30 Mar 2010
Expanded guarantees for banks
This article argues that the expansion of existing and the introduction of new guarantees for financial institutions has been a key element of the policy response to the recent financial crisis. Essentially, the government expanded its role as the provider of the safety net for banks by adopting the function of a guarantor of last resort. Among the various policy response measures, the expansion of guarantees has the benefit of entailing lower upfront fiscal costs relative to other options. Guarantees are not without cost however. Even if they do not generate significant upfront fiscal costs, they create contingent fiscal liabilities. Other potential costs include those arising from distortions to competition and incentives (moral hazard). For example, there may be a perception that similar guarantees will always be made available at low costs. The fact that the expansion of guarantees has not been as closely co-ordinated across borders as might have been desired has resulted in additional costs. To avoid additional costs arising from inconsistencies in exit strategies, close communication and coordination regarding pricing and timing issues is required, especially as a more formal framework for the public provision of insurance would still need to be developed.
30 Mar 2010
Insurance companies and the financial crisis
The current financial crisis may primarily be a banking crisis, and the solvency of the insurance sector as a whole does not appear to be threatened. Nonetheless, insurance companies have been affected, and in mostly adverse ways. For many insurers, direct exposure to the epicentre of the crisis, the US mortgage market, and to related securities appears to have been limited. But the financial crisis has nonetheless had an increasingly visible impact on the insurance industry, primarily through their investment portfolios, as the crisis spread and financial market valuations and the outlook for real activity deteriorated significantly. Also, a number of concentrated exposures to credit and market risks have been revealed, including in US mortgage and financial guarantee insurance companies, as well as in parts of certain other insurance-dominated financial groups. Thus, while insurers as a group may have cushioned rather than amplified the downward pressures during the financial crisis, some clearly have added to downward pressures. Financial instruments that were at the core of difficulties served an insurance function and, thus, it is not so surprising that some institutions from that sector have been affected by the crisis on one or the other side of their balance sheets.
30 Mar 2010
The financial industry and challenges related to post-crises exit strategies
30 Mar 2010
Private pensions and the financial crisis
The current economic and financial crisis has shaken confidence in funded pension systems in general and in defined contribution (DC) pension plans in particular. The crisis has highlighted the impact of market conditions on retirement savings accumulated in DC pension plans and the uncertainty as to whether those retirement savings may prove adequate to finance retirement – particularly for those close to retirement. The purpose of this paper is to provide recommendations on how to ensure adequate retirement income from DC pension plans. In this context, this paper addresses three main questions: 1) How much do people need to save? 2) How can the effects of market risk on DC pension plans be alleviated? 3) How can retirement income be protected during the payout phase? The analysis concludes that in order to deliver adequate retirement income from DC pension plans with a certain degree of certainty, there is a need for comprehensive measures which include: higher contributions; increasing the contribution period by postponing retirement; setting as default options relatively conservative investment policies including life-cycle strategies; and managing risk in the payout phase with inflationindexed life annuities.
30 Mar 2010
Responding to the crisis
Tougher issuance conditions related to the surge in government borrowing needs are the reasons why issuance arrangements have not always been working as efficiently as before the crisis. This prompted debt management offices (DMOs) in the OECD area to review existing issuance policies and procedures. The crisis also had an impact on the use of indicators or guidelines relating to the key risks of the maturity structure of issuance or outstanding debt. Although OECD issuance procedures are likely to differ considerably at the level of technical standards and detailed institutional arrangements, increased integration of global financial markets has encouraged the standardisation of financial instruments and convergence of general issuance procedures. As a result, OECD issuance policies and procedures are broadly similar with a high degree of transparency and predictability. However, in response to tougher issuance conditions, DMOs have implemented changes in existing issuance procedures and policies that may have led to a somewhat greater diversity of primary market arrangements and procedures. The paper also reviews strategies and indicators for the management of the debt portfolio. Although issuance procedures and targets for portfolio management may have become somewhat more opportunistic in some jurisdictions, debt managers continue to emphasise the importance of transparency and predictability.
30 Mar 2010
Current and structural developments in the financial systems of OECD enhanced engagement countries
This paper discusses the financial systems of OECD Enhanced Engagement Countries (EE5: Brazil, China, India, Indonesia, and South Africa). Rather than providing a comprehensive survey of each financial system, it is designed to highlight some of the salient features of EE5 financial systems, emphasising those aspects of the system that these countries have in common and those that are different from those in OECD countries. While there are significant differences among EE5 countries, this group shares some distinctive characteristics. EE5 have relatively lower financial assets/GDP ratios and their financial intermediation remains relatively bank dominated and less international. Equity markets have reached proportions comparable to those of OECD countries, but fixed income markets (especially private debt markets) remain relatively backward. At the same time, the financial systems of EE5 countries have been developing rapidly supported by steady reforms. Going forward, many institutions outside OECD countries are likely to become bigger players in financial markets, and the emergence of large asset holdings, rising shares of world equity and bond markets and the emergence of powerful financial institutions in new regions of the world are likely to influence the contours of the world financial system in years to come.
30 Mar 2010
Policy framework for effective and efficient financial regulation
The structure and operation of the financial system have undergone marked changes in the past couple of decades, driven by dramatic improvements in technology, rapid product innovation, integration of financial systems, competition in financial services, and policy, regulatory, and trade reforms. These developments have led to a dynamic, sophisticated, and global financial services arena which fostered economic growth. Yet, the financial and economic crisis has brought to the fore many inappropriate or ill-adapted elements of our approach to financial regulation.
The crisis has forced us to think hard about the financial system: how it works, the objectives it should fulfil, and the tools and policies to help shape it.
The Policy Framework for Effective and Efficient Financial Regulation, supported by General Guidance and a High-Level Checklist, is a tool that can support ongoing efforts by policymakers, regulators, and supervisors to achieve a stronger, more resilient financial system. It is not meant to substitute for the more focused, micro-prudential principles and guidelines of international standard-setting bodies. But it can guide our strategic thinking and promote governmental leadership and action so that the financial system can play its vital role in the functioning of the economy, both domestically as well as globally. The Policy Framework, including the General Guidance and High-Level Checklist, is the product of work by the Committee on Financial Markets and the Insurance and Private Pensions Committee, and was the subject of a broad public consultation. The Policy Framework challenges policy makers to think about the fundamentals of financial regulation in a globalised financial system. It also invites them to improve their understanding of the financial system and work in close cooperation with other countries to develop proper tools and instruments so that public policy objectives are met. I hope that policymakers will use the Policy Framework in setting national policy and in working with international partners.
30 Mar 2010
The elephant in the room: The need to deal with what banks do
Contagion risk and counterparty failure have been the main hallmarks of the current crisis. While some large diversified banks that focused mainly on commercial banking survived very well, others suffered crippling losses. Sound corporate governance and strong riskmanagement culture should enable banks to avoid excessive leverage and risk taking. The question is whether there is a better way, via leverage rules or rules on the structures of large conglomerates, to ensure volatile investment banking functions do not dominate the future stability of the commercial banking and financial intermediation environment that is so critical for economic activity. While there is a main consensus on the need for reform of capital rules, dynamic provisioning, better co-operation for future crises, centralised trading of derivatives etc., the question is whether such reforms will be sufficient if they do not address contagion and counterparty risk directly. The world outside of policy making is waiting for a fundamental reassessment of banks’ business models: what banks are supposed to do and how they compete with each other. It is the "elephant in the room" on which some policy makers have not yet had the time or inclination to focus. This article emphasises not only the need for transparent and comparable accounting rules and for improvements in corporate governance, but also supports the imposition of a group leverage ratio to provide a binding capital constraint (that Basel riskweighted rules have been unable to achieve) and proposes a Non- Operating Holding Company Structure (NOHC) – reforms that are essential to deal with contagion and counterparty risk that are so integral to the ‘too big to fail’ issue.
30 Mar 2010
Regulatory issues related to financial innovation
This note explores various regulatory issues related to financial innovation. It starts from a premise that financial innovations are neither always helpful (or benign) nor always threatening. Innovations have the potential to provide for a more efficient allocation of resources and thereby a higher level of capital productivity and economic growth. Many financial innovations have had this effect. But others have not. Examples of the latter include products that may have been misrepresented to end-users and resulted in delinquencies, bankruptcies or other problems among them, or products that have been inadequately managed with respect to the various credit or market risks they entail. Considerations of problems aside, innovation should be seen as a natural aspect of the workings of a competitive system. Thus, the ideal policy approach is to find an appropriate balance between preserving safety and soundness of the system and allowing financial institutions and markets to perform their intended functions. That approach entails first ensuring that the necessary market-framing and market-perfecting rules are in place and then establishing a proper structure for reviewing financial innovations. Seven steps needed to accomplish this task are outlined in the report.
30 Mar 2010
The surge in borrowing needs of OECD governments
OECD governments are facing ongoing, unprecedented challenges in raising smoothly large volumes of funds at lowest possible cost, while balancing refinancing-, repricing- and interest rate risks. Amidst continued uncertainty about the pace of recovery as well as the timing and sequencing of the steps of the exit strategy, gross borrowing needs of OECD governments are expected to reach almost USD 16 trillion in 2009, up from an earlier estimate of around USD 12 trillion. The tentative outlook for 2010 shows a stabilising borrowing picture at around the level of USD 16 trillion. A looming additional challenge is the risk that when the recovery gains traction, yields will start to rise. Although there are signs that issuance conditions are becoming tougher, most OECD debt managers have been successful in financing the surge in funding needs. Less successful auctions can therefore best be interpreted as "single market events" and not as unambiguous evidence of systemic market absorption problems. The future could become more challenging though, given that rising issuance is occurring in tandem with increasing overall debt levels and debt service costs. In response, sovereign debt managers, with the essential support of the fiscal authorities, need to implement a timely and credible medium-term exit strategy to avoid future "crowding out" and systemic issuance problems, while reducing government borrowing costs.