However it would be foolish to expect market

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Unformatted text preview: ments (capital adequacy in particular) as commercial banks and in exchange benefit from LOLR services.83 However, reflecting their reduced responsibilities towards retail investors and the payment system, regulated non‐bank intermediaries would be subject to a lower entry capital (i.e., the minimum capital needed to open) and less cumbersome fit‐and‐proper tests than those applicable to commercial banks (otherwise all non‐bank intermediaries would become universal banks). The unregulated intermediaries, by contrast, would not need to satisfy capital adequacy requirements nor be subjected to an entry capital threshold. In exchange, however, they would be restricted to funding themselves only from regulated intermediaries, banks or non‐banks (i.e., they could not borrow directly from—or acquire contingent liabilities with—the market).84 This proposal has many benefits. As in the case of universal banking, it would comply with regulatory neutrality. Because unregulated intermediaries could only fund themselves from regulated intermediaries, a dollar lent to a final borrower through an unregulated intermediary would end up paying the same capital charge as a dollar lent through a regulated intermediary. Hence, systemic risk would be evenly internalized across all possible paths of financial intermediation, whether they involve regulated intermediaries or not.85 83 Following the same logic of regulatory neutrality, all asset‐backed securities issued with some form of recourse (including reputational) to the regulated intermediary, or purchased by a regulated intermediary, should carry an equity tranche retained by the issuer at least equivalent to the uniform capital adequacy requirement imposed on the intermediation system. 84 Thus, hedge funds that wish to remain unregulated would be allowed to borrow only from banks or other regulated intermediaries. In addition, they (as well as all other prudentially unregulated financial institutions) would not be permitted to engage as counterparties in credit derivatives transactions and other forms of default hedging and insurance (these give rise to contingent liabilities whose payment at the time they fall due may exert systemic stress by requiring asset fire sales). At the same time, a clear dividing line would also need to be established between financial and non‐financial corporations, with the latter not being allowed to engage in finance operations beyond basic trade credit 85 Some regulatory bias between intermediated debt and direct debt issues would persist, since systemic risk would be internalized only in the former case. However, because it would not involve leveraged intermediation or expose financial intermediaries, this residual bias should be much less problematic and more manageable. Notice also that our proposal is only meant to address the systemic risks associated with debt‐funded intermediation, but not those attached to unleveraged asset managers such as mutual funds, whose contribution to downw...
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This document was uploaded on 11/14/2013.

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