removes the competition between regulators that prevents laziness and

Removes the competition between regulators that

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removes the competition between regulators that prevents laziness and encourages innovations to be allowed. - Centralization of decision making makes it more likely that one or two mistaken regulatory decisions could harm the entire US financial system, instead of just one sector. - Concentration of power may also make it easier for regulated businesses to sway rules in their favor. With fewer people to influence, a phenomenon known as “regulatory capture,” where agencies serve the interests of the industry they regulate rather than those of the public generally, becomes more likely. - The new regulation grants regulators discretion to set rules on an ad-hoc basis and pushes the United States even further from a rules-based system. A rules-based system with publicly understandable and observable goals is necessary to create the certainty and predictability that are essential for investment, prudent risk-taking, and growth. - Dodd-Frank’s reticence to push regulators to rely on market-based data in formulating and pursuing supervisory objectives increases regulators’ reliance on command-and-control policies divorced from the disciplining function of markets. - Dodd-Frank removes the stability that could emerge from a system where multiple regulators operate on nearly equal footing. C. Read “Free Lunch for Now” (Item 19.4) and answer the following: i. What is the justification for imposing capital standards on banks? Why not rely on market discipline? When deposit insurance was introduced, depositors stopped caring about the risks banks took. As a result, banks could lower their equity without having to pay more for deposits, since the increased risk is borne by the government not the depositors. In principle, capital standards increase the losses from risks a bank
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must bear itself, so makes them more careful. Market standards ii How did the Basel capital standards alter bankers’ incentives? How did banks respond? Tier 1 capital: the book value of stock plus retained earnings Tier 2 capital: the sum of loan-loss reserves and subordinated debt Total capital: the sum of tier 1 and tier 2 capital The requirement for each category of capital is based on the amount of a bank’s risk-weighted assets: - Risk-weighted assets: an index of the value of a bank’s assets, weighting each category by a risk weight between 0 and 1 - Less risky = lower weighting Off-balance sheet commitments are included in the total of risk-adjusted assets through conversion into a “credit equivalent” of an on-balance- sheet item Subordinated debt: long-term debt that, in the event of insolvency, is paid off only after depositors and other creditors have been paid - same protection against insolvency as equity Initially banks shifted to lower risk assets, because these required less equity. This resulted in a credit crunch for companies, and reduced profits.
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