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Basel 2.5, Basel 3, and Dodd-Frank
National Bank Act of 1864
Federal Reserve Act of 1913
To Amend the National Banking Laws and the Federal Reserve Act
Banking Act of 1933
•The Glass-Steagall Act.
Banking Act of 1935
•FDIC Federal Deposit Insurance Act of 1950
Bank Holding Company Act of 1956
International Banking Act of 1978
Financial Institutions Regulatory and Interest Rate Control Act of 1978
Depository Institutions Deregulation and Monetary Control Act of 1980
Depository Institutions Act of 1982
•Garn-St Germain
Competitive Equality Banking Act of 1987
Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA)
Crime Control Act of 1990
Federal Deposit Insurance Corporation Improvement Act of 1991 (FDCIA)
Housing and Community Development Act of 1992
RTC Completion Act
Riegle Community Development and Regulatory Improvement Act of 1994
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
Economic Growth and Regulatory Paperwork Reduction Act of 1996
Gramm-Leach-Bliley Act of 1999
International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001
Sarbanes-Oxley Act of 2002
Fair and Accurate Credit Transactions Act of 2003
Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010
This time is the same: Regulation follows crises
This time
• Basel 2.5: Redefinition of market risk requirements – Substantial increase in capital for banks with large
trading activities
• Basel 3: New capital standards, but fully implemented in 2019 – Substantial increase in common equity requirement,
especially for SIFIs; liquidity requirements
• Dodd-Frank: Addresses all aspects of the financial sector except for Fannie and Freddie.
Oversight and
Systemic Risk
Financial Stability Oversight Council
Orderly Liquidation Authority
Federal Reserve Emergency Credit
Financial Institutions
Regulation of banking organizations
Volcker Rule
Private fund investment advisers
Insurance companies
Supervision of payment, clearing and
settlement
Capital Markets
Derivatives and swaps clearinghouses
Securitization
Credit Rating Agencies
Investor protection and securities enforcement
Business Conduct and
Practices
Governance and compensation
Consumer protection
Dodd-Frank
But
• We have a long way to go with Dodd-Frank.
• Parts of it could get repealed.
• The most important rules may be the ones that are discussed little: Bailouts have become much harder to implement.
• Yet, there is no solution of resolution of multinational banks.
Do the changes matter?
• Banks will have to more than double their common equity capital compared to before the crisis.
• Banks look at the world through ROE. Hence, their ROE falls in half if they do nothing.
• Few banks have market-to-book greater than 1. So, they are more likely to work on their balance sheet than to issue equity.
• Not all activities are affected equally.
9
7
8
9
9
8
3
6
4
8
7
15
16
Product-specific RoEs show highest impact on
structured products, especially credit and rates
Total 20
Prop Trading 35
Prime Svcs 15
EQD - Strctrd 27
EQD - Flow 25
Cash Equities 25
Commodities 20
Credit - Strctrd 17
Credit - Flow 18
Rates - Strctrd 15
Rates - Flow 19
FX 30
Pre regulation
1
2a
2b
3a
3b
4
5
6a
6b
7
8
Post regulation Asset class
-59
-77
-65
-83
-61
-39
-65
-68
-46
-80
0
-8
-6
-4
-8
-9
-6
-5
-8
-10
-22
-7
1 3 2 6/7
X Delta, percent
Most significant impact
8a 8b
RoE (effect), Percent (Percentage points)
Mkt risk
RWA red.
Rev. impact
Cap. / Lev CCR
B II.5 Basel III/Other
Lqd./ Fund.
0
-5
-6
0
-2
-3
0
-1
-4
0
-1
-3
4
2
1
0
0
1
1
0
1
0
0
2
-5
-1
-1
0
-1
-1
-1
0
-1
0
-1
-1
-4
-2
-1
-1
-1
-2
-3
-2
-2
-6
-2
-2
-2
-2
-1
-1
-1
-1
-2
-2
-2
-1
-2
-1 -64
-46
3 WHAT BANKS NEED TO DO
Borrowed from McKinsey/Toni Santomero
Consequences
• Banks will shrink.
• Tailored products will become more expensive.
• Non-bank financial activities will expand.
• Offshore financial activities will expand.
Do the changes address the causes of bank poor performance during the
crisis?
• Did an international study of performance of large banks during the crisis with Andrea Beltratti.
• All public banks with more than $50 billion assets.
• Stock performance from July 2007 to December 2008.
Key differences
0.00%
10.00%
20.00%
30.00%
40.00%
50.00%
60.00%
70.00%
80.00%
Fagility Deposits Tangible equity Ownership Board index
Bottom quartile
Top quartile
Where the banks that did better less risky in 2006?
• No, except for leverage.
• They had higher idiosyncratic volatility.
• They had lower distance to default.
• Same beta, same real estate beta.
• However, much higher tangible equity:
– 6.35% versus 4.10%
Banks Banks + Non-banks
Tier 1 45.026***
Tangible equity 2.122
Funding fragility -0.636*** -0.250***
Real estate beta -65.649*** -61.371***
Board -3.421*** -3.013**
Regression results: Key variables
Is Volcker right?
• Regulation is not related to performance except that banks from countries with more restrictions on bank activities did better.
• But, banks from countries with more restrictions were not less risky.
• Those banks could not invest in some activities that performed poorly, but these activities were not expected to perform poorly.
Regulation, governance, macro
• Banks that did better come from tougher regulation, weaker governance, current account surplus countries.
• All banks in the bottom quartile of performance come from countries with formal deposit insurance.
Are we on the right track?
• Ever more complicated and intrusive regulation can’t work.
• It would be much better to make the system safer by making sure that the collapse of a financial institution has no significant impact.
• We have gone the opposite way, though.