Implementing Regulatory Reforms to Effectively Manage Risks relating

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Implementing Regulatory Reforms to Effectively Manage Risks relating to Financial Innovation, Emerging Products and

Implementing Regulatory Reforms to Effectively Manage Risks relating to Financial Innovation, Emerging Products and Trends Jennifer Elliott Monetary and Capital Markets Department International Monetary Fund April 2015

Lessons from the GFC Credit Market contagion Interconnectedness

Lessons from the GFC Credit Market contagion Interconnectedness

Lessons for Reform • Institutions were not sufficiently resilient ▫ Capital ▫ Liquidity ▫

Lessons for Reform • Institutions were not sufficiently resilient ▫ Capital ▫ Liquidity ▫ Funding profiles • The full picture of the financial system was missing

Lessons for Reform • Effect of a nonbank failure on a common asset market

Lessons for Reform • Effect of a nonbank failure on a common asset market ▫ Bear Stearns, Lehman Brother: impact on repo, commercial paper markets

Lessons for Reform • Credit asset markets had a broad impact • Banks exposed

Lessons for Reform • Credit asset markets had a broad impact • Banks exposed to mispriced asset market ▫ CDS market: mispriced because AIG finance arm was not regulated and was mispricing its risk. ▫ AIG had to be saved to preserve this market, otherwise bank balance sheets would have collapsed ▫ Monolines and credit guarantees

Lessons for Reform ▫ Nonbank role in Funding markets : � US Money Market

Lessons for Reform ▫ Nonbank role in Funding markets : � US Money Market Funds: key investors in commercial paper, asset backed commercial paper and repos; vulnerable to abrupt withdrawal �Luxembourg money market funds: major source of short term funding for European banks; vulnerable to withdrawals/German bank guarantees

What about innovation? • • Securitization CDS Whole sale funding Mortgages

What about innovation? • • Securitization CDS Whole sale funding Mortgages

G 20 Reform agenda • Bank centered ▫ Market and trading risk ▫ Loss

G 20 Reform agenda • Bank centered ▫ Market and trading risk ▫ Loss absorption and resilience to liquidity events ▫ Too Big To Fail

Nonbank sector • Still work in progress ▫ OTC: trade reporting, CCPs ▫ MMMFs:

Nonbank sector • Still work in progress ▫ OTC: trade reporting, CCPs ▫ MMMFs: IOSCO standards ▫ Shadowbanking: �Data gaps �Monitoring framework �Securities lending

Doing it differently: lessons for evolving markets • Protect the core • Better supervision

Doing it differently: lessons for evolving markets • Protect the core • Better supervision (intrusiveness) • Identify data needs (much is missing in nonbanks) • Identify issues for perimeter of regulation • Understand the channels of contagion or the risk picture • Resolution and crisis management tools

Asset management, an example • • Systemically important non banks? Changes in profile? Search

Asset management, an example • • Systemically important non banks? Changes in profile? Search for yield? Recommendations ▫ Data and analysis ▫ More attention to liquidity profile �Supervision ▫ Macroprudential outlook

Why do we emphasize supervision? • Global Financial Crisis exposed supervisory failures • FSAPs

Why do we emphasize supervision? • Global Financial Crisis exposed supervisory failures • FSAPs consistently show regulatory frameworks stronger than supervisory practices

What is good supervision? • Ability to Act ▫ Legal Authority ▫ Human and

What is good supervision? • Ability to Act ▫ Legal Authority ▫ Human and technological capacity ▫ Clear supervisory strategy ▫ Robust internal organization ▫ Coordination/cooperation with other agencies • Will to Act ▫ Independence ▫ Accountability ▫ Skilled staff ▫ Healthy relationship with industry ▫ Partnership with governing boards of banks and other institutions

What does good supervision look like? • • • Intrusive Proaction Adaptive Comprehensive Conclusive

What does good supervision look like? • • • Intrusive Proaction Adaptive Comprehensive Conclusive

FSAP Findings • BCP, ICP and IOSCO ratings on principles related to independence and

FSAP Findings • BCP, ICP and IOSCO ratings on principles related to independence and resources and legal authority are consistently weaker points • Increased focus on these elements in post crisis FSAPs • Not just a problem for emerging and developing markets, although clear correlation to income and some regional differences

17 Global Implementation 100 2011 Methodology 90 Independence 2003 Methodology 80 Supervision and Enforcement

17 Global Implementation 100 2011 Methodology 90 Independence 2003 Methodology 80 Supervision and Enforcement 60 Resources and Powers 50 40 30 20 10 P 37 P 36 P 35 P 34 P 33 P 32 P 31 P 30 P 29 P 28 P 27 P 26 P 25 P 24 P 23 P 22 P 21 P 20 P 19 P 18 P 17 P 16 P 15 P 14 P 13 P 12 P 11 P 10 P 9 P 8 P 7 P 6 P 5 P 4 P 3 P 2 0 P 1 percent of countries 70

Conclusions • Innovation carries potential risks • Supervision needs to play its role ▫

Conclusions • Innovation carries potential risks • Supervision needs to play its role ▫ ▫ ▫ Understanding risks Understanding the big picture Challenging the market Policing the perimeter Strong internal culture of supervion=agility in the face of change • Life as a regulator will never be dull