Regulation of global banking principles and policies taylor

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Global Bank Regulation Dedications: For Pete, Steve, Thor and John (H.M.S.) For J.B., as always (M.W.T.) Acknowledgments: We thank our editor at Elsevier J Scott Bentley for his patience and encouragement from the very beginning to the much delayed end of this project We are also grateful to Elsevier’s production team, including Melinda Rankin, for assistance in seeing this book through the press We also thank various anonymous referees for their thoughtful input; David Llewellyn and Howell Jackson for their support; and Timothy Mueller for his excellent research assistance Students in various classes that we have taught over the years have helped us to refine individual chapters and the concept of the book To our families, we are grateful for their forbearance (which when not practiced by regulators is a virtue) Global Bank Regulation Principles and Policies Heidi Mandanis Schooner Michael W Taylor AMSTERDAM • BOSTON • HEIDELBERG • LONDON NEW YORK • OXFORD • PARIS • SAN DIEGO SAN FRANCISCO • SINGAPORE • SYDNEY • TOKYO Academic Press is an imprint of Elsevier Academic Press is an imprint of Elsevier 30 Corporate Drive, Suite 400, Burlington, MA 01803, USA 525 B Street, Suite 1900, San Diego, California 92101-4495, USA 84 Theobald’s Road, London WC1X 8RR, UK © 2010 ELSEVIER Inc All rights reserved No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage and retrieval system, without permission in writing from the publisher Details on how to seek permission, further information about the Publisher’s permissions policies and our arrangements with organizations such as the Copyright Clearance Center and the Copyright Licensing Agency, can be found at our website: www.elsevier.com/permissions This book and the individual contributions contained in it are protected under copyright by the Publisher (other than as may be noted herein) Notices Knowledge and best practice in this field are constantly changing As new research and experience broaden our understanding, changes in research methods, professional practices, or medical treatment may become necessary Practitioners and researchers must always rely on their own experience and knowledge in evaluating and using any information, methods, compounds, or experiments described herein In using such information or methods they should be mindful of their own safety and the safety of others, including parties for whom they have a professional responsibility To the fullest extent of the law, neither the Publisher nor the authors, contributors, or editors, assume any liability for any injury and/or damage to persons or property as a matter of products liability, negligence or otherwise, or from any use or operation of any methods, products, instructions, or ideas contained in the material herein Library of Congress Cataloging-in-Publication Data Schooner, Heidi M   Global bank regulation : principles and policies / Heidi M Schooner, Michael Taylor    p cm   Includes bibliographical references and index   ISBN 978-0-12-641003-7 (alk paper)   1.  Bank management.  2.  Financial institutions.  3.  Globalization.  I.  Taylor, Michael (Michael W.), 1962-  II.  Title   HG1615.S36 2009   332.1′5—dc22 2009029850 British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library ISBN: 978-0-12-641003-7 For information on all Academic Press publications visit our Web site at www.elsevierdirect.com Printed in the United States of America 09  10  11  12  13  9  8  7  6  5  4  3  2  Working together to grow libraries in developing countries www.elsevier.com | www.bookaid.org | www.sabre.org Contents Introduction: The Global Financial System and the Problems of Regulation xi The Changing Nature of Banks Definitions Money, Credit Creation, and Fractional Reserve Banking Financial Innovation and the Changing Nature of Banks Three Distinctive Features of Modern Banking References Further Reading 11 17 17 Panics, Bank Runs, and Coordination Problems 19 The Structure of Banks’ Balance Sheets Coordination Problems and Bank Runs Panic and Contagion in Modern Financial Systems Free Riders and Regulation References Further Reading 20 24 27 32 34 34 Collapsing Dominos and Asset Price Spirals 35 Collapsing Dominos Asset Price Spirals The Global Financial Crisis of 2007–2009 References Further Reading 36 42 45 49 49 The Financial Safety Net and Moral Hazard 51 The Financial Safety Net Moral Hazard Is There an Alternative? References Further Reading 53 60 67 70 72 vi Contents Sources of Financial Regulation National Laws International Law References Further Reading Bank Licensing and Corporate Governance The Purpose of Bank Licensing The Fundamentals of Bank Licensing Fitness and Propriety of Bank Management Significant Changes in Ownership Choice of Bank Charter Cross-Border Issues Principles of Sound Corporate Governance Sarbanes-Oxley Act of 2002 References Further Reading Bank in Corporate Groups: Ownership and Affiliation Bank-Commerce Linkages The Separation of Banking and Finance Changes to Structural Regulation of the Combination of Banking and Other Financial Services References Further Reading The Rationale for Bank Capital Regulation Why Regulate Bank Capital? Leverage Ratios Risk-Weighted Capital Criticisms of the Basel Capital Accord References The New Capital Adequacy Framework: Basel II and Credit Risk The Standardized Approach The Internal Ratings-Based (IRB) Approaches Dealing with Financial Innovation 73 74 76 87 88 89 92 95 97 99 100 103 105 107 109 110 111 112 121 124 129 130 131 132 135 137 141 144 147 149 152 159 Contents vii References Further Reading 10 The New Capital Adequacy Framework: Basel II and Other Risks Market Risk Operational Risks Pillar Risks References Further Reading 11 Direct Limits on Banks’ Risk Taking Credit Concentration Risk Liquidity Risk References 12 Consolidated Supervision and Financial Conglomerates What Is Consolidated Supervision? The Need for Consolidated Supervision Consolidated Supervision of Cross-Border Banks Financial Conglomerates References 13 Anti-Money Laundering What Is Money Laundering? The Impact on Banks International Response Banco Delta Asia Case Study References Further Reading 14 Bank Insolvency The Goals and Types of Bank Insolvency Regimes Legal Framework for Bank Insolvency Determination of Insolvency Administration Orders and Conservatorships Receivership References Further Reading 164 164 165 166 174 177 182 182 183 184 193 202 205 208 211 215 216 222 223 224 225 226 235 238 239 241 243 245 245 246 247 258 258 viii Contents 15 Institutional Structures of Regulation Institutional and Functional Regulation Rise of the Integrated Regulator Twin Peaks (Objectives) Approach Role of the Central Bank in Bank Supervision Evaluation of Structural Reforms References Further Reading 259 260 265 267 269 273 276 277 16 Regulation After the Global Financial Crisis 279 The Causes of the Crisis Rethinking the Assumptions of Regulation New Directions in Capital Adequacy More Radical Options The International Dimension References 280 284 286 289 292 294 Appendix: Introduction to Regulation and Market Failure Index 297 307 312  Index generalized bank runs, 26–27 Global Financial Crisis (2007–2009), 46 interbank market, 28–29 as justification for regulation, 32–33 Continental Illinois National Bank, 63, 194b, 234–236 control environment, assessment of, 180 conventions, international See international law; treaties conversion of bank charter, 102 Convertibility Law (Argentina), 69 cooperation, international, 85, 293 See also soft law international standards cooperation with law enforcement, 231–232 coordination problems, 24–27 See also bank runs generalized bank runs, 26–27 core capital, 138–139, 139f Core Principles for Deposit Insurance (IADI), 57–58 Core Principles for Effective Banking Supervision (BCBS), 81–82, 93, 95, 106 on large exposures policies, 192–193 list of, 106 on significant changes to ownership, 99 Core Principles for Systemically Important Payment Systems (CPSS), 83 Core Principles Methodology (BCBS), 81 corporate governance practices, 90–91 cross-border issues, 103–105 defined, 105–106 entry requirements, 90 failures in (Global Financial Crisis), 282–283 general insolvency law and, 226 licensing See licensing requirements liquidity management, 197 managerial fitness See fitness and propriety of bank management principles of, 105–107 Basel Principles on Corporate Governance See Core Principles for Effective Banking Supervision (BCBS) failures, Global Financial Crisis and, 282–283 general insolvency law and, 226 Principles of Corporate Governance (OECD), 83, 91, 105–106 correlation between financial markets, 171–172 correspondent banks, 40–41 Corrigan, Gerald, 202 cost of bank failures, 135 See also bank capital regulation cost of banking crises, 51–52 cost of regulation, 304–305 countercyclical capital requirements, 288–289 Countering the Financing of Terrorism (CFT) See terrorist financing Counterparty Risk Management Policy Group, 202 court-administered process for bank insolvency, 227 determination of insolvency, 226–235 IMF on, 227–228 covenants, international See international law; treaties covered transactions, 212 CPSS See Committee on Payment and Settlement Systems creating money See money creation credit cards, credit concentration risk, 178, 184–193 bank failure from, 224 international standards, 192–193 large exposure limits (EU), 189–192 large exposure limits (U.K.), 187–189 lending limits, U.S., 185–187 single borrower limitation, 185–186, 191 See also lending limits, U.S credit crunch, manifestations of, 55–56 credit default swaps, 42, 47 credit derivatives, 163–164 credit institutions, Credit Institutions Directive (EU, 2000), 189 Crédit Mobilier (France), 117 credit rating agencies encouraging international compliance, 85–86 recognized for regulatory purposes, 152 reliance on, 283–284 credit ratings hedging against deterioration of See credit derivatives internal, 154–155 reliability of, 178, 283–284 reliance on, 283–284 risk weightings tied to See Standardized Approach (Basel II) credit risk See entries at risk credit scores, 154–155 Creditanstalt bank (Austria), 29–30 creditworthiness, linked for several borrowers, 184 See also credit concentration risk crises Asia (1997–1998), 30, 58–59 insider lending, 121 overleveraging in Korean banks, 121 costs of, 51–52 financial safety net See financial safety net global (2007–2009) See Global Financial Crisis (2007–2009) Japan banking (1990s), 58–59 Latin America (1980s), 29–30 prevention through regulation See regulation, reasons for (against) Thailand (1990s), 31 U.S banking crisis (1980s-1990s), 224 Cross-Border Bank Resolution Group, 236 cross-border banking, 8–10 consolidated supervision of, 215–216 See also consolidated supervision fundamental questions, 103–105 rethinking regulations after Global Financial Crisis, 292–294 CSE program, 169 currency conversion between, creation of, currency transaction reports (CTRs), 231–232 current market prices, 167–168 customer due diligence and record keeping, 228 Customer Due Diligence for Banks (BCBS), 227 customer identification policies, 226–229 D-D model, 25 debt of bank affiliates, liability for, 211 capital vs bank dept, 132–135 debt/equity ratio (loan/deposit ratio), 11, 134–135 upper limit (leverage ratios), 135–137, 287–288 decisions (European Communities legislation), 78 deductible with deposit insurance, 64–65 default rate estimates, 178–179 demandable debt instruments, Democratic People’s Republic of Korea (DPRK), 235–238 demutualized building societies, 199b–200b Department of Treasury See Treasury (U.S.) deposit insurance, 52, 56–59 applying for (U.S.), 95–96 See also Federal Deposit Insurance Corporation Argentinian no-bailout policy (1991), 69 CDIC See Canadian Deposit Insurance Corporation design to limit moral hazard, 64–66 efficient market hypothesis and, 68 and least-cost rule on insolvency resolutions, 234–235 moral hazard with See moral hazard problem principal objectives of, 57–58 receivership and, 232 deposit insurer as bailout source, 60 depositors expectations as self-fulfilling, 25 information asymmetry problem, 27, 33 insuring See deposit insurance deposits on balance sheet, 20, 132, 133f created by central banks, 54 See also money creation as demandable debt, maturity transformation (maturity gap), 20–21, 118–119 money laundering See money laundering moral hazard and, 61, 62f reliance on See loan/deposit ratio Index  313 repay-on-demand contract, 25 required reserves See required reserves role of, 3–4 taking of, as defining feature, 2–3 deregulation See entries at regulation deregulation of banking and finance (1980s), 9, 279–280 derivatives markets See credit derivatives desegregation of banking from financial services, 10 design of regulatory institutions See institutional structures of regulation determination of insolvency, 226–235 Deutsche Bank, 117 direct benefit test, 185–186 direct investment, defined, direct limits on risk taking, 184–193 See also credit concentration risk; liquidity risk Directive on the Reorganization and Winding up of Credit Institutions, 237 directives (European Communities legislation), 78–79 directors of banks, independence of, 119–120 See also ownership of bank DIS See deposit insurance disaggregation of loan function, 15–16 disclosure of information asymmetry of See information asymmetry problem cooperation with law enforcement, 231 cross-border banking, 104 information-based contagion, 27 obfuscation by complex group structures, 214–215 public, Basel II requirements on, 148–149 as responsibility of regulatory authority, 274 secrecy laws, 104 Bank Secrecy Act, 229–230, 230f, 233f money laundering and, 228 discount rate, discount window lending, dishonest bank managers See fitness and propriety of bank management disintermediation, 10–11 diversification credit concentration risk, 178 financial conglomerates, 124 insider lending and, 121 operational risk and, 174–176 domino-like collapse, 35–42 Bankhaus Herstatt collapse, 39b–41b too big to fail, 60, 63–64, 225, 291 constructive ambiguity, 64 Continental Illinois National Bank as, 234 too interconnected to fail, 42, 63–64 double coincidence of wants, double gearing, 213, 214f dual banking system, 100–103 dynamic provisioning, 288 314  Index EAD See exposure at default EC sec, 79 ECB See European Central Bank economic capital, 179–180 economic development, financing of, 117 economic goals with bank supervision, 271–272 economic sector, several borrowers in, 184, 192 See also credit concentration risk economics of information See asymmetry of information economies of scope, 123 effective bank management See fitness and propriety of bank management efficient market hypothesis, 67 Efficient Markets School, 52, 67–68, 285–286 emergency loans See government bailout; lender of last resort employees (bank), ethical standards for, 229–231 enforcement See compliance entry requirements, 90 equity See capital (equity) equity market system See Anglo-Saxon separation of banking and commerce equity securities, market risk with, 170 equity/assets ratio, 135–136 risk assets ratio, 138 target and trigger capital ratios, 181 ESFS (European System of Financial Supervisors), 293 ESRC (European Systemic Risk Council), 293 ethical standards of conduct and deterrence, 229–231 European Central Bank (ECB), 102 See also central banks federal European charters, 102–103 European Communities secondary legislation, 77–78 European Court of Justice, 78 European System of Financial Supervisors (ESFS), 293 European Systemic Risk Council (ESRC), 293 European Union See also Capital Requirements Directive bank-commerce linkages in, 117–118 bank-finance linkages, 125–126 Directive on the Reorganization and Winding up of Credit Institutions, 237 Financial Conglomerates Directive, 216–221 function of banks, international agreements regarding banks, 77–78 large exposure limits, 189–192 passporting system, 101–102 risk-weighted capital requirements (RWCR), 137 See also Standardized Approach (Basel II) secondary legislation, 77–78 supervision of conglomerates, 212 evaluation of structural reforms, 273–276 ex ante funding of deposit insurers, 58 ex post funding of deposit insurers, 58 excessive risk taking, 60–63, 89–90 See also moral hazard problem; risk management direct limits on risk taking, 184–193 innovation and See financial innovation leverage ratios (LRs) and, 136–137 management compensation and, 235, 283, 285 minimizing, 64–66 See also regulation, types of exchange rates Bretton Woods system, 8–9 currency conversion, between metal coins, expectations of depositors, 25 expected losses (ELs), 152–154 experience as future predictor, 65 expert judgment system, 154–155 exposure at default (EAD), 153–154 estimating, 154 exposure limits See large exposures policies externalities, 298–300 Basel II failure to address, 289 negative externalities, 298–299 positive externalities, 299–300 taxing, 290 extrajudicial regulatory process for bank closure, 227 administration orders and conservatorships, 227–229 determination of insolvency, 226–235 IMF on, 227–228 failure, bank See insolvency; insolvency risk failure to comply See compliance failures in regulation (Global Financial Crisis), 283–284 fallacy of composition, 285 FATF See Financial Action Task Force FDIC See Federal Deposit Insurance Corporation FDICIA (Federal Deposit Insurance Corporation Improvement Act), 235 fear See panic in modern financial systems Fed Funds Rate See short-term money market interest rates Federal Deposit Insurance Corporation (FDIC), 57 applications for deposit insurance from, 95–96 capital-to-asset ratio requirements, 136 in definition of bank, 115 insolvency and FDIC as conservator, 229–230 FDIC as receivor, 230 study of bank failures, 224 risk-adjusted premiums, 65 as risk-minimizer deposit insurers, 58 Federal Deposit Insurance Corporation Improvement Act (FDICIA), 235 federal European charters, 102–103 Federal Financial Institutions Examination Council, 230 federal financial services provider (FFSP), 268 federal insurance institution (FII), 268 Federal Reserve, 38 See also central banks on bank-finance linkages, 127 Commercial Paper Funding Facility (CPFF), 56 explicit responsibility for systemic risk, 289–290 Term Asset-Backed Securities Loan Facility (TALF), 56 as umbrella supervisor for financial conglomerates, 218–219, 263–264 without authority over ILCs, 115–116 Federal Reserve Act (Australia), 268–269 supervision of conglomerates, 212 federal-insured depository institution (FIDI), 268 federally chartered banks See dual banking system Fedwire, 38 FFSP (federal financial services provider), 268 fiat money system, 54 FIDI (federal-insured depository institution), 268 FII (federal insurance institution), 268 Financial Action Task Force (FATF), 83–84, 226 on bank supervision (self-regulation), 233 on cooperation with law enforcement, 231 on customer due diligence and record keeping, 228 The Forty Recommendations (FATF), 226–227 on standards of conduct and deterrence, 229–231 on terrorist financing, 226, 234–235 financial conglomerates, 10, 123–124, 216–221 See also bank-finance linkages capital adequacy of, 219–221 complex group structures, 214–215 consolidated supervision of, 205–206 See also consolidated supervision contagion with, 212–213 institutional reform following, 266 intragroup exposures, 212–213 lead regulator concept, 217–219 Financial Conglomerates Directive (EU), 216–221 financial innovation, 7–11 after 3–6–3 banking, 10–11 Basel II and, 159–164 credit derivatives, 162–164 securitization, 160–162 encouraged by regulatory weaknesses, 283–284 as factor in Global Financial Crisis, 281–282 features of modern banking, 11–17 originate to distribute (OTD) model, 14–17 Index  315 reliance on money market funding, 11–13 securitization, 13–14 financial institutions as bank owners, 121–124 changes to structural regulation, 124–129 financial intelligence units (FIUs), 231 financial regulation See entries at regulation financial reports, consolidated, 209 See also consolidated supervision financial safety net, 51–72, 89–90 deposit insurance See deposit insurance fiscal support of, 52, 59–60 Argentinian no-bailout policy (1991), 69 moral hazard with See moral hazard problem as politically unpopular, 70 lender of last resort, 52–56 discount window lending vs., moral hazard with See moral hazard problem purchaser of last resort, 56 moral hazard with See moral hazard problem Financial Sector Assessment Program (FSAP), 86, 273 Financial Services and Markets Act (2000) (FSMA), 2–3, 75, 97, 125–126, 265 Minimum Standards provisions, 104 Financial Services Authority (FSA), 75, 96–97, 199b–200b bank-finance linkages, 125–126 creation of, 265 ensuring supervision by, 105 fitness and propriety of bank management, 98–99 repeal of 1987 Banking Act, 189 responsibilities of, 274–275 Financial Services Compensation Scheme (FSCS) as ex post funded, 58 as pay box system, 58 Financial Stability Board (FSB), 66, 84 guidelines for deposit insurers, 57–58 mandates for deposit insurers, 58 Financial Stability Forum See Financial Stability Board (FSB) financial statements certification of, 91, 107–109 complex group structures and, 215 financial subsidiaries of banks See bank-finance linkages FinCEN, 235–238 fiscal support See government bailout Fit and Proper Principles (BIS), 97–98 Fitch See rating agencies fitness and propriety of bank management, 97–99 See also corporate governance practices in bank-commerce linkages, 119–120 as factor in Global Financial Crisis, 282–283 Internal Capital Adequacy Assessment Process (ICAAP), 178–179 316  Index principles of corporate governance See corporate governance—principles of Sarbanes-Oxley Act (2002), 91, 107–109 flight to quality, 29 forbearance, 235 forecasts, value of, 302–303 The Forty Recommendations (FATF), 226–228 bank supervision (self-regulation), 233 cooperation with law enforcement, 231 customer due diligence and record keeping, 228 ethical standards of conduct and deterrence, 229–231 terrorist financing, 226 forward rate agreements (FRAs), 166–167 Foundation internal ratings-based approach, 154 rating system selection, 156–157 securitization and, 161–162 fractional reserve banking, 21–22 emergence of, required reserves See required reserves FRAs See forward rate agreements fraud, protection from See corporate governance practices free market revolution (1980s), free-rider problem, 32–33, 299–300 French Crédit Mobilier, 117 FSA See Financial Services Authority FSAP See Financial Sector Assessment Program FSB See Financial Stability Board (FSB) FSCS (Financial Services Compensation Scheme) as ex post funded, 58 as pay box system, 58 FSF See Financial Stability Board (FSB) FSF (Financial Stability Forum) guidelines for deposit insurers, 57–58 mandates for deposit insurers, 58 FSMA See Financial Services and Markets Act (2000) functional regulation, 260–265, 262t rise of integrated regulation, 262t, 265–267 funding for deposit insurers, 58 funding liquidity risk See liquidity risk future, information about, 302–303 game theory, 24–25 gearing ratio, 11, 134–135 upper limit (leverage ratios), 135–137, 287–288 General Guide to Account Opening and Customer Identification (BCBS), 227 general insolvency law See insolvency general market risk, 169–170, 171t generalized bank runs, 26–27 geographical area, several borrowers in, 184, 192 See also credit concentration risk geography, knowledge of, 29–30 Glass, Carter, 122 Glass-Steagall Act (1933), 9, 122–123, 262–263 modernized version of, 290–291 repeal of, 126 GLB See Gramm-Leach-Bliley Act (1999) Global Financial Crisis (2007–2009), 45–49, 224–225 blanket guarantees in response to, 58–59 causes of, 280–284 financial innovation, 281–282 macroeconomic background, 280–281 regulatory failures, 283–284 risk management and internal control failures, 282–283 FDICIA obligations during, 236 gearing ratio, Swiss banks, 135 government interventions, 48–49 investment banking industry, 46–47 management governance and, 91 market liquidity risk, 198–199, 201 regulation changes after capital adequacy, 286–289 international considerations, 292–294 radical options, 289–292 rethinking regulatory assumptions, 284–286 reliability of credit ratings, 178, 283–284 SEC responsibility for consolidated supervision, 218 systemic risk exception, 234–235 trading book losses, 168 U.S FDIC and, 57 global financial regulatory agency, 292 global imbalances, 280 Goldman Sachs, 46–47, 169 good bank, separating from bad bank, 232 governance See corporate governance practices government agencies, 75 government bailout, 52, 59–60 Argentinian no-bailout policy (1991), 69 moral hazard with See moral hazard problem as politically unpopular, 70 government failures, 304–305 government printing press See money creation government regulation See entries at regulation government-sponsored enterprises (GSEs), 13–14 Gramm-Leach-Bliley Act (1999) (GLB), 9–10, 116, 123, 126–127, 262–263 Greenspan, Alan, 61, 91 Group of Twenty, 79 group-wide risk assessment, 209 guarantees on large banks, 64 haircuts, 44 hedging credit risk See credit derivatives herding behavior, 31–32, 285–286 See also bank runs; contagion in modern financial systems Herstatt See Bankhaus Herstatt collapse highly leveraged, banks as, 22–23 high-powered money, 54 Hirsch, Fred, 53 historic cost, 166–167 hoarding liquidity, 45 holding companies, 95–96, 114–115 consolidated supervision and, 209–210, 216 fitness and propriety of bank management, 120 home country supervisors, right to gather information, 104 See also consolidated supervision honesty, managerial See fitness and propriety of bank management IADI See International Association of Deposit Insurers IAIS See International Association of Insurance Supervisors IASB See International Accounting Standards Board ICAAP (Internal Capital Adequacy Assessment Process), 178–179 identity-of-customer policies, 226–229 IIF (Institute for International Finance), 201–202 ILCs See industrial loan companies illiquidity risk See liquidity risk IMF See International Monetary Fund incompetent bank managers See fitness and propriety of bank management inconsistency in internal ratings systems, 158–159 incorporation, 92–93 incremental risk capital charge (IRC), 168 independence of board with banks in commercial groups, 119–120 independence of central banks, 269, 272–273 Indonesia, bank-commerce relationships in, 118 industrial firms as owners See bank-commerce linkages industrial loan companies (ILCs), 115–116 industry sector, several borrowers in, 184, 192 See also credit concentration risk industry-specific regulation See institutional regulation IndyMac Bank, 224–225 information asymmetry problem, 27, 33, 300–305 information disclosure cooperation with law enforcement, 231 cross-border banking, 104 obfuscation by complex group structures, 214–215 public, Basel II requirements on, 148–149 as responsibility of regulatory authority, 274 secrecy laws, 104 Bank Secrecy Act, 229–230, 230f, 233f money laundering and, 228 information-based contagion, 27 Index  317 innovation See financial innovation insider lending, 120–121 insolvency, 241–258 bank closure regimes, 243–244 administrative process for bank closure, 226–235 judicial process for bank closure, 226–235 conservatorships, 227–229 receiverships vs., 230 determination of, 226–235 legal framework for, 225–226 receivership, 229–231 resolution mechanisms, 231–232 insolvency risk, 22, 132–133 lack of regulation and, 24–27 maturity transformation risk, 20–21, 118–119 insolvent banks, lending to, 55 See also government bailout instability of unregulated banking, 67 See also Efficient Markets School Institute for International Finance (IIF), 201–202 institutional regulation, 260–265 rise of integrated regulation, 265–267 institutional structures of regulation, 259–277 evaluation of structural reforms, 273–276 global financial regulatory agency, 292 rise of integrated regulation, 265–267 role of central bank, 269–273 bank supervision, 270 concentration of power, 272 independence, 269, 272–273 macroeconomic and microeconomic goals, 271–272 Twin Peaks (objectives) approach, 267–269 weaknesses in, 283–284 insurance against credit quality deterioration See credit derivatives on deposits, 265–267 hazard of See moral hazard problem against systemic risk, 290 insurance companies financial institutions as bank owners, 121–124 changes to structural regulation, 124–129 solvency of, calculating, 220 technical provisions, 220 insured deposits See deposit insurance Interagency Charter and Federal Deposit Insurance Application, 96 interbank accounts, settling, 37 interbank market, 28–29 asset price spirals See asset price spirals Northern Rock and, 199b–200b too interconnected to fail, 42, 63–64 too-big-to-fail institutions, 63 interconnection of borrowers See credit concentration risk interest rate risk, 178 318  Index interest rates central bank responsibility over, 269 short-term money market interest rates, 7, 28, 269 Bankhaus Herstatt collapse, 39b–41b reliance on money market funding, 11–13 volatility following deregulation, 11 intermediated investment, defined, Internal Capital Adequacy Assessment Process (ICAAP), 178–179 internal control, failures of, 282–283 internal credit scores, 154–155 drawbacks of, 158–159 internal market risk models, 172 internal models approach to determining market risk, 171–174 internal ratings-based approaches (IRB), 107, 149–159 Advanced approach, 154 rating system selection, 156–157 securitization and, 161–162 assessment of, 157–159 estimating probability of default (PD), 154–155 expected and unexpected loss, 152–154 Foundation approach, 154 rating system selection, 156–157 securitization and, 161–162 rating system selection, 156–157 securitization and, 161–162 International Accounting Standards Board (IASB), 83 Consolidated and Separate Financial Statements, 209 dynamic provisioning, 288 International Association of Deposit Insurers (IADI), 57–58, 83 Core Principles for Deposit Insurance, 57–58 International Association of Insurance Supervisors (IAIS), 82 compliance, traditional approach to, 85 International Bank for Reconstruction and Development See World Bank international banks See cross-border banking International Conference of Banking Supervisors, 81 international contagion, 29–32 international cooperation See cooperation, international international financial regulatory agency, 292 International Financial Reporting Standards (IASB), 83 international law, 76–87 compliance with, 85–87 nonbinding standards, 76–77, 85 See also soft law international standards peer pressure, 85 international agreements, 77–79 rethinking regulations after Global Financial Crisis, 292–294 soft law, 74, 76, 79–84, 292–293 International Monetary Fund (IMF), 77, 84 on administration orders, 229 encouraging compliance in developing countries, 86 evaluation of structural reforms, 273 on insolvency regimes, 227 on receivership, 230 ROSC See Reports on the Observance of Standards and Codes International Organization of Securities Commissions (IOSCO), 82 compliance, traditional approach to, 85 intragroup transactions and exposures (ITEs), 212 investment banking industry, in Global Financial Crisis (2007–2009), 46–47 IOSCO See International Organization of Securities Commissions IRB See internal ratings-based approaches IRC See incremental risk capital charge ITEs (intragroup transactions and exposures), 212 Japan Banking Act, banking crisis (1990s), 58–59 combination of banking and commerce, 117 JMB (Johnson Matthey Bankers), 184–185, 187–188 Johnson Matthey Bankers (JMB), 184–185, 187–188 Joint Forum, 82–83 judicial opinions, 74 judicial process for bank closure, 227 determination of insolvency, 226–235 IMF on, 227–228 junk bonds, 149–150 jurisdiction civil law jurisdictions, 74 common law jurisdictions, 74 keiretsu, 117–118 Keynes, John Maynard, 184, 285–286, 303–304 knowledge asymmetry, 27, 33 know-your-customer See KYC Policies Korea, bank-commerce relationships in, 118, 121 KYC (know-your-customer) policies, 226–229 Customer Due Diligence for Banks (BCBS), 227 General Guide to Account Opening and Customer Identification (BCBS), 227 Lamfalussy, Alexandre, 39b–41b large complex financial institutions (LCFIs), 291–292 Large Exposures Directive (EU, 1994), 189 large exposures policies, 184–185 European Union, 189–192 exemptions, 191–192 international standards, 192–193 intragroup transactions and exposures (ITEs), 212 United Kingdom, 187–189 U.S lending limits, 185–187 Larosiere report, 237 Latin American debt crisis (1980s), 29–30 law See also entries at regulation international See international law national See national laws public vs private, 74 law enforcement, cooperation with, 231–232 law of large numbers, 24 LCFIs (large complex financial institutions), 291–292 lead regulator concept, 217–219 least-cost rule on insolvency resolutions, 234–235 Leeson, Nick, 175b–176b legal framework for insolvency, 225–226 legal tender, creating See money creation Lehman Brothers, 46–47, 169 asset price spiral, 43 bankruptcy, 48 lemons problem, 301–302 lender of last resort, 52–56 discount window lending vs., moral hazard with See moral hazard problem purchaser of last resort, 56 lending limits, U.S., 184–187 failure to comply, 187 leverage ratios (LRs), 135–137, 287–288 LGD See loss given default liabilities on balance sheet, 20 deposits as See deposits determination of insolvency, 228–229 of mutual funds, 23 LIBOR See London Interbank Offered Rate (LIBOR) licensing requirements, 90–91 choice of bank charter, 100–103 pan-European charters, 100–103 cross-border issues, 103–105 fundamentals of, 95–97 management quality See fitness and propriety of bank management purpose of, 92–95 significant changes to ownership, 99 limited liability, 92–93 liquid assets, 196 liquidation, 232–233 liquidity, heavy demands for See illiquidity risk liquidity conversion factors, 196 Index  319 liquidity hoarding, 45 liquidity insolvency, determining, 228–229 liquidity ladders, 197 liquidity premium, 134 liquidity ratios, 194–196 liquidity risk, 20–23, 193–202 in interbank markets, 28–29 lack of regulation and, 24–27 liquidity ratios, 194–196 market liquidity risk, 193, 198–202, 266 pipeline liquidity risk, 281 reserve requirements See required reserves stabilizing with public lending See lender of last resort standards for managing, 196–198 liquidity squeeze, manifestations of, 55–56 liquidity surplus, before Global Financial Crisis, 280–281 loan loss reserves, 153 loan/deposit ratio See debt/equity ratio loans asset price spirals See asset price spirals on balance sheet, 20 insider lending, 120–121 lending limits (U.S.), 185–187 as long-term, 20–21, 119 maturity transformation risk, 20–21, 118–119 mortgages See mortgage finance nonperforming, 22–23 “one borrower” limitation, 185–186, 191 See also lending limits, U.S securitization of See securitization Lombard Street, 55 London Interbank Offered Rate (LIBOR), 28 See also short-term money market interest rates long-term, loans as, 20–21, 119 maturity transformation risk, 20–21, 118–119 loss given default (LGD), 153–154 estimating, 154 loss of public confidence, 224, 300 loss reserves See capital adequacy LRs See leverage ratios M0 measure, Macao, 235–238 macroeconomic goals of bank supervision, 269, 271–272 macroeconomic policy, Global Financial Crisis and, 280–281 macroprudential perspective, 268–269, 286 management compensation, 235, 283, 285 management governance See corporate governance practices mandates for deposit insurers, 58 mandatory disclosure, 33 mandatory subordinated debt, 65 Manhattan Company, 113–114 320  Index mark to market valuations, 46 market correlation, 171–172 market failures, 298, 304 market liquidity risk, 193, 198–202, 266 market operations See open market operations market prices, 167–168 market risk, 166–174 bank failure from, 224 building block approach, 168–170 equity securities example, 170 internal models approach, 171–174 trading book and banking book, 167–168 Market Risk Amendment (MRA), 166–174 building block approach, 168–170 equity securities example, 170 internal models approach, 171–174 trading book and banking book, 167–168 market-centered financial systems, 13 marking to market, 167–168 mark-to-market accounting, 283–284 maturity, unexpected losses and, 153–154 maturity transformation (maturity gap), 20–21, 118–119 Mavrodi, Sergei, 90b–91b maximum debt/equity ratios See leverage ratios Maximum Liquidity Outflow (MLO), 202 MBSs See mortgage-backed securities McCulloch v Maryland (1819), 74–75 Memorandum of Understanding (MOU), 237, 264, 273–274 merchant banking, 116 mergers, 234–235 Merrill Lynch, 46–47, 169 metal coins, creation of, microeconomic goals of bank supervision, 271–272 microprudential regulation, 268–269 more radical options, 289–292 minimum capital requirements See bank capital regulation minimum risk assets ratio, 140–141 Minimum Standards for the Supervision of International Banking Groups and their Cross-Border Establishments (1992), 103–105 mitigating credit risk See risk management MLO (Maximum Liquidity Outflow), 202 MMM pyramid scheme, 90b–91b MMMFs See money market mutual funds Model Law on Cross-Border Insolvency, 236–237 model statutes (model codes), 75 modern financial systems features of modern banking, 11–17 originate to distribute (OTD) model, 14–17 reliance on money market funding, 11–13 securitization, 13–14 interwoven network of financial obligations, 42 See also too big to fail panic and contagion in, 27–32 interbank market, 28–29 international contagion, 29–32 Monetary Control Act (1980) (MCA), 195 monetary policy, 269 before Global Financial Crisis, 280 money, 3–7 money changers, money creation, 5–6, 54 money laundering, 223–239 Banco Delta Asia case study, 235–238 bank supervision (self-regulation), 232–233 cooperation with law enforcement, 231–232 customer identity, 227–229 defined, 224–225 ethical standards of conduct and deterrence, 229–231 impact on banks, 225–226 international standards for, 226–227 terrorist financing, 234–235 money laundering, defined, 224–225 money market funding, reliance on, 11–13 money market mutual funds (MMMFs), 12 liabilities as equity, 23 Moody’s See rating agencies moral hazard problem, 52, 60–66, 62f, 89–90, 301–302 excessive risk taking, 60–63, 89–90 direct limits on risk taking, 184–193 innovation and See financial innovation leverage ratios (LRs) and, 136–137 management compensation and, 235, 283, 285 minimizing, 64–66 See also regulation, types of limiting, 64–66 See also regulation, types of capital adequacy See Basel I; Basel II capital adequacy framework too big to fail, 60, 63–64, 225, 291 constructive ambiguity, 64 Continental Illinois National Bank as, 234 Morgan Stanley, 46–47, 169 mortgage finance, 13–14 securitization of loans See securitization subprime See subprime lending and borrowers mortgage-backed securities (MBSs), 14, 166–167 MOU See Memorandum of Understanding mutual fund liabilities, 23 National Bank Act (1863 and 1864), 74–75, 100, 114 national laws, 74–75 negative capitalization See insolvency risk negative correlation between financial markets, 171–172 negative externalities, 298–299 Netherlands, 267 Index  321 New Capital Adequacy Framework (1999) See Basel II capital adequacy framework nonbank banks, 115 nonbinding norms See soft law international standards noncompliance See compliance nonexcludability attribute of public goods, 299–300 nonfinancial activities of banks See bankcommerce linkages nonperforming loans, 22–23 nonrivalry attribute of public goods, 299–300 North Korea, 235–238 Northern Rock, 16, 27, 43 agency responsibilities and, 274–275 co-insurance with, 65 market liquidity risk and, 199b–200b originate and hold model, 14 originate to distribute (OTD) model, 14–17, 201, 281 originate-and-hold assets, 166–167 OTD See originate to distribute model ownership of bank See also bank holding companies; fitness and propriety of bank management; licensing requirements administration orders and conservatorships, 229 by commercial or industrial firms See bank-commerce linkages by financial institutions, 121–124 changes to structural regulation, 124–129 Internal Capital Adequacy Assessment Process (ICAAP), 178–179 transfer of bank licensure, 99 objectives approach to regulation, 267–269 OCC See Office of the Comptroller of the Currency OECD See Organisation for Economic Cooperation and Development Office of the Comptroller of the Currency bank-finance linkages, 126 certification of financial statements, 107–108 See also Sarbanes-Oxley Act (2002) dual banking system and, 101 ethical standards of conduct and deterrence, 231 lending limits, 187 Office of the Comptroller of the Currency (OCC), 74–75 balancing competition and licensing, 93–94 granting licenses, 95–96 Office of Thrift Supervision, 218 “one borrower” limitation, 185–186, 191 See also lending limits, U.S one-bank holding companies, 115 open market operations, insider lending, 120–121 perfect markets, 133 operating constraints in forbearance, 235 operational risks, 174–177 Advanced Measurement Approach (AMA), 177 Basic Indicator Approach (BIA), 176–177 Standardized Approach, 177 opinions (European Communities legislation), 78 optimum capital levels, 177–181, 286–287 ICAAP (Internal Capital Adequacy Assessment Process), 178–179 SRP (Supervisory Review Process), 148–149, 180 Organisation for Economic Cooperation and Development (OECD), 83, 260 Principles of Corporate Governance, 83, 91, 105–106 risk weighting and, 142, 150 pan-European bank charters, 102–103 panic in modern financial systems, 27–32, 55–56 interbank market, 28–29 international contagion, 29–32 as justification for regulation, 32–33 panic runs See bank runs paper money, creation of, pari passu principle, 236 passporting system, 101–102 past experience as future predictor, 65 pay box system, 58 payments system, collapsing dominos and, 36 payments-clearing arrangements, 37 underwriting by central banks, 41 PD See probability of default peer pressure (international), 85 perfect markets, 133 permissible activities of licensed institutions, 95 perpetual subordinated debt, 138 physical transfer of bank notes, 36 Pinochet, Augusto, 227 pipeline liquidity risk, 281 political pressure for deposit insurance, 68–70 Politically Exposed Persons (PEPs), 227 portfolio of assets diversification, OTD model and, 16–17 stress testing, 178–179 trading book as, 172 positive correlation between financial markets, 171–172 positive externalities, 299–300 power, concentrated, of central banks, 272 predictions based on past experience, 65 price stability, 269, 271–272 primary money laundering concern, 235 Principles for Sound Liquidity Risk Management and Supervision (BCBS), 196–197 Principles of Corporate Governance (OECD), 83, 91, 105–106 322  Index private law, 74 probability of default (PD), 153 estimating, 154–155, 155t probity of bank management See fitness and propriety of bank management procyclical, IRB as, 158 product-based regulation See functional regulation proprietary trading, 14 propriety, managerial See fitness and propriety of bank management protocols, international See international law; treaties provisional administration See administrative process for bank closure prudential reports, consolidated, 209 See also consolidated supervision public bad and public good, 298–299 public confidence, 224, 300 public disclosure requirements (Basel II), 148–149 public funds for bank assistance, 233 public law, 74 public ownership of shares of corporation See Anglo-Saxon separation of banking and commerce public regulation See entries at regulation public-sector capital injections See government bailout punitive damages, encouraging, 33 purchase and assumption (P&A), 234–235 purchaser of last resort, 56 pure panic contagion, 26–27 pyramid schemes, 90b–91b Qatar, definition of bank, QIS See Quantitative Impact Studies quality of management See corporate governance practices; fitness and propriety of bank management Quantitative Impact Studies (QIS), 176, 287 “race to the bottom” regulation, 187 rating agencies See credit rating agencies; credit ratings rating systems See internal ratings-based approaches (IRB) ratings See credit ratings Ratings-Based Approach (RBA), 162 RBA See Ratings-Based Approach readily marketable collateral, 186–187 Real Time Gross Settlement (RTGS) system See RTGS network receivership, 229–231 See also insolvency resolution mechanisms, 231–232 recognition between nations, 236 recommendations (European Communities legislation), 78 regulation, alternatives to, 67–70 regulation, reasons for (against), 67, 304–305 bank capital regulation, 132–135 Basel I, criticisms on, 141–144 Efficient Markets School, 52, 67–68, 285–286 financial safety net, 52 moral hazard of See moral hazard problem moral hazard reduction from, 66 See also regulation, types of panic and contagion, 32–33 regulation, sources of, 73–88 international law See international law national laws, 74–75 regulation, types of anti-money laundering See money laundering bank management governance See bank management governance; fitness and propriety of bank management; sound governance principles bank-commerce linkages, 112–121 call for modern regulations on, 290–291 in Continental Europe and Asia, 117–118 regulations against (Anglo-Saxon), 112–116 special risks for banks, 118–121 capital regulation See bank capital regulation; Basel I; Basel II capital adequacy framework; capital adequacy consolidated supervision See consolidated supervision direct limits on risk taking, 184–193 credit concentration risk See credit concentration risk liquidity risk See liquidity risk entry requirements, 90 general insolvency law, 280–284 global financial regulatory agency, 292 institutional vs functional, 260–265, 262t large exposures policies, 184–185 European Union, 189–192 exemptions, 191–192 international standards, 192–193 intragroup transactions and exposures (ITEs), 212 United Kingdom, 187–189 U.S lending limits, 185–187 lending limits, U.S., 184–187 failure to comply, 187 licensing See licensing requirements self-policing, 52, 279–280 regulation after Global Financial Crisis, 279–295 capital adequacy, new directions in, 286–289 radical options, 289–292 rethinking regulatory assumptions, 284–286 regulations (European Communities legislation), 78 regulators, defined, 33 regulatory agency structure, 259–277 evaluation of structural reforms, 273–276 global financial regulatory agency, 292 institutional vs functional regulation, 260–265, 262t rise of integrated regulation, 265–267 role of central bank, 269–273 bank supervision, 270 concentration of power, 272 independence, 269, 272–273 macroeconomic and microeconomic goals, 271–272 Twin Peaks (objectives) approach, 267–269 weaknesses in, 283–284 regulatory assumptions, rethinking, 284–286 regulatory failures in Global Financial Crisis, 283–284 regulatory forbearance, 235 regulatory insolvency, 228 administration orders and conservatorships, 227–229 reliability of credit ratings, 178, 283–284 repay-on-demand contract, 25 repo markets, 28 reporting to law enforcement See cooperation with law enforcement Reports on the Observance of Standards and Codes (ROSC), 86 Republic of Albania, definition of bank, Republic of Armenia, definition of bank, reputation risk, 224 required reserves, 6, 194–196 See also capital adequacy cash ratio, 8, 22 countercyclical requirements and, 288–289 desire to minimize, 21–22 dynamic provisioning, 288 of financial conglomerates, 213–214, 219–221 key risk capital weights, 140f new directions after Global Financial Crisis, 286–289 operational risks, 174–177 Advanced Measurement Approach (AMA), 177 Basic Indicator Approach (BIA), 176–177 Standardized Approach, 177 optimum capital levels, 177–181, 286–287 securitization and, 143, 161 systemic risk and, 290 reserve banking See fractional reserve banking reserve banks, Reserve Primary Fund, 23 reserve ratio (cash ratio), 8, 22 reserve requirements See required reserves reserves, on balance sheet, 20 resolving insolvent banks, 231–232 respect between nations, 236 retail depositors, 11 Riggs Bank of Washington,.D.C., 227 ring-fencing, 255 risk assets ratio, 138 Index  323 risk management with bank-commerce linkages, 118–121 board independence, 119–120 insider lending, 120–121 maturity transformation risk, 118–119 capital adequacy See bank capital regulation; Basel I; Basel II capital adequacy framework; capital adequacy collective action problem, 32 direct limits on risk taking, 184–193 double gearing, 213, 214f excessive risk taking See excessive risk taking as factor in Global Financial Crisis, 282–283 group-wide See consolidated supervision hedging risk with credit derivatives, 163–164 innovation and See financial innovation insider lending, 121 KYC (know-your-customer) policies, 226–229 large exposures policy exemptions, 191–192 leverage ratios (LRs) and, 136–137 liquidity risk, 196–198 See also liquidity risk moral hazard See moral hazard problem optimum capital levels, 177–181, 286–287 OTD model and, 16–17 risk vs uncertainty, 174, 302–303 risk-adjusted deposit insurance premiums, 65 risk-based approaches to anti-money laundering, 228–229 risk-based deduction (capital requirements), 220–221 risk-minimizer deposit insurers, 58 risks, specific asset price spirals See asset price spirals collective action problem, 32 credit concentration See credit concentration risk domino-like collapse See domino-like collapse illiquidity See liquidity risk insolvency See insolvency risk moral hazard See moral hazard problem pipeline liquidity risk, 281 reputation damage See reputation risk risk-weighted capital requirements (RWCR), 137–141 Basel I categories, 140f, 141–143 Basel II Standardized Approach See Standardized Approach (Basel II) criticisms of, 141 ROSC See Reports on the Observance of Standards and Codes RTGS network, 41 runs See bank runs RWCR See risk-weighted capital requirements S&L See savings and loan institutions Sarbanes-Oxley Act (2002), 91, 107–109 savings and loan institutions, 8–9 interest rate risk, 178 324  Index savings behaviors, global imbalances in, 280 scaling factor (VaR), 172–173 search for yield, 281 SEC consolidated supervised entities program, 218 secondary legislation, EC, 77–78 secondary market for loans, 20–21 secrecy laws, 104 Bank Secrecy Act, 229–230, 230f examination procedures, 233f money laundering and, 228 sector, several borrowers in, 184, 192 See also credit concentration risk Securities and Exchange Commission (SEC), 218, 263 securities firms See financial institutions as bank owners securitization, 13–14, 266, 283–284 Basel I framework and, 143, 161 Basel II framework and, 160–162 pipeline liquidity risk, 281 regulatory failures, 284 supporting one’s own SIVs, 48 segmentation of financial services See bank-finance linkages segregation of banking from financial services, 9–10 self-fulfilling, depositors’ expectations as, 25 self-policing (self-regulation), 52, 279–280 self-regulating organisations (SROs), 264 selling bank licenses, 99 selling credit derivatives, 163–164 selling loans, knowledge of customer and, 20–21 Senate Committee on Banking and Currency (1931), 122 separate entity approach (insolvent cross-border banks), 236 separation of banking and commerce See bank-commerce linkages service-based regulation See functional regulation settlement periods, interbank accounts, 37, 41 SFA See Supervisory Formula Approach shadow banking system, 47 shareholders of banks, independence of, 119–120 shell banks, 229–230 short selling, 170 short-term money market interest rates, 7, 28, 269 Bankhaus Herstatt collapse, 39b–41b reliance on money market funding, 11–13 side effects See externalities single borrower limitation, 185–186, 191 See also lending limits, U.S single entry approach (insolvent cross-border banks), 236 single regulatory agencies, emergence of, 265–267 SIVs See Structured Investment Vehicles Small and Medium Enterprises (SMEs), 152 SMEs See Small and Medium Enterprises Smith, Adam, 67 SNB (Swiss National Bank), 287–288 social cost of bank failures, 135 See also capital regulation soft law international standards, 74, 76, 79–84, 292–293 See also international law solo capital requirements, within financial conglomerates, 210–211, 220–221 SOLO RATIO, 210–211 solvency of insurance companies, calculating, 220 solvency ratio, 138 solvency support See government bailout sound governance principles, 105–107 See also corporate governance practices Basel Principles on Corporate Governance See Core Principles for Effective Banking Supervision (BCBS) failures, Global Financial Crisis and, 282–283 general insolvency law and, 226 Principles of Corporate Governance (OECD), 83, 91, 105–106 sound management See licensing requirements sources of regulation, 73–88 international law See international law national laws, 74–75 special insolvency regimes, 225–226, 230 See also insolvency specialization of loan function, 15 special-purpose vehicles (SPVs), 14, 160 specific market risk, 169–170, 171t SPVs See special-purpose vehicles SROs See self-regulating organisations SRP See Supervisory Review Process stability of price, maintaining, 269 stability of unregulated banking, 67 See also Efficient Markets School Standard & Poor’s, 149–150 See also rating agencies Standardized Approach (Basel II), 149–152, 150t–151t assessment of, 157–159 calculating operational risk, 177 problems of, 151–152 securitization and, 161–162 standards, international See international law stare decisis, 74 state-chartered banks See dual banking system Statement of Principles on the Prevention of Criminal Use of the Banking System for the Purpose of Money-Laundering (BCBS), 226 statistical estimation of probability of default, 154–155 Statute of the International Court of Justice, Article 38, 76 statutes See national laws Stern School approach, 291–292 stock and commodities markets See also bank-finance linkages volatility following deregulation, 11 stress testing of portfolios, 178–179 structure of regulatory agencies, 259–277 evaluation of structural reforms, 273–276 global financial regulatory agency, 292 institutional vs functional regulation, 260–265, 262t rise of integrated regulation, 265–267 role of central bank, 269–273 bank supervision, 270 concentration of power, 272 independence, 269, 272–273 macroeconomic and microeconomic goals, 271–272 Twin Peaks (objectives) approach, 267–269 weaknesses in, 283–284 Structured Investment Vehicles (SIVs), 281 in Global Financial Crisis (2007–2009), 47–48 market liquidity risk and, 199–200 subordinated debt, 65, 138 subprime lending and borrowers, 45, 281–282 market liquidity risk, 198–199, 201 supervision of cross-border banking See consolidated supervision supervisors, defined, 33 See also fitness and propriety of bank management Supervisory Formula Approach (SFA), 162 Supervisory Review Process (SRP), 148–149, 180 supplementary capital, 138–139, 139f supremacy, 78 suspicious activity reports (SARs), 231 suspicious transaction reports (STRs), 231 Swedish financial crisis (1990–1991), 58–59 Swedish Riksbank, Swiss National Bank (SNB), 287–288 systemic risk exception, 234–235 systemic risks asset price spirals See asset price spirals collapsing dominos See domino-like collapse deposit insurance and, 58–59 limiting, new regulations for, 289–290 RTGS network and, 41–42 target capital ratios, 181 taxes, debt vs equity and, 133 taxing externalities, 290 TBTF See too big to fail technical provisions of insurance companies, 220 Term Asset-Backed Securities Loan Facility (TALF), 56 terrorist financing, 234–235 Thailand bank-commerce relationships in, 118 financial crisis (1990s), 31 Index  325 Third Directive on Anti-Money Laundering, 228–229 on bank supervision (self-regulation), 233 on cooperation with law enforcement, 231–232 on standards of conduct and deterrence, 230 3–6–3 banking, 7–10 three-pillar structure, Basel II, 148–149, 148f Tier capital, 138–139, 139f Tier capital, 138–139, 139f too big to fail, 60, 63–64, 225, 291 constructive ambiguity, 64 Continental Illinois National Bank as, 234 too big to save, 60 too interconnected to fail, 42, 63–64 trading book, 163–164, 167–168 banking book vs., 168 setting capital against risk building block approach, 168–170 internal models approach, 171–174 tranching, 160 transaction costs, 297–298 transaction reports, 231–232 Trans-European Automated Real-time Gross settlement Express Transfer (Target) system, 38 transfer of bank licensure, 99 transfer orders, 37 transformation gap, 23 transparency of regulatory agencies, 274 Travelers insurance company, acquisition of, 126–129 Treasury (U.S.) on bank-finance linkages, 127 Blueprint for a Modernized Financial Regulatory Structure (Blueprint), 267–268 currency transaction reports (CTRs), 231–232 USA PATRIOT Act, 229, 235 ethical standards of conduct and deterrence, 230 identity-of-customer policies, 229 treaties, 76–77 See also international law Treaties of the European Communities and the European Union, 77–78 trigger capital ratios, 181 trust, insurance and, 60 See also moral hazard problem Twain, Mark, 53 Twin Peaks (objectives) approach, 267–269 two-party transfers, 36 umbrella supervisor, Federal Reserve as, 218–219, 263–264 uncertainty vs risk, 174, 302–303 UNCITRAL (United Nations Commission on International Trade Law), 236–237 underwriting, 14–15 unexpected losses (ULs), 152–154 uninsured subordinated debt, 65 326  Index United Dominions Trust v Kirkwood (1966), United Kingdom bank-finance linkages, 121–124 deregulatory changes, 124–129 Banking Act (1979), 2–3 Banking Act (1987), 187–189 banking-commerce separation, 112–116 definition of bank, Financial Services Compensation Scheme (FSCS) as ex post funded, 58 as pay box system, 58 fitness and propriety of bank management, 98–99 institutional reform, 265–267 large exposure limits, 187–189 LIBOR See short-term money market interest rates licensing process, 96–97 Northern Rock, 27 United Nations Commission on International Trade Law (UNCITRAL), 236–237 IMF See International Monetary Fund (IMF) United States bank-finance linkages, 121–124 deregulatory changes, 124–129 banking crisis (1980s-1990s), 224 banking-commerce separation, 112–116 definition of bank, dual banking system and, 100–103 Fed Funds Rate See short-term money market interest rates lending limits, 185–187 monetary policy (early 2000s), 280 risk-weighted capital requirements (RWCR), 137 See also Standardized Approach (Basel II) supervision of conglomerates, 212 U.S Banking Act See Glass-Steagall Act (1933) U.S FDIC See Federal Deposit Insurance Corporation U.S Federal Reserve See Federal Reserve U.S Treasury See Treasury (U.S.) unrated borrowers, risk weighting of, 152 unregulated banking See entries at regulation Unstable Markets School, 68, 285–286, 302–303 USA PATRIOT Act, 229, 235 ethical standards of conduct and deterrence, 230 identity-of-customer policies, 229 Value at Risk (VaR), 171–174 value chain analysis, 15–16 VaR See Value at Risk Vienna Convention on the Law of Treaties (1969), 76 volatility following deregulation, 11 Wachovia, Citigroup’s acquisition of, 234–235 Wal-Mart Bank, 115–116 weak bank managers See fitness and propriety of bank management well capitalized, defining, 181 wholesale funding See money market mutual funds Wolfsberg Group, 232–233 Working Group on Deposit Insurance, FSF, 57–58, 66 World Bank, 84 encouraging compliance in developing countries, 86 ROSC See Reports on the Observance of Standards and Codes World Financial Organization, 292–293 zaibatsu, 117–118 [...]... Global Financial System and the Problems of Regulation This book examines the principles, policy, and law relating to the regulation of international banking Other regulation textbooks focus on the laws and regulations of one particular country, be it the United States or Britain or some other important banking center This approach is understandable, since regulations have traditionally been made and. .. from the public, and the grant of credits or the investment for its own account, as well as the issue of payments in the form of electronic money.”5 Japan’s Banking Act defines banking business as “any of the following acts: (i) Both acceptance of deposits or Installment Savings, and loans of funds or discounting of bills and notes; or Conducting of exchange transactions.”6 In Qatar, the banking business... United States, the cost of resolving the savings and loan crisis of the late 1980s was roughly 5.1% of GDP According to the IMF, the costs of restructuring banking systems as the result of banking crises have varied from 4.5% of GDP in Norway and Sweden in 1991 to 19.6% of GDP in Chile in 1985 Given the substantial costs associated with a systemic crisis, regulation throughout much of the world for the... discussion of the policy networks, including bodies like the BCBS, which assist regulators with this global challenge The output of these networks, in the form of international standards and agreements, is the main focus of this book Finally, we end with a brief overview of the book’s structure and how it might be used in teaching courses on the regulation of international banking The Rationale for Regulation. .. of the supply of money in a modern 4  Republic of Armenia Law on Banks and Banking Article 34(1)  Article 4(2) On Banks in the Republic of Albania 6 Banking Act (Act No 59 of 1981) 7  Decree Law No 15 of the Year 1993 Establishing Qatar Central Bank 8 Banking Act 1959 5 4  Global Bank Regulation economy We are often accustomed to think of money in terms of physical objects like metallic coins or paper... swathes of the economy and led to a wave of privatizations in which many state-owned companies—including banks and other financial institutions— were sold to private investors The deregulation of banking and finance was a core component of the free market policies pursued in the 1980s For the benefits of deregulation in other economic sectors to be realized, it was argued, it was necessary for capital and. .. around the world have attempted to define bank or banking and then turn to consider what it is about banks that has made them subject to a level of regulation that exceeds that applied to most other types of economic activity Central to the traditional definition of banking is the concept of deposit taking, and the nature of banking involves both the extension of long-term credit while at the same time promising... for its own benefit, for one or more of the purposes of making temporary loans and discounts; of dealing in notes, foreign and domestic bills of exchange, coin, bullion, credits, and the remission of money; or with both these powers, and with the privileges, in addition to these basic powers, of receiving special deposits and making collections for the holders of negotiable paper, if the institution... Union and Eastern Europe, many of which have enacted these statutes only since the mid-1990s For example, the Republic of Armenia’s banking statutes provide a comprehensive list of bank activities, and the first two provide that “banks … may: a accept demand and term deposits; [and] b provide commercial and consumer credits…”4 In the Republic of Albania, bank activity is defined as “the receipt of monetary... markets, and institutions turned global Each of the leading international banks now operates in dozens of countries and is therefore subject to oversight by dozens of regulatory agencies Nationally based regulators, in the most developed and in developing countries, have adapted to the new realities of the global financial system through new forms of cooperation and coordination, with international standard-setting
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