On Tackling the Credit Cycle and Too Big To Fail

Transcription

1 On Tackling the Credit Cycle and Too Big To Fail Andrew Haldane Bank of England January

2 Peak to trough metrics: Cost of Crisis Temporary loss of world output: $ 4 trillion Loss of banks market value: $ 5 trillion Government intervention: $ 15 trillion Mark-to-market asset loss: $ 24 trillion NPV loss of world output: $ trillion 2

3 Two root causes: Roots of Systemic Risk Credit cycle conjuncture Too-big-to-fail structure Two roots inter-twined during this crisis Ireland is a prime case study of both 3

4 Credit Growth Growth of domestic credit Percentage change oya Ireland Portugal Spain UK Greece Source: IMF International Financial Statistics (IFS). (a) Domestic credit includes lending to the private sector, government and financials. Data are not seasonally adjusted. (b) Data prior to euro area ascension adjusted for exchange rate effects. 4

5 Credit Cycles in History UK US Credit cycle as much a stylised fact as business cycle only bigger 5

6 Asset Price Cycle in History UK US And asset price cycle bigger still 6

7 Credit Cycles and Crises Crisis Frequency (%) Credit Boom Frequency (%) % Credit Booms with Crisis Within 5 Years US 22% 7% 67% UK 16% 7% 78% France 16% 8% 60% Canada 12% 9% 55% Spain 26% 10% 63% Average 17% 7% 51% Credit cycles typically precede crisis 7

8 Chuck Prince Dynamics Price-to-Book ratios (UK, US and European banks) European LCFIs US LCFIs Major UK banks (b) Ratio Credit cycles often rooted in copy-cat competition 8

9 Chuck Prince Dynamics Dispersion of US bank/non-bank returns Dispersion of US bank/non-bank ROEs Co-ordination failures keeping up with Jones's 9

10 International Credit Cycles Credit GDP Credit cycle increasingly international 10

11 From Credit Cycles to Banking Structure Liabilities (2001=100) of banks and building societies by size Credit growth driven by big banks 11

12 From Credit Cycles to Banking Structure Much of lending within financial sector 12

13 From Credit Cycles to Banking Structure Network connectivity balloons 13

14 Size +... Average assets relative to GDP of US commercial banks Much bigger banks 14

15 Concentration + Concentration of the US banking system More concentrated banking system 15

16 ... Leverage + Capital ratios for UK and US banks With higher leverage 16

17 ... Illiquidity = Sterling liquid assets relative to total assets And fewer liquid assets 17

18 = Moral Hazard... Estimated size of total implicit funding subsidy to UK banks and building societies split by size 18

19 The Doom Loop Size + Leverage + Illiquidity = Moral Hazard Size + Leverage + Illiquidity = (Moral Hazard) 2... Credit cycles and TBTF an evolutionary equilibrium 19

20 Two key dimensions: Policy Options Micro-prudential regulation Macro-prudential regulation 20

21 Micro-prudential Regulation Basel III agreement in 2010 repairing cracks More of the same but better More capital but better quality More liquidity but better quality More regulators/ions but better quality Sound familiar? 21

22 Re-considering the Basel Basics Complexity? Robustness? Timeliness? How much is enough? 22

23 Complexity and Basel Risk Categories Calculations Basel I 7 7 Basel I: back of envelope calculation 23

24 Complexity and Basel Risk Categories Calculations Basel I 7 7 Basel II/III >200,000 >200 million Basel I: back of envelope calculation Basel II/III: big envelope over-fitted? Little of this is transparent to the market 24

25 10.0% Timeliness and Basel 9.0% 8.0% 7.0% 'No crisis' banks 6.0% 'Crisis' banks 5.0% 8% threshold 4.0% Lehman failure 15 Sep % 2.0% 1.0% 0.0% May 02 Nov 02 May 03 Nov 03 May 04 Nov 04 May 05 Nov 05 May 06 Nov 06 May 07 Nov 07 May 08 Nov 08 25

26 Uncertainty and Basel: Retail Credit 26

27 An Alternative Capital Structure C(oCos) + D(ebt) + E(quity) = CDE CoCos have market-based triggers Simple Timely Contractual prompt corrective action Quasi-automatic lessons time-consistency problem 27

28 15.0% Timeliness and Market Measures 12.5% 'No crisis' banks 10.0% 'Crisis' banks 7.5% 5% threshold 5.0% 2.5% Lehman failure 15 Sep % May 02 Nov 02 May 03 Nov 03 May 04 Nov 04 May 05 Nov 05 May 06 Nov 06 May 07 Nov 07 May 08 Nov 08 28

29 Problems with CoCos Cost? Speculative attack? Demand? 29

30 Banks Optimal Capital Structure 30

31 Resilience and Cocos Major UK banks' Tier 1 capital ratio assuming banks paid half of dividends and bonuses as contingent capital Cumulative amount of Tier 1 capital if the major UK banks had paid half of bonuses and dividends as contingent capital 31

32 Macro-prudential Regulation Time-series Taming credit cycle Cross-section Tackling TBTF New institutional apparatus FSOC (US) ESRB (EU) FPC (UK) 32

33 Taming the Credit Cycle Counter-cyclical capital ratios Basel III agreements Counter-cyclical risk weights Sectoral exuberance Loan-to-value ratios? Asian experience 33

34 Counter-cyclical Capital Capital surcharges for cyclical overexuberance 34

35 Tackling TBTF Capital surcharges Basel/FSB calibration Resolution regimes: Commission consultation document Bail-In debt Recovery and resolution plans Structure of banking UK Independent Commission 35

36 Impact of EU bank bail-in proposals European banks US banks (a) Index: 30 December 2010 = December January 80

37 Systemic Capital Capital surcharges for spillover risk 37

38 Conclusion World cannot afford another systemic crisis on this scale literally and metaphorically Fundamental reform essential to break doom loop Progress but more required 38