Regulators should throw out the old rule book that uses such policies as consolidation to manage bank competition and instead focus on addressing the “too-big-to-fail” issue.
Lenders in advanced economies have high incentives to take risks and large banks have access to cheaper funding than smaller ones, according to an International Monetary Fund working paper published last week. Those banks need to shrink, said author Lev Ratnovski.
“The most direct tool to do so is to impose taxes or fines on large banks, to extract their unfair competitive advantage,” Washington-based Ratnovski wrote. “From the perspective of competition policy, this would ensure a level playing field. From the prudential perspective, such taxes or fines would reduce the excess incentives of banks to grow, reducing the too-big-to-fail problem and enhancing financial stability.” Banks deemed too big to fail are systemically important financial institutions, whose collapse would harm the global economy. In the U.S., the 2010 Dodd-Frank Act gives the Federal Deposit Insurance Corp tools to resolve the largest banks. The U.S. Federal Reserve is also using the new legislation to stress test and raise capital and liquidity standards on systemically important institutions.
Implicit guarantees that too-big-to-fail banks will be bailed out in times of crisis can provide a funding advantage of as high as 0.8 percentage point a year, Ratnovski said, citing research in a separate IMF working paper by Kenichi Ueda and Beatrice Weder di Mauro.
“Historically, most interventions in too-big-to-fail banks were de facto bailouts, which protected their creditors and sometimes shareholders too from full distress-related losses,” Ratnovski wrote. “The anticipation of bailouts increases the incentives of too-big-to-fail banks to take risk, and introduces a race among banks to become too big to fail, in order to have a lower cost of funding due to the protection against losses.”
Bank competition policy should also be part of macro prudential measures -- a term given to efforts to reduce the risk posed by the financial system as a whole rather than individual institutions -- as it affects risk-taking by lenders, Ratnovski wrote. Too much competition may increase incentives to take risk, while little competition may lead to inefficiencies and add to the too-big-to-fail problem, he said.
“Sometimes there is a need to sacrifice some competition to ensure more financial stability,” he said. “Bank competition policy may require rules that are distinct from those for non-financial firms.”
To help after a crisis, competition policy should be structured to temporarily allow higher government control of banks, Ratnovski said.
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As a surge in news stories containing the word “tapering” underscores rising debate over when and how the Federal Reserve should reduce the pace of U.S. stimulus, Deutsche Bank Securities Inc. found that Chairman Ben S. Bernanke’s quantitative easing has had a greater impact on global assets than the efforts of other central banks.
Quantitative easing has also become less potent over time in influencing commodities and emerging-market stocks even as they become more correlated with U.S. asset returns, economists Peter Hooper, Torsten Slok and Matthew Luzzetti wrote in a May 23 research note.
“The Fed’s balance sheet expansions, much more than those of other central banks, have been associated with a rise in cross-asset correlations or risk-on, risk-off movements in financial markets, while such correlations have declined in the absence of these QE programs,” they wrote.
More than 80 percent of the rise in the Standard & Poor’s 500 Index has taken place when QE programs were active, starting from QE1 in December 2008, the economists said. International equities, especially those in emerging markets, rose sharply in response to the Fed’s QE3 announcement, they said.
“Increased liquidity, particularly from the Fed, tends to lead to markets where returns are driven less by asset-specific fundamentals and more by a common QE factor,” the Deutsche Bank economists said. “The Fed’s exit from quantitative easing should eventually result in a return to more normal functioning of asset markets, with returns driven more by asset-specific fundamentals and less by cross-asset correlations.”
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A report from the World Bank examining why some countries have economic recoveries without a pickup in bank lending showed such phenomena are “neither rare nor insurmountable.” Fortunately, they also don’t have a damping effect in the long run.
A study of 96 countries and 272 recoveries found that more than 25 percent were so-called credit-less revivals, authors Naotaka Sugawara and Juan Zalduendo said in a working paper published May 24. Forty-five percent of those credit-less recoveries occurred in 2009-2010, they said. A study by the European Union and the International Labor Organization estimated that fiscal stimulus by Group of 20 nations amounted to $2 trillion in 2008-2009.
“Fiscal loosening tends to be related to credit-less events while monetary easing and a country’s decision to seek an International Monetary Fund-supported program reduce the probability of credit-less recoveries,” they wrote. “Output and investment growth tends to be lower in credit-less events but, by eight quarters after the trough date, the gap between credit-less and credit-with episodes is mostly exhausted.”
Recoveries are much slower when they aren’t accompanied by lending growth, Sugawara and Zalduendo said. Such credit-less upturns are also are more common in emerging markets, they said. Openness in trade decreases the likelihood of a credit-less recovery as it is a more stable source of financing, they wrote.
The findings suggest that “a credit-less recovery is not a reason for extreme concern,” according to the working paper.
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China’s currency policy has undergone a shift.
Recent strong yuan appreciation suggests authorities prefer to let the exchange rate gain rather than stick with persistent intervention, according to Australia & New Zealand Banking Group Ltd. (ANZ) analysts Richard Yetsenga and Khoon Goh. The choice to allow the currency to strengthen comes as costs of sterilization rise, they said, referring to a situation where central banks drain money from other parts of the financial system to offset the new funds being pumped in.
Financial stability historically meant intervening to absorb any fund inflows and limiting currency volatility. Now, policy makers may be trying to accomplish that goal by allowing the yuan to move more in line with underlying capital flows, Sydney-based Yetsenga and Singapore-based Goh wrote in a May 29 research note.
“Over time, persistent intervention on one side of the market becomes increasingly difficult to sterilize, leaks out and results in excess-credit-generated side effects,” the analysts said. “Excessive local government borrowing, the rise of the shadow banking system and widespread housing market speculation are relatively recent developments in China.”
Policy changes from late-2008 to mid-2010 included a de facto peg against the U.S. dollar. From mid-2010 to end-2011, a robust domestic and global economy led to a strengthening in the yuan, Yetsenga and Goh said.
The yuan has risen sharply against a basket of currencies this year, reaching a series of records against the dollar, they said.
“The increase in the pace of appreciation, effectively back towards the pace seen in 2011, is certainly much stronger than what one would expect if the focus was merely based on China’s domestic situation,” they said. “The economic data out of China has been below expectations of late. Certainly one can point to an apparent divergence between some financial and real economy indicators in China over the past year.”
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