boe markadamspresentation

7/29/2019 BoE MarkAdamsPresentation

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1


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e orm n e wa e o e

Financial Stability

22/02/2012


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..

Berlin 1931Argentina 1997

UK 2007


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..

4


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a appene e ore an urng e crs s

What factors caused it?

What has been done about the fault-lines it exposed?


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Summer 2007: failures ofhedge funds linked tolarge banks. Cost forbanks to borrow moneybegins to rise.

Autumn 2007:September-October 2008:

Spring 2007: firstUS sub-prime

lenderbankruptcies

major banksannounce lossesof tens of billions

of dollars

March 2008: BearStearns fails.Bought out by J P

Morgan and theFederal Reserve.

Lehman fails on 15September bringing global

financial system close tocollapse.

Spring 2009:extent of globalrecession

becomes clear

Spring 2010:Europeansovereign debt

crisis begins....

Rescues of AIG, MerrillLynch, HBOS, Bradford &Bingley, and more followquickly.

Icelandic banks collapse and

Ireland guarantees mostbank debts.

September 2007:Run on the Rock first wholesalecreditors then

depositors run onNorthernRock.

April 2008:Bank of Englandstarts exceptionallending to whole

market (the SLS)

,countries, announcemassive bankrecapitalisations,guarantees, and centralbank lending.

Regulatory reformeffort begins: UKreforms bankinsolvency law; G20

launches internationalreformeffort.

Supported by lending25bn from Bank ofEngland and agovernmentguarantee


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...

...led to low interest rates and a rise in borrowing...

...


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-

10Per cent of own GDP

Gold Standard Curren

World economies in surplusWorld economies in deficitPer cent

account balances

4

6

8retton

Woods

2

3

uro-area economes n surp usEuro-area economies in deficit

(d)

0

2

1

0

1

-

+

-6

-4

-

China France

Germany Japan

UK US 4

3

2

-

1870 1885 1900 1915 1930 1945 1960 1975 1990 2005

(a) 5-year moving average

1995 1998 2001 2004 2007 2010 2013 2016


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...


... nc u ng a searc or ye n nanc a mar e s w clead to increasingly complex financial products and...


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.. Reliance on ability to sell loans, once granted, off to private investors (securitisation).


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Once the shock hit, difficult to fi ure out who was affected


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..Network of large exposures between UK

(a)(b)

Source: FSA and Bank calculations

(a) Large exposures are defined as those that exceed 10% of the .

(b) Based on 2009 Q2 data.


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...


... nc u ng a searc or ye n nanc a mar e s w clead to increasingly complex financial products and...

...and rapid, unbalanced growth in bank balance


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A declinin share of reliabl li uid assets combined with an increased

reliance on (short term) wholesale funding

Sterling liquid assets ratio of UK Average maturity of debt

banking sector securities issued by banks

Euro Area

UKAverage maturity (years)

14

1618

US

8

10

12

2

4

6

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08


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Size, interconnectedness, and complexity of institutions made the cost of

.

The result: Banks receive an implicit subsidy: lower funding costs due to the

expectation of public support.

Large European banks implicit subsidy

40US$ billions

30

35Interquartilerange

20

25Median

10

15

0

2007 2008 2009 2010


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Followed b the bust..

The end of the US housing boom led to rising sub-prime defaults...

... amplified through the financial system, causing

fear of bank failures.. .. causing a collapse of confidence, falls in asset

prices, and sustained market illiquidity...

... tri erin a hu e lobal recession and lar ebailouts...

...which to ether have caused soverei n debt crises

in Europe


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..Network of large exposures between UK

(a)(b)





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Market-implied default probabilities over the next five


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What ar w doin to r v nt a r at?

FinancialStability RiskAssessment

Division21


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Too much micro, not enou h macro.

Decomposition of UK credit

July 2006 Financial Stabili ty

Major UK banks published capital

ratios remain comfortably above

Basel regulatory minima.


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Which missed a build u in asset rices.....

600

CommercialPropertyPrices

400

500HousePrices

300

200

0

100

86 88 90 92 94 96 98 00 02 04 06 08 10


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And a deterioration in lendin standards

High LTV and LTI mortgages as a

proportion of new UK mortgages

Spreads on mortgages and

corporate bonds


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, ,

havetobeabletoabsorbmorelosses

Basel IIIliquidity:allbankswillhavetoholdmoreasse sw c can eso eas y nacr s s

FinancialStability RiskAssessmentDivision 25


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, ,


Basel IIIliquidity:allbankswillhavetoholdmoreasse sw c can eso eas y nacr s sMaking bankfailurelesscostly Bankresolutionregimes: Newinsolvencylawsfor

banks(UKBankingAct,USDoddFrank,futureEU

directive)

Structuralreform:Regulatethelegalstructureofbankstoensureresolutionregimescanwork(Vickers

Comm ss on,Vo c erRu e

Depositinsurancereform:UKlimitincreasedfrom2000(for100%insurance)to85,000



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, ,


Basel IIIliquidity:allbankswillhavetoholdmoreasse sw c can eso eas y nacr s sMaking bankfailurelesscostly Bankresolutionregimes: Newinsolvencylawsfor

banks(UKBankingAct,USDoddFrank,futureEU

directive)

Structuralreform:Regulatethelegalstructureofbankstoensureresolutionregimescanwork(Vickers

Comm ss on,Vo c erRu e

Depositinsurancereform:UKlimitincreasedfrom2000(for100%insurance)to85,000

Complexity&Opacity Independent CommissiononBankingRules ontheretention&disclosureofsecuritisations



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Global/Eurozoneimbalances ?



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acropru en a po cy

Coalition commitment:

The Government believes that the current system of financial

regulation is fundamentally flawed and needs to be

...repeat of the financial crisis



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The new Financial Policy Committee (FPC)

,policy

Members of the FPC Bank of England senior staffand external financial sector experts

FPC meets quarterly and its tasks will include:

Monitoring risks to stability and publishing FSR

Formal owers over olic tools


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The required toolkit needs to address:

Amplification channels: excess leverage and maturity mismatch

Dimensions of systemic risk: cyclical (aggregate risk) and structural

(network risk)

Tools must be specific, system-wide, and subject to national discretion

FPC due to advise HMT on initial set of instruments over which it would likedirective power by 2012H1.

First FPC discussion on tools in September and the Bank published a

Discussion Paper in December


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Balance sheets of financial institutions

Capital-based tools

-

-

Terms and conditions of financial Minimum mort a e LTVstransactions (collateral limits)

Disclosure requirements

Market structures Requirements to trade / settletransactions through certain


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overegn an an ng exposure sc osure

Forbearance data atherin

Monitor complexity ETFs

Strengthen levels of capital and liquidity positions



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e s new an eve op ng There is lots of work to do at the cutting edge of policy!

The Bank is a key player in the international debate Part of all the key international committees

The range of work is very broad

Some of the work is about short-term developments

Other work is about long-term research

ary respons y com ne w suppor


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Any questions?



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HIDDEN SLIDES



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Regulatory failure too much micro, not enough macro.

e.g. A focus on individual institutions and not systemic risk missed adeterioration in lending standards and asset quality

USmortgagedelinquencies

Source:Geanakoplos (2010)


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Network of large exposures between UK(a)(b)





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Overreliance on securitisation: Reliance on ability to sell loans, once granted, off toprivate investors (securitisation).


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250

300

200

100

150

50

0

1855 1875 1895 1915 1935 1955 1975 1995

Source: 1855-2007 Hills, Thomas and Dimsdale (Bank of England Quarterly Bulletin 2010), 2007-2009 ONS series code RUTO.

Note: The ONS calculate public sector net debt as financial liabilities less liquid assets and does not include all assets and liabilities of the public sector. The public

sector, including the banks classified to the public sector, owns considerable amounts of illiquid assets, but these are not taken into account in the calculation of netdebt.



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400

450

500Corporate

Household

%

300

350Financial

200

250

50

100

0

1987 1990 1993 1996 1999 2002 2005


Thenewregulatoryarchitecture institutionsandroles


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g y

FPCContributing to the Banks objective to protect and enhance

financial stability, through identifying and taking action toremove or reduce systemic risks, with a view to protecting and

Protecting and enhancing the stability of thefinancial system of the United Kingdom, aiming towork with other relevant bodies including the

Treasury, the PRA and the FCA. The BanksS ecial Resolution Unit is res onsible for resolvin

enhancing the resilience of the UK financial system.

FPCpowersofrecommendationand

direction to address s stemic risk

failing banks using the special resolution regime.

FCA

Enhancing confidence in the UK financial

subsidiary

PRA

Market-implied default probabilities overMarket-implied default probabilities over

system by facilitating efficiency and choice in

services, securing an appropriate degree ofconsumer protection, and protecting andenhancing the integrity ofthe UK financial s stem.

the safety and soundness of PRA

authorised persons, including minimisingthe impact of their failure.

debt(a)

debt(a)

prudential

regulation

prudential

regulation

conductregulationprudential&

conduct

regulation

investment firms & exchanges,

deposit-takers, insurance, some

investment firms

central counterparties, settlement

systems and payment systems

including IFAs, investment

exchanges, insurance brokers andfund managers


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Proposed mandate of the FPC

Protecting and enhancing the resilience of the UK financial system.

Two as ects of s stemic risk hi hli hted: structural features of financial markets or the distribution of risk

within the financial sector

, .

Requirement to take adverse impacts on medium or long-term economicgrow n o accoun an cons ra n s mpose y n erna ona aw.

[Its not about stabilising house prices nor financial imbalances per se]

Chart 1.3 Ratio of gross sovereign debt to GDP in selected


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advanced economies

Source: IMF Fiscal Monitor(September 2011).


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Change in five-year yields, five years forward(a)(b)

.

(a) The real cost of borrowing in five years time for a period of five years, as implied by nominal yields and inflation swaps. For Germany, euro-area inflation

swaps are used.(b) Change in basis points since the J une 2011Report.

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