session6 - Session 6 Regulation Session Overview Problems...

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Session 6 Regulation
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2 Session Overview Problems facing banks liquidity capital information uncertainty Are market solutions enough? The case for regulation Regulation in practice
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3 Inherent Banking Risks Imperfect information Market uncertainty Moral hazard Adverse selection Lemons Free riders Skewed incentives
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4 Key Considerations Assets liquidity revenue credit risk Liabilities capital adequacy cost reliability Overall trust risk spread risk operational risk Profitability Solvency
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5 Balance Sheet Basics Liquidity ratio = R/D Core capital ratio = E/A Gearing ratio = D/E D eposits linked with R eserves E quity linked with profits/solvency LIABILITIES £bn ASSETS £bn D eposits 80 R eserves 10 Borrowing 10 Securities 30 E quity 10 L oans 60 Liabilities total 100 A ssets total 100
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6 Liquidity Crunch Run on bank deposits can wipe out reserves Immediate action required! LIABILITIES £bn ASSETS £bn D eposits 70 -10 R eserves 0 -10 Borrowing 10 Securities 30 E quity 10 L oans 60 Liabilities total 90 -10 A ssets total 90 -10
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7 Managing Liquidity Action Problems Borrow from other banks Costly (fed funds rate); available? Borrow from the Fed Costly (discount rate) Borrow from markets Costly (market yields); available? Shrink lending Contracts? Customer relations? Reduced profitability Sell securities Selling into falling market? Lowering returns * Liquidity shortage more likely if Fed tightening monetary policy * * Banks’ reactions will add to macro squeeze * * Potential for a sharp downward correction *
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8 Protecting Liquidity Customer service Convertibility suspension Insurance pools Guarantees & back-stops
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Northern Rock Conventional building Conversion to UK bank (1997) Risky assets? Risky liabilities! Sub-prime infection
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session6 - Session 6 Regulation Session Overview Problems...

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