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The international
financial crisis and the
way forwardCarmine Di Noia
66th EP/US Congress Interparliamentary Meeting
Transatlantic Legislators’ Dialogue
Prague
April 18, 2009
Index
Macro or Micro Financial Crisis?
Financial Regulation and Regulatory architecture
Supervision by Objective
Fixing management incentives
Macroeconomic causes
Global imbalances
Stock market bubble
House bubble
0
200
400
600
800
1000
1200
1400
1600
1800
1900 1906 1912 1918 1924 1930 1936 1942 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008
0
50
100
150
200
250Real S&P 500 Composite Stock Price Index (left scale) Real Home Price Index (right scale, 1900 = 100)
Annual data. For stock price index value for 2008 as of December. Data sources: own calculations based on Shiller 2009.
Stock Price and Home Price Indexes in the United States, 1900-2008
0
5
10
15
20
25
30
35
40
45
1900 1906 1912 1918 1924 1930 1936 1942 1948 1954 1960 1966 1972 1978 1984 1990 1996 2002 2008
0
0.2
0.4
0.6
0.8
1
1.2
1.4
1.6
Real S&P 500 price earnings ratio (10-yrs moving average, left scale) House price/rent ratio (1970-2008, right scale)
Data sources: own calculations based on Shiller 2009 for price earnings and on Gros 2009 for price rent ratio.
Price Earnings and Price Rent ratios in the United States, 1900-2008
US $ REER
80
100
120
82.7
118.6
91.4
-
-
-
US balance of payments, official reserves and real effective exchange rate (REER), 1996-2008
Notes: Net capital inflow calculated as residual. For real effective exchange rate, 100 = average of sample period.Data sources: Bureau of Economic Analysis 2009 for current account and GDP; IMF 2009 for official foreign exchange reserves and real effective exchange rate.
A microeconomic cause: excessive leverage
Large financial institutions over-leveraged
Excessive leverage especially for European banks and US investment banks (leverage ratio for US bank holding companies)
G-20, FSF: introduction of a simple, non-risk based leverage ratio to supplement risk-based capital requirements
Institution Total assets/equity Deposits and short-termfunding/total assets (%)
ABN Amro 33 78
Bank of America 12 73
Barclays 38 71
Bear Stearns 34 13
BNP Paribas 29 79
Citigroup 19 66
Credit Suisse 24 55
Deutsche Bank 53 80
Goldman Sachs 22 16
HSBC 17 74
JPMorgan Chase 13 68
Lehman Brothers 31 19
Merrill Lynch 32 29
Morgan Stanley 33 30
RBS 21 75
Société Générale 34 70
UBS 52 91
Avg. EU banks 33 75
Avg. US banks(excl. investment banks)
14 69
Avg. US investment banks 30 22
Data source: Bankscope, 2008.
Leverage and short-term liabilities of selected financial institutions, 2007
Regulatory structure
Regulatory structures: sectoral, by objective, functional, integrated, unified
Wave of reforms: trend towards single regulator
Still high degree of cross-country eterogeneity
Different role and involvement of central bank in prudential supervision
Banks Securities Insurance Establishment of integrated or
unified supervisors
(year)
Organisational model
Central bank with primary
responsibility for micro-prudential
supervisionAustralia P/C 1998 By objectives noAustria U U U 2002 Unified yesa
Belgium U U U 2004 Unified noDemark U U U 1988 Unified noFinland BS BS I 1993 Integrated nob
France B B/S I Sectoral/by objective
no
Germany U U U 2002 Unified yesa
Greece CB S I Sectoral yesIreland U(CB) U(CB) U(CB) 2003 Unified yesItaly CB/S CB/S I Sectoral/
by objectiveyes
Japan U U U 2000 Unified noLuxembourg BS BS I 1999 Integrated noNetherlands P(CB)/C 2004 By objective yesPortugal CB CB/S I Sectoral/
by objectiveyes
Spain CB S I Sectoral yesSweden U U U 1991 Unified noUK U U U 1997 Unified noUS CB/B S I Sectoral/by
objective/functional
no
B = One or more authorities specialised in banking oversight. BS = Authority specialised in oversight of the banking sector and securities markets. C = Authority in charge of conduct of business supervision for all sectors. CB = Central bank. I = One or more authorities specialised in oversight of the insurance sector. P = Authority in charge of prudential supervision for all sectors. P (CB) = Central bank in charge of macro- and micro-prudential supervision for all sectors. S = One or more authorities specialised in oversight of securities markets. U = Single authority for all sectors. U (CB) = Unified regulator is an agency of the central bank.a Central bank is entrusted by law to conduct only specific supervisory tasks.b The integrated regulator is an independent agency of the central bank.
Source: Herring & Carmassi (2008).
Regulatory structure of selected industrial countries
New global regulatory structure
Focus on systemic risk and systemically important financial institutions (G-20, FSF, US Treasury)
G-20: IMF and Financial Stability Board in charge of monitoring global systemic risk and safeguarding financial stability (also through Early Warning Exercises)
Proposal: two-levels regulatory system in the US and EU, by objective; IMF and FSB on top of the global regulatory structure
A Global System of Financial Regulation
Federal Reserve
System
US System ofPrudential
Supervision
US System for Investor Protection
Market Stability Regulator (Federal Reserve)
Local branches
Business Conduct
RegulatorLocal
branches
Prudential Financial Regulator
Local branches
Coordination Committee
European System of
Central Banks
European System of Prudential
Supervision
European System for
Investor Protection
European System for
Competition
ECB
European Investor
Protection Authority
European Prudential Regulation Authority
European Antitrust Authority
Coordination Committee
National Central Banks
Prudential SupervisionAuthorities
Investor Protection Authorities
Antitrust Authorities
International Monetary FundFinancial Stability Board
International Monetary FundFinancial Stability Board
US System for
Competition
AntitrustLocal
branches
US Market Stability
Regulator (Federal Reserve Board)
US Business Conduct
Regulator
US Prudential Financial Regulator
US Antitrust Authority
Coordination Committee
Coordination Committee
Fixing management incentives
Distortions in the design of compensation packages
Need to balance competing interests in governance arrangements of financial institutions
Salary structure heavily skewed in favour of the variable component and of short-term returns that were readily cashed in
Fixing management incentives
Absolute limits on pay attractive, but probably not a good solution in the long run: risk of keeping away good management and attracting lower-quality staff
Key issue: how to align compensations with the creation of long-term value for shareholders?
Need of organisational changes: risk management and control to be made fully independent of profit centres and directly accountable to an independent audit committee and, eventually, to the board
Fixing management incentives
G-20, FSF: boards of directors should play an active role in the design, operation, and monitoring of compensation schemes; need to strengthen links between compensation and risk and time horizon; public disclosure of clear, comprehensive, and timely information about compensation
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