Globalization and Systemic Risk

The following sections are included:

• Preface

• Acknowledgments

• Contents

The following sections are included:

• Features of Financial Globalization

• What is Systemic Risk?

• How to Control Systemic Risk

• What Needs to Be Changed?

• Role of the International Monetary Fund

The following sections are included:

• Introduction

• What Have We Learned?
  • Financial crises can stem from external financial problems
  • Domestic factors are important, but not only those that were the center of attention before 1995
  • Phoenix miracles

• Sub-Prime Crisis and Latin America

• References

The following sections are included:

• How Should a Lender of Last Resort Operate?
  • Restore confidence in the financial system by quickly providing liquidity
  • Limit moral hazard by encouraging adequate prudential supervision
  • Act as a lender of last resort infrequently

• Current Challenges for an International Lender of Last Resort

The following sections are included:

• The Crisis
  • A historical perspective

• Descriptive Evidence: The Credit Cycle

• Descriptive Evidence: The Housing Market

• The Nonbank Financial Sector, Financial Innovation, and Financial Crises

• International Spillovers

• Policy Lessons

• References

The following sections are included:

• Introduction

• Current State of Financial Globalization

• Implications for Financial Stability
  • Stabilizing effects from improved risk-sharing
  • Destabilizing effects from financial contagion

• Conclusions

• References

The following sections are included:

• Introduction and Summary

• Measuring and Assessing Advances in Financial Integration

• Risk-Adjusted Growth Opportunities and Financial Integration

• Conclusion

• References

The following sections are included:

• The Current State of Financial Globalization in Asia
  • Capital flows and saving–investment correlations
  • Asset price correlations and foreign direct investment

• Further Progress

Were financial globalization a stock, its price would have displayed remarkable volatility in recent months, for reasons to which I shall turn below. The papers in this session by Gianni De Nicolò and Philip Lowe remind us of the upside of financial globalization, for which we shall be thankful. I did not have the opportunity to see the paper by Falko Fecht, Hans-Peter Grüner, Philipp Hartmann and Marco Lo Duca, in part as a result of the “dark side” of financial globalization, namely the recent turbulence in financial markets. This provides an opening for me to discuss those events here, even though it has received less attention in most of the papers…

The following sections are included:

• Understanding National Safety Nets and How Weakly They are Linked
  • Components of national nets
  • Tissue connecting national nets in open economies

• Incentive Conflicts Built into National Regulatory Cultures
  • Dimensions of regulatory culture
  • Importance of transparency and deterrency
  • What if monitoring and policing costs were zero?

• Global and National Incentive Conflicts in Safety Net Management
  • What countries manage the global safety net?
  • Differences in hub-country cultures
  • Repurchase agreement as particularly opaque last resort loans
  • How repurchase agreements substitute for discount-window loans

• Where Implicit Subsidies Originate: The Political Economy of Last Resort Lending

• Policy Implications

• Summary Implications

• References

The following sections are included:

• Introduction

• The Cost–Benefit Analysis of the Safety Net
  • Direct benefits of bailouts
  • Preventing contagion
  • Indirect contagion
  • The cost of a bailout

• The International Safety Net: Preventing the International Interbank Market Gridlock

• Cost–Benefit Analysis of a Multinational Bank Bailout
  • Perfect information
    • A unique regulator
    • Decentralization with two countries

• Implementing the Bailout of a Multinational Bank
  • Optimal ex post decision
  • The ex post mechanism
    • Improvised cooperation
    • Noncommitment and truthful revelation
    • Proxy-based mechanisms
  • Asymmetric information and regulatory cooperation

• Regulatory Implications

• References

The following sections are included:

• Introduction

• Institutional Background

• A First Look at the Data
  • Total assets of foreign banks in Japan
  • Broad yen carry trade

• Carry Trades and Risk Appetite

• Carry Trades and Monetary Policy

• Concluding Remarks

• References

The following sections are included:

• Introduction

• Hattori and Shin on the Yen Carry Trade

• The Safety Net

• Kane and Freixas on the LLR in a Global Context

• References

The following sections are included:

• Interaction with the Financial System

• Interaction with “Real Life”

• Risk-Based Solvency

• Transparency and Disclosure — IAIS and Pillar 3

• Increased Interaction with the Capital Markets

• Need for Effective Groupwide Supervision

• Conclusion

It is a pleasure and an honor to attend the Tenth Annual International Banking Conference. I would like to thank colleagues at the Chicago Federal Reserve and at the International Monetary Fund for inviting me to participate in this panel. This combination of national and international financial institutions has demonstrated perfect timing in arranging this conference just a few weeks after the July/August liquidity and price disruptions that impacted financial markets around the world!…

The following sections are included:

• State-Sponsored Pension Schemes

• Private and State and Local Pension Plans

• Conclusion

The following sections are included:

• Introduction

• Methodology

• Data

• Common Exposure to Shocks

• Evolution of Systemic Risk

• Are Common Exposure and Systemic Risk Related?

• Conclusion

• References

The following sections are included:

• Introduction

• Integration and Systemic Risk

• Securitization and Systemic Risk

• Innovation and Systemic Risk
  • Using past asset returns
  • Using linear asset-pricing models

• Incentives and Systemic Risk
  • Free-riding
  • Lemons
  • Combining the frictions

• Tackling Tail Risk
  • Calibrating tail risk
  • Dynamic stress-testing
  • Liquidity policies and practices

• References

The following sections are included:

• Introduction

• Networks of Debt and Contagion of Insolvency: The Eisenberg–Noe Model

• Applications to Domestic and International Banking Systems

• How Could the Model be Improved?

• Conclusions

• References

Good morning. It is a long way to come to Chicago from New Zealand, but I think well worth it with the presentations we've had today.

I will comment just briefly on the papers. Then I will talk a bit more about some of the policy issues and the approach to some of those issues in New Zealand. New Zealand was discussed yesterday, and we always seem to come up at conferences even though it is a small country at the end of the world. And maybe it is of interest again in this situation, because New Zealand remains very vulnerable to external financial and other shocks. I will talk a bit about how the Reserve Bank of New Zealand (RBNZ) has been responding to the recent financial turmoil…

The following sections are included:

• Introduction

• Observed Volatilities

• Implied Volatilities

• Skew

• Regression Results

• Conclusion

• References

The following sections are included:

• Introduction

• Hedge Funds
  • Arbitrage, information, and hedge funds
  • Managerial compensation and performance
  • Agency problems

• Systemic Risk

• Regulatory Coordination and Competition

• References

The following sections are included:

• Introduction

• The Sample of Large Hedge Funds
  • Style distribution of large funds
  • Principal component analysis

• A Simple 8-Factor Model of Hedge Fund Risk
  • Equity factors
  • Bond factors
  • Trend-following factors
  • Emerging market factors

• Exposures of Large Hedge Funds Using Monthly Returns
  • The effects of serial correlation in hedge fund returns
  • Exposure of average hedge funds

• Corroboration of Exposures Using Daily Investible Indices

• Conclusion

• References

These are three very good papers dealing with different aspects of the relationship between capital market depth and systemic risk. For the purpose of these comments, I will focus on one issue that is common to the three papers: do hedge funds contribute to an increase or decrease in systemic risk? What was their role in the financial turmoil of the summer of 2007?…

In the US, the Federal Deposit Insurance Corporation's (FDIC) primary role is to maintain the stability and the public's confidence in the nation's banking system. Maintenance of sound risk management practices along with prudent capital requirements is critical toward successfully achieving the FDIC's mission. Given that the FDIC, for almost 75 years has had a successful deposit insurance program and supervisory program to ensure safety and soundness and, above all, appropriate capital levels, we are committed to sharing our framework and to understanding banking risks of other countries to maintain a sound global system. From a global perspective, much has to be considered when we think about crisis management. There have been lessons learned from the issues in the United States, Sweden, Japan, and Mexico. The Basel Committee on Banking Supervision (BCBS) in 1995 met in Halifax, Nova Scotia, and put forth five key areas of reform…

The following sections are included:

• Introduction

• Existing Framework for Safeguarding Financial Stability and the Ongoing EU Debate

• EU's Challenge of Providing a Pan-European Financial-Stability Public Goods

• Two Models for Evaluating Current EU Financial-Stability Frameworks
  • Decentralized decision-making in providing a “pure” public good (such as European-wide financial stability)
  • Decentralized decision-making in providing both “exclusive” (nationally-oriented financial stability) and “pure” public goods (European-wide financial stability)

• Summary and Conclusions

• References

The following sections are included:

• The Challenges for Crisis Management and Crisis Resolution

• Moving Forward from Today's Framework

• Conclusion

The following sections are included:

• Discussion

• Conclusions

I would like to take this opportunity to draw some lessons from the interesting discussions that we have had over the past two days of this conference and the implications for systemic risk arising from the recent turmoil. Over the last two months, we have experienced a very relevant test of the financial system. At first, we at the Fund viewed this as the first real test of structured credit products — a topic that we had been following and analyzing for some time. But this episode has deepened into more than that, and has raised issues that are at the heart of central banking and financial stability…

Whether we call what we have just been going through a crisis or just turmoil, I shall use the word “crisis” because the question is not so much what we do now, but whether we are prepared for a real crisis. One way to approach that question is to define crisis rather broadly to see exactly how our governments — individually and collectively — react to unexpected challenges in international financial markets…

The following sections are included:

• Introduction

• So What are Some of the Elements of Our Ongoing Supervisory Process That are Designed to Limit the Occurrence of Significant Problems at Major Firms?
  • We coordinate on broad policy development
  • Another level of coordination is the ongoing supervision of individual institutions
  • A third level of coordination is conceptually between the first two

• What Does This Mean in the Current Situation and Going Forward?

The following sections are included:

• The Global Economy

• Sub-Prime, Derivatives, and Financial Bubbles

• Lessons from Sub-Prime and Macroeconomy Implications

• Carry Trade

• Where Do We Go from Here?

The papers at this conference have developed a coherent and consistent explanation of the causes and consequences of what, we are generally agreed, would be premature to call the sub-prime “crisis”. The consensus of opinion is that the recent turmoil in the credit markets has its roots in the “originate and distribute” model of banking that has become such a central feature of the financial system in the past decade. Until recently, central bankers and regulators have perhaps been a little too ready to assume that this was a trend that had market-stabilizing properties. In particular, we have tended to suppose that collateralized debt obligations (CDOs) and credit derivatives have allowed risk to be distributed around the financial system so that no single institution would have a life-threatening concentration of bad assets. While this is one possible consequence of recent financial innovation, it has also had some less welcome consequences for financial stability that this conference has identified…

The following sections are included:

• International Agenda

• Index