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Is A Less Pro-Cyclical Financial System An Achievable Goal? P y y G Lessons For Domestic and Global Financial Regulation

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This document summarizes a presentation given at a Central Bank of Argentina conference on the financial crisis. The presentation discusses [1] how regulatory rules like mark-to-market accounting and value-at-risk contributed to procyclical behavior in the financial system. It also examines [2] how to reduce this procyclicality, such as by using time-varying capital requirements or mandatory convertible debt. Finally, it outlines [3] four lessons for regulatory reform focusing on controlling leverage, managing deleveraging, and tying rules to the underlying incentives around equity financing.

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30 views8 pages

Is A Less Pro-Cyclical Financial System An Achievable Goal? P y y G Lessons For Domestic and Global Financial Regulation

Uploaded by

api-26091012
This document summarizes a presentation given at a Central Bank of Argentina conference on the financial crisis. The presentation discusses [1] how regulatory rules like mark-to-market accounting and value-at-risk contributed to procyclical behavior in the financial system. It also examines [2] how to reduce this procyclicality, such as by using time-varying capital requirements or mandatory convertible debt. Finally, it outlines [3] four lessons for regulatory reform focusing on controlling leverage, managing deleveraging, and tying rules to the underlying incentives around equity financing.

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Attribution Non-Commercial (BY-NC)
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CENTRAL BANK OF ARGENTINA

MONEY AND BANKING CONFERENCE

“LESSONS AND CHALLENGES FOR EMERGING COUNTRIES


DURING THE CRISIS”
August 31-September 1, 2009
Buenos Aires, Argentina

Is a less ppro-cyclical
y financial system
y an achievable ggoal?
Lessons for domestic and global financial regulation

Anil K Kashyap

1
Sources of Procyclicality
• Regulatory

– Mark to Market plus Value at Risk

• Inevitable Market Discipline

2
Leverage and Asset Growth for Large US Commercial Banks

Leverage and Asset Growth for Large US Banks

0.06

0.05

0.04

0.03
Asset (log change)

0.02

0.01

0 2008-Q4

-0.01 1992-Q4 2009-Q2

2009-Q1
0 02
-0.02
2001-Q4
-0.03
-0.08 -0.06 -0.04 -0.02 0 0.02 0.04 0.06
Leverage (log change)

Source: updated from Greenlaw, Hatzius, Kashyap, Shin (2008)

3
Combating Procyclicality

C apital
• Regulation concerns Assets

• Preventing deleveraging means either:


• Stopping asset sales
• Forcing institutions to raise capital from the market
• Hard-wiring capital infusions

5
Policy options
• Time-varying capital requirements
– But, capital is a tax to the banks (agency costs)
– Forbearing during a crisis is unlikely to help

• Mandatory Convertible Debt


– Better response to fundamental reluctance to hold
capital
– Various potential triggers
• Flanneryy
• Kashyap, Rajan, Stein
• Squam Lake Working Group

6
(New/Old Idea) Capital Permits
(Kashyap-Stein
(Kashyap Stein 2004)

• Auction p
permits that count as “capital
p duringg
booms” (i.e. when the market capital constraint
is NOT binding).
g)

• Macro prudential regulator could target the


price of these permits or the quantity of permits
– Adds a tool that is separate from monetary policy
– Generates some useful information for the regulator

7
Four lessons for regulatory reform
1. De-leveraging is very disruptive

2. We need to pay more attention to leverage and think


about how to manage it

3. The short term interest rate matters for repo


p and hence
leverage

4. Regulation should be tied to fundamental frictions that


lead financial firms to have little equity financing

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