Systemic Risk and the Banking System
The overall goal of this two-day workshop is for participants to gain a solid grounding in the causes of systemic risk, underlying economic theory, the correlation of banking system and sovereign risk, and appreciation of the shift in regulators' attitude to the provision of support.
Key Learning Outcomes:
- Understand the nature of systemic risk and why the banking system is particularly vulnerable to systemic risk
- Understand the economic context and why there have been numerous banking crises and why the last one was particularly severe
- Overview of key regulatory initiatives to reduce systemic risk
- Recognise the importance of sovereign credit in the support of financial institutions.
Historical context and review of current crisis.
Economic theory: why banks periodically fall into crisis
- Market Failure: efficient markets vs. market failure
- Adam Smith and why banks are an exception
- Market failure: Pigou's concept of "spillovers"
- Leverage and the credit cycle
- Hyman Minsky: 3 stages of the credit cycle
History of system-wide failures and their causes, Tulips to Lehman
Exercise: Analysis of systemic collapse in Argentina Indonesia and Ireland.
Nature of systemic risk
Interconnectedness of banks and other elements of the global financial system
- "Touch points"
- Domino effect: diminution of asset value in one financial institution causes capital erosion in the next
- Roubini's "transmission" channels of crisis
- How the crisis spread from US sub-prime to French mutual funds, German commercial lenders and beyond
- Pre-crisis distribution theory of systemic risk vs. high correlation reality
- Bank systemic risk indicators
- Exercise: Identifying countries with significant systemic risk.
Identification of systemically important financial institutions (SIFI)
- Official recognition of international systemically important banks
- Identification of national champions
- Will these be moving targets?
Drivers of banks' Issuer default ratings
- Viability vs. support ratings
- Exercise: Review of various banking systems ratings - driven by viability or support?
Early warning signs of bank failure
- Financial and non-financial indicators of distress
- Market indicators; equity, CDS and bond indicators
- Exercise: Financial and market indicators of weakening credit in banks.
Getting too big to fail
- Purchases and disposals - an acquisition too far or selling the family silver?
- Emergence of deregulation in the late 1980s and its progression around the globe
- Light touch regulation vs. proactive regulation
- New mood in regulation following 2008 crisis
- The commissioning of reports and enquiries; Walker report, Turner review, Sir John Vickers Independent Commission on Banking
- Changing regulation; Dodd Frank and the Volcker rule, living wills, bank resolution
- Response: increase regulatory oversight
Basel 2.5 and Basel III: global initiative to discourage or mitigate systemic risk
Market Risk Rules:
- Stressed VaR
- Credit risk measurement in the trading book
- Stressed liquidity horizons.
- Stress testing: market model inputs & regulatory scaling factors
- Increased margining periods for collateral
- Identification of exposure/counterparty correlation.
- LCR/NSFR: treatment of interbank exposures
- Tight definition of liquidity pools
- Higher capital requirements and quality standards
- Limits on leverage including OBS
- All deductions from CET 1
Pillars 2 and 3
Impact on banks' profits and the economic implications of deleveraging
Exercise: Safety vs. profitability and economic growth.
- Sovereign ratings
- Size of banking system v. size of economy
- Sovereign ability and willingness to support banking system
- Moral hazard
Support and Reducing the Support Burden
Review the different techniques for supporting a banking system, when these have been used and to what effect
- Depositor insurance
- Bad bank
Measures to reduce the necessity for tax payer funded bail outs
- Ring fencing
- Bail in vs. bail out
- The identification of and commitment to systemically important banks.
The role of Supernational and non-sovereign bodies
- World Bank
- Multilateral and regional development banks
- EFSF and ESM
- Foreign Parent banks.
A review of successful interventions to summarise.
Who should attend
This course is designed for Financial Institution Analysts, Bank Supervisors, Government Economic and Trade Departments, and Bank Equity and Bond Investors.