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What can be achieved by structural reform in banking


Title: Managerial Report Author: Engel Last modified by: KAMPARE Mara Tereze Created Date: 12/30/2005 10:31:24 AM Document presentation format: On-screen Show (4:3) – PowerPoint PPT presentation

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Title: What can be achieved by structural reform in banking

What can be achieved by structural reform in
MPI Collective Goods Martin Hellwig
  • Brussels, December 2, 2014

Structural Reform Why?
  • Structural measures
  • size limits,
  • separation Glass-Steagall/Volcker, Liikanen, EU
  • Ring-fencing Vickers,
  • Why? To increase the safety of the financial
    system and to protect taxpayers!!!???
  • How? I have yet to see a comprehensive analysis
  • If we eliminate problems in one place, could they
    emerge elsewhere?

Flawed Nostalgia
  • Under Glass-Steagall, the US financial system was
    safe!!! Really???
  • From the 1930s to ca. 1960, the system was safe
    No big risks (interest rates, exchange rates),
    lack of competition (Regulation Q)
  • From 1970 on, the system became unsafe Interest
    rate risk, Money Market Fund competition
  • 1980s Insolvency of SLs, due to interest rate
  • 1990s Problems of Commercial Banks, due to
    specialization and eroding margins... Push into
    competition with investment banks

Dangerous Illusions
  • Commercial Banking is risky Crises of the early
    1990s were due to real-estate and SME lending
  • Credit risk is a much bigger chunk than trading
    risk (so far)
  • Depositor protection and the payment system are
    not the only reasons for systemic concerns
  • Market making as an infrastructure Lehman
    Brothers was a major market maker
  • Money markets as a major source of funding The
    domino effect of Lehman Brothers on Reserve
    Primary was a major source of chaos in 2008
  • Lehman Brothers was an investment bank!!!

What matters Governance
  • How are funds channeled from final investors to
    final assets?
  • Full separation Investor MMF Lehman Brothers
    mortgages in warehousing
  • Full integration Investor UBS UBS Investment
    Bank CDOs in own portfolio (as well as MBS in
  • Hybrid system Investor Savings Bank
    Landesbank SIV (guaranteed) CDOs
  • None of these arrangements has provided good

Issues in Governance
  • Investor protection What products are being
    marketed and how? (Pecora moral hazard in
    investment bank access to commercial bank
    customers German savings banks as sales agencies
    for Lehmns?)
  • Due diligence in investment of surplus funds
  • Professional-investor protection Is caveat
    emptor enough when securities are potentially
  • Are restrictions on activities and investments of
    depository institutions sufficient? Regulation
    By type of institution in which they can invest
    what about products?

What matters Contagion
  • Risk sharing inside an institution can reduce
    system effects in the crises of the early 1990s,
    universal banks could use profits from
    derivatives to compensate for losses in SME
  • Risk sharing inside an institution can support
    moral hazard, e.g., as investment bankers and
    traders rely on AAA rating of the parent
  • Should we think of separation into sub-groups as
    an arrangement that yields risk sharing without
    moral hazard? This depends on overall group
    management and group culture

More on contagion
  • Separation gives a bigger weight to links by
    contracts as opposed to internal governance
    potentially greater number of domino effects but
    the domino effects are potentially smaller
  • With separation, the network of contracts may
    become more intransparent
  • What are the effects of separation on firesale
    contagion, i.e. banks holding things and having
    to write them down when prices decline?

What matters Resolution
  • How should separation be designed so that
    resolution becomes easier?
  • Issues Cross-border resolution
  • Issues Ring-fencing other systemic activities,
    e.g. market making
  • Proposed regulation mentions the need to
    coordinate with resolution authorities but does
    not say much in terms of substance.
  • What is the standing of intra-group contracts in
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