1. Introduction to Banking & Finance
Bank regulation & supervision

2. Today’s objectives To understand bank capital regulation
To evaluate strategies to identify problem banks and successful bank restructuring procedures
To identify the main causes of banking crises
To understand the different approaches taken to resolve a banking crisis
To identify the key regulatory initiatives to reduce systemic risk

3. The financial safety net

4. Deposit insurance

5. Deposit insurance Paybox Model narrow settlement scope Paybox plus
settlement and also responsible for resolution role
Cost reducer model
settlement
managing insolvency and externality occurrence
Resolution facilitator model
additional support powers to facilitate restructuring of banks including merging
Supervisor model: broadest mandate not independent of the supervisory system
Move towards a “cost minimiser” approach: includes selling off bank assets to help funding

6. Deposit insurance: who pays and how?
The banks!
Ex ante
Bank levy with additional funds available from centre
Ex-post
No extant fund: members of the DIS fund on an ad hoc basis
Which is better? ֎
Ex ante: depositors like it! Fosters confidence, should manage moral hazard if includes risk adjusted premiums BUT Difficult to manage, how do you set premiums, how do you price in systemic risk?
Ex-post: fosters market discipline (supposedly), may be delays in getting the funds from banks and if lots of failures, can cause domino effect

7. DIS country comparison

8. Lender of last resort (LOLR)
Main function of most central banking models
Provides liquidity to banks at times of financial crisis
Individual banks can borrow when no one else will lend
Can be problematic when goes cross border: e.g. EU
Has been linked with moral hazard
Not supported as a function by the free banking lobby
Cite Northern rock ֎

9. Special resolution regimes (SRR)
Bankruptcy / insolvency legislation specifically for banks
Highly political
Many different approaches
UK: Banking Act Permanent framework
Bank of England, Prudential Regulation Authority
USA: Fed Dep. Insurance Corp.
Canada: Canada Deposit Ins. Corp.
EU: Single Resolution Mechanism 2013
Hong Kong specifies a public interest objective
NZ, same as HK but has no DIS
Financial stability board (BIS) Key attributes for SRRs
Most have a cost minimisation focus and a stability / systemic risk management requirement
Have a look at pp : summary

10. Limitations of regulation
Moral Hazard
Too Big To Fail (TBTF)
Regulatory forbearance
Time inconsistency
Agency capture
Costs limitations
At the start of the financial crisis: SEC had 3,000 employees, FSA had 39
Regulatory forbearance may be caused by Time inconsistency; regulations that may have helped before the crisis may not be appropriate after it happens. May ahve to wait for things to calm down before implementation.
Agency capture: regulation used by banks for their own ends: too much big bank influence, focus on small banks, movement of funds from bank to trading book etc ֎

11. Bank regulation: key concepts

12. The three pillars of Basel֎

13. Why is capital important?
Remember: banking is all about risk management
The reason for holding capital is that it should provide protection against unexpected losses.
NB; this is not the same as expected losses which are covered by provisions, reserves and
current year profits. ֎

14. CREDIT RISK + MARKET RISK
Capital adequacy and Basel II: the logic
(the ratio of a bank's core capital to its total risk-weighted assets)
TIER 2 CAPITAL
TIER 1
CAPITAL
CAPITAL BASE
CREDIT RISK + MARKET RISK
Undisclosed Reserves
Revaluation Reserves
General Provisions
Hybrid Instruments
Subordinated Term Debt
Equity
Reserves (disclosed)
Preference shares
MINIMUM 4%
> 8%

15. CREDIT RISK + MARKET RISK
Capital adequacy and Basel II: the logic
> 8%
TIER 1
CAPITAL
TIER 2 CAPITAL
CAPITAL BASE
CREDIT RISK + MARKET RISK
RISK WEIGHTED
ON-BALANCE -
SHEET ASSETS
OFF- BALANCE
SHEET ITEMS
Credit Conversion as if on-balance sheet
RISK WEIGHTED

16. Current proposals: Basel III
Talking about a leverage ration: Tier 1capital / exposure to on and off balance sheet items ֎

17. Basel III: phase in arrangements
Liquidity cover ratio (LCR) High quality liquid assets/total net outflows (next 30 days) >
Net stable funding ration (NSFR)
Talking about a leverage ratio: Tier 1 capital / exposure to on and off balance sheet items

18. What Basel III means to banks
The estimated medium-term impact of Basel III implementation on GDP growth is in the range of to percentage point per annum. Economic output is mainly affected by an increase in bank lending spreads as banks pass a rise in bank funding costs, due to higher capital requirements, to their customers.
To meet the capital requirements (4.5% for the common equity ratio, 6% for the Tier 1 capital ratio), banks are estimated to increase their lending spreads on average by about 15 basis points.
The capital requirements effective as of 2019 (7% for the common equity ratio, 8.5% for the Tier 1 capital ratio) could increase bank lending spreads by about 50 basis points.
Slovik, P. and B. Cournède (2016), “Macroeconomic Impact of Basel III”, OECD

19. SIFIs, G-SIFIs & G-SIBs
SIFI = Systemically Important Financial Institution
G-SIFI = Global Systemically Important Financial Institution
G-SIB = Global Systemically Important Bank
Subject to higher capital requirements:
Greater supervision / scrutiny ֎

20. Additional capital requirements