From Bail-out to Bail-in: Mandatory Debt Restructuring of Systemic Financial Institutions

From Bail-out to Bail-in: Mandatory Debt Restructuring of Systemic Financial Institutions. By Zhou, Jian-Ping; Rutledge, Virginia; Bossu, Wouter; Dobler, Marc; Jassaud, Nadege; Moore, Michael
IMF Staff Discussion Notes No. 12/03
April 24, 2012            
ISBN/ISSN: 978-1-61635-392-6 / 2221-030X
Stock No: SDNETEA2012003
http://www.imf.org/external/pubs/cat/longres.aspx?sk=25858.0

Excerpts

Executive Summary

Large-scale government support of the financial institutions deemed too big or too important to fail during the recent crisis has been costly and has potentially increased moral hazard. To protect taxpayers from exposure to bank losses and to reduce the risks posed by too-big-tofail (TBTF), various reform initiatives have been undertaken at both national and international levels, including expanding resolution powers and tools.

One example is bail-in, which is a statutory power of a resolution authority (as opposed to contractual arrangements, such as contingent capital requirements) to restructure the liabilities of a distressed financial institution by writing down its unsecured debt and/or converting it to equity. The statutory bail-in power is intended to achieve a prompt recapitalization and restructuring of the distressed institution. This paper studies its effectiveness in restoring the viability of distressed institutions, discusses potential risks when a bail-in power is activated, and proposes design features to mitigate these risks. The main conclusions are:

1. As a going-concern form of resolution, bail-in could mitigate the systemic risks associated with disorderly liquidations, reduce deleveraging pressures, and preserve asset values that might otherwise be lost in a liquidation. With a credible threat of stock elimination or dilution by debt conversion and assumption of management by resolution authorities, financial institutions may be incentivized to raise capital or restructure debt voluntarily before the triggering of the bail-in power.

2. However, if the use of a bail-in power is perceived by the market as a sign of the concerned institution’s insolvency, it could trigger a run by short-term creditors and aggravate the institution’s liquidity problem. Ideally, therefore, bail-in should be activated when a capital infusion is expected to restore a distressed financial institution to viability, with official liquidity support as a backstop until the bank is stabilized.

3. Bail-in is not a panacea and should be considered as one element of a comprehensive solution to the TBTF problem. It should supplement, not replace, other resolution tools that would allow for an orderly closure of a failed institution.

4. Most importantly, the bail-in framework needs to be carefully designed to ensure its effective implementation.

• The triggers for bail-in power should be consistent with those used for other resolution tools. They should be set at the point when a firm would have breached the regulatory minima but before it became balance-sheet insolvent. To make bail-in a transparent tool, its scope should be limited to (i) elimination of existing equity shares as a precondition for a bail-in; and (ii) conversion and haircut to subordinated and unsecured senior debt.  Debt restructuring under a bail-in should take into account the order of priorities applicable in a liquidation.
• A clear and coherent legal framework for bail-in is essential. The legal framework needs to be designed to establish an appropriate balance between the rights of private stakeholders and the public policy interest in preserving financial stability. Debt restructuring ideally would not be subject to creditor consent, but a “no creditor worse off” test may be introduced to safeguard creditors’ and shareholders’ interests. The framework also needs to provide mechanisms for addressing issues associated with the bail-in of debt issued by an entity of a larger banking group and with the cross-border operations of that entity or banking group.
• The contribution of new capital will come from debt conversion and/or an issuance of new equity, with an elimination or significant dilution of the pre-bail in shareholders.  Bail-in will need to be accompanied by mechanisms to ensure the suitability of new shareholders. Some measures (e.g., a floor price for debt/equity conversion) might be necessary to reduce the risk of a “death spiral” in share prices.
• It may be necessary to impose minimum requirements on banks for issuing unsecured debt or to set limits on the encumbrance of assets (which have been introduced by many advanced countries). This would help reassure the market that a bail-in would be sufficient to recapitalize the distressed institution, thus forestalling potential runs by short-term creditors and avert a downward share price spiral. The framework should also include measures to mitigate contagion risks to other systemic financial institutions, for example, by limiting their cross-holding of unsecured senior debt.

Conclusions

Bail-in power needs to be considered as an additional and complementary tool for the resolution of SIFIs. Bail-in is a statutory power of a resolution authority, as opposed to contractual arrangements, such as contingent capital requirements. It involves recapitalization through relatively straightforward mandatory debt restructuring and could therefore avoid some of the operational and legal complexities that arise when using other tools (such as P&A transactions), which require transferring assets and liabilities between different legal entities and across borders. By restoring the viability of a distressed SIFI, the pressure on the institution to post more collateral, for example against their repo contracts, could be significantly reduced, thereby minimizing liquidity risks and preventing runs by short-term creditors.

The design and implementation of a bail-in power, however, need to take into careful consideration its potential market impact and its implications for financial stability. It is especially important that the triggering of a bail-in power is not perceived by the market as a sign of the concerned institution’s non-viability, a perception that could trigger a run by short-term creditors and aggravate the institution’s liquidity problem. An effective bail-in framework generally includes the following key design elements:

• The scope of the statutory power should be limited to (i) eliminating or diluting existing shareholders; and (ii) writing down or converting, in the following order, any contractual contingent capital instruments, subordinated debt, and unsecured senior debt, accompanied by the power of the resolution authority to change bank management.
• The triggers for bail-in power should be consistent with those used for other resolution tools and set at the point when an insititution would have breached the regulatory minima but before it became balance-sheet insolvent, to allow for a prompt response to an SIFI’s financial distress. The intervention criteria (a combination of quantitative and qualitative assessments) need to be as transparent and predictable as possible to avoid market uncertainty.
• It may be necessary to require banks or bank holding companies to maintain a minimum amount of unsecured liabilities (as a percentage of total liabilities) beforehand, which could be subject to bail-in afterwards. This would help reassure the market that bail-in is sufficient to recapitalize the distressed institution and restore its viability, thus reduce the risk of runs by short-term creditors.
• To fund potential liquidity outflows, and given the probable temporary loss of market access, bail-in may need to be coupled with adequate official liquidity assistance.
• Bail-in needs to be considered as one element of a comprehensive framework that includes effective supervision to reduce the likelihood of bank failures and an effective overall resolution framework that allows for an orderly resolution of a failed SIFI, facilitated by up-to-date recovery and resolution plans. In general, statutory bail-in should be used in instances where a capital infusion is likely to restore a distressed financial institution to viability, possibly because, other than a lack of capital, the institution is viable and has a decent business model and good riskmanagement systems. Otherwise, bail-in capital could simply delay the inevitable failure.

Central Bank Independence and Macro-prudential Regulation. By Kenichi Ueda & Fabian Valencia

Central Bank Independence and Macro-prudential Regulation. By Kenichi Ueda & Fabian Valencia
IMF Working Paper No. 12/101
Apr 2012
http://www.imf.org/external/pubs/cat/longres.aspx?sk=25872.0

Summary: We consider the optimality of various institutional arrangements for agencies that conduct macro-prudential regulation and monetary policy. When a central bank is in charge of price and financial stability, a new time inconsistency problem may arise. Ex-ante, the central bank chooses the socially optimal level of inflation. Ex-post, however, the central bank chooses inflation above the social optimum to reduce the real value of private debt. This inefficient outcome arises when macro-prudential policies cannot be adjusted as frequently as monetary. Importantly, this result arises even when the central bank is politically independent. We then consider the role of political pressures in the spirit of Barro and Gordon (1983). We show that if either the macro-prudential regulator or the central bank (or both) are not politically independent, separation of price and financial stability objectives does not deliver the social optimum.

Excerpts

Introduction

A growing literature based on models where pecuniary externalities reinforce shocks in the aggregate advocates the use of macro-prudential regulation (e.g. Bianchi (2010), Bianchi and Mendoza (2010), Jeanne and Korinek (2010), and Jeanne and Korinek (2011)). Most research in this area has focused on understanding the distortions that lead to financial amplification and to assess their quantitative importance. The natural next question is how to implement macro-prudential regulation.

Implementing macro-prudential policy requires, among other things, figuring out the optimal institutional design. In this context, there is an intense policy debate about the desirability of assigning the central bank formally with the responsibility of financial stability. This debate has spurred interest in studying the interactions between monetary and macro-prudential policies with the objective of understanding the conflicts and synergies that may arise from different institutional arrangements.

This paper contributes to this debate by exploring the circumstances under which it may be suboptimal to have the central bank in charge of macro-prudential regulation. We differ from a rapidly expanding literature on macro-prudential and monetary interactions, including De Paoli and Paustian (2011) and Quint and Rabanal (2011), mainly in that our focus is on the potential time-inconsistency problems that can arise, which are not addressed in existing work. Our departure point is the work pioneered by Kydland and Prescott (1977) and Barro and Gordon (1983) who studied how time-inconsistency problems and political pressures distort the monetary authority’s incentives under various institutional arrangements. In our model, there are two stages, in the first stage, the policymaker (possibly a single or several institutions) makes simultaneous monetary policy and macro-prudential regulation decisions. In the second stage, monetary policy decisions can be revised or “fine-tuned” after the realization of a credit shock.  This setup captures the fact that macro-prudential regulation is intended to be used preemptively, once a credit shock (boom or bust) have taken place, it can do little to change the stock of debt. Monetary policy, on the other hand, can be used ex-ante and ex-post.

The key finding of the paper is that a dual-mandate central bank is not socially optimal. In this setting, a time inconsistency problem arises. While it is ex-ante optimal for the dual-mandate central bank to deliver the socially optimal level of inflation, it is not so ex-post. This central bank has the ex-post incentive to reduce the real burden of private debt through inflation, similar to the incentives to monetize public sector debt studied in Calvo (1978) and Lucas and Stokey (1983).  This outcome arises because ex-post the dual-mandate central bank has only one tool, monetary policy, to achieve financial and price stability.

We then examine the role of political factors with a simple variation of our model in the spirit of Barro and Gordon (1983). We find that the above result prevails if policy is conducted by politically independent institutions. However, when institutions are not politically independent (the central bank, the macro-prudential regulator, or both) neither separate institutions nor combination of objectives in a single institution delivers the social optimum. As in Barro and Gordon (1983), the non-independent institution will use its policy tool at hand to try to generate economic expansions. The non-independent central bank will use monetary policy for this purpose and the non-independent macro-prudential regulator will use regulation. Which arrangement generates lower welfare losses in the case of non-independence depends on parameter values. A calibration of the model using parameter values from the literature suggest, however, that a regime with a non-independent dual-mandate central bank almost always delivers a worse outcome than a regime with a non-independent but separate macro-prudential regulator.

Finally, if the only distortion of concern is political interference (i.e. ignoring the time-inconsistency problem highlighted earlier) all that is needed to achieve the social optimum is political independence, with separation or combination of objectives yielding the same outcome.  From a policy perspective, our analysis suggests that a conflict between price and financial stability objectives may arise if pursued by a single institution. Our results also extend the earlier findings by Barro and Gordon (1983) and many others on political independence of the central bank to show that these results are also applicable to a macro-prudential regulator. We should note that we have abstracted from considering the potential synergies that may arise in having dual mandate institutions. For instance, benefits from information sharing and use of central bank expertise may mitigate the welfare losses we have shown may arise (see Nier, Osinski, J´acome and Madrid (2011)), although information sharing would also benefit fiscal and monetary interactions. However, we have also abstracted other aspects that could exacerbate the welfare loss such as loss in reputation.


Conclusions

We consider macro-prudential regulation and monetary policy interactions to investigate the welfare implications of different institutional arrangements. In our framework, monetary policy can re-optimize following a realization of credit shocks, but macro-prudential regulation cannot be adjusted immediately after the credit shock. This feature of the model captures the ability of adjusting monetary policy more frequently than macro-prudential regulation because macro-prudential regulation is an ex-ante tool, whereas monetary policy can be used ex-ante and ex-post. In this setting, a central bank with a price and financial stability mandate does not deliver the social optimum because of a time-inconsistency problem. This central bank finds it optimal ex-ante to deliver the social optimal level of inflation, but it does not do so ex-post. This is because the central bank finds it optimal ex-post to let inflation rise to repair private balance sheets because ex-post it has only monetary policy to do so. Achieving the social optimum in this case requires separating the price and financial stability objectives.

We also consider the role of political independence of institutions, as in Barro and Gordon (1983).  Under this extension, separation of price and financial stability objectives delivers the social optimum only if both institutions are politically independent. If the central bank or the macro-prudential regulator (or both) are not politically independent, they would not achieve the social optimum. Numerical analysis in our model suggest however, that in most cases a non-independent macro-prudential regulator (with independent monetary authority) delivers a better outcome than a non-independent central bank in charge of both price and financial stability.

Principles for financial market infrastructures, assessment methodology and disclosure framework

CPSS Publications No 101

April 2012

http://www.bis.org/publ/cpss101.htm

Final version of the Principles for financial market infrastructures

The report Principles for financial market infrastructures contains new and more demanding international standards for payment, clearing and settlement systems, including central counterparties. Issued by the CPSS and the International Organization of Securities Commissions (IOSCO), the  new standards (called "principles") are designed to ensure that the infrastructure supporting global financial markets is more robust and thus well placed to withstand financial shocks.

The principles apply to all systemically important payment systems, central securities depositories, securities settlement systems, central counterparties and trade repositories (collectively "financial market infrastructures"). They replace the three existing sets of international standards set out in the Core principles for systemically important payment systems (CPSS, 2001); the Recommendations for securities settlement systems (CPSS-IOSCO, 2001); and the Recommendations for central counterparties (CPSS-IOSCO, 2004). CPSS and IOSCO have strengthened and harmonised these three sets of standards by raising minimum requirements, providing more detailed guidance and broadening the scope of the standards to cover new risk-management areas and new types of FMIs.

The principles were issued for public consultation in March 2011. The finalised principles being issued now have been revised in light of the comments received during that consultation.

CPSS and IOSCO members will strive to adopt the new standards by the end of 2012. Financial market infrastructures (FMIs) are expected to observe the standards as soon as possible.

Consultation versions of an assessment methodology and disclosure framework

At the same time as publishing the final version of the principles, CPSS and IOSCO have issued two related documents for public consultation, namely an assessment methodology and a disclosure framework for these new principles.

Comments on these two documents are invited from all interested parties and should be sent by 15 June 2012 to both the CPSS secretariat (cpss@bis.org) and the IOSCO secretariat (fmi@iosco.org). The comments will be published on the websites of the Bank for International Settlements (BIS) and IOSCO unless commentators request otherwise. After the consultation period, the CPSS and IOSCO will review the comments received and publish final versions of the two documents later in 2012.

Other documents

A cover note that explains the background to the three documents above and sets out some specific points on the two consultation documents on which the committees are seeking comments during the public consultation period is also available.

A summary note that provides background on the report and an overview of its contents is also available.

• Cover note
• Summary note
• Principles for financial market infrastructures
• Assessment methodology for the principles for FMIs and the responsibilities of authorities
• Disclosure framework for financial market infrastructures

America's Voluntary Standards System--A "Best Practice" Model for Innovation Policy?

America's Voluntary Standards System--A "Best Practice" Model for Innovation Policy? By Dieter Ernst
East-West Center, Apr 2012
http://www.eastwestcenter.org/publications/americas-voluntary-standards-system-best-practice-model-innovation-policy

For its proponents, America's voluntary standards system is a "best practice" model for innovation policy. Foreign observers however are concerned about possible drawbacks of a standards system that is largely driven by the private sector. There are doubts, especially in Europe and China, whether the American system can balance public and private interests in times of extraordinary national and global challenges to innovation. To assess the merits of these conflicting perceptions, the paper reviews the historical roots of the American voluntary standards system, examines its current defining characteristics, and highlights its strengths and weaknesses. On the positive side, a tradition of decentralized local self-government, has given voice to diverse stakeholders in innovation, avoiding the pitfalls of top-down government-centered standards systems. However, a lack of effective coordination of multiple stakeholder strategies tends to constrain effective and open standardization processes, especially in the management of essential patents and in the timely provision of interoperability standards. To correct these drawbacks of the American standards system, the government has an important role to play as an enabler, coordinator, and, if necessary, an enforcer of the rules of the game in order to prevent abuse of market power by companies with large accumulated patent portfolios. The paper documents the ups and downs of the Federal Government’s role in standardization, and examines current efforts to establish robust public-private standards development partnerships, focusing on the Smart Grid Interoperability project coordinated by the National Institute of Standards and Technology (NIST). In short, countries that seek to improve their standards systems should study the strengths and weaknesses of the American system. However, persistent differences in economic institutions, levels of development and growth models are bound to limit convergence to a US-Style market-led voluntary standards system.

BCBS: Implementation of stress testing practices by supervisors

Implementation of stress testing practices by supervisors: Basel Committee publishes peer review

BCBS

April 13, 2012

http://www.bis.org/press/p120413.htm

The Basel Committee on Banking Supervision has today published a peer review of the implementation by national supervisory authorities of the Basel Committee's principles for sound stress testing practices and supervision.

Stress testing is an important tool used by banks to identify the potential for unexpected adverse outcomes across a range of risks and scenarios. In 2009, the Committee reviewed the performance of stress testing practices during the financial crisis and published recommendations for banks and supervisors entitled Principles for sound stress testing practices and supervision. The guidance set out a comprehensive set of principles for the sound governance, design and implementation of stress testing programmes at banks, as well as high-level expectations for the role and responsibilities of supervisors.

As part of its mandate to assess the implementation of standards across countries and to foster the promotion of good supervisory practice, the Committee's Standards Implementation Group (SIG) conducted a peer review during 2011 of supervisory authorities' implementation of the principles. The review found that stress testing has become a key component of the supervisory assessment process as well as a tool for contingency planning and communication. Countries are, however, at varying stages of maturity in the implementation of the principles; as a result, more work remains to be done to fully implement the principles in many countries.

Overall, the review found the 2009 stress testing principles to be generally effective. The Committee, however, will continue to monitor implementation of the principles and determine whether, in the future, additional guidance might be necessary.

Conference on macrofinancial linkages and their policy implications

Bank of Korea - Bank for International Settlements - International Monetary Fund: joint conference concludes on macrofinancial linkages and their policy implications

April 12, 2012

http://www.bis.org/press/p120412.pdf
 

The Bank of Korea, the Bank for International Settlements and the International Monetary Fund have today brought to a successful conclusion their joint conference on "Macrofinancial linkages: Implications for monetary and financial stability policies". Held on April 10-11 in Seoul, Korea, the event brought together central bankers, regulators and researchers to discuss a variety of topics related to interactions between the financial system and the real economy. The goal of the conference was to promote a continuing dialogue on the policy implications of recent research findings.

The conference programme included the presentation and discussion of research on the following issues:

• Banks, shadow banks and the macroeconomy;
• Bank liquidity regulation;
• The macroeconomic impact of regulatory measures;
• Macroprudential policies in theory and in practice;
• Monetary policy and financial stability.

Efforts to recast monetary and financial stability policies to reduce the frequency and severity of financial crises have focused attention on the interactions between the financial system and the macroeconomy. The crisis demonstrated that financial system weaknesses can have sudden and long-lasting macroeconomic effects.

The conference concluded with a panel discussion chaired by Stephen Cecchetti (BIS), and including Jun Il Kim (Bank of Korea), Jan Brockmeijer (IMF), Hiroshi Nakaso (Bank of Japan), and David Fernandez (JP Morgan). The panel discussion focused on the lessons or guideposts for the formulation and implementation of macroprudential and monetary policies that can be drawn from the intensive research efforts on macrofinancial issues in recent years, as well as on the empirical evidence on the effectiveness of policy measures. The roundtable also included a discussion of weaknesses in our understanding of macrofinancial linkages and touched on priorities for future research, analysis, and continuing cooperation between central banks, regulatory authorities, international organisations and academics.

Introducing the conference, Choongsoo Kim, Governor of the Bank of Korea, said, "Since major countries' measures to reform financial regulations, including Basel III of the BCBS, focus mostly on the prevention of crisis recurrence, we need to continuously monitor and track how these measures will affect the sustainability of world economic growth in the medium- and long-term. In doing so, we should be careful so that the strengthening of financial regulation does not weaken the benign function of finance, which is to drive the growth of the real economy through seamless financial intermediation. Moreover, in today's more closely interconnected world economy, the strengthening of financial regulation with a primary focus on advanced countries does not equally affect the financial system in emerging market countries with their significantly different financial structure. Hence, in examining the implementation of regulations, an in-depth analysis should be conducted of how these regulations will affect the financial industries of emerging market countries and all other countries other than the advanced economies and their careful monitoring is called for."

Stephen Cecchetti, Economic Adviser and Head of the BIS Monetary and Economic Department, remarked that "It is important that we continue to learn about the mechanisms through which financial regulation helps to stabilize the economic and financial system. We are not only exploring the effectiveness of existing tools, but also working to fashion new ones. Doing this means refining the intellectual framework, including both the theoretical models and empirical analysis, that forms the basis for macroprudential policy and microprudential policy, as well as conventional and unconventional monetary policy. The papers presented and discussed in this conference are part of the foundation of this new and essential stability-oriented policy framework."

Jan Brockmeijer, Deputy Director of the IMF Monetary and Capital Markets Department, added that "All the institutions involved in developing macroprudential policy frameworks are on a learning curve both with regard to monitoring systemic risks and in using tools to limit such risks. In such circumstances, sharing of views and experiences is crucial to identifying best practices and moving up the learning curve quickly. The Fund is eager to help its members in this regard, and the conference co-organised by the Fund is one way to serve this purpose."

IMF Global Financial Stability Report: Risks of stricter prudential regulations

IMF Global Financial Stability Report
Apr 2012
http://www.imf.org/External/Pubs/FT/GFSR/2012/01/index.htm

Chapter 3 of the April 2012 Global Financial Stability Report probes the implications of recent reforms in the financial system for market perception of safe assets. Chapter 4 investigates the growing public and private costs of increased longevity risk from aging populations.

Excerpts from Ch. 3, Safe Assets: Financial System Cornerstone?:

In the future, there will be rising demand for safe assets, but fewer of them will be available, increasing the price for safety in global markets.  In principle, investors evaluate all assets based on their intrinsic characteristics. In the absence of market distortions, asset prices tend to reflect their underlying features, including safety. However, factors external to asset markets—including the required use of specific assets in prudential regulations, collateral practices, and central bank operations—may preclude markets from pricing assets efficiently, distorting the price of safety. Before the onset of the global financial crisis, regulations, macroeconomic policies, and market practices had encouraged the underpricing of safety. Some safety features are more accurately reflected now, but upcoming regulatory and market reforms and central bank crisis management strategies, combined with continued uncertainty and a shrinking supply of assets considered safe, will increase the price of safety beyond what would be the case without such distortions.

The magnitude of the rise in the price of safety is highly uncertain [...]

However, it is clear that market distortions pose increasing challenges to the ability of safe assets to fulfill all their various roles in financial markets. [...] For banks, the common application of zero percent regulatory risk weights on debt issued by their own sovereigns, irrespective of risks, created perceptions of safety detached from underlying economic risks and contributed to the buildup of demand for such securities. [...]

[...] Although regulatory reforms to make institutions safer are clearly needed, insufficient differentiation across eligible assets to satisfy some regulatory requirements could precipitate unintended cliff effects—sudden drops in the prices—when some safe assets become unsafe and no longer satisfy various regulatory criteria. Moreover, the burden of mispriced safety across types of investors may be uneven. For instance, prudential requirements could lead to stronger pressures in the markets for shorter-maturity safe assets, with greater impact on investors with higher potential allocations at shorter maturities, such as banks.

Money and Collaterall, by Manmohan Singh & Peter Stella

Money and Collateral, by Manmohan Singh & Peter Stella
IMF Working Paper No. 12/95
Apr 2012
http://www.imf.org/external/pubs/cat/longres.aspx?sk=25851.0

Summary: Between 1980 and before the recent crisis, the ratio of financial market debt to liquid assets rose exponentially in the U.S. (and in other financial markets), reflecting in part the greater use of securitized assets to collateralize borrowing. The subsequent crisis has reduced the pool of assets considered acceptable as collateral, resulting in a liquidity shortage. When trying to address this, policy makers will need to consider concepts of liquidity besides the traditional metric of excess bank reserves and do more than merely substitute central bank money for collateral that currently remains highly liquid.

Excerpts:

Introduction

In the traditional view of a banking system, credit and money are largely counterparts to each other on different sides of the balance sheet. In the process of maturity transformation, banks are able to create liquid claims on themselves, namely money, which is the counterpart to the less liquid loans or credit.2 Owing to the law of large numbers, banks have—for centuries— been able to safely conduct this business with relatively little liquid reserves, as long as basic confidence in the soundness of the bank portfolio is maintained.

In recent decades, with the advent of securitization and electronic means of trading and settlement, it became possible to greatly expand the scope of assets that could be transformed directly, through their use as collateral, into highly liquid or money-like assets. The expansion in the scope of the assets that could be securitized was in part facilitated by the growth of the shadow financial system, which was largely unregulated, and the ability to borrow from non-deposit sources. This meant deposits no longer equaled credit (Schularick and Taylor, 2008). The justification for light touch or no regulation of this new market was that collateralization was sufficient (and of high quality) and that market forces would ensure appropriate risk taking and dispersion among those educated investors best able to take those risks which were often tailor made to their demands. Where regulation fell short was in failing to recognize the growing interconnectedness of the shadow and regulated sectors, and the growing tail risk that sizable leverage entailed (Gennaioli, Shleifer and Vishny, 2011).

Post-Lehman, there has been a disintermediation process leading to a fall in the money multiplier. This is related to the shortage of collateral (Singh 2011). This is having a real impact—in fact deleveraging is more pronounced due to less collateral. Section II of the paper focuses on money as a legal tender, the money multiplier; then we introduce the adjusted money multiplier. Section III discusses collateral, including tail-risk collateral.  Section IV tries to bridge the money and collateral aspects from a “safe assets” angle. Section V introduces collateral chains and describes the economics behind the private pledged collateral market. Section VI brings the monetary and collateral issues together under an overall financial lubrication framework. In our conclusion (section VII) we offer a useful basis for understanding monetary policy in the current environment.



Conclusion

“Monetary” policy is currently being undertaken in uncharted territory and may change some fundamental assumptions that link monetary and macro-financial policies. Central banks are considering whether and how to augment the apparently ‘failed’ transmission mechanism and in so doing will need to consider the role that collateral plays as financial lubrication (see also Debelle, 2012). Swaps of “good” for “bad” collateral may become part of the standard toolkit.31 If so, the fiscal aspects and risks associated with such policies—which are virtually nil in conventional QE swaps of central bank money for treasuries—are important and cannot be ignored. Furthermore, the issue of institutional accountability and authority to engage in such operations touches at the heart of central bank independence in a democratic society.

These fundamental questions concerning new policy tools and institutional design have arisen at the same time as developed countries have issued massive amounts of new debt.  Although the traditional bogeyman of pure seigniorage financing, that is, massive monetary purchases of government debt may have disappeared from the dark corners of central banks, this does not imply that inflation has been forever arrested. Thus a central bank may “stand firm” yet witness rises in the price level that occur to “align the market value of government debt to the value of its expected real backing.” Hence current concerns as to the potential limitations fiscal policy places on monetary policy are well founded and indeed are novel only to those unfamiliar with similar concerns raised for decades in emerging and developing countries as well as in the “mature” markets before World War II.

IMF Background Material for its Assessment of China under the Financial Sector Assessment Program

IMF Releases Background Material for its Assessment of China under the Financial Sector Assessment Program
Press Release No. 12/123
April 5, 2012

A joint International Monetary Fund (IMF) and The World Bank assessment of China's financial system was undertaken during 2010 under the Financial Sector Assessment Program (FSAP). The Financial System Stability Assessment (FSSA) report, which is the main IMF output of the FSAP process, was discussed by the Executive Board of the IMF at the time of the annual Article IV discussion in July 2011.

The FSSA report was published on Monday, November 14, 2011. As background for the FSSA, comprehensive assessments were undertaken by the FSAP mission of the financial regulatory infrastructure and the Detailed Assessment Reports of China's observance with international financial standards were prepared during the FSAP exercise. At the request of the Chinese authorities, these five reports are being released today.

The documents published are as follows:

Detailed Assessment of Observance Reports

1. Observance of Basel Core Principles for Effective Banking Supervision
2. Observance of IAIS Insurance Core Principles
3. Observance of IOSCO Objectives and Principles of Securities Regulation
4. Observance of CPSS Core Principles for Systemically Important Payment Systems
5. Observance of CPSS-IOSCO Recommendations for Securities Settlement Systems and Central Counterparties

The FSAP is a comprehensive and in-depth analysis of a country’s financial sector. The FSAP findings provide inputs to the IMF’s broader surveillance of its member countries’ economies, known as Article IV consultations. The focus of the FSAP assessments is to gauge the stability of the financial sector and to assess its potential contribution to growth. To assess financial stability, an FSAP examines the soundness of the banks and other financial institutions, conducts stress tests, rates the quality of financial regulation and supervision against accepted international standards, and evaluates the ability of country authorities to intervene effectively in case of a financial crisis. Assessments in developing and emerging market countries are done by the IMF jointly with the World Bank; those in advanced economies are done by the IMF alone.

This is the first time the Chinese financial system has undergone an FSAP assessment.

Since the FSAP was launched in 1999, more than 130 countries have volunteered to undergo these examinations (many countries more than once), with another 35 or so currently underway or in the pipeline. Following the recent global financial crisis, demand for FSAP assessments has been rising, and all G-20 countries have made a commitment to undergo regular assessments.

For additional information on the program, see the Factsheet and FAQs.

Original link: http://www.imf.org/external/np/sec/pr/2012/pr12123.htm

Management Tips from the Wall Street Journal

Management Tips from the Wall Street Journal


Developing a Leadership Style

        Leadership Styles
        What do Managers do?
        Leadership in a Crisis – How To Be a Leader
        What are the Common Mistakes of New Managers?
        What is the Difference Between Management and Leadership?
        How Can Young Women Develop a Leadership Style?

Managing Your People

        How to Motivate Workers in Tough Times
        Motivating Employees
        How to Manage Different Generations
        How to Develop Future Leaders
        How to Reduce Employee Turnover
        Should I Rank My Employees?
        How to Keep Your Most Talented People
        Should I Use Email?
        How to Write Memos

Recruiting, Hiring and Firing

        Conducting Employment Interviews – Hiring How To
        How to Hire New People
        How to Make Layoffs
        What are Alternatives to Layoffs?
        How to Reduce Employee Turnover
        Should I Rank My Employees?
        How to Keep Your Most Talented People

Building a Workplace Culture

        How to Increase Workplace Diversity
        How to Create a Culture of Candor
        How to Change Your Organization’s Culture
        How to Create a Culture of Action in the Workplace

Strategy

        What is Strategy?
        How to Set Goals for Employees
        What Management Strategy Should I Use in an Economic Downturn?
        What is Blue Ocean Strategy?

Execution

        What are the Keys to Good Execution?
        How to Create a Culture of Action in the Workplace

Innovation

        How to Innovate in a Downturn
        How to Change Your Organization’s Culture
        What is Blue Ocean Strategy?

Managing Change

        How to Motivate Workers in Tough Times
        Leadership in a Crisis – How To Be a Leader
        What Management Strategy Should I Use in an Economic Downturn?
        How to Change Your Organization’s Culture

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Encouraging workers to keep track of what they're doing can make them healthier and more productive

Employees, Measure Yourselves. By H. James Wilson
Encouraging workers to keep track of what they're doing can make them healthier and more productiveThe Wall Street Journal, Apr 2012
http://online.wsj.com/article/SB10001424052970204520204577249691204802060.html

Imagine how much better workers could do their jobs if they knew exactly how they spend their day.

Suppose they could get a breakdown of how much time they spend actually working on their computer, as opposed to surfing the Web. Suppose they could tell how much an afternoon workout boosts their productivity, or how much a stressful meeting raises their heart rate.

Thanks to a new wave of technologies called auto-analytics, they can do just that. These devices—from computer software and smartphone apps to gadgets that you wear—let users gather data about what they do at work, analyze that information and use it to do their job better. They give workers a fascinating window into the unseen, unconscious little things that can make such a big difference in their daily work lives. And by encouraging workers to start tracking their own activities—something many already are doing on their own—companies can end up with big improvements in job performance, satisfaction and possibly even well-being.

The key word here is encouragement. It is not the same as insistence. Bosses should be careful to stay out of workers' way, letting employees experiment at their own pace and find their own solutions. They should offer them plenty of privacy safeguards along the way. Too much managerial interference could make the programs seem like Big Brother and dissuade workers from signing on. There's a big difference between employees wanting to measure themselves, and bosses demanding it.

Here's a look at three areas of auto-analytics that are gaining followers in the workplace—and that merit encouragement from managers.

Tracking Screen Time
Many companies monitor what their employees are doing on the computer all day, by watching network traffic or even taking screenshots at random times. But all that oversight is designed to make sure people aren't slacking off; it doesn't help them figure out how to do their jobs better. And besides, a lot of workers probably think it's kind of creepy to have someone watching over their shoulder.

On the other hand, workers are a lot more comfortable with close scrutiny when they're the ones doing the watching.

People are signing on in droves to a new technology called knowledge workload tracking—recording how you use your computer. Software like RescueTime measures things like how long you spend on an open window, how long you're idle and how often you switch from one window to another. The software turns all those measurements into charts so you can see where you're spending your time. From there, you can set up automatic alerts to keep yourself away from distractions; you might send yourself a message if you, say, spend too much time on Twitter.

Programs like these also let you look a lot deeper into your behavior. One employee I observed saw that he got a lot more done when he switched tasks at set intervals. So he had the software remind him to change things up every 20 minutes. (He also set up an algorithm that suggested the best activity to do next.)

Another employee, a programmer, thought his online chats were eating into his work time. So he tested the theory: He looked at how long he spent chatting during certain periods, then looked at how much code he wrote during those times. But in fact, the more he talked, the more code he wrote. Gabbing online with colleagues and customers helped his work.

Managers should encourage experiments and help workers get the ball rolling. They might, for instance, find workers who got good results from the software and have them give presentations to other employees.

Again, though, companies need to use a light touch in encouraging employees: Many workers might be reluctant to track what they do if they think the company might get access to the information, or use it against them. Companies should emphasize that this type of software usually comes with lots of privacy controls. Workers can often store their data in the cloud, for instance, or locally on their machines. In some cases, they can pause tracking and delete pieces of personal data they choose. Likewise, they can also create a list of sites that they want to track by name and label all the other sites they visit as generic.



Collecting Thoughts

Tracking clicks and keystrokes is one thing. But another set of tools goes one step deeper and lets employees track their mental performance—and maybe even improve it.

These tools come in a variety of styles. For example, there's Lumosity, from Lumos Labs Inc., an online system that serves up games employees can play during downtime at work. The games promise to develop memory, thinking speed, attention and problem-solving abilities.

You might have to sort a batch of words into two piles depending on whether or not they follow a certain rule. Or you might be presented with two equations and have to figure if the one on the left is greater than, less than or equal to the one on the right. The software will feed you tougher challenges once you've mastered one level of difficulty.

So far, that might not sound much different than other games you might play at the office. (Minesweeper, anyone?) The difference is tracking. The games offer a scorecard of your performance and let you follow changes in performance over time, so you can see if you're getting better or backsliding. You can also choose what skills you want to improve. If you're having trouble remembering things, for instance, you might ask for memory-boosting games. So, while it may seem like just another game, it can home in on skills you're trying to sharpen for work—and improve them.

Another set of tools promises to help with a couple of age-old problems: forgetting ideas or the context in which you thought of them (or having so many of them you can't decide which will work best for the task at hand).

The method, called cognitive mapping, powers software like TheBrain, from TheBrain Technologies LP. When you get an idea related to work, you type it into the software on your desktop or mobile device. You place it near related ideas by clicking on a visual map that shows clusters of concepts grouped together by category like constellations on your screen.

Let's say your job is designing products for a household-goods company, and you get an idea about a new kind of sponge. You might click on the cluster of ideas for kitchen-cleaning products, which covers mops and paper towels as well as sponges. Then you'd click on the smaller cluster of ideas about sponges and type in your new notion. You'd also be able to attach things like links to websites, photos and meeting notes.

Later on, if you need to come up with some ideas in a particular area, you might type in a few search terms to see the thoughts you've had on the topic and the clusters of ideas and information you originally associated with those terms. Thus, you not only have a historical record of your thoughts, but also detailed insight into the context in which they were created.

As with knowledge workload tracking, employers should encourage workers to use these systems and give them freedom to experiment. But companies can probably be more active in pushing these products, since they don't have the same Big Brother associations as tracking work. So managers might buy subscriptions for influential employees who can help seed interest across the company. If they think it's warranted, managers might even buy companywide subscriptions, as they do for other types of software.




The Physical Side

There's one area where employers are already doing a lot to encourage workers to track themselves: company-sponsored wellness programs. More than two-thirds of companies around the world run wellness programs, and self-tracking tools are fast becoming a common feature.

Usually, the third-party companies that manage the programs give workers tracking devices that can synch up with an external database through a smartphone or work computer. That way, employees can crunch their own data and come up with options for improving health and job performance.

For instance, you might wear a device like Jawbone's UP wristband, which tracks sleep quantity and quality. You could then analyze your data to see how different amounts of sleep affect your work. Do you close more sales on days when you get more quality sleep? Or do you post better numbers when you sacrifice some shut-eye to entertain clients until all hours?

Another approach is tracking how your body works over the course of a workday with a tool such as the emWave2, from HeartMath LLC, which monitors your pulse. You can then look at your stats on a desktop dashboard to see, for instance, what sorts of situations cause you the most stress. The program can then recommend ways to reduce anxiety, such as breathing techniques that can help you reduce your heart rate during a big presentation.

Tracking things at this intimate level might set off all sorts of alarm bells for workers. Many might wonder if an employer could get hold of the information and use it against them. So bosses should ensure that workers have the chance to encrypt or otherwise protect their data.


Mr. Wilson is senior researcher at Babson Executive Education