macro-prudential vs market regulation

8/3/2019 Macro-Prudential vs Market Regulation

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Macro-prudential vs Market regulation

Presentation at the VNFinance ConferenceDec. 11th 2010

Duc PHAM-HI, ECE Quantitative Fi dept.

The views presented should be considered as the authors ownpersonal opinions and do not relate to any of the cited

institutions


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VNFinance - D.Pham-HiDec 11 2010 Page 2

Regulation

Definition

To render regular

To make rules

Both meanings have ramifications

Human/Economic societies abide by rules

Even inanimate systems may need regulation(tidal basin, steam engine)

iu-l vs. iu-hnh


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Rule making

Consistency

As much as Gdel will permit

Efficiency

If instruments outnumber goals

Reinforcement of the rules

Supervisorial bodies

Constitutionality ?


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Adjustments and control

Aim at objective levels

Where rules making aim at behaviour

Postulates solving the measurement problem

Tools & instruments

In economics and finance

In legislative / jurisdiction


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Thinking the western concept of control

Presupposes existence of a system

Driven by mechanicsThe laws of which are known

Effects are measurable

An collective utility function exists, preferencesare set

other unspecified unknowns are negligible

All of the above are stable in time and this system is unique


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Market regulation

Disambiguation: which market ?

as in the Market economy

or as in Capital markets ?

A clear drift from the one to the other

Sometimes diagnosed as the financiarizationof the Economy

Cap markets is eating up the real economy


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Market Regulation

Supervisors & Regulators

USA banks

Federal Reserve System & Board , FOMC FDIC, OTS, State Level

OCC , CFDT

France

ACP

UK

In-system actors

Fed, Banque de France before 1980s

Direction du Trsor


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Goals

Economic stability

Monetary is a clear goal

Prices Interest rates

What about consumption ?

What about Trade ? ( commerce )And Foreign exchange ?

Foreign investments

Industrial policy ?

Measurement


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Tools ( in the olden days)

Budgetary policy

TVA, pure consumer spending

Monetary policy many vectors

Liquidity

Money supply

Interest rates

ForexEvolution in their use due to constraints

Fiscal policyNot only through purchasing power

Trickle down economics, Thatcherism, ReaganismIndustrial policies

Plan Calcul, plan


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Tools ( modern times )

Money matters

Prime rate

Liquidity

Capital costs

Actors from monetary circles

Banks traders, funds managers,

Other intermediaries Insurers, credit enhancers

Consumers play a passive role

Loans and mortgage

Refinancing

Latest example : QE2

Behaviour related !


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Macro-Prudential regulation

Goal

Used to be only banking system stability

OrganizationsFed systems (Research economists)

ACP Direction de la Surveillance gnrale

Interfaces between Industry and Regulators :very important

Measurement

Real new innovation : internal systems


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Just what is Macro Prudential

Prudential

is not Law

but delegated to a law-making process is risk orientated, therefore forward looking

binding to members of a community only

Start at microeconomic level

Financial institutions and companies

Gradually took over system-wide scope


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History of a worldwide effort: Basel II - III

Basel I (Cooke ratio) imposed

Since 1988 dialog led to

Market risk management additionQuantitative Impact Studies 2 and 3

Loss data collection exercises

Even before 2001

Consultative Papers

With Call for comments

Analyses of the comments : a sincere effort

International homogeneity of process

Even non-participants are actively involved


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In Europe

3 levels

Basel II text : ICCMCS Capital Requirements Directive

National transposition

Modifications process

Expert subgroups on new subjects

Many local interests !


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Examples from Operational risk

How do you calculate a Terrorist threat ?

How do you calculate a Fraud threat ?

How do you calculate the H1N1 threat ?

How do you calculate the Paris Centenial flood threat ?

How do you calculate,with N ~ Poisson and X ~ Weibull

= =

=8

1

)(

1

)(

,

i

tN

k

t

kitXL


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Characteristics

Self Regulation based on self-interest

Personal liability

Responsible for if not guilty of

Increased control

Internal teams

Different concerns Periodic vs. Permanent

Meaning at any moment !

But still missing the temporal dimension

Based on statistics yet


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Increased role of modelling

Extract from ICCMCS 272

Correlation

(R) = 0.12 (1 EXP(-50 PD)) / (1 EXP(-50)) + 0.24 [1 (1 EXP(-50 PD)) / (1 EXP(-50))]

Maturity adjustment

(b) = (0.11852 0.05478 ln(PD))^2

Capital requirement

(K) = [LGD N[(1 R)^-0.5 G(PD) + (R / (1 R))^0.5 G(0.999)] PD x LGD] x (1 1.5 x b)^-1 (1 + (M 2.5) b)

Risk-weighted assets

(RWA) = K x 12.5 x EAD

Internal ratings

Private External Credit Assessment Institutions


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Superstructure context

Basel II negociations

Accord Implementation Group-ORCommittee of European Bank Supervisors

Both upwards and downwards

Fuzzy rules are a necessity

Constraints from projects business politics

Supranational EC issues

Bloc issues


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To wrap up

Both levels are necessary

Different goals, different time scales

Politics should not rely too much on financialactors

Cf. Quantitative Easing

Some fundamentals seem to have beenforgotten

Industry orientation

But the contagion and systemic threatsshould be at the center of all efforts now.

macro-prudential vs market regulation

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