AEI Shadow Financial Regulatory Committee Conference
American Enterprise Institute
“Shadow Financial Regulatory Committee Conference”
Monday, December 7, 2015
Key Topics & Takeaways
· Total Loss Absorbing Capacity (TLAC): The Wharton School’s Herring noted some concerns that the Shadow Financial Regulatory Committee (SFRC) has with the Federal Reserve’s (Fed’s) proposal, such as that it: 1) focuses too much on long-term debt when regular issues of new debt would more effectively bring in market-based pricing and discipline that could promote corrective actions on the part of firms; 2) only adds another layer to an already overly complex capital structure; and 3) continues the focus on risk-weighting when regulators should, in the Committee’s view, instead rely more on robust leverage ratios.
· Too Big to Fail Policies: Boston College’s Kane said retaining regulatory discretion in too big to fail policies promotes risk-taking behavior and demonstrates that the Fed does not believe its post-crisis reforms have established robust standards that could end subsidies for the largest banks.
· Post-Crisis Reforms: Herring said that while risks on bank balance sheets are down, risks have migrated to other areas that regulators cannot observe so easily. He also commented that the post-crisis reform effort has been “much more expensive than it needs to be,” referring to its complexity.
Participants
- George Kaufman, Loyola University Chicago
- Richard Herring, Wharton School of the University of Pennsylvania
- Edward Kane, Boston College
- Chester Spatt, Carnegie Mellon University
Opening Remarks
George Kaufman, Loyola University Chicago, opened the conference by noting that the Shadow Financial Regulatory Committee (SFRC) was created 30 years ago in February of 1986, and has been organized under the American Enterprise Institute for the past 20 years. He noted the SFRC’s work over the decades to promote regulatory transparency and accountability, and stated that the SFRC’s quarterly meetings would be suspended after the day’s event.
Statement on TLAC
Richard Herring of the Wharton School of the University of Pennsylvania discussed the SFRC’s views of the Financial Stability Board’s recent proposal for Total Loss Absorbing Capacity (TLAC) in globally systemically important banks (GSIBs), Statement No. 361. He noted that the SFRC has long urged regulators to put more emphasis on market discipline to supplement supervisory discipline, particularly with the issuance of subordinated debt. Herring said TLAC can be considered a variant of this idea, with holders of TLAC having a strong incentive to monitor and discipline the risk-taking of the institutions that borrow from them.
Herring said bankers and regulators are calling TLAC “the last nail in the coffin” for too big to fail as the final part of an elaborate new regulatory capital architecture. He called TLAC critical to resolution, saying it is “essentially contingent capital, like a pre-packaged bankruptcy.” However, he noted some concerns the SFRC has with the proposal, such as that it: 1) focuses too much on long-term debt when regular issues of new debt would more effectively bring in market-based pricing and discipline that could promote corrective actions on the part of firms; 2) only adds another layer to an already overly complex capital structure; and 3) continues the focus on risk-weighting when regulators, he argued, should instead rely more on robust leverage ratios.
Statement on Deposit Insurance, Government Guarantees and Too Big to Fail
Edward Kane of Boston College discussed SFRC Statement No. 362, commenting that TLAC is “not the last nail in the coffin” to end too big to fail, and that recent actions by the Federal Reserve are “pulling out the other nails.” He explained that explicit deposit insurance and government guarantees are formal arrangements for backing up financial sector liabilities. Kane said post-crisis reforms typically strengthen formal backup regulatory systems, but that the regulators have “consistently undercut” the effectiveness of many post-crisis reforms in the interest of preserving their discretionary powers.
Kane stated that too big to fail policies have in past crises served to restore the solvency of a collapsing financial system, essentially by dispensing government subsidies to “large, complex, or politically well-connected firms.” He criticized the Fed’s recent final rule governing the use of its 13(3) emergency lending authority for preserving too much of the Fed’s discretion by undercutting the force of potentially restrictive terms in its definitions. He expressed doubt that the new rule would have prevented the Fed from channeling to particular firms the same credit it offered during the crisis.
Overall, Kane said retaining such regulatory discretion in too big to fail policies promotes risk-taking behavior and demonstrates that the Fed does not believe its post-crisis reforms have established robust standards that could end subsidies for the largest firms. He suggested that regulators, rather than pretending that their new backup arrangements can end subsidies, could better enhance financial stability by setting up systems to measure, test and respond to changes in the value of the subsidies large banks receive.
Question and Answer
Asked by an audience member whether the SFRC supports the overall course of post-crisis reforms, Herring answered that the banking system is now stronger. However, he added that while risks on bank balance sheets are down, risks have migrated to other areas that regulators cannot observe so easily. He also commented that the post-crisis reform effort has been “much more expensive than it needs to be,” referring to its complexity.
Kaufman added that he is concerned that many of the reforms are “deadweight losses” that impose high costs with little benefit to financial stability.
Chester Spatt of Carnegie Mellon University commented that optimal policy for reforms during a crisis should consider the long-term effects of regulation, but that regulators did not do so during the last crisis which is now hurting the financial system.
For more information on this event, please click here.
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American Enterprise Institute
“Shadow Financial Regulatory Committee Conference”
Monday, December 7, 2015
Key Topics & Takeaways
· Total Loss Absorbing Capacity (TLAC): The Wharton School’s Herring noted some concerns that the Shadow Financial Regulatory Committee (SFRC) has with the Federal Reserve’s (Fed’s) proposal, such as that it: 1) focuses too much on long-term debt when regular issues of new debt would more effectively bring in market-based pricing and discipline that could promote corrective actions on the part of firms; 2) only adds another layer to an already overly complex capital structure; and 3) continues the focus on risk-weighting when regulators should, in the Committee’s view, instead rely more on robust leverage ratios.
· Too Big to Fail Policies: Boston College’s Kane said retaining regulatory discretion in too big to fail policies promotes risk-taking behavior and demonstrates that the Fed does not believe its post-crisis reforms have established robust standards that could end subsidies for the largest banks.
· Post-Crisis Reforms: Herring said that while risks on bank balance sheets are down, risks have migrated to other areas that regulators cannot observe so easily. He also commented that the post-crisis reform effort has been “much more expensive than it needs to be,” referring to its complexity.
Participants
- George Kaufman, Loyola University Chicago
- Richard Herring, Wharton School of the University of Pennsylvania
- Edward Kane, Boston College
- Chester Spatt, Carnegie Mellon University
Opening Remarks
George Kaufman, Loyola University Chicago, opened the conference by noting that the Shadow Financial Regulatory Committee (SFRC) was created 30 years ago in February of 1986, and has been organized under the American Enterprise Institute for the past 20 years. He noted the SFRC’s work over the decades to promote regulatory transparency and accountability, and stated that the SFRC’s quarterly meetings would be suspended after the day’s event.
Statement on TLAC
Richard Herring of the Wharton School of the University of Pennsylvania discussed the SFRC’s views of the Financial Stability Board’s recent proposal for Total Loss Absorbing Capacity (TLAC) in globally systemically important banks (GSIBs), Statement No. 361. He noted that the SFRC has long urged regulators to put more emphasis on market discipline to supplement supervisory discipline, particularly with the issuance of subordinated debt. Herring said TLAC can be considered a variant of this idea, with holders of TLAC having a strong incentive to monitor and discipline the risk-taking of the institutions that borrow from them.
Herring said bankers and regulators are calling TLAC “the last nail in the coffin” for too big to fail as the final part of an elaborate new regulatory capital architecture. He called TLAC critical to resolution, saying it is “essentially contingent capital, like a pre-packaged bankruptcy.” However, he noted some concerns the SFRC has with the proposal, such as that it: 1) focuses too much on long-term debt when regular issues of new debt would more effectively bring in market-based pricing and discipline that could promote corrective actions on the part of firms; 2) only adds another layer to an already overly complex capital structure; and 3) continues the focus on risk-weighting when regulators, he argued, should instead rely more on robust leverage ratios.
Statement on Deposit Insurance, Government Guarantees and Too Big to Fail
Edward Kane of Boston College discussed SFRC Statement No. 362, commenting that TLAC is “not the last nail in the coffin” to end too big to fail, and that recent actions by the Federal Reserve are “pulling out the other nails.” He explained that explicit deposit insurance and government guarantees are formal arrangements for backing up financial sector liabilities. Kane said post-crisis reforms typically strengthen formal backup regulatory systems, but that the regulators have “consistently undercut” the effectiveness of many post-crisis reforms in the interest of preserving their discretionary powers.
Kane stated that too big to fail policies have in past crises served to restore the solvency of a collapsing financial system, essentially by dispensing government subsidies to “large, complex, or politically well-connected firms.” He criticized the Fed’s recent final rule governing the use of its 13(3) emergency lending authority for preserving too much of the Fed’s discretion by undercutting the force of potentially restrictive terms in its definitions. He expressed doubt that the new rule would have prevented the Fed from channeling to particular firms the same credit it offered during the crisis.
Overall, Kane said retaining such regulatory discretion in too big to fail policies promotes risk-taking behavior and demonstrates that the Fed does not believe its post-crisis reforms have established robust standards that could end subsidies for the largest firms. He suggested that regulators, rather than pretending that their new backup arrangements can end subsidies, could better enhance financial stability by setting up systems to measure, test and respond to changes in the value of the subsidies large banks receive.
Question and Answer
Asked by an audience member whether the SFRC supports the overall course of post-crisis reforms, Herring answered that the banking system is now stronger. However, he added that while risks on bank balance sheets are down, risks have migrated to other areas that regulators cannot observe so easily. He also commented that the post-crisis reform effort has been “much more expensive than it needs to be,” referring to its complexity.
Kaufman added that he is concerned that many of the reforms are “deadweight losses” that impose high costs with little benefit to financial stability.
Chester Spatt of Carnegie Mellon University commented that optimal policy for reforms during a crisis should consider the long-term effects of regulation, but that regulators did not do so during the last crisis which is now hurting the financial system.
For more information on this event, please click here.