One reason that a lot of people are enamored with the Brown-Vitter approach to bank regulation is that it’s very simple, and everyone deep down sort of thinks that the simple answer has to be better than the complicated one. “You don’t need risk-based capital or stress tests or liquidity coverage ratios or VaR models or multiple tiers of capital or bail-in debt,” Brown and Vitter promise. “You just need to make sure that big banks don’t have assets of more than ~6x their common equity.”
Some people disagree1 and by all means feel free to question those people’s motives. Certainly some people benefit from complexity, bankers above all but also banking regulators, former regulators, and I suppose me too. Simple banking seems really boring, though maybe Brown-Vitter simple banking wouldn’t be.
Anyway that seems like the background to this interesting speech by Fed governor Daniel Tarullo about financial stability, which you could if you like read as sort of the Fed’s initial response to Brown-Vitter. And it’s not not that; the speech engages with Brown-Vitter on the capital stuff, basically defending the status quo of risk-based regulatory capital while conceding a little to Brown-Vitter’s call for higher capital.2
But he seems at least as focused on another source of systemic risk: not banks but wholesale funding markets, not capital but liquidity. You could see why the Fed might be focused there. Read more »
One reason that it’s silly to get worked up about banks gambling with your deposits is that they’re mostly not. Your deposits have a tendency to be structurally senior, insured, at regulated subs, etc.; nothing all that bad will happen to them. Banks are gambling with your money market funds, and with the securities-lending proceeds from your mutual funds. Which are not insured, or particularly regulated, but which fund something like $1.9 trillion of securities dealers’ inventory through tri-party repo, as well as providing some $6 trillionish in other collateralized funding for dealer and hedge fund inventories. And this is really much worse, crisis-wise. Since deposits are insured, runs on them are rare. Runs on repo probably caused the financial crisis. Maybe.
NY Fed President William Dudley gave a pretty good speech about this stuff today; you should read it, or read some summaries here or here. The most fun parts for me had to do with the tri-party repo market.
First of all, if you’re following that market you may be aware that the Fed is moving to get rid of “the unwind,” in which
- by day, cash investors deposit their cash at JPMorgan and BoNY and JPM/BoNY lend cash to securities dealers, but
- by night, those cash investors lend the cash directly to the dealers in the freaky unregulated shadow banking market.
Those two activities sort of live on a continuum – traditional(ish) banking by day, shadow banking by night, but still the same provision of credit to the same people based on the same collateral. It’s just that during the day the cash investors’ risk is wrapped in the gentle embrace of the clearing bank; at night the cash investor snuggles up directly with the collateral. Dudley argues that this combined the risks of shadow banking with the complacency of regular banking: Read more »
The Financial Stability Board is … is a thing, first of all, did you know that? It’s not the Financial Stability Oversight Council, though it is as far as I can tell a global version of that with similar composition (senior regulators! in a room!) and obsessions (shadow banking! money market funds!). It’s also not the Systemic Risk Council, which is different, insofar as it’s just a thing that Sheila Bair made up. I am going to make up a thing – the “Systemic Stability Oversight Board” seems available – and if you ask me nicely I will invite you to join it and we will make beautiful, beautiful reports together.
Like the FSB did with their report about shadow banking1 released yesterday. “Shadow banking,” like “junk bonds,” is a term that sort of assumes the panic it sets out to create, and so the report dutifully provides a number that is bigger than another number:
The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought, leading global regulators to seek more oversight of financial transactions that fall outside traditional oversight. … The FSB, a global financial policy group comprised of regulators and central bankers, found that shadow banking grew by $41 trillion between 2002 and 2011.
Here is that in graphical form:
Holy crap look at that purplish line go! Oh wait that purplish line is just regular banks; shadow banks are the red line. Which also goes up. Just not as fast. If it worries you that shadow banks added $41 trillion in assets in 2002-2011, you might spare a thought for non-shadow banks adding, what, $80 trillion in assets? I submit to you that non-shadow banks have shadowy places of their own; I half-seriously submit to you that the term “shadow banking” functions to make regular banking sound less shadowy, like Disneyland in Baudrillard.2 Here it is in percentage terms: Read more »