Maurice Greenberg: State and federal agencies are hurting shareholders and undermining confidence in the banking system

The Regulatory Attack on J.P. Morgan Feels Familiar. By Maurice Greenberg
State and federal agencies are hurting shareholders and undermining confidence in the banking system.http://online.wsj.com/article/SB10001424052702303464504579109563311240116.
The Wall Street Journal, October 3, 2013, on page A13

A thriving financial-services sector requires a delicate balance of regulation and risk management. Realizing how vital this industry's health is to the economy, regulators and private businesses have spent the past century trying to create a system that ensures stability while encouraging investment. Responsible regulators understand just how difficult this is to accomplish. Others who ignore that reality often keep markets from functioning properly.

Regulators can help minimize risk to the investing public by learning from past regulatory mistakes. But it doesn't appear that they have. Now they're after J.P. Morgan Chase Co., a great American company led by arguably the best chief executive on Wall Street.

I experienced regulatory overreach first-hand at AIG. For nearly four decades, I led a team that included some of the most honorable and competent professionals in the insurance industry. We built the world's largest and most respected insurer, employing more than 90,000 people and opening markets across the world. That made AIG an attractive target for Eliot Spitzer, then New York's attorney general, in 2005.

Displaying an astonishing lack of knowledge of the insurance industry, Mr. Spitzer, by threatening to criminally indict the company, succeeded in separating the industry's most accomplished group of executives from a company that insured virtually every business sector across 130 countries. The replacement management took steps that made AIG vulnerable to the world-wide financial collapse of 2008. That provided a set of federal regulators with the opportunity to seize tens of billions of dollars from AIG's shareholders.

Nearly all of Mr. Spitzer's original allegations of accounting irregularities have been discarded or quietly dismissed by him and his successors. The remaining claims—on which no damages are sought—involve the accounting for reinsurance transactions that were not material to AIG. The real scandal, of course, is the fact that the attorney general brought this lawsuit and continues to prosecute it even today.

History seems to be repeating itself with the case of J.P. Morgan. The global bank is now under siege by federal and state regulators. The most ironic claim against J.P. Morgan is an allegation from current New York Attorney General Eric Schneiderman of mortgage fraud at Bear Stearns that allegedly took place prior to J.P. Morgan's acquisition of that firm. J.P. Morgan acquired Bear Stearns at the urging of federal officials who feared that fallout from Bear's collapse would damage the entire economy.

Like AIG, J.P. Morgan plays a central role in both the U.S. and world economies. There are no more than a handful of executives with the requisite experience, talent and intelligence to lead that bank. Its chief executive, James Dimon, is one of those rare individuals. By diverting his attention from his responsibilities, government officials are hurting shareholders, pension funds, countless employees, the City of New York, and the national and global economy—not to mention undermining confidence in our banking system.

Those regulators have pushed their dubious claims to the point of requiring the bank to pay over $11 billion in fines. I hope the board of directors at J.P. Morgan will have the wisdom and courage to support their CEO and not cave to demands from regulators that can only harm the company and its stakeholders. That would send a strong message to the nation's business community and allow J.P. Morgan to continue to benefit from Mr. Dimon's leadership.

I have spent my entire career opening markets in China, Eastern Europe and across the world. When we took AIG public in 1969, we chose New York as the company's place of business because the state offered a predictable regulatory environment. And yet what I see in New York and Washington is a regulatory culture that seems manifestly determined to make this state and nation the last places where any responsible CEO would want to do business. Incredible as it seems, federal and state regulators are now negotiating for their share of the "credit"—their cut of the cash—for the damage they are currently inflicting on J.P. Morgan, competing with one another to inherit Spitzer's "Sheriff of Wall Street" title. Some people never learn.

Mr. Greenberg is chairman and CEO of C.V. Starr & Co.

IMF: Key Aspects of Macroprudential Policy + Implementing Macroprudential Policy/Selected Legal Issues

Key Aspects of Macroprudential Policy - Background Paper
IMF, June 10, 2013
http://www.imf.org/external/pp/longres.aspx?id=4804

Summary

The countercyclical capital buffer (CCB) was proposed by the Basel committee to increase the resilience of the banking sector to negative shocks. The interactions between banking sector losses and the real economy highlight the importance of building a capital buffer in periods when systemic risks are rising. Basel III introduces a framework for a time-varying capital buffer on top of the minimum capital requirement and another time-invariant buffer (the conservation buffer). The CCB aims to make banks more resilient against imbalances in credit markets and thereby enhance medium-term prospects of the economy—in good times when system-wide risks are growing, the regulators could impose the CCB which would help the banks to withstand losses in bad times.


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IMF: Implementing Macroprudential Policy - Selected Legal Issues
IMF, June 10, 2013
http://www.imf.org/external/pp/longres.aspx?id=4802

Summary
As countries design and implement macroprudential policies, they face the challenge of determining what—if any—changes need to be made to their legal and institutional framework to ensure that these policies are effective. Based on a review of experience, it is clear that there are a variety of approaches that can be taken by members, in light of the legal constraints and institutional preferences of each country. Whichever approach is followed, a number of issues need to be addressed when designing legislation in this area, both with respect to the substantive legal provisions and the allocation of institutional responsibilities. As background to ”Key Aspects of Macroprudential Policy“, this paper provides an overview of these legal and institutional issues, while recognizing that macroprudential policy is an area that is still evolving.

Financial Inclusion for Financial Stability: Improving Access to Deposits and Bank Resilience in Sync

Financial Inclusion for Financial Stability: Improving Access to Deposits and Bank Resilience in Sync. By Martin Melecky
World Bank Blogs
Tue, Sep 10, 2013
http://blogs.worldbank.org/allaboutfinance/financial-inclusion-financial-stability-improving-access-deposits-and-bank-resilience-sync

From 2006 to 2009, growth of bank deposits dropped by over 12 percentage points globally. The most affected by the 2008 global crisis were upper middle income countries that experienced a drop of 15 percentage points on average. Individual countries such as Azerbaijan, Botswana, Iceland, and Montenegro switched from deposit growth of 58 percent, 31 percent, 57 percent, and 94 percent in 2007 to deposit declines (or a complete stop in deposit growth) of -2 percent, 1 percent, -1 percent, -8 percent in 2009, respectively.

In times of financial stress, depositors get anxious, can run on banks, and withdraw their deposits (Diamond and Dybvig, 1983). Large depositors are usually the first ones to run (Huang and Ratnovski, 2011). By the law of large numbers, correlated deposit withdrawals could be mitigated if bank deposits are more diversified. Greater diversification of deposits could be achieved by enabling a broader access to and use of bank deposits, i.e. involving a greater share of adult population in the use of bank deposits (financial inclusion). Based on this assumption, broader financial inclusion in bank deposits could significantly improve resilience of banking sector funding and thus overall financial stability (Cull et al., 2012).

In the recent background paper for the World Development Report 2014 (Han and Melecky, 2013), we investigate the implications of a broader access to deposits for the dynamics of bank deposits during the global financial crisis. Namely, we analyze whether access to bank deposits by a larger share of a country’s population can help explain differences in the drop of deposit growth over 2007-2010 across our sample of 95 countries. We also separately estimate the differences in the relationship between the drop in deposit growth and access to deposits for low-income (LIC), middle-income (MIC), and high-income (HIC) countries.

Our paper responds to an existing gap in the empirical literature linking greater access to deposits with greater financial (banking sector) stability. While the literature postulates that an inclusive financial sector will have a more diversified, stable retail deposit base that can increase systemic stability, empirical research confirming existence of such a relationship, especially at the level of the financial system, is largely absent in the literature (Cull et al., 2012; Prasad, 2010).

We find that a broader access to and use of bank deposits can significantly mitigate bank deposit withdrawals or growth slowdowns in times of financial stress. Specifically, the estimated coefficient on the variables measuring access to deposits indicates that a 10 percent increase in the share of people that have access to bank deposits can mitigate the deposit growth drops (or deposit withdrawal rates) by about three to eight percentage points. While this finding holds for the entire sample of HICs, MICs, and LICs, it could be particularly strong in MICs, where a large share of population still lacks access to bank deposits, trust in banks is yet to be firmly established, and the integration in global financial flows is growing.

Our findings have important policy implications. Policy makers face tradeoffs when deciding whether to focus on reforms to promote financial development (financial inclusion, innovation, competition, etc.) or whether to focus on further improvements in financial stability (microprudential, macroprudential, business conduct supervision, etc.). However, synergies between promoting financial development and financial stability can also exist as shown in our paper.

We recommend that policy makers focus first on taking advantage of such synergies in their framework for financial sector policy. This framework is typically formulated in a national financial sector strategy which sets the development goals in finance, in view of systemic risk associated with achieving these goals and the risk preference of the country government. Namely, we argue that involving more people in the use of bank deposits could be beneficial for people, economic development, and stability of the financial system alike.

Drawing on our paper, the World Development Report 2014, in its chapter on the financial system, makes similar recommendations; namely, that countries should strive to promote a broader and responsible use of financial tools not only to aid economic development and poverty alleviation, but also to complement the mainstream (macroprudential) policies to enhance financial stability and prevent financial crises.

Again, these policy efforts, their synergetic effects, and the plan for their implementation, including the resulting responsibilities of different government agencies, should be clearly described in the national financial sector strategy. With proper regulation and oversight in place, initiatives such as Kenya’s M-PESA and M-KESHO projects (Demombynes and Thegeya, 2012) or South Africa’s Mzansi accounts (Bankable Frontier Associates, 2009) could serve as good examples of promoting a broader use of bank accounts (deposits) and enhancing the reliability of bank deposit funding at the same time.

References

• Bankable Frontier Associates. 2009. "The Mzansi Bank Account Initiative in South Africa." Report commissioned by FinMark Trust. Bankable Frontier Associates, Somerville, MA.
• Cull, Robert, Asli Demirguc-Kunt and Timothy Lyman. 2012. "Financial Inclusion and Stability: What Does Research Show?" CGAP Brief 71305, CGAP, Washington, DC.
• Demombynes, Gabriel and Aaron Thegeya. 2012. "Kenya's Mobile Revolution and the Promise of Mobile Savings." Policy Research Working Paper 5988. World Bank, Washington, DC.
• Diamond, Douglas W. and Philip H. Dybvig. 1983. "Bank Runs, Deposit Insurance, and Liquidity." Journal of Political Economy 91(3): 401­–19.
• Huang, Rocco, and Lev Ratnovski. 2011. "The Dark Side of Bank Wholesale Funding." Journal of Financial Intermediation 20: 248–263.
• Prasad, Eswar S. 2010. "Financial Sector Regulation and Reforms in Emerging Markets: An Overview." NBER Working Paper 16428, Cambridge, MA.

Margin requirements for non-centrally cleared derivatives - final report issued by the Basel Committee and IOSCO

Margin requirements for non-centrally cleared derivatives - final report issued by the Basel Committee and IOSCO
September 2, 2013

The Basel Committee on Banking Supervision and the International Organization of Securities Commissions (IOSCO) released today the final framework for margin requirements for non-centrally cleared derivatives. The framework is available on the websites of the Bank for International Settlements and IOSCO.

Under the globally agreed standards published today, all financial firms and systemically important non-financial entities that engage in non-centrally cleared derivatives will have to exchange initial and variation margin commensurate with the counterparty risks arising from such transactions. The framework has been designed to reduce systemic risks related to over-the-counter (OTC) derivatives markets, as well as to provide firms with appropriate incentives for central clearing while managing the overall liquidity impact of the requirements.

The final requirements have been developed taking into account feedback from two rounds of consultation (a July 2012 consultative paper and a February 2013 near-final proposal) as well as a quantitative impact study that helped inform the policy deliberations.

Compared with the near-final framework proposed earlier this year, the final set of requirements includes the following modifications:

• The framework exempts physically settled foreign exchange (FX) forwards and swaps from initial margin requirements. Variation margin on these derivatives should be exchanged in accordance with standards developed after considering the Basel Committee supervisory guidance for managing settlement risk in FX transactions.
• The framework also exempts from initial margin requirements the fixed, physically settled FX transactions that are associated with the exchange of principal of cross-currency swaps. However, the variation margin requirements that are described in the framework apply to all components of cross-currency swaps.
• "One-time" re-hypothecation of initial margin collateral is permitted subject to a number of strict conditions. This should help to mitigate the liquidity impact associated with the requirements.

A number of other features of the framework are also intended to manage the liquidity impact of the margin requirements on financial market participants. In particular, the requirements allow for the introduction of a universal initial margin threshold of €50 million below which a firm would have the option of not collecting initial margin. The framework also allows for a broad array of eligible collateral to satisfy initial margin requirements, thus further reducing the liquidity impact.

Finally, the framework published today envisages a gradual phase-in period to provide market participants with sufficient time to adjust to the requirements. The requirement to collect and post initial margin on non-centrally cleared trades will be phased in over a four-year period, beginning in December 2015 with the largest, most active and most systemically important derivatives market participants.

The Basel Committee and IOSCO acknowledge that the margin requirements are new to the market and that their precise impact will depend on a number of factors and market conditions that will only be realised over time as the requirements are put into practice. Accordingly, the Basel Committee and IOSCO will monitor and assess the impact of the requirements as they are implemented globally.

Review of Thomas Healy's The Great Dissent

What Democracy Requires. By Joshua
Review of Thomas Healy's The Great Dissent
Justice Holmes changed his mind about free speech—and rediscovered the original intent of the First Amendment.
The Wall Street Journal, August 23, 2013, on page C5
http://online.wsj.com/article/SB10001424127887324108204579022881137648134.html

In the working sections of the Supreme Court building in Washington, D.C., the quiet places where the justices have their chambers and the staffs go about their work, portraits of the former members of the court peer out from almost every room and hallway. I used to find myself, when I worked there some years ago, pausing beneath the past luminaries and wondering what they might have to say about the court's current cases.

I never got very far with Oliver Wendell Holmes (1841-1935). His portrait didn't invite inquiry. He sat straight-backed in his judicial robes, his lips pursed beneath a virile white mustache, eyes boring directly ahead. He conveyed simultaneously grandeur and skepticism, as if he might interrupt you at any moment to say, "That's nonsense." This is Holmes in his Solomonic pose, the man hailed as the "Master of Sentences," lionized in an early biography as the "Yankee from Olympus," his life made the subject of a 1950s Hollywood film. It was an image that Holmes spent nearly the whole of his adult life cultivating, driven on by his galloping ambition. "I should like to be admitted," he told a correspondent in 1912, "as the greatest jurist in the world."

Holmes would surely have approved of Thomas Healy's "The Great Dissent." The subtitle conveys the narrative's gist: "How Oliver Wendell Holmes Changed His Mind—and Changed the History of Free Speech in America." Mr. Healy recounts Holmes's emergence late in his career as a champion of free speech and tells the story of the coterie of young intellectuals, led by Felix Frankfurter and Harold Laski, who worked assiduously to shape Holmes's views. It is a fascinating tale—and a charming one, of an aging and childless Holmes befriended by a rising generation of legal thinkers, surrogate sons who persuade him over time to take up their cause.

Mr. Healy, a professor of law at Seton Hall, is at his best detailing the younger men's campaign to win Holmes to their view of the First Amendment. In March 1919, Holmes still believed that the government could punish "disloyal" speech and wrote an opinion supporting the 1917 Espionage Act, which made it illegal to criticize the draft or American involvement in World War I. In Debs v. United States, the Supreme Court unanimously upheld the prosecution of Socialist Party leader Eugene Debs for his critical statements about the war. Less than nine months later, Holmes had changed his mind, dramatically. In Abrams v. United States, he broke with his colleagues and with his own earlier views and argued that the Constitution didn't permit the government to punish speech unless it posed a "clear and present danger" of public harm. Laws penalizing any other type of public speech were unconstitutional. Holmes's Abrams opinion is the "great dissent" of Mr. Healy's title.

The youthful acolytes had made the difference. As Mr. Healy elaborates, Holmes had developed a knack for collecting young admirers in his years on the Supreme Court (1902-32). In 1919, Holmes's circle included Frankfurter, a junior professor at Harvard Law School serving in the Wilson administration, and the Englishman Harold Laski, just 25 and like Frankfurter a Jew and a teacher at Harvard. Both men would go on to illustrious careers—Frankfurter on the Supreme Court and Laski as a political theorist and chairman of the British Labour Party. Both admired Holmes for his modernist intellectual outlook: for his skepticism about moral absolutes and dislike of formal legal doctrine; and for what they believed (mistakenly) to be Holmes's progressive political views.

Even before the Debs case, Laski had been plying Holmes with arguments about free speech. After Holmes's disappointing opinion in that case, Laski redoubled his efforts, assisted by letters from Frankfurter and well-timed essays from the pair's allies at the New Republic magazine. As it happened, both Laski and Frankfurter suffered professionally in 1919 for their sometimes outspoken political views—both were briefly in danger of being dismissed from Harvard. Mr. Healy implies that their ordeal may have heightened Holmes's appreciation for free speech. But the more likely turning point came in the summer of 1919, when Laski forwarded to Holmes an article defending freedom of speech for its social value and then introduced Holmes to its author, another young Harvard law professor named Zechariah Chafee Jr.

Chafee, who was no sort of progressive and whose specialty was business law, argued that free speech advanced a vital social interest by promoting the discovery and spread of truth, which in turn allowed democracy to function. Holmes had never been much of a proponent of individual liberty, but he was profoundly committed to majoritarian democracy. Free speech as a social good was a rationale he could buy. And in his Abrams dissent a few months later, he did. He would eventually conclude that the First Amendment shielded speech from both federal and state interference.

Mr. Healy tells this conversion story well, bringing the reader into Holmes's confidence and into the uneasy, war-weary milieu of 1919 America. "The Great Dissent" is compelling, too, for the glimpses it gives of the human Holmes rather than the Olympian public figure. Here is Holmes standing at his writing desk to compose his court opinions, keeping them brief lest his legs tire; waxing rhapsodic each spring about the bloodroot flowers in Rock Creek Park. He was unfailingly decorous to his colleagues—even as he was indifferent to his wife—but quivered and fumed at the merest hint of criticism, unable to acknowledge that he had ever been mistaken about anything of importance.

All too often, however, Mr. Healy lapses into hagiography and an annoyingly Whiggish mode of storytelling, in which our modern free-speech doctrine —which protects the right of individuals and corporations to speak on most any topic at most any time—is portrayed as the Inevitable Truth toward which constitutional history has been marching all along. In this story, Holmes's embrace of free speech emerges as the very culmination of his life's work and its linchpin. "It was almost as if Holmes had been working toward this moment his entire career," Mr. Healy says triumphantly.

Not quite. Holmes's endorsement of free speech as a constitutional principle was far more ambivalent than Mr. Healy lets on and in considerable tension with the rest of his jurisprudence. This is precisely what makes it so interesting. Holmes's struggle to reconcile freedom of speech with his other legal ideas helped him to see connections that contemporary Americans are apt to miss.

Holmes made his name on the court as an advocate of judicial restraint. He thought courts should overturn the judgment of democratic legislatures in only the most extraordinary of circumstances. He was a skeptic. He believed law didn't have much to do with morality—"absolute truth is a mirage," he once said—or even logic. As he saw it, law was nothing more than "the dominant opinion of society." The Constitution placed no firm bounds on the right of the majority to do as it pleased. It was "made for people of fundamentally differing views," he said. The majority could choose the view and pursue the policies it wanted, for the reasons it wanted.

All this being true, the judiciary had no business substituting its views for those of the public. If law was based merely on opinion and raw preference, the people's preferences should count, not judges'.

How then did Holmes come to hold that the First Amendment could be used to strike down laws of Congress and even of the states? The answer is that Holmes came to see the principle of free speech as an essential part of majority rule; it was valuable because it helped majorities get their way.

Mr. Healy notes the influence on Holmes of Chafee's "social argument" for free speech but fails to explain just how central it was to his conversion experience. In his dissenting opinion in Abrams, Holmes wrote: "The best test of truth is the power of the thought to get itself accepted in the competition of the market." Truth was whatever the majority thought it was, but if the majority was going to make up its mind in a sensible way, it needed to have as many options before it as possible. Then too, majorities changed their minds, and protecting speech that was unpopular now preserved opinions that the majority might come to favor in the future. "The only meaning of free speech," Holmes wrote in 1925, is that every idea "be given a chance" to become in time the majority creed.

Such reasoning tethered free speech to majority rule, but it was less than perfectly consistent. Even as he valorized the right to speak, Holmes continued to insist that "the dominant forces in the community" must get what they wanted. Yet if free speech were to mean anything at all as a constitutional right, it would mean that majorities could not get their way in all circumstances. From time to time, Holmes recognized as much; in one of his last opinions he wrote that the "principle of free thought" means at bottom "freedom for the thought we hate." How forcing the majority to tolerate speech it hated facilitated that same majority's right to have its way is a formula Holmes never quite explained.

Mr. Healy suggests that with Holmes's dissent in Abrams, the modern era of First Amendment law had arrived. But Holmes's majoritarianism didn't prevail as the principal rationale for free speech at the Supreme Court, which has instead emphasized individuals' right to speak regardless of the social interests involved. Still, for all its internal tensions, Holmes's unfinished view—he continued to puzzle over the problem right through his retirement from the court in 1932—captures something that the contemporary adulation of free speech has hidden.

Holmes saw that the Constitution's commitment to freedom of speech is inextricably bound up with the project of self-government that the Constitution was designed to make possible. That project depends on an open exchange of ideas, on discussion between citizens and their representatives, on the ability of everyday Americans to talk and reason together.

This sort of government is a way of life, and the First Amendment helps makes it possible by prohibiting the state from censoring the organs of social communication. The government may not control newspapers or printing presses or stop citizens from stating their views. Government may not halt the dissemination of ideas.

In the past half-century, however, the Supreme Court has increasingly spoken of the right to free speech as a right to free expression. Under that rubric, it has expanded the First Amendment to cover all manner of things unconnected to public life, be it art or pornography or commercial advertising. This trend has been even more pronounced in popular culture, where the right to express oneself is now widely regarded as the essence of the freedom to speak.

And to be sure, individual expression is a valuable thing. The danger is in coming to think of free speech as merely expression. That reductionism encourages Americans to see freedom of speech, and freedom generally, as mainly about the pursuit of private aims. But in the end, such thinking represents a loss of confidence, or worse, a loss of interest in the way of living that is self-government—in the shared decisions and mutual persuasion that is how a free people makes a life together. Ours is a country saturated with talk and shouted opinions and personal exhibitionism but one less and less interested in the shared civil discourse that democracy requires.

Holmes wouldn't have described free speech or self-government in such elevated terms. He was too much the skeptic for that. But he came to understand, in his own way, the profound value of free speech to a free people. The story of this discovery is worth revisiting.

—Mr. Hawley, an associate professor of law at the University of Missouri and former judicial clerk to Chief Justice of the United States John G. Roberts Jr., is the author of "Theodore Roosevelt: Preacher of Righteousness" (2008).

Macroeconomic impact assessment of OTC derivatives regulatory reforms report issued by the Macroeconomic Assessment Group on Derivatives

Macroeconomic impact assessment of OTC derivatives regulatory reforms report issued by the Macroeconomic Assessment Group on Derivatives (MAGD)
August 26, 2013
www.bis.org/press/p130826.htm

The Macroeconomic Assessment Group on Derivatives (MAGD) today published a report on the macroeconomic effects of OTC derivatives regulatory reforms.

In this report, the MAGD focuses on the effects of (i) mandatory central clearing of standardised OTC derivatives, (ii) margin requirements for non-centrally cleared OTC derivatives and (iii) bank capital requirements for derivatives-related exposures. In its preferred scenario, the Group found economic benefits worth 0.16% of GDP per year from avoiding financial crises.

It also found economic costs of 0.04% of GDP per year from institutions passing on the expense of holding more capital and collateral to the broader economy. This results in net benefits of 0.12% of GDP per year. These are estimates of the long-run consequences of the reforms, which are expected to apply once they have been fully implemented and had their full economic effects.

The MAGD was set up by the OTC Derivatives Coordination Group (ODCG), comprised of the Chairs of the Basel Committee on Banking Supervision (BCBS), the Committee on the Global Financial System (CGFS), the Committee on Payment and Settlement Systems (CPSS), the Financial Stability Board (FSB) and the International Organization of Securities Commissions (IOSCO). It comprises financial and economic modelling experts from 29 central banks and other authorities, chaired by Stephen Cecchetti, Economic Adviser of the Bank for International Settlements (BIS).


Executive summary (excerpts)

In February 2013, the Over-the-counter Derivatives Coordination Group (ODCG) commissioned a quantitative assessment of the macroeconomic implications of over-the-counter (OTC) derivatives regulatory reforms to be undertaken by the Macroeconomic Assessment Group on Derivatives (MAGD), chaired by Stephen G Cecchetti of the Bank for International Settlements (BIS). The Group comprised 29 member institutions of the Financial Stability Board (FSB), working in close collaboration with the IMF. Guided by academics and other official sector working groups, and in consultation with private sector OTC derivatives users and infrastructure providers, the Group developed and employed models that provide an estimate of the benefits and costs of the proposed reforms. This report presents those findings.

Counterparty exposures related to derivatives traded bilaterally in OTC markets helped propagate and amplify the global financial crisis that erupted in 2008. Many of these exposures were not collateralised, so OTC derivatives users recorded losses as counterparty defaults became more likely or, as in the case of Lehman Brothers, were realised. Furthermore, since third parties had little information about the bilateral exposures among derivatives users, they became less willing to provide credit to institutions that might face such losses.

In response, policymakers have developed and are implementing reforms aimed at reducing counterparty risk in the OTC derivatives market. These include requirements for standardised OTC derivatives to be cleared through central counterparties (CCPs), requirements for collateral to be posted against both current and potential future counterparty exposures, whether centrally cleared or non-centrally cleared, and requirements that banks hold additional capital against their uncollateralised derivative exposures.

While these reforms have clear benefits, they do entail costs. Requiring OTC derivatives users to hold more high-quality, low-yielding assets as collateral lowers their income. Similarly, holding more capital means switching from lower-cost debt to higher-cost equity financing. Although these balance sheet changes reduce risk to debt and equity investors, risk-adjusted returns may still fall. As a consequence, institutions may pass on higher costs to the broader economy in the form of increased prices.

This report assesses and compares the economic benefits and costs of the planned OTC derivatives regulatory reforms. The focus throughout is on the consequences for output in the long run, ie when the reforms have been fully implemented and their full economic effects realised. The main beneficial effect is a reduction in forgone output resulting from a lower frequency of financial crises propagated by OTC derivatives exposures, while the main cost is a reduction in economic activity resulting from higher prices of risk transfer and other financial services.

These long-run benefits and costs depend on how the reforms interact with derivatives portfolios and affect the structure of the derivatives market more broadly, as this can significantly alter the amount of netting obtainable from gross counterparty exposures. In response, the Group analysed three scenarios that differ mainly in terms of the assumed degree of netting. [...]

Briefly, the main benefit of the reforms arises from reducing counterparty exposures, both through netting as central clearing becomes more widespread and through more comprehensive collateralisation. The Group estimates that in the central scenario this lowers the annual probability of a financial crisis propagated by OTC derivatives by 0.26 percentage points. With the present value of a typical crisis estimated to cost 60% of one year’s GDP, this means that the reforms help avoid losses equal to (0.26 x 60% =) 0.16% of GDP per year. The benefit is balanced against the costs to derivatives users of holding more capital and collateral. Assuming this is passed on to the broader economy, the Group estimates that the cost is equivalent to a 0.08 percentage point increase in the cost of outstanding credit. Using a suite of macroeconomic models, the Group estimates that this will lower annual GDP by 0.04%. Taken together, this leads to the Group’s primary result: the net benefit of reforms is roughly 0.12% of GDP per year.

As one would expect, for the scenarios with higher and lower netting these net benefits are respectively slightly higher and slightly lower. Importantly, the Group concludes that the economic benefits are essentially constant across scenarios because the reforms demand collateralisation of the vast majority of net counterparty exposures, whatever their size. But shifting between netting and collateralisation does affect the estimated costs and hence the net benefits.

Uncertainties arising from a combination of modelling limitations and data scarcity were handled in a variety of ways. First, examining a variety of macroeconomic models helped the Group to improve the precision of estimates of the impact of the reforms’ direct costs on the real economy. Second, by varying the structure of the network of bilateral OTC derivatives exposures within feasible limits as well as the strength of the relationship between losses on these exposures and the creditworthiness of the institution incurring them, the Group managed two other potentially large uncertainties. And finally, while some assumptions bias the results towards higher net benefits, many deliberately bias them in the other direction. For example, the funding costs of increased collateral and capital holdings were based on historical prices, rather than prices that reflect improvements in credit quality associated with these balance sheet changes.

In the course of completing the analysis reported here, the Group encountered a number of technical challenges. One related to a shortage of information about the structure of the OTC derivatives exposure network. In the absence of data on bilateral exposures, these were estimated using aggregate data and distributional assumptions. Conversations with derivatives users, infrastructure providers and regulators then helped to validate the estimated network. More generally, the Group found little prior analysis of how derivatives can affect the economy.

Despite statistical uncertainty and the need to make various modelling assumptions and to employ only the limited data available, the group concludes that the economic benefits of reforms are likely to exceed their costs, especially in the scenarios with more netting. Therefore, to maximise the net benefit of the reforms, regulators and market participants must work to make as many OTC derivatives as possible safely centrally clearable, with either a modest number of central counterparties or with central counterparties that interoperate. This should include efforts to harmonise the rules governing cross-border transactions, so that market participants have equal access to CCPs.

Mortgage insurance: market structure, underwriting cycle and policy implications

Mortgage insurance: market structure, underwriting cycle and policy implications
Joint Forum, Aug 20, 2013
http://www.bis.org/press/p130820.htm

The Joint Forum released today its final report on Mortgage insurance: market structure, underwriting cycle and policy implications.   

The events of the last few years, particularly those in the global financial crisis that began in 2007, demonstrate that mortgage insurance is subject to significant stress in the worst tail events. This report examines the interaction of mortgage insurers with mortgage originators and underwriters. It makes the following set of recommendations directed at policymakers and supervisors which aim at reducing the likelihood of mortgage insurance stress and failure in such tail events:

1. Policymakers should consider requiring that mortgage originators and mortgage insurers align their interests;
2. Supervisors should ensure that mortgage insurers and mortgage originators maintain strong underwriting standards;
3. Supervisors should be alert to - and correct for - deterioration in underwriting standards stemming from behavioural incentives influencing mortgage originators and mortgage insurers;
4. Supervisors should require mortgage insurers to build long-term capital buffers and reserves during the troughs of the underwriting cycle to cover claims during its peaks;
5. Supervisors should be aware of and take action to prevent cross-sectoral arbitrage which could arise from differences in the accounting between insurers' technical reserves and banks' loan loss provisions, and from differences in the capital requirements for credit risk between banks and insurers;
6. Supervisors should be alert to potential cross-sectoral arbitrage resulting from the use of alternatives to traditional mortgage insurance; and
7. Supervisors should apply the FSB Principles for Sound Residential Mortgage Underwriting Practices to mortgage insurers noting that proper supervisory implementation necessitates both insurance and banking expertise.

The Joint Forum based its recommendations on an analysis of existing mortgage underwriting standards and the underwriting cycle.

Thomas Schmitz-Lippert, Chairman of the Joint Forum and Executive Director International Policy at the German Federal Financial Supervisory Authority, BaFin, said: "Mortgage origination and mortgage insurance were at the very core of the financial crisis. The Joint Forum Recommendations on Mortgage Insurance provide guidance to national policymakers and supervisors in order to avoid mistakes of the past and strengthen resilience in the future."

An earlier version of this report was issued for consultation in February 2013.

Do Relationships Matter? Evidence from Loan Officer Turnover

Do Relationships Matter? Evidence from Loan Officer Turnover. By Alejandro, Drexler, and Antoinette Schoar
World Bank Blogs, Mon Aug 12, 2013
http://blogs.worldbank.org/allaboutfinance/do-relationships-matter-evidence-loan-officer-turnover

One of the most frequent causes of credit constraints is the presence of asymmetric information between businesses and investors. Asymmetric information is particularly problematic for micro-entrepreneurs where the information about cash flows and investment decisions is not formally recorded. Furthermore, micro-entrepreneurs many times have few assets to pledge as collateral and do not have a guarantor with a solid financial condition, making it even more difficult for them to access the credit market.

Microfinance institutions specialize in lending to these types of borrowers and have lending technologies that do not rely on formal records. Instead, revenues and expenses are estimated based on non-verifiable information collected by loan officers during field visits to the borrowers’ houses and businesses.

During these field visits, loan officers observe the premises of the business, the inventory, and other relevant information the borrowers can demonstrate. They also discuss business matters with the entrepreneurs as well as personal matters that might affect their repayment capacity.

Loan officers’ expertise is crucial to estimate the financial health of a business during these short visits. For example, experienced loan officers are able to estimate businesses’ inventories and revenues by observing key variables, including the products on the shelves or the number of clients that show up at the business during the visit. Although these observations cannot be verified and are considered soft information, the types of skills that lead to such information can be acquired through training, are not loan officer-client specific, and can be applied even if the loan officer is not acquainted with the entrepreneur.

However, an important fraction of the information required to make a microfinance lending decision is private and is collected during the social interactions between the loan officers and the entrepreneurs. The flow of this type of information strongly depends on the interpersonal ties between the borrowers and the loan officers (Uzzi, 1996). For example,it is unlikely that borrowers would disclose their health expenses, alimony expenses, or other expenses they incur to support family members in need to a stranger. Therefore, this type of information is lost when a loan officer leaves the bank, unless the private information can be credibly transferred to a new loan officer, and/or if the departing loan officer can convince borrowers to share “personal information” with the new loan officer.

The social relationship between the loan officers and the borrowers not only helps the bank to make better lending decisions, but also might increase the willingness of the borrowers to get debt. This is particularly important for borrowers that associate a negative connotation with debt, are unfamiliar with financial services, or mistrust financial institutions. On the downside, making lending decisions based on these social interactions makes banks dependent on loan officers and subject to their misinterpretation or misreporting of information.

While it is recognized that the social relationship between the loan officers and the entrepreneurs can have important implications for the lenders and the borrowers, little is known about the costs associated with disruptions to these relationships.

In a recent study, we test the importance of interpersonal relationships in the lending process. In particular, we study whether the banks’ lending decision and the borrowers’ repayment rate, willingness to get debt at the bank, and willingness to get debt at other banks are affected when a loan officer is absent for long periods of time.

We find that the relationship between loan officers and borrowers has first-order implications on entrepreneurs’ credit availability, repayment behavior, and borrowing decisions. When loan officers are absent, we observe a 20% decrease in the probability that clients get a new loan. This reduction is the consequence of both a 5% decrease in the bank’s loan approval rate and a 15% reduction in the number of applications. We do not observe a change in credit terms such as interest rates or maturity; this indicates that the bank adjusts the risk by cutting credit and not by adjusting the price of the loans. We also observe a 22% increase in the probability of missing a payment and an 18% increase in the probability of default for the borrower.

To understand the conditions in which this information can be transferred or generated by the new loan officer, we look at variations in: (1) how well the absence of loan officers can be planned in advance, since it is more difficult to transfer soft information in the case of completely unplanned leaves, and (2) whether the departing loan officers have any incentives to collaborate in conveying information to replacement loan officers. We observe four different types of absences due to sickness, resignation, pregnancy, and dismissal. We use sickness leaves as a baseline, because they are both unexpected and exogenous.

During sickness leaves, we still observe a decrease in lending and an increase in delinquency, but we do not see an increase in outright default. This finding indicates that most payment delays are caused by reduced monitoring and not caused by financial distress. We also observe a decrease in the probability of applying for a new loan at the bank, but an increase in the probability of applying for credit at other banks, suggesting a reduction in the loyalty of clients toward the bank.

We observe similar results during maternity leaves, but we do not observe an increase in the probability of approaching other banks. This is natural since maternity leaves are exogenous but anticipated, and the loan officers can set up their clients with new loans before they leave.

The strongest reduction in credit and the strongest increase in default are observed after loan officers are dismissed. We believe this is the result of poor past performance of the dismissed loan officers as well as a lack of incentive to transfer any soft information.

However, clients of resigning loan officers are less affected by the leave; application probability does not present a significant decrease and the default rate does not increase. This might indicate that when given enough time, loan officers can brief the replacing loan officers about the soft information of the clients. It also suggests that when having the right incentives, the departing loan officers can familiarize the new loan officers with the clients and gain their confidence.

We also study whether the importance of social relationships depends on borrowers’ characteristics. As expected, the probability of the bank approving a loan to firms with larger and better credit risks less affected by loan officer leaves, probably because hard information about the clients is more readily available. However, we also observe that the probability of applying for a new loan at the bank and the probability of applying for a new loan at other banks do not change after the leave. This finding can indicate that the relationship between clients with large and good credit scores and the bank is less dependent on loyalty.

We also find that female clients are more affected by loan officers’ absences, which is probably because female clients have fewer assets and many times operate informal businesses from home. Therefore, cash flows are particularly difficult to verify and personal information is particularly relevant. This finding highlights the importance of micro-credit lending on promoting women’s financial inclusion.

Overall the results in the study support the view that personal relationships are crucial to reduce credit constraints and improve entrepreneurs’ incentives to repay. The results suggest that close social ties between the loan officers and the borrowers can increase the offer of credit to micro entrepreneurs, but also indicate that the demand for credit can depend on social ties. In light of these results, the high turnover observed in the loan officers’ labor market can be very costly for banks and borrowers and can be one of the factors that impede many micro-businesses to grow beyond subsistence level.



References

Drexler, Alejandro, and Antoinette Schoar. 2012. Do Relationships Matter? Evidence from Loan Officer Turnover. Working Paper. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2144337

Uzzi, Brian. 1996. The Sources and Consequences of Embeddedness for the Economic Performance of Organizations: The Network Effect. American Sociological Review pp. 674–698.

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks - consultative report

Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks - consultative report
The Joint Forum
August 2013

http://www.bis.org/publ/joint31.htm

The ageing population phenomenon being observed in many countries poses serious social policy challenges. Longevity risk - the risk of paying out on pensions and annuities longer than anticipated - is significant when measured from a financial perspective. Longevity risk transfer markets: market structure, growth drivers and impediments, and potential risks (PDF) is a forward-looking report released by the Joint Forum on longevity risk transfer (LRT) markets.


Recommendations:

Whether or not policymakers should play a more active role in encouraging longevity risk transfer from private pension plans to (re)insurers and ultimately to broader capital markets depends on considerations regarding where this risk is best held. Answering this question is beyond the scope of this preliminary analysis, but some relevant factors are worth mentioning.

Advocates of more LRT (see, e.g., Towers Watson, 2011, and Swiss Re, 2012) point to already visible and unwieldy corporate pension benefit obligations and to the heavy underfunding of DB pension funds.31 In this context, they recognise that not only are pension obligations a sizeable distraction to corporate core business lines, but a significant longevity shock could undermine the firm’s own existence. In addition, they point out that some LRT instruments (namely buy-outs) may provide pensioners with a more stringently regulated (re)insurer counterparty.

In addition, policymakers may want to encourage (re)insurers to use LRT markets to free up capital in order to give (re)insurers (or any other entities allowed to provide annuity products) the possibility of writing more of these annuities, which are useful and unique retirement products. On the other hand, the transfer of risk from a mature sector with significant capital requirements to an LRT market that may not have these safeguards may not be in the employees’ best interests, and may even create new systemic risks.

At the same time, when longevity risk is shifted from the corporate sector to a limited number of (re)insurers, with global interconnections, there may be systemic consequences in the case of a failure of a key player (as was the case in the CRT market). Most countries in which this view is shared incentivise the private sector to provide adequate retirement benefits to employees, sometimes providing explicit protection to corporate pension funds with government-supported guarantee schemes. In other countries, this view is expressed implicitly by allowing pension funds to value their liabilities with a discount rate that is higher than the one used for (re)insurers’ reserves.

Motivated by the aforementioned preliminary findings, the Joint Forum proposes the following recommendations to supervisors and policymakers:

1. Supervisors should communicate and cooperate on LRT internationally and cross-sectorally in order to reduce the potential for regulatory arbitrage.
2. Supervisors should seek to ensure that holders of longevity risk under their supervision have the appropriate knowledge, skills, expertise and information to manage it.
3. Policymakers should review their explicit and implicit policies with regards to where longevity risk should reside to inform their policy towards LRT markets. They should also be aware that social policies may have consequences on both longevity risk management practices and the functioning of LRT markets.
4. Policymakers should review rules and regulations pertaining to the measurement, management and disclosure of longevity risk with the objective of establishing or maintaining appropriately high qualitative and quantitative standards, including provisions and capital requirements for expected and unexpected increases in life expectancy.
5. Policymakers should consider ensuring that institutions taking on longevity risk, including pension fund sponsors, are able to withstand unexpected, as well as expected, increases in life expectancy.
6. Policymakers should closely monitor the LRT taking place between corporates, banks, (re)insurers and the financial markets, including the amount and nature of the longevity risk transferred, and the interconnectedness this gives rise to.
7. Supervisors should take into account that longevity swaps may expose the banking sector to longevity tail risk, possibly leading to risk transfer chain breakdowns.
8. Policymakers should support and foster the compilation and dissemination of more granular and up-to-date longevity and mortality data that are relevant for the valuations of pension and life insurance liabilities.

References

• Aegon, 2011, “Paying the Price for Living Longer: What is the Right Price for Removing Longevity Risk?” Aegon Global Pensions View.
• A.M. Best, 2009, “Life Settlement Securitization,” Criteria – Insurance-Linked Securities, November 24.
• An, Heng, Zhaodan Huang, and Ting Zhang, 2013, "What Determines Corporate Pension Fund Risk-Taking Strategy?" Journal of Banking & Finance, Vol. 37, No. 2, pp. 597–613.
• Aon Hewitt, 2011, Global Pension Risk Survey 2011. Available at www.aon.com/netherlands/persberichten/2011/Aon_Hewitt_GRS_EURO_2011.pdf)
• Barrieu, Pauline, Harry Bensusan, Nicole El Karoui, Caroline Hillairet, Stephane Loisel, Claudia Ravanelli, Yahia Salhi, 2012, "Understanding, Modelling and Managing Longevity Risk: Key Issues and Main Challenges," Scandinavian Actuarial Journal, Volume 2012, Issue 3, pp. 203-231.
• Biffis, Enrico and David Blake, 2009, “Mortality-Linked Securities and Derivatives,” October 7. Available at SSRN: http://ssrn.com/abstract=1340409
• Biffis, Enrico and David Blake, 2012, “How to Start a Capital Market in Longevity Risk Transfers,” Unpublished manuscript, September.
• Biffis, Enrico, David Blake, Lorenzo Pitotti, and Ariel Sun, 2011, “The Cost of Counterparty Risk and Collateralization in Longevity Swaps,” Cass Business School Pension Institute Working Paper (London: City University, April.
• Black, Fischer, 1980. "The Tax Consequences of Long-Run Pension Policy," Financial Analysts Journal, Vol. 36, No. 4, pp. 21-28.
• Blake, David, Tom Boardman, and Andrew Cairns, 2010, “Sharing Longevity Risk: Why Governments Should Issue Longevity Bonds,” Cass Business School Pension Institute Working Paper, (London: City University, March).
• Bodie, Zvi, Jay O. Light, Randall Morck, and Robert A. Taggart Jr., 1987. "Funding and Asset Allocation in Corporate Pension Plans: An Empirical Investigation," In: Bodie, Zvi, John B. Shoven, and David A. Wise, (Eds.), Issues in Pension Economics, University of Chicago Press, Chicago, pp. 15-47.
• Brown, Jeffrey R., Jeffrey R. Kling, Sendhil Mullainathan, and Marian V. Wrobel, 2008, “Why Don’t People Insure Late Life Consumption? A Framing Explanation of the Under-Annuitization Puzzle,” National Bureau of Economic Research Working Paper No. 13748, January.
• Cairns, Andrew J.G., 2013, "Modelling and Management of Longevity Risk," Unpublished Working Paper, March.
• Cardinale, Mirko, 2007. "Corporate Pension Funding and Credit Spreads," Financial Analysts Journal, Vol. 63, No. 5, pp. 82-101.
• Cass Business School, 2005, “Is longevity risk a one-way market?” Cass Business School Pension Institute. Available at www.pensions-institute.org/conferences/longevity/conference_summary_18.02.05.pdf
• Coughlan, Marwa Khalaf-Allah, Yijing Ye, Sumit Kumar, Andrew J.G. Cairns, David Blake, and Kevin Dowd, 2011, “Longevity Hedging 101: A Framework for Longevity Basis Risk Analysis and Hedge Effectiveness,” North American Actuarial Journal, Vol. 15, No. 2, pp. 150–76.
• Cox, Samuel H. and Yijia Lin, 2007, “Natural Hedging of Life and Annuity Mortality Risks,” North American Actuarial Journal, Vol. 11, No. No. 3, pp. 1–15.
• CRO Forum, 2010, “Longevity,” CRO Briefing Emerging Risks Initiative Position Paper. Available at www.thecroforum.org/publication/eri_longevity.
• Dowd, Kevin, David Blake, Andrew J.G. Cairns, and Paul Dawson, 2006, “Survivor Swaps,” Journal of Risk and Insurance, Vol. 73, No. 1, pp. 1–17.
• Financial Stability Report (FSB), 2013, “OTC Derivatives Market Reforms: Fifth Progress Report on Implementation,” April 15.
• Fitch Ratings, 2012, “Pension Plan Changes Incrementally Positive to GM's Credit Profile,” Fitch Ratings Endorsement Policy, June 1.
• Fong, Joelle H. Y., Olivia S. Mitchell, and Benedict S.K. Koh, 2011, “Longevity Risk Management in Singapore’s National Pension System,” Journal of Risk and Insurance, Vol. 78, No. 4, pp. 961-981.
• Francis, Jere R., and Sara Ann Reiter, 1987, "Determinants of Corporate Pension Funding Strategy," Journal of Accounting and Economics, Vol. 9, pp. 35-59.
• Gallagher, Ronan C., and Donal G. McKillop, 2010, "Unfunded Pension Liabilities and the Corporate CDS Market," Journal of Fixed Income, Winter, pp. 30-46.
• Groome, Todd, John Kiff, and Paul Mills, 2011, “Influencing Financial Innovation: The Management of Systemic Risks and the Role of the Public Sector,” in Beder, Tanya, and Cara M. Marshall, 2011, Financial Engineering: The Evolution of a Profession, John Wiley & Sons Inc.
• International Monetary Fund (IMF), 2012, Global Financial Stability Report, World Economic and Financial Surveys (Washington, April).
• Joint Forum, 2008, Credit Risk Transfer - Developments from 2005 to 2007, July.
• Joint Forum, 2010, Review of the Differentiated Nature and Scope of Financial Regulation, January.
• Lee, Yung-Tsung, Chou-Wen Wang, Hong-Chih Huang, 2012, "On the valuation of reverse mortgages with regular tenure payments," Insurance: Mathematics and Economics, Vol. 51, pp. 430–441.
• Li, Johnny Siu-Hang, and Mary R. Hardy, 2011, “Measuring Basis Risk in Longevity Hedges,” North American Actuarial Journal, Vol. 15, No.2, pp. 177–200.
• Monk, Ashby H.B., 2010, “Pension Buyouts: What Can The USA Learn From The UK Experience?” International Journal of Financial Services Management, Vol. 4, No. 2, pp. 127-150.
• McFarland, Brendan, Gaobo Pang, and Mark Warshawsky, 2009, "Does Freezing a Defined-Benefit Pension Plan Increase Company Value? Empirical Evidence," Financial Analysts Journal, Vol. 65, No. 4., pp. 47-59.
• Moody’s, 2009, “Managing Ratings with Increased Pension Liability,” Moody’s Investor’s Service, March.
• Moody’s, 2012, “Moody's says GM's Credit Profile and Rating Unchanged by Salaried Pension Actions,” Moody’s Investor’s Service, June 1.
• Organisation for Economic Co-operation and Development (OECD), 2012a, “OECD Pensions Outlook 2012,” June.
• Organisation for Economic Co-operation and Development (OECD), 2012b, “Pension Markets in Focus,” September.
• Pension Protection Fund, 2011, “PPF 7800 Index,” United Kingdom Pension Protection Fund, October 31. (www.pensionprotectionfund.org.uk/Pages/PPF7800Index.aspx)
• Ponds, Eduard, and Bart van Riel, 2009, “Sharing the Risk: The Netherlands’ New Approach to Pensions, Journal of Pension Economics and Finance 8, pp. 91-105.
• Sagoo, Pretty, and Roger Douglas, 2012, “Recent Innovations in Longevity Risk Management; A New Generation of Tools Emerges,” Eighth International Longevity Risk and Capital Markets Solutions Conference, September 8. Available at www.cass.city.ac.uk/__data/assets/pdf_file/0008/141587/Sagoo_Douglas_presentation.pdf
• Sharpe, William, F., 1976. "Corporate Pension Funding Policy," Journal of Financial Economics, Vol. 3, No. 3, pp. 183-193.
• Standard & Poor’s (S&P), 2011, “Life Settlement Securitizations Present Unique Risks,” Structured Finance Research, March 2.
• Standard & Poor’s (S&P), 2012, “General Motors Co.'s Proposed Actions On U.S. Salaried Pension Plans Do Not Affect Ratings,” Standard & Poor’s Bulletin, June 1.
• Stone, Charles and Anne Zissu, 2006, "Securitization of Senior Life Settlements: Managing Extension Risk." Journal of Derivatives, Spring.
• Swiss Re, 2010, A Short Guide to Longer Lives: Longevity Funding Issues and Potential Solutions. Available at http://media.swissre.com/documents/Longer_lives.pdf
• Swiss Re, 2012, A Mature Market: Building a Capital Market for Longevity Risk. Available at http://media.swissre.com/documents/Mature_Market_EN.pdf
• Szymanoski, Edward J. , Jr., 1990, "The FHA Home Equity Conversion Mortgage Insurance Demonstration: A Model to Calculate Borrower Payments and Insurance risk, U.S. Department of Housing and Urban Development, October.
• Szymanoski, Edward J. , Jr., 1994, "Risk and the Home Equity Conversion Mortgage," Journal of the American Real Estate and Urban Economics Association, Vol. 22, No. 2, pp. 347-366.
• Towers Watson, 2011, Insights into Global Pension Risk.
• Treynor, Jack L., 1977. "The Principles of Corporate Pension Finance," Journal of Finance, Vol. 32, No. 2, pp. 627-638.
• UK Pension Protection Fund, 2006, The Purple Book: DB Pensions Universe Risk Profile, Jointly prepared by the UK Pension Protection Fund and The Pensions Regulator. Available at www.pensionprotectionfund.org.uk/Pages/ThePurpleBook.aspx
• Waddell, Melanie, 2010, “Biggest Barriers to Lifetime Income Adoption: Fiduciary Liability, Insurer Insolvency,” AdvisorOne.com, September 14.
• Zelenko, Ivan, 2011, “Longevity Risk Hedging and the Stability of Retirement Systems,” World Bank presentation given at the Cass Business School Pension Institute Seventh International Longevity Risk and Capital Markets Solutions Conference, Frankfurt, September 8

Evaluating early warning indicators of banking crises: Satisfying policy requirements

Evaluating early warning indicators of banking crises: Satisfying policy requirements
By Mathias Drehmann and Mikael Juselius
BIS Working Papers No 421

Aug 2013

http://www.bis.org/publ/work421.htm
 

Early warning indicators (EWIs) of banking crises should ideally be evaluated on the basis of their performance relative to the macroprudential policy maker's decision problem. We translate several practical aspects of this problem - such as difficulties in assessing the costs and benefits of various policy measures as well as requirements for the timing and stability of EWIs - into statistical evaluation criteria. Applying the criteria to a set of potential EWIs, we find that the credit-to-GDP gap and a new indicator, the debt service ratio (DSR), consistently outperform other measures. The credit-to-GDP gap is the best indicator at longer horizons, whereas the DSR dominates at shorter horizons.

JEL classification: C40, G01
Keywords: EWIs, ROC, area under the curve, macroprudential policy


Excerpts:

In the empirical part of the paper, we apply our approach to assess the performance of 10 different EWIs. We mainly look at the EWIs individually, but at the end of the paper we also consider how to combine them. Our sample consists of 26 economies, covering quarterly time series starting in 1980. The set of potential EWIs includes more established indicators such as real credit growth, the credit-to- GDP gap, growth rates and gaps of property prices and equity prices (eg Drehmann et al (2011)) as well as the non-core liability ratio proposed by Hahm et al (2012).  We also test two new measures: a country’s history of financial crises and the debt service ratio (DSR). The DSR was first suggested in this context by Drehmann and Juselius (2012) and is defined as the proportion of interest payments and mandatory repayments of principal to income. An important data-related innovation of our analysis is that we use total credit to the private non-financial sector obtained from a new BIS database (Dembiermont et al (2013)).

We find that the credit-to-GDP gap and the DSR are the best performing EWIs in terms of our evaluation criteria. Their forecasting abilities dominate those of the other EWIs at all policy-relevant horizons. In addition, these two variables satisfy our criteria pertaining to the stability and interpretability of the signals. As the credit-to- GDP gap reflects the build-up of leverage of private sector borrowers and the DSR captures incipient liquidity constraints, their timing is somewhat different. While the credit-to-GDP gap performs consistently well, even over horizons of up to five years ahead of crises, the DSR becomes very precise two years ahead of crises. Using and combining the information of both indicators is therefore ideal from a policy perspective. Of the remaining indicators, only the non-core liability ratio fulfils our statistical criteria. But its AUC is always statistically smaller than the AUC of either the credit-to-GDP gap or the DSR. These results are robust with respect to different aspects of the estimation, such as the particular sample or the specific crisis classification used.

Recovery of financial market infrastructures - consultative report

Recovery of financial market infrastructures - consultative report
BIS, Aug 2013
www.bis.org/publ/cpss109.htm

The Committee on Payment and Settlement Systems (CPSS) and the International Organization of Securities Commissions (IOSCO) have published for public comment a consultative report on the Recovery of financial market infrastructures.

The report provides guidance to financial market infrastructures such as CCPs on how to develop plans to enable them to recover from threats to their viability and financial strength that might prevent them from continuing to provide critical services to their participants and the markets they serve. It also provides guidance to relevant authorities in carrying out their responsibilities associated with the development and implementation of recovery plans and tools.

The report has been produced in response to comments received on the July 2012 CPSS-IOSCO report on Recovery and resolution of financial market infrastructures that requested more guidance on what recovery tools would be appropriate for FMIs.

The report supplements the CPSS-IOSCO Principles for financial market infrastructures (PFMI) , the international standards for financial market infrastructures (FMIs) published in April 2012. It provides guidance on how FMIs can observe the requirements in the PFMI that they have effective recovery plans. It does not itself create additional standards for FMIs. The report is also consistent with the Financial Stability Board's Key attributes of effective resolution regimes for financial institutions, published in October 2011 and which also covers the importance of recovery planning. Aspects of the consultation report concerning FMI resolution have been included in a new draft annex to the FSB Key attributes and will be included in a forthcoming assessment methodology for the Key attributes.

Financial market infrastructures (FMIs), which include payments systems, securities settlement systems, central securities depositories, central counterparties and trade repositories, play an essential role in the global financial system. The disorderly failure of an FMI could lead to severe systemic disruption if it caused markets to cease to operate effectively.

 Published with the report is a cover note that lists specific issues on which the committees seek comments during the public consultation period. Comments on the report are invited from all interested parties and should be sent by 11 October 2013 to both the CPSS secretariat (cpss@bis.org) and the IOSCO secretariat (fmirecovery@iosco.org). The comments will be published on the websites of the BIS and IOSCO unless commentators have requested otherwise.

• Full report (32 pages, 244 kb)
• Cover note (2 pages, 37 kb)

Views from Japan: Nuclear Weapons

Views from Japan: Nuclear Weapons

Questions sent to a Japanese citizen:

konnichiwa, dear [xxx]-san

I was reading the book "Strategy in the Second Nuclear Age: Power, Ambition, and the Ultimate Weapon" by Toshi Yoshihara and James R. Holmes (Editors), and there is a chapter on Thinking About the Unthinkable - Tokyo's Nuclear Option

We'd like to publish a post and would like:

1  to have arguments in favor and against (specially in favor, since we never see them published) such nuclear option, made by Japanese politicians;
2  to have your opinion on this.

[...]

Thank you very much, sir.

[signature removed]


---
Answer (edited):
konnichiwa,

how are you going? it's been incredibly hot these days... I almost start melting.

sorry, I haven't read the book. so i'm not very sure my opinions match to your point. anyway, I give you what I see and think. is it about nuclear weapons? (or total nuclear power?) i refer nuke weapons for this moment. please let me know if you need more about nuclear in japan.

1.it seems 3 big opinions among politicians (and citizens too) :

#1. it's better to have nu-bombs. because we are facing dangers of Chinese and North Korean nukes. it's the only way to be against nukes.

#2. let's talk and think about nuclear weapons to possess seriously now. it's actually been the biggest taboo in japan even only to talk about the option because of our experiences of Hiroshima, Nagasaki and recently Fukushima which are big trauma for us. I can call it "nuclear allergy". but we are indeed surrounded and threatened by nu-weapons of China and Korea now. it's the time to think about it... and even just the debates will be able to restrain China and Korea (they know our technology is good enough to make nu-weapons immediately if we try).

#3. nobody should even talk or think about it. all nuclear in the world just should be thrown away and banned. because we've learnt from the past



#2 seems the most major opinion, #1 is a sort of extreme... #3 is mainly supported by liberal people. extreme on the other side.


2. my opinion: I used to think like #3, but slightly have changed to #2. I'm sure #3 is right, but too much ideal. no matter how japan says this to the world, no countries will abandon them (at least near future).

japanese people's been used to live in peace by American forces, however people's started to realize no peace for free. i think we are on the way to "normal" country.

please don't understand me, I believe almost all of people don't want to have nu-weapons in real, people's just getting more serious to think about what our country is and what is the best for us.


I wish I got points you need. mail me if you have something not sure.

best regards(^_^)/

[signature removed]

HEAT! A Bank Health Assessment Tool. By Li L. Ong, Phakawa Jeasakul and Sarah Kwoh

HEAT! A Bank Health Assessment Tool. By Li L. Ong, Phakawa Jeasakul and Sarah Kwoh
IMF Working Paper No. 13/177
August 09, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40872.0

Summary: Developments during the global financial crisis have highlighted the importance of differentiating across financial systems and institutions. Assessments of financial stability have increasingly considered the characteristics of individual banks within a financial system, as well as those with significant international reach, to identify vulnerabilities and inform policy decisions. This paper proposes a simple measure of bank soundness, the Bank Health Index (BHI), to facilitate preliminary analyses of individual financial institutions relative to their peers. The evidence suggests that the BHI is useful for a first-pass identification of bank soundness conditions. Automated spreadsheet templates of the bank Health Assessment Tool (HEAT!) are provided for users with access to the BankScope, Bloomberg and/or SNL database(s).

Introduction

The impact of the global financial crisis on individual banking systems and banks has highlighted the importance of differentiating across countries and among financial institutions. Traditionally, macroprudential surveillance of the financial sector has complemented the microprudential oversight of individual financial institutions by supervisors (The World Bank/IMF, 2005). However, the growing systemic importance of these institutions, notably banks, and their potential impact on policy and the public purse have underscored the need to extend any macroprudential analysis to include individual systemic institutions as well.

The depth and protracted nature of the current crisis have revealed vast divergences in the resilience of individual banks. This is, in large part, attributable to banks’ business models and management quality, sometimes mitigated by the various pre-emptive or supportive policy actions taken by country authorities. In many cases, specific knowledge of characteristics underpinning individual banks’ financial health has been crucial for identifying vulnerabilities and informing policy decisions for crisis prevention or management purposes. Looking ahead, lessons learned from this crisis suggest that more granular, bank-specific analysis will become increasingly more important in that it could:

• enable early identification of vulnerabilities in global systemically important banks (G-SIBs) and domestic systemically important banks (D-SIBs), which could help prevent widespread spillovers from any realization of tail risks if appropriate mitigation actions are put in place;

• inform system-wide reform strategies by differentiating the core, healthy banks from the very weak ones that require significant restructuring or even resolution, so that the strong banks are not burdened with a “one size fits all” solution for an entire system; and 

• inform restructuring decisions, such as mergers and acquisitions, recapitalization and/or liquidity support, by highlighting banks’ weaknesses or identifying the weak banks.

To this end, this paper proposes a simple, broadly-based measure of bank soundness that would allow preliminary, first-pass analysis of the health of individual financial institutions and, consequently, financial systems. We develop a Bank Health Index (BHI) and provide automated spreadsheet templates, the bank Health Assessment Tool (HEAT!), to facilitate the exercise. We show that the BHI, albeit simple, can be useful for initial identification of relative bank soundness and is also able to identify more specific areas of vulnerability.  However, we also note its limitations and acknowledge that such analyses would need to be complemented by more rigorous and robust quantitative (e.g., stress tests) and qualitative (e.g., supervisory and regulatory frameworks) assessments.


Concluding Remarks

The global financial crisis has underscored the importance of individual banks to the stability of their own or even the global financial system. Thus, analyses of the health of individual banks, especially the systemic ones, are becoming a matter of course for surveillance purposes and for crisis management decisions. We have developed the BHI to enable simple, preliminary analyses of individual banks in financial systems around the world and introduced an Excel-based spreadsheet tool (HEAT!) to facilitate its calculation and presentation. Our back-test, based on actual developments in the Spanish banking system, suggests that the BHI is able to accurately differentiate banks according to their financial soundness.

That said, there are strong caveats attached to the use of the BHI and its components. Any representation about the health of individual banks using this method should be made with care. Specifically, the Index is an aggregation of ratios, so the performance of the individual components should also be considered in any analysis. Moreover, the associated z-scores do not provide an absolute assessment of the health of banks, but rather, their relative health within a sample, which means that the selection of the sample itself matters. The differences in banks’ business models at any point in time and their changing nature over time, as well as the definitions used in calculating the constituent components of the BHI should also be taken into account when interpreting the results. Last but not least, it is also important for the user to be familiar with the peculiarities of any banking system being analyzed and to ensure that any assessment is supplemented with other quantitative and qualitative information.

Nearly 450 Innovative Medicines in Development for Neurological Disorders

Neurological Disorders
innovation.org
July 30, 2013
www.innovation.org/index.cfm/FutureofInnovation/NewMedicinesinDevelopment/Neurological_Disorders

Nearly 450 Innovative Medicines in Development for Neurological Disorders

Neurological disorders—such as epilepsy, multiple sclerosis, Alzheimer’s disease, and Parkinson’s disease—inflict great pain and suffering on patients and their families, and every year cost the U.S. economy billions of dollars. However, a growing understanding of how neurological disorders work at a genetic and molecular level has spurred improvements in treatment for many of these diseases.

America’s biopharmaceutical research companies are developing 444 medicines to prevent and treat neurological disorders, according to a new report released by the Pharmaceutical Research and Manufacturers of America (PhRMA). 

The report demonstrates the wide range of medicines in development for the more than 600 neurological disorders that affect millions of Americans each year. These medicines are all currently in clinical trials or awaiting Food & Drug Administration (FDA) review. They include 82 for Alzheimer’s disease, 82 for pain, 62 for brain tumors, 38 for multiple sclerosis, 28 for epilepsy and seizures, 27 for Parkinson’s disease, and 25 for headache.

Many of the potential medicines use cutting-edge technologies and new scientific approaches. For example:

• A medicine that prompts the immune system to protect neurons affected by amyotrophic lateral sclerosis (ALS), also known as Lou Gehrig's disease
• A gene therapy for the treatment of Alzheimer’s disease
• A gene therapy to reverse the effects of Parkinson’s disease

These new medicines promise to continue the already remarkable progress against neurological disorders and to raise the quality of life for patients suffering from these diseases and their families. Read more about selected medicines in development for neurological disorders.

Alzheimer's Disease

Every 68 seconds someone in America develops Alzheimer’s disease, according to the Alzheimer’s Association, and by 2050 it could be every 33 seconds, or nearly a million new cases per year. Disease-modifying treatments currently in development could delay the onset of the disease by five years, and result in 50 percent fewer patients by 2050.

There are also potential cost savings offered by innovative disease-modifying treatments. As the 6th leading cause of death in the United States and one of the most common neurological disorders, Alzheimer’s disease currently costs society approximately $203 billion. This number could increase to $1.2 trillion by 2050; however, delaying the onset of the disease by five years could reduce the cost of care of Alzheimer’s patients in 2050 by nearly $450 billion.

Additional Resources

• New Medicines in Development for Neurological Disorders Report
• Selected Medicines in Development for Neurological Disorders
• Alzheimer’s disease overview page

Comments on "Why does intelligence analysis sometimes fail?" (Science Daily)

Comments on "Why does intelligence analysis sometimes fail?" (Science Daily)

1  There are several things that are objectionable about this Science Daily piece [1] and other jobs...

First of all, the author seems not to have read the article in full. It says that Wirtz "focuses in particular on the contribution of the scholar Robert Jervis," as if this happened by no special reason.

Not so, Wirtz's article [2] is, as said in the acknowledgements, a contribution to a book [3] __in honor__ of R Jervis:

This article was previously published in a collection of essays in honor of Robert Jervis.

And second, it loads too much the conclusions. Science Daily's writer says that "The way to reduce failures Jervis believed [...] was to improve agents' analytical skills rather than endlessly reorganising the bureaucracy."

Wirt'z essay says that "Jervis focuses on analytic tradecraft, not bureaucratic reorganization, as the best way to improve intelligence. In that sense, he agrees with intelligence analysts, who often identify the quest for better tradecraft as the best guarantee against intelligence failure," which is a bit different of that statement by SD's writer. Maybe Jervis believed what SD published, but Wirtz goes not so far, he only says that Jervis focuses on analysis improvements.

To me, it is not in Wirt'z paper that Jervis is in some way against all reorganizations after intel failures or that he was skeptical of reorganization, generally speaking, as SD suggests with "rather than endlessly." Maybe both things, reorganization and analytic improvements, are needed in many occasions: First, make heads roll and dissolve some directorates or units after intel failures, and second, improve the craft.


2  Going now to Wirtz's job, maybe Jervis did focus "on analytic tradecraft, not bureaucratic reorganization, as the best way to improve intelligence" [2] because, one, he wasn't a manager and didn't have to focus in reorganizations, and was not contracted to give opinions of that field of reorganization, but in the one of analytic craft; and two, because he "is best known for his scholarship on international relations; especially the way human cognition shapes foreign and defence policies". [1] As Jervis said, as described in the presentation of his book, [4] "Give someone a hammer, everything is a nail."

This is applicable to Prof Jervis, isn't it? Like to everyone of us.


3  More generally, many scholars and professionals think like Prof Jervis: "In light of these critical intelligence failures, Jervis says, “We can do better.”" [4]

I doubt we can. And not only me. Jeffrey Cooper suggests, in a work he did for the CIA, [5] several, many ways to improve the analyst's job, but after those, he reminds us of Kahneman's suggestion of using methodologists in the teams to watch over the analysts' work, to prevent our falling in some trap of our sad, human nature, which is a way of saying there is no training or changes in our way of thinking/working that can compensate for our analytical pathologies:

Finally, the introduction of a "process watcher," as suggested by Kahneman, is intended to bring a clear and unbiased, outside expert’s eye to analytic teams. The process watcher function, unlike that of a Red Team, is intended to focus exclusively on identifying errors in the analytic process, not on alternative interpretations of the evidence or different logic chains.

Also, I infer from this recommendation that our bosses and organizations are also let's say less than capable of guaranteeing quality for the taxpayer's bucks.

Aside of the need of experts not in the contents, but in the methods, since we are not capable of working/reasoning/computing well [6 and references therein], can anyone compute the costs of adding to the intelligence units more personnel to improve the quality of our analysis?



References

[1]  Why does intelligence analysis sometimes fail?. ScienceDaily. Retrieved July 28, 2013, from http://www.sciencedaily.com­ /releases/2013/07/130723073955.htm?goback=%2Egde_2216219_member_260803925

[2]  James J. Wirtz. The Art of the Intelligence Autopsy. Intelligence and National Security, Mar 2013; DOI: 10.1080/02684527.2012.748371

[3]  James W. Davis (ed.), Psychology, Strategy and Conflict: Perceptions of Insecurity in International Relations (Oxford: Routledge 2012).

[4] Saltzman Lecture Report. Why Intelligence Fails: Lessons from the Iranian Revolution and the Iraq War New York, New York – March 9, 2010. Retrieved July 28, 2013, from http://www.siwps.com/events/professor-robert-jervis-why-intelligence-fails.attachment/jervis/Jervis%203-9-10.pdf

[5]  Jeffrey R Cooper: Curing Analytic Pathologies - Pathways to Improved Intelligence Analysis. Langley, VA: CIA, December 2005

[6]  Biased Policy Professionals. Sheheryar Banuri, Stefan Dercon, and Varun Gauri. World Bank Policy Research Working Paper 8113. https://www.bipartisanalliance.com/2017/08/biased-policy-professionals-world-bank.html

Liquidity coverage ratio disclosure standards - consultative document

Liquidity coverage ratio disclosure standards - consultative document
BCBS, July 19, 2013
http://www.bis.org/publ/bcbs259.htm

The Basel Committee on Banking Supervision has today issued for consultation Liquidity coverage ratio disclosure standards.

Following the publication of the LCR standard in January 2013, the Basel Committee indicated its intention to develop associated disclosure standards. Public disclosure improves transparency, reduces uncertainty in the markets and strengthens market discipline. To promote the benefits of disclosure the Committee believes that it is important that banks adopt a common disclosure framework to help market participants consistently assess the liquidity risk position of banks. Moreover, to promote consistency and ease of use of disclosures related to the LCR, the Basel Committee has agreed that internationally-active banks across Basel member jurisdictions will be required to publish their LCR according to a common template.

In designing the disclosure standards for the LCR, the Basel Committee has balanced the benefits of promoting market discipline against the challenges associated with disclosure of liquidity positions under certain circumstances, including the potential for undesirable dynamics during periods of stress.

Bank Resolution Costs, Depositor Preference, and Asset Encumbrance

Bank Resolution Costs, Depositor Preference, and Asset Encumbrance. By Daniel C. Hardy
IMF Working Paper No. 13/172
July 18, 2013
http://www.imf.org/external/pubs/cat/longres.aspx?sk=40799.0

Summary: Depositor preference and collateralization of borrowing may reduce the cost of settling the conflicts among creditors that arises in case of resolution or bankruptcy. This net benefit, which may be capitalized into the value of the bank rather than affect creditors’ expected returns, should result in lower overall funding costs and thus a lower probability of distress despite increasing encumbrance of the bank’s balance sheet. The benefit is maximized when resolution is initiated early enough for preferred depositors to remain fully protected.


Conclusions and next steps (edited)


Bank resolution, like bankruptcy and debt restructuring generally, inherently involves a great deal of negotiation and uncertainty; these are situations in which contracts are far from complete. Experience from many sectors, most notably the financial sector, suggest that the attendant conflicts among claimants can add substantially to costs and delays in resolution.

The prospective costs attached to such conflicts, which should depend on the magnitude of residual assets, can influence the optimal composition and conditions of financing, and, in particular, motivate the introduction of provisions that make some claims “bankruptcy remote.” Bankruptcy remoteness can be achieved through statute and policy, as when depositors enjoy preferred status as a matter of law, or through private agreements, as when banks issue covered bonds backed by a pool of high-quality assets. The asset encumbrance that results from either mechanism can be desirable insofar as it reduces bankruptcy costs, and, through lower overall funding costs, lowers the probability of distress. This substantive effect from the composition of financing is not due to asymmetric information or related mechanisms, but to the gain from containing conflict resolution costs.

In the first instance, the gain should be capitalized into the value of the bank, which enjoys an overall reduction in funding costs. The extension of preferred status to some creditors (including a DGS) need not make them better off. Nor need non-secured borrowers be disadvantaged in expectational terms: they earn more when the bank survives but bear larger net losses in case of resolution (though they spend less contending for their claims). Granting preferred status to (some) depositors need not provoke increased collateralization of other credits: from the point of view of the borrowing bank, collateralization and statutory depositor preference are near substitutes, with the difference that collateralization can be increased at the bank’s initiative, albeit at an increasing marginal cost. However, the achievement of full benefits and their distribution will depend on pricing being risk-sensitive; the probability of distress might not be reduced if those that benefit from collateralization demand an interest rate that ignores the reduction in LGD that collateralization should achieve.

For these measures to be valuable, a high degree of legal certainty of their implementation must be achieved, and it is important that the resolution process starts when the borrowing bank still has enough residual assets that preferred or collateralized claims can be met. If, ex post, these conditions are not met, conflict may be intensified. Hence, bank stability might be enhanced by limiting total asset encumbrance (preferred deposits plus collateralized borrowing) to below the likely minimum level of residual assets. Authorities that are willing and able to take early corrective action, and therefore rarely have to deal with banks left with scant residual assets, can be more sanguine about asset encumbrance.

The analysis presented here lead on to other questions of practical relevance, which may be addressed in further research using an extension of the framework. Some of these questions include the following:

• What systematic evidence might be examined to determine whether and how bankruptcy costs depend on the intensity of conflict over residual assets? Some anecdotal evidence indicates that bankruptcy proceedings and bank resolutions are characterized by intensive lobbying in various forms, which considerably inflate the costs to all concerned. There is also some statistical evidence that bankruptcy costs and delays are related to the complexity of the affected corporation, and complexity is plausibly connected to the number of interest groups and thus expenditure on lobbying. But it would be worthwhile to investigate also who bears costs and receives benefits ex ante, as measured, for example, by the reaction of market prices to relevant regulatory innovations.

• Why is information on bank asset encumbrance not more readily available? Appropriate pricing of both collateralized and non-collateralized borrowing depends on making good estimates of probability of failure and of loss given default facing different creditors, and thus of the degree of outstanding asset encumbrance. Yet it is difficult to obtain current or detailed, bank-by-bank information: one may use published accounts to quantify a bank’s deposit base—if deposits enjoy preferential status—and the volume of covered bonds that it has issued, but typically one cannot know the volume of assets pledged in the interbank market, to the central bank, in liquidity swap and derivative deals, etc. Presumably a bank in a weak position is afraid to reveal that fact and face a “squeeze” on its position. However, there seem to be incentives for strong banks to disclose information, and thus to force others to reveal more. To some extent this occurs: many banks repaid as early as possible financing from the ECB’s Long-Term Refinancing Operation, presumably to demonstrate their strength. If banks do not volunteer much information on encumbrance, there could be grounds for imposing greater transparency through regulation, but national authorities have traditionally reserved the right to provide central bank refinancing on a confidential basis. [The European Systemic Risk Board recently issued recommendations to enhance prudential oversight of asset encumbrance and related market transparency, but explicitly prohibits the revelation of data on assets encumbered to central banks (see "Recommendations of European Systemic Risk Board of 20 December 2012 on funding of credit institutions" (ESRB/2012/2), available at http://www.esrb.europa.eu/pub/pdf/recommendations/2012/ESRB_2011_2.en.pdf?e622821b9c3171124f1d85f3a1b4d40e ).]

• What are the implications for funding behavior and stability of heterogeneity among creditors in their litigating/lobbying ability and incentives? Welch (1997) has initiated a discussion of the question, with a focus on a non-financial corporate facing a dominant bank creditor, but the situation of banks, with many retail and wholesale counterparties, may be rather different. The interests of those most effective in lobbying may not coincide with those of society or the prudential regulator. One advantage of depositor preference is that it protects the interests of a large number of creditors with a substantial portion of claims for whom, however, it is individually relatively expensive to defend those claims in case of resolution; the weak atomistic depositors are molded into one dominant creditor. In this connection, differences in lobbying ability could account for aspects of market segmentation: those with low costs might specialize in the holding of certain instruments, and those with high costs (or funding constraints) might want to concentrate on holding secured, bankruptcy-remote assets.

• In what ways would statutory bail-in of unsecured creditors be symmetric to the granting depositors preferred status, and in what ways would contingent capital (“CoCos”) be symmetric to collateralized credit?

The framework would need to be extended to analyze how different forms of asset encumbrance might affect bank liquidity risk, taking into account the availability of other liquidity buffers and interaction with solvency risk. Indeed, liquidity and solvency risk are deeply connected, especially for banks. Furthermore, illiquidity, like bankruptcy, is “a situation in which existing claims are inconsistent,” and so suited to an analysis based on costly resolution of conflict, rather than the application of predetermined rules and contracts. In all cases, one category of claimant is assigned a special status in case of bankruptcy or resolution—some are assigned an especially weak position, others an especially strong one. The incentives for, and ability of the different claimants to lobby for larger compensation is therefore affected. For example, those clearly subject to a statutory bail-in would not devote resources to contesting claims with those in a clearly superior position, and thus bankruptcy costs could be reduced. Holders of bail-in-able securities or CoCos would presumably demand higher yields to compensate for this risk, which in itself may increase risk of distress, but there could be some net benefit.