The limits of systemic risk regulators

By Felix Salmon
June 25, 2010
86-page study on this question from Deloitte, and the conclusion, though predictable, is sobering:

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What kind of information will a systemic risk regulator need from banks? Sifma has just commissioned an 86-page study on this question from Deloitte, and the conclusion, though predictable, is sobering:

There is much work to be done, both domestically and globally, in order to address the issue of systemic risks in the financial system… Information gaps are inevitable, however, as noted by the FSB, “These gaps are highlighted, and significant costs incurred, when a lack of timely, accurate information hinders the ability of policy makers and market participants to develop effective policy responses.”

One of the reasons why Basel II was never fully implemented in the US is that many of the banks here simply don’t have the requisite sophistication to implement it. (In hindsight, this was a good thing.) And worldwide, it’s inevitable that many banks will lack the IT infrastructure needed to be able to give systemic-risk regulators the information they need, especially in a crisis.

You can’t regulate what you can’t measure, and it’s likely to prove impossible, in practice, to get all the world’s biggest banks up and running in terms of reliably reporting all of the information that regulators need, in an easily-tractable and standardized form. Inevitably, regulators are going to end up spending an inordinate amount of time regulating the known knowns rather than the known unknowns, like the economist looking for his keys underneath a lamppost.

As for the unknown unknowns, those you just have to resign yourself to, and hope that size, leverage, liquidity and capital-adequacy restrictions somehow keep them in check. Which is why Basel III is so important. Regulators are important, but rules are too.

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International regulators focus on “information gaps”

Source: IMF and FSB Hold Joint Conference on Implementing G-20 Recommendations on Information Gaps IMF press release, April 16, 2010

The International Monetary Fund (IMF) Statistics Department and the Financial Stability Board (FSB) Secretariat jointly organized a conference on April 8 and 9, 2010, on the Financial Crisis and Information Gaps.

Senior officials from G20 economies, other FSB members, and representatives from international institutions took part. The conference was hosted by the Bank for International Settlements (BIS) in Basel, Switzerland.
The conference was organized as part of the consultation process to develop a concrete plan of action to implement the 20 recommendations in the report “The Financial Crisis and Information Gaps,” that were endorsed at the meeting of the G-20 Finance Ministers and Central Bank Governors in St. Andrews, Scotland on November 7, 2009.

The report identified data gaps in assessing the build-up of risks in the financial sector, understanding international network connections, and monitoring vulnerabilities of domestic economies to shocks. It made recommendations to close these gaps and to improve the communication of official statistics. The report is available.

The joint conference sought participants’ views on action plans to address each of the recommendations and the required timeline. Participants discussed the pertinent issues in developing the plans, and through break-out groups discussed challenges and constraints in implementation. The conference recognized that some of the most challenging recommendations to implement–such as measuring aggregate leverage and maturity mismatches, and gaining a better understanding of financial networks–were among the most relevant for financial stability analysis.

The outcomes from the conference will inform the preparation of the progress report requested by the G-20 Finance Ministers and Central Bank Governors for their meeting on June 4 and 5, 2010. A summary from the conference will be posted on the IMF website in the coming weeks.

http://freerisk.org/wiki/index.php/Natio nal_Institute_of_Finance#International_r egulators_focus_on_.22information_gaps.2 2

Posted by Cate_Long | Report as abusive

Felix, you’re perpetuating one of the most toxic ideas in our policy discourse, which is that complexity and imperfect information make intelligent regulation impossible. We will never have perfect information, but we can do better at gathering the most important systemic information and applying our best minds to it, rather than their own individual trading books and year-end bonuses. It is true that lots of organizations would be unable to generate accurate, useful, timely information on a regular basis (see Lehman and the difficulty the bankruptcy court has had even figuring out what the assets and liabilities were); however, this is indicative not of irreducible complexity that must be tolerated, but poor management that must be incentivized to improve or find a new line of work. Strong institutions care about data collection, organization, and access, because the internal leaders need to be able to see this information. To the extent that our capitalists are unable to run their businesses without government hand-holding (and most of them are – see the hasty registration as a BHC and issuance of government-backed equity and debt even at the mighty Goldman Sachs), their regulators need to be able to look over their shoulders at the same high-quality information. The business of banks has become too complicated for us to accept any longer the existence of a systemically important bank that can’t rapidly generate an accurate historical cost and mark-to-market inventory of all its positions and a convincing explanation of any hedging. It’s just not acceptable any more to have this data scattered across dozens of unlinked Excel spreadsheets updated intermittently by hand, as Lehman did. We have had the computer technology to do much better for more than 10 years now, and it’s time to get serious about information management rather than continuing to treat IT departments as vehicles to help the HFT guys shave a few more milliseconds off their trade times.

Posted by najdorf | Report as abusive
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