Central Banking at a Crossroads: Europe and Beyond (Anthem Frontiers of Global Political Economy and Development)

This Book Reflects On The Innovations That Central Banks Have Introduced Since The 2008 Collapse Of Lehman Brothers To Improve Their Modes Of Intervention, Regulation And Resolution Of Financial Markets And Financial Institutions. Authors From Both Academia And Policy Circles Explore These Innovations Through Four Approaches: ?bank Capital Regulation? Examines The Basel Iii Agreement; ?bank Resolution? Focuses On Effective Regimes For Regulating And Resolving Ailing Banks; ?central Banking With Collateral-based Finance? Develops Thought On The Challenges That Market-based Finance Pose For The Conduct Of Central Banking; And ?where Next For Central Banking? Examines The Trajectory Of Central Banking And Its New, Central Role In Sustaining Capitalism. Introduction / Charles Goodhart, Daniela Gabor, Ismail Ertürk, And Jakob Vestergaard -- Constraining Descretion In Bank Regulation / Andrew G. Haldane -- Myths And Fallacies In The Discussion On Capital Regulation / Anat R. Admati, Peter M. Demarzo, Martin F. Hellwig, And Paul Pfleiderer -- Complexity, Interconnectedness: Business Models And The Basel System / Adrian Blundell-wignall, Paul Atkinson, And Caroline Roulet -- At The Brink Of Insolvency: Shallow Recapitalization Exercise Fails To Bolster Europe's Ailing Banks / Jakob Vestergaard And Maria Retana -- Bank Resolution In Comparative Perspective : What Lessons For Europe? / Charles Goodhart -- Resolving Problem Banks : A Review Of The Global Evidence / Martin Cihák And Erlend Nier -- Bank Resolution In New Zealand And Its Implications For Europe / David G. Mayes -- Collateral And Monetary Policy / Manmohan Singh -- The Ecb And The Political Economy Of Collateral / Daniela Gabor -- The Backstory Of The Risk-free Asset : How Government Debt Became Safe / Nina Boy -- Central Banking Post-crisis : What Compass For Uncharted Waters? / Claudio Borio -- Reconceptualizing Central Bank Unconventional Policies : Long Positions On No-growth Capitalism / Ismail Ertürk -- The Relationship Between Central Banks And Governments : What Are Central Banks For? / Sheila C. Dow -- Is New Governance The Ideal Architecture For Global Financial Regulation? / Annelise Riles -- Index. Edited By Charles Goodhart, Daniela Gabor, Jakob Vestergaard And Ismail Ertürk. Includes Bibliographical References And Index. Central Banking at a Crossroads: Europe and Beyond 4 Contents 6 Preface 8 1 Charles Goodhart & al.: Introduction 10 Background and Key Themes 10 Overview of Chapters 13 Part 1: Bank Capital Regulation 13 Part 2: Bank Resolution 15 Part 3: Central Banking with Collateral-Based Finance 17 Part 4: Where Next for Central Banking? 19 Part 1: Bank Capital Regulation 22 2 Andrew G. Haldane: Constraining Descretion in Bank Regulation 24 Introduction 24 The Emergence of Self-Regulation 24 Unfulfilled Ambitions 26 Leveling the playing field 26 Complexity and risk sensitivity 30 Risk shifting and robustness 32 Unintended Consequences 33 Cost of compliance 34 The unlevel playing field 34 Transparency and market discipline 35 Where Next? 36 Greater transparency 36 Imposing floors 37 Prioritizing leverage ratios 38 Conclusion 38 Notes 39 References 39 3 Anat R. Admati & al.: Myths and Fallacies in the Discussion on Capital Regulation 42 Introduction 42 Capital Structure Fallacies 43 What is capital and what are capital requirements? 43 Equity requirements and balance sheet mechanics 44 Equity requirements and return on equity 46 Capital structure and the cost of capital 47 Arguments Based on a Confusion of Private and Social Costs 48 Tax subsidies on debt 48 Bailouts and implicit government guarantees 49 Debt overhang and resistance to leverage reduction 50 Equity Requirements and Bank Lending 51 Policy Recommendations 53 Concluding Remarks 55 Notes 56 References 57 4 Adrian Blundell-Wignall, Paul Atkinson, and Caroline Roulet: Complexity, Interconnectedness: Business Models and the Basel System 60 Abstract 60 I. Introduction 60 II. The Basel System Historically 61 III. The Basel III Reforms 63 National approaches recognize that Basel III is not enough 66 Assessing Basel III 67 Complexity and leverage 68 Interconnectedness and business model risk 70 Counterparty derivatives and repo risk that is separable from leverage rules 71 IV. New Empirical Evidence on Leverage and Interconnectedness Risk 74 The distance to default 74 Modeling the DTD 75 No one capital rule will suffice 77 Concluding Remarks 79 Notes 80 References 81 5 Jakob Vestergaard and María Retana: At the Brink of Insolvency: Shallow Recapitalization Exercise Fails to Bolster Europe’s Ailing Banks 84 I. Introduction 84 II. Stress Tests and Recapitalization Exercises 85 From stress tests to recapitalization 85 Scapegoating Southern European banks? 86 III. The Continued Undercapitalization of European Banking 88 Methodology 88 Overall results 89 The core of the problem is in the core of the Eurozone: German and French banks 91 IV. European Recapitalization in Perspective 93 Capital requirements weaker than Basel III though presented as tougher 93 Equity capital requirements far too low to significantly enhance resilience 94 V. The CRD4: Institutionalizing the Reluctance to Recapitalize? 95 Controversies 96 The CRD4 is a major setback compared to Basel III 96 Discussion 97 VI. Concluding Remarks 98 Notes 100 References 100 Part 2: Bank Resolution 104 6 Charles Goodhart: Bank Resolution in Comparative Perspective: What Lessons for Europe? 106 Introduction 106 What Should Happen? 108 What May Go Wrong and What to Do About It 108 Cross-border, universal banks and the point of entry 108 The timing of intervention 111 The coverage of deposit insurance 112 Bail-inable bond and contagion 113 The banking resolution fund 114 Conclusions 114 Notes 115 References 116 7 Martin Čihák and Erlend Nier: Resolving Problem Banks: A Review of the Global Evidence 118 Introduction 118 The Case for Special Resolution Regimes 118 Changes in Resolution Regimes during the Global Financial Crisis 120 Principles and Design of the Framework 121 Principles 121 Scope 122 Thresholds 122 Early intervention 123 Tools 124 Beyond the Special Resolution Regime 126 Cross-Border Issues 128 Conclusion 129 Notes 129 References 130 8 David G. Mayes: Bank Resolution in New Zealand and Its Implications for Europe 132 Splitting the Bank 134 Can One Ignore the Australians? 135 Bailing In 137 Swift Action 141 An Error over Deposit Insurance 142 Concluding Remarks 144 Notes 145 References 147 Part 3: Central Banking with Collateral-Based Finance 150 9 Manmohan Singh: Collateral and Monetary Policy 152 Introduction 152 Price of Money and Price of Collateral 153 The Changing Collateral Space 154 Central banks 155 New regulations 156 Custodians 156 New (net) debt issuance 158 What does all this mean for the new collateral space? 158 Collateral and Monetary Policy, via the IS/LM Framework 159 The Collateral Implications of Exit Strategies 162 Conclusion 164 Notes 164 References 165 10 Daniela Gabor: The ECB and the Political Economy of Collateral 166 Introduction 166 Theoretical Perspectives: Central Banks’ Intervention in Financial Markets 167 The relationship between central banks and financial markets during “normal times” 167 The relationship between central banks and financial markets during crisis 168 Sovereign funding costs as benchmark for banks ’debt issuance during crisis times 174 Repo (collateralized market) funding and collateral management strategies 174 Understanding the ECB’s Dilemmas 177 Conclusion 182 Notes 183 References 183 11 Nina Boy: The Backstory of the Risk-Free Asset: How Government Debt Became “Safe” 186 I. Introduction 186 II. The Mystery/History of Sovereign Safety 187 III. Fiction and Public Credit 190 IV. Conclusion 193 Notes 193 References 194 Part 4: Where Next for Central Banking? 198 12 Claudio Borio: Central Banking Post-Crisis: What Compass for Uncharted Waters? 200 Introduction 200 I. The Evolving Intellectual Backdrop 201 Pre-crisis 202 Post-crisis 203 II. A Way Forward? Working Hypotheses 204 III. A Way Forward? Implications for Central Banking 208 Proposed adjustments to policy regimes 208 Challenges and open questions 209 Conclusion 211 Postscript 212 I. Some Stylized Facts 212 II. How Far Has the Compass Provided Guidance? 214 III. Assessment of Outcomes and Risks 215 Conclusion 218 Notes 218 References 220 13 Ismail Ertürk: Reconceptualizing Central Bank Unconventional Policies: Long Positions on No-Growth Capitalism 226 Convergence to Central Bank Unconventional Policies in Core Capitalist Countries after the 2007 Crisis 226 The Rise of Unconventional Central Bank Policies 227 Central Banks’ Long Position on a Low-Growth Capitalism 230 Large-Scale Asset Purchases as a Long Position on Low-Growth Capitalism 232 Conclusion 235 References 237 14 Sheila C. Dow: The Relationship Between Central Banks and Governments: What Are Central Banks For? 238 Introduction 238 Banking History and the Role of Collateral 239 Central Banks and Financial Stability 241 Central Bank Independence 245 Conclusion 250 Notes 250 References 251 15 Annelise Riles: Is New Governance the Ideal Architecture for Global Financial Regulation? 254 Introduction: Regulatory Pluralism and the Interrelationship of Legal Regimes 254 Part II: The FSB Approach to Global Financial Architecture 256 A. The challenge of G-SIFIs as a problem of international legal coordination 256 B. The limits of harmonization as a coordination technique 258 C. Three key elements of FSB methodology 260 D. Conclusion to Part II 262 Part III: The New Governance Approach 262 A. What is new governance? 262 B. Addressing the democracy deficit 263 C. Conclusion to Part III 263 Part IV: New Governance in Practice: A Critical Appraisal 264 A. Lessons learned from new governance in financial regulation prior to 2008 264 B. Practical shortcomings in the application of new governance by the FSB 265 Part V: Conclusion 268 A. Possible avenues for reform 268 B. Recommendation 270 Note 271 References 271 List of Contributors 274 Index 280 Since the 2008 collapse of Lehman Brothers, central banking has changed dramatically. Over the past five years central banks have intervened in both public and private debt markets, taking on functions of dealers of last resort, while simultaneously designing regulatory and resolution frameworks with the explicit aim of changing bank business models, all in order to contain and better address systemic risk. This book explores these developments through collected essays from authors from both academia and policy circles, and sets them in the context of the European crisis. Central Banking at a Crossroads reflects on the innovations central banks have made to improve their modes of intervention, regulation and resolution of financial markets and financial institutions in four related sections: Bank Capital Regulation examines the Basel III agreement, identifying its key novelties and shortcomings vis-a-vis its predecessor, Basel II; Bank Resolution focuses on effective regimes for regulating and resolving ailing banks; Central Banking with Collateral-Based Finance develops thought on the challenges that market-based finance pose for the conduct of central banking in periods of economic stability and, through a critical theoretical angle, the important role that governments play for financial markets as manufacturers of high-quality collateral or safe assets; and, finally, Where Next for Central Banking examines the trajectory of central banking, its issues, and its new, central role in sustaining capitalism. " Preface; 1. Introduction; 2. Constraining Discretion in Bank Regulation; 3. Fallacies and Irrelevant Facts in the Discussion of Capital Regulation; 4. Complexity, Interconnectedness: Business Models and the Basel System; 5. At the Brink of Insolvency: Shallow Recapitalization Exercise Fails to Bolster Europe’s Ailing Banks; 6. Bank Resolution in Comparative Perspective: What Lessons for Europe?; 7. Resolving Problem Banks: A Review of the Global Evidence; 8. Bank Resolution in New Zealand and Its Implications for Europe; 9. Collateral and Monetary Policy; 10. The ECB and the Political Economy of Collateral; 11. The Backstory of the Risk-Free Asset: How Government Debt Become “Safe”; 12. Central Banking Post-Crisis: What Compass for Uncharted Waters?; 13. Reconceptualising Central Bank Unconventional Policies: Long Positions on No-Growth Capitalism; 14. The Future Relationship between Central Banks and Governments: What Are Central Banks For?; 15. Is New Governance the Ideal Architecture for Global Financial Regulation?; Contributors; Index