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Regulation and Banking After the Crisis A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Balling, Morten et al. Proceedings Regulation and Banking after the Crisis SUERF Studies, No. 2011/2 Provided in Cooperation with: SUERF – The European Money and Finance Forum, Vienna Suggested Citation: Balling, Morten et al. (2011) : Regulation and Banking after the Crisis, SUERF Studies, No. 2011/2, ISBN 978-3-902109-57-6, SUERF - The European Money and Finance Forum, Vienna This Version is available at: http://hdl.handle.net/10419/163496 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu SUERF2011_2.book Page 1 Wednesday, April 20, 2011 3:50 PM Regulation and Banking after the Crisis SUERF2011_2.book Page 2 Wednesday, April 20, 2011 3:50 PM SUERF2011_2.book Page 3 Wednesday, April 20, 2011 3:50 PM REGULATION AND BANKING AFTER THE CRISIS Edited by Frank Browne, David T. Llewellyn and Philip Molyneux Chapters by: Morten Balling and Ernest Gnan Patrick Honohan David T. Llewellyn Nigel Jenkinson Aerdt Houben and Jan Kakes Pat Farrell Patricia Jackson Edward J. Kane Alistair Milne A joint publication with the Central Bank of Ireland SUERF – The European Money and Finance Forum Vienna 2011 SUERF Study 2011/2 SUERF2011_2.book Page 4 Wednesday, April 20, 2011 3:50 PM CIP REGULATION AND BANKING AFTER THE CRISIS Editors: Frank Browne, David T. Llewellyn and Philip Molyneux Authors: Morten Balling and Ernest Gnan, Patrick Honohan, David T. Llewellyn, Nigel Jenkinson, Aerdt Houben and Jan Kakes, Pat Farrell, Patricia Jackson, Edward J. Kane, Alistair Milne Keywords: banking, bank business models, eurozone, intervention strategies, Ireland, OAD, regulation, risk management, securisation, supervision, systemic risk, too big to fail JEL Codes: G01, G18, G21, G28 Vienna: SUERF (SUERF Studies: 2011/2) – May 2011 ISBN: 978-3-902109-57-6 © 2011 SUERF, Vienna Copyright reserved. Subject to the exception provided for by law, no part of this publica- tion may be reproduced and/or published in print, by photocopying, on microfilm or in any other way without the written consent of the copyright holder(s); the same applies to whole or partial adaptations. The publisher retains the sole right to collect from third parties fees payable in respect of copying and/or take legal or other action for this purpose. SUERF2011_2.book Page 1 Wednesday, April 20, 2011 3:50 PM 1 TABLE OF CONTENTS List of Authors. 5 Preface. 7 Frank Browne, David T. Llewellyn and Philip Molyneux 1. Regulation and Banking after the Crisis . 9 Morten Balling and Ernest Gnan 2. Banks and the Budget: Lessons from Europe. 19 Patrick Honohan 2.1. Two-way Channels of Influence Between Banks and the Budget – the Irish Example . 19 2.2. Other Recent European Examples of Banks Imposing Costs on the Budget . 24 2.3. From Budget to Banks. 26 3. Post Crisis Regulatory Strategy: A Matrix Approach. 29 David T. Llewellyn 3.1. Some Key Issues . 29 3.2. Instruments in a Regulatory Regime . 32 3.3. Lowering the Probability of Bank Failures. 36 3.4. Minimising the Costs of Bank Failures . 46 3.5. Summary of the Argument: A Regulatory Strategy . 54 References . 56 4. Strengthening the International Framework for Financial Regulation: Some Key Issues and Challenges. 61 Nigel Jenkinson 4.1. Introduction . 61 4.2. Strengthening the system-wide perspective . 62 4.3. Initiatives to Contain the Build Up of Risks. 66 4.4. Initiatives to Improve the Resilience to Stress . 68 4.5. Containing Moral Hazard and Managing Failure . 71 4.6. Challenges to the Design of the New Regulatory Framework 74 4.7. Conclusions. 77 References . 77 larcier SUERF2011_2.book Page 2 Wednesday, April 20, 2011 3:50 PM 2 REGULATION AND BANKING AFTER THE CRISIS 5. Risk Identification and Mitigation: Lessons from the Crisis. 79 Aerdt Houben and Jan Kakes 5.1. Introduction . 79 5.2. Risk Identification and the Credit Crisis . 79 5.3. Scope for Improvement . 83 5.4. Concluding Remarks. 88 References . 89 Annex 1. Ambiguity in Risk Assessments: Pre-crisis Views on CRT 91 Annex 2. Ambiguity in Risk Assessments: Initial Assessments of Lehman Collapse. 93 6. Banking as a Social Contract – The New Regulatory Paradigm. 95 Pat Farrell 7. A False Sense of Security: Lessons from the Crisis for Bank Management and Regulators . 101 Patricia Jackson 7.1. Introduction . 101 7.2. Lessons from the Crisis . 102 7.3. Misleading Signals. 103 7.4. Risk Governance and Incentives . 111 7.5. Market Failure – Time Inconsistency and Incomplete Information . 113 7.6. Conclusions. 114 References . 115 8. Redefining and Containing Systemic Risk . 117 Edward J. Kane 8.1. When Do Risks Become Systemic? . 119 8.2. Adverse Consequences of Misdiagnosing the Policy Problem 120 8.3. Alternative Definitions of Systemic Risk Lead to Different Strategies of Regulatory Reform . 121 8.4. Why Incentive Defects Persist . 123 8.5. Steps that Government and Industry Could Take Toward Genuine Reform . 124 8.6. Summary Implications. 130 References . 131 9. The Case for Limited Liability Eurozone Government Debt . 133 Alistair Milne 9.1. Introduction . 133 larcier SUERF2011_2.book Page 3 Wednesday, April 20, 2011 3:50 PM TABLE OF CONTENTS 3 9.2. The Proposals . 136 9.3. Does Monetary Union Require Fiscal Rules?. 139 9.4. The Costs of Debt Restructuring: Need They Be so Large? . 142 9.5. Summary and Conclusion: The Euro Area Authorities Are Playing with Fire . 144 References . 146 SUERF – Société Universitaire Européenne de Recherches Financières . 147 SUERF Studies. 147 larcier SUERF2011_2.book Page 4 Wednesday, April 20, 2011 3:50 PM SUERF2011_2.book Page 5 Wednesday, April 20, 2011 3:50 PM 5 LIST OF AUTHORS Morten BALLING Emeritus Professor of Finance, Aarhus School of Business and SUERF Pat FARRELL Chief Executive, Irish Banking Federation Ernest GNAN SUERF Secretary General and Head, Economic Analysis Division, Oesterreichische Nationalbank Patrick HONOHAN Governor, Central Bank of Ireland Aerdt HOUBEN Director, Financial Stability Division, De Nederlandsche Bank Patricia JACKSON Partner, Ernst & Young LLP, London; Adjunct Professor, Imperial College, London and Centre for Economic Policy Research Nigel JENKINSON Adviser, Financial Stability Board, Basel Jan KAKES Senior Economist, Financial Stability Division, De Nederlandsche Bank Edward J. KANE Professor of Finance, Boston College David T. LLEWELLYN Professor of Money and Banking, Loughborough University and SUERF Alistair MILNE Senior Lecturer, Cass Business School, City University, London larcier SUERF2011_2.book Page 6 Wednesday, April 20, 2011 3:50 PM SUERF2011_2.book Page 7 Wednesday, April 20, 2011 3:50 PM 7 PREFACE Frank Browne, David T. Llewellyn and Philip Molyneux The Central Bank of Ireland and SUERF organised a joint conference in Dublin on 20th September, 2010 on the general theme of Regulation and Banking after the Crisis. In the best traditions of SUERF, the programme included papers and presentations from the three main constituencies of SUERF: Central Banks (including notably the Governor of the Central Bank of Ireland), academics, and financial practitioners. As always, the papers illuminated some of the different perspectives of the three constituencies. We are grateful to the many distinguished contributors who were prepared to make powerful contributions to the confer- ence. When constructing the programme, we were conscious that there had been many conferences devoted to the causes of the crisis, the nature and extent of official intervention, and the impact of the crisis. Rather than add yet another conference to this well-trodden topic, and conscious that the crisis could prove to be trans- formational in many dimensions, we chose to focus on aspects of the post crisis scenarios for the possible future structure of financial systems, business models of banks, risk management implications, and the implications for the future regula- tory and supervisory regime. In so doing, it was also designed to be a precursor to the 2011 Colloquium to be held in Brussels in May on the topic of New Para- digms in Money and Finance? Many of the issues raised at the Dublin conference will doubtless be re-visited in the May Colloquium. Our intention was to focus on three broad strategic issues in the three sessions of the conference: (1) Post Crisis Regulation and Intervention Strategies with papers from Nigel Jenkinson (BIS), Aerdt Houben (De Nederlandsche Bank), and Pat Farrell (Irish Banking Federation), (2) New Business Models in the Post Crisis Financial System with papers from Luc Riedweg (Banque de France), David Marques Ibañez (ECB) and Patricia Jackson (Ernst & Young), and (3) Regulation and the Changing Financial Landscape with papers from Edward J. Kane (Boston College), Alistair Milne (CASS Business School) and Jesús Saurina (Banco de España). The three sessions were preceded by two keynote Addresses from Patrick Honohan (Governor of the Central Bank of Ireland) and David T. Llewellyn (Loughborough University and SUERF Council Member). What follows are the two Keynote Addresses, a conference overview by SUERF Secretary General Ernest Gnan and Morten Balling of SUERF, and the majority of the papers given in the three sessions of the conference.
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