Capital Ratio AmountRWAMinimum Capital requirement Treasury Bond 0%8%$1,000$0 Municipal Bond 20%8%$1,000$200$16 Residential Mortgage 50%8%$1,000$500$40 Unsecured loan 100%8%$1,000 $80

© Patrick Leblond – June 30, What might be missing? Who assesses the riskiness of assets and liabilities? Supervision of multinational banks –Who supervises what? Bankruptcy mechanism for multinational financial institutions Countercyclical (i.e. dynamic) policies to prick asset bubbles –Make borrowing more expensive as risk increases Global stress-testing? Monitoring of national implementation –Sanctions?

© Patrick Leblond – June 30, Conclusion

© Patrick Leblond – June 30, Conclusions The global financial crisis showed that the existing financial regulatory regime does not work –We cannot rely on markets to regulate themselves Let the G20 process run its course –It is on the right track –Seoul will be the key meeting –New regulatory standards will come in to play starting in 2012 –But the devil will be in the details and national implementation Will it be enough to prevent the next crisis? –Probably not –Hopefully, it will be less acute and spread out

© Patrick Leblond – June 30, My Contact Information University of Ottawa Graduate School of Public and International Affairs 55 Laurier Street East, Office Ottawa, ON K1N 6N5 Canada Tel: (ext. 2953)

© Patrick Leblond – June 30, THANK YOU!