[GA - In Queue] Fair Depository Standards Act

Discussion in 'WA Affairs' started by bowloftoast, Apr 14, 2019.

  1. bowloftoast

    bowloftoast Not Just For Breakfast - -

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    [​IMG]
    Fair Depository Standards Act
    Category: Regulation | Area of Effect: Consumer Protection
    Proposed by: Lusane | Onsite Topic
    Voting Instructions:
    • Vote For if you want the Delegate to vote For the resolution.
    • Vote Against if you want the Delegate to vote Against the resolution.
    • Vote Abstain if you want the Delegate to abstain from voting on this resolution.
    • Vote Present if you are personally abstaining from this vote.

    Detailed opinions with your vote are appreciated and encouraged!
     
  2. bowloftoast

    bowloftoast Not Just For Breakfast - -

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    Information for Voters

    This resolution suffers somewhat from a rush to submission that prevented the proper vetting of some of its mandates. A few of the ideas suggested are incomplete, with no instruction as to how to carry them out effectively. For example, the resolution recommends a fixed capital reserve requirement for financial institutions. The resolution does not, however, provide the established Depository Regulators Committee (DRC) the ability to develop regulations that would harmonize how capital reserves should be calculated. Since there is no existing body in the WA to create such a regulation, and since there are innumerable jurisdictions, this creates a disconnect. The DRC is the enforcement agency, but there is no organization created through the resolution to draft the regulations themselves. Similarly, the resolution allows institutions to appeal DRC decisions around non-compliance, but there currently exists no WA organization to handle such appeals. The resolution doesn’t make clear to whom appeals would be made and provides no instruction for the development of such a body. There are a few other structural issues of this nature, and, some important investment areas and institution types that probably should have been included as part of the resolution weren’t. In general, there is a sense that the Act is somewhat incomplete, and some of its mandates fail to address the more complex aspects of finance and investment.

    For this reason, The Ministry of World Assembly Affairs recommends a vote Against this proposal.
     
    Last edited: Apr 15, 2019
  3. bowloftoast

    bowloftoast Not Just For Breakfast - -

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    Leaning for on this one, in spirit, but have some reservations:
    1. Resolution cites an independent body that may review decisions made by the DRC, as part of an appeal, but there is no specific body indicated for such reviews. It feels like unfinished business. Would aggrieved parties simply be appealing to another WA element, and if so which? How can impartiality be maintained if that is the case? If not a WA institution, who would have the authority to impartially review these cases? Is there a need for an enhancement to this, or a secondary, contiguous resolution to set up some sort of tribunal, to this end?
    2. PROHIBITS institutions from placing holds, freezes, or closures on depository accounts without reason. That's awfully ambiguous language. I think a clearer line needs to be established around what is and isn't acceptable 'reason' for institutions taking these actions. This strikes me a the chink in the armour that causes this thing to get repealed if it passes.

    WA Nation is THX1138
     
  4. El Fiji Grande

    El Fiji Grande MiniComm - - -

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    What bowloftoast has described are indeed the only weaknesses to this legislation. So much so, in fact, that I failed to even recognize his first point until looking his comments over and rereading the entire proposal. These are not sufficiently significant reasons to prevent my support, and I generally agree with the consumer protections provided in this resolution.

    For.


    Against. See post below.

    WA: El Fiji Grande
     
    Last edited: Apr 14, 2019
  5. Imperium Anglorum

    Imperium Anglorum TNPer

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    They're not the only weaknesses to this legislation. The proposal only applies most of these regulations to corporations or government institutions. Things like limited liability partnerships are not corporations.

    Moreover, the idea of what a lender is excludes mortgages, which fall into the definition given, except that the loans are collateralised by the real estate of the house, rather than some amount of money or currency. The definition of investment brokerage is similarly broken, because people can invest for capital gains (buying low, selling high) instead of dividend payments.

    I still have no idea what a situational basis is. It wasn't corrected when I raised that question to the author in a ridiculously long discussion/response post on the forum.

    And this clause "REQUIRES institutions to hold capital reserve equal to or above nine and one-half percent of their depositor's accounts total value, to limit consumer exposure to insolvency" is moronic because while many regulators around the world use something around a ten per cent capital reserve, there are lots of issues in enforcement. (1) What is capital? (2) What counts as a reserve? Is it Tier 1 capital? Tier 2? (3) Why this figure specifically? (4) What about areas without deposit insurance which would increase the likelihood of bank default? Should not their reserves be higher? (5) In recessions, lowering the capital reserve allows banks to make more loans and thus expand the money supply; why should that ability be curtailed, leading to large and appreciable negative impacts on the real economy?

    Those are not the only problems with the proposal. But I'll address an implicit credibility point as well: Why should you believe me? I work in a US federal banking regulator. I'm not going to release my PII on this forum, but if you want confirmation, ask Sciongrad and Separatist Peoples.
     
    Last edited: Apr 14, 2019
  6. El Fiji Grande

    El Fiji Grande MiniComm - - -

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    You're arguing this proposal does not protect consumers? I think it very clearly does, and I'm not sure how LLPs come into it. I'm not sure what you're trying to say.

    Those are good points. While it seems clear that 'money or currency' was intended to mean money, currency, property, or anything of mutually recognized and agreed upon value, I can see how strictly limiting it to 'money and currency' would be restrictive.

    I was going to say something to extent of "Well, I think it means...." and then I realized that's precisely your point.

    The lack of a clear mechanism through which enforcement of these policies can occur doesn't really trouble me. Can't that be covered in separate legislation? However, your later points are quite convincing. The lack of specificity with which the proposal answers the questions you raise is problematic. At this point, I agree with your thesis that the bill should be rejected, and hereby change my vote to Against. Nevertheless, I think this proposal is a good start, and with a committed effort to address the concerns you've raised, could be resubmitted.

    For the record, while I completely believe you, this qualification only goes to show that you're an expert in the field. It does not, however, dictate that the WA must mirror the IRL policies and norms that the US - or any other country for that matter - follow.
     
  7. Imperium Anglorum

    Imperium Anglorum TNPer

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    Regulatory arbitrage. This is something that comes up a lot, especially in the United States. The patchwork of competing jurisdictions means that firms can choose to headquarter in certain places, have certain types of charters, etc. that exempt them from certain types of regulation. In this case, firms would just reclassify themselves from corporations to limited liability partnerships to evade regulations.

    The counter-argument that I can think of instantly is: banks are corporations. That's not necessarily true. One can easily imagine a company that does very bank-like things which is not a corporation. And moreover, even if banks are corporations, the vast majority of banks are private. And private corporations can easily change their chartering to become an LLP, thereby evading these regulations.

    Secondarily, these inaccurate and misleading definitions are partly why the resolution is written so poorly.

    For other readers, to add impact to this point: If we desire to protect borrowers, is it not important to protect people borrowing to purchase a house? Or borrowers giving, say, their development as collateral for the creation of the development? Are not these borrowers deserving of protection?

    Why then, should be pass legislation that would only protect the sort of borrowers who would be able to front cash to collateralise their borrowing, insofar as borrowing is fundamentally centred on the inability to front cash for desired purchases?

    I'm not sure whether I touched on enforcement. I don't find enforcement arguments in the GA interesting or impactful, mostly because separate resolutions already exist to coerce compliance. If you are referring to Tier 1 and Tier 2 capital, this is important because the types of capital on hand are not the same. If I can fulfil my capital requirement solely in mortgage-backed securities, and there is a crisis having to do with mortgage-backed securities, (1) that capital is worthless and (2) the requirement to have it is meaningless.

    Furthermore, different types of capital have different values, and something like marked-to-market accounting is going to attempt to capture those values. But the error in marked-to-market evaluations of fair market value is not inconsiderable and should definitely be considered before setting a capital requirement.

    If the WA wants to set a capital requirement, I think it's probably so complicated that it is not something which should be done by specific legislation, but instead, by secondary legislation delegated to a committee.

    I included this section to show that I'm not talking out of my arse when it comes to financial regulation. That is my specific vocation and specifically what I am an expert in.

    However, I'm unclear why you included this section on US-specific financial regulation. I'm decently familiar with non-US jurisdictional financial regulations, and standard international ones, like Basel I to Basel III. Nor did I propose or have I proposed specifically US-centred financial regulations, something which is definitely good, because nobody should be emulating the absurd Holy Roman Empire-esque patchwork of infinitely game-able regulations and regulatory authorities that the US has created ... instead of a normal regulatory system that is consistent and standardised.
     
    Last edited: Apr 14, 2019
  8. bowloftoast

    bowloftoast Not Just For Breakfast - -

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    LLP's could be covered in future legislation (and given the complications of the inherent lack of accountability, probably should be.)

    The collateral is understood to have an ultimate (and often appraised) currency value, so I think this is forgivable.

    Pretty minor.

    I take that to mean case-by-case (in each situation) instead of by broad, inflexible rules. Harmless.

    I think it's fairly commonly understood among financial institutions how capital is 'supposed' to be calculated. Given that the resolution creates a regulatory body, we have to assume the regulations would also be harmonized under that body. That would obviously include how capital is calculated.

    Happy medium, considering Basel.

    Absolutely not, if the goal is tougher regulation on institutions, to mitigate them taking on unnecessary risk and placing people and economies in jeopardy. This is the best part of this resolution. It doesn't bend the rules to enable those who choose to fly closer to the sun, it puts the emphasis on preventing them doing so - leveling the playing field for the financial security of all, and a sober return to well-regulated, commodities-based financial models.

    But they don't. During recessions, banks close ranks and reduce their lending, limiting their exposure. What they do instead is use their previously secured capital, now liberated, to invest outside of their institutions. Sure, that still puts more money out there, but that's quite a bit different from 'lending more'.
    In your case, The Fed drives that agenda, and that incestuous relationship between The Fed and big banks also enabled the sort of wanton deregulation that allowed the US to screw up the economy of the entire world in 20072008. Exactly the sort of thing this resolution seeks to prevent.

    Yes, this resolution puts pressure on fiat currency and economies that are built on it, but the WA is not the US. History is showing us that that model is subject to never-ending boom/bust cycles and is ultimately unsustainable. That cycle also causes people a great deal of hardship, and this resolution seeks to prevent that, as well.

    I think what I like most about this resolution is that it moves away from laissez-faire practices, instead of trying to accommodate them.
     
    Last edited: Apr 14, 2019
  9. Lusane

    Lusane Citizen -

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    I am not sure that I would agree that Limited Liability Partnerships have anything to do with depository transactions themselves. At thought, most LLPs (including attornies, accountants and other professional services) do have a transaction with consumer funds, however; the funds are placed in depository accounts with financial institutions which are regulated under the provision.

    The provision on lenders is very clear; it refers directly to collateralized loans in the form of currency -- i.e. a down payment, credit builder products, secured credit cards, etc. This legislation is by no means made to handle real estate, nor does it state that it is. Mortgages do not fall under the provision as written. The act handles depository standards directly -- real estate has nothing to do with deposits.


    Further speaking of investment brokerages, rather they are investing for capital gains or not, there is still funds; in an account (on deposit) that are covered by this act. Further, IRAs and other similar interests are held in brokerages ON DEPOSIT.


    Perhaps the provision in which "situational basis" is stated could have been better clarified in the legislation itself; however the provision is meant to handle reported situations by member-nations and determine an outcome rather that be disciplinary or not.

    To begin with, this clause was changed specifically at your recommendation, where you stated:

    "Most modern nations do not have capital reserve ratios above 10 per cent. That is in part because of higher confidence in the financial system due to deposit insurance but also because 10 per cent of a bank's depositors do not suddenly come looking for their money back, even in a run."

    The capital reserve was set at 9.5 to be under your recommendation, to comply with the statement of "most modern nations do not have capital reserve ratios above 10 percent.".

    I can acknowledge that capital reserves could have been better defined in the provision. However, the length your trying to define this provision at is like squeezing a rock for water.

    I congratulate you on your position as a federal banking regulator. I am a law student, it's my hope to one day aid in scaling the liability of the Fortune 500. I can see that your position may contribute to the need to over define what should pose as simple provisions to offer consumer protections.

    I would like to restate that this provision has nothing to do with property. it refers directly to collateralized loans in the form of currency -- i.e. a down payment, credit builder products, secured credit cards, etc. The act handles depository standards, not lending standards.

    I would like to bring to your attention that I don't agree that these definitions are innaccurate or misleading. I have made no attempt to mislead any individual or nation in this act. Further to address the thought that the act is poorly written, you've passed acts that consist merely of one sentence.

    Again, you're misconstruing the act to be in the protection to borrowers. When coverage under the act is only qualified to lenders when they're using a security interest in the form of currency -- again for effects like secured credit cards where a consumers hard currency is being held in a depository account. This is the Fair DEPOSITORY Standards Act, not the Fair Lending Standards Act. While I agree borrowers should be afforded protections, that can be covered in future legislation; as this act does not address it.

    This is the exact meaning of the term "situational basis".


    I hope my response may have been able to address direct concerns that you had regarding the Act. I have attempted to build a proposal that caters to consumers that are involved in deposit relationships -- not lending relationships, however: you need understand that some lenders take a deposit when it comes to certain products offered by their institution, as addressed above. I do not believe my provisions are "moronic" as stated by Imperium, however; I can concede they could have been better explained or worded. Further, I do ask why if you had these specific concerns, why you did not address them in this manner instead of dancing around them in NS Forum, Imperium? This type of criticism could have better formed the Act from inception. It dosen't seem you had an intention to aid the legislation in being anything better than "poorly written", as you stated, from the get-go. But that's my opinion.

    If there is anything else I can address, please ask. I'd be happy to.
     
    Last edited: Apr 14, 2019
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  10. Praetor

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  11. Siwale

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  12. Imperium Anglorum

    Imperium Anglorum TNPer

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    Firstly, having to do with bowloftoast's comments.

    Collateralisation, currency and fair market value. The collateralisation element cannot possibly be interpreted in the manner in which you want it to be interpreted, insofar as it explicitly says "in which a security interest in the form of currency is placed in a transactional account". It is specifically currency and it is specifically in a transaction account. A house is not currency. A house cannot be put in a transaction account.

    Capital requirements. The specific figure is different between jurisdictions. There are also different capital requirements between jurisdictions and different conceptions of what that capital is. The composition of the capital reserve is not a matter without merit. The abstraction of all of those matters to committee doesn't in fact give clarification, because the committee is not empowered to make those assessments, rather, it is directed to enforce the regulations. The GA consensus is (this isn't debatable) that the law does what the law says, and there does not seem to exist any sort secondary legislative authority granted by the proposal.

    Basel. Comparisons to Basel are unapt, insofar as Basel deals with risk-weighted assets and not deposits themselves. Moreover, there are different kinds of deposits (e.g. Core and not core, like brokered) which are treated by the banks and regulators differently. The percentages may be similar, but the numerator and denominator's composition, meaning, and interpretation are substantially different.

    Monetary policy. Your comment here:

    Absolutely not, if the goal is tougher regulation on institutions, to mitigate them taking on unnecessary risk and placing people and economies in jeopardy. This is the best part of this resolution. It doesn't bend the rules to enable those who choose to fly closer to the sun, it puts the emphasis on preventing them doing so - leveling the playing field for the financial security of all, and a sober return to well-regulated, commodities-based financial models.
    doesn't coincide with how banks work. Higher capital requirements make banks safer. I asked whether or not higher capital requirements ought be required in countries which have more fragile depository sectors. If you want to make them safer, increase the capital requirements. I'm not sure whether I'm interpreting your statement correctly, but it seems to me to imply that your believe that raising those requirements will make depository institutions less safe. That's wrong.

    If you want to limit the size of the amplitude of business cycle shocks, you want more effective monetary and fiscal stabilisers. Reducing the scope of monetary stabilisers has the opposite effect and makes life worse in the short run for society writ large. I'm not sure where you're coming with this, because the warrants you give are all ones which have to do with alleviating economic downturns, but you use them to justify a policy (floors on reserve ratios) that would make them worse.

    Secondly, on to Lusane's remarks.

    Corporations. My issue with the repeated use of corporations is that there are many forms of industrial chartering which are not corporations. LLPs are examples of this. Your proposal does not cover them because they are not corporations or government entities. Banks can recharter themselves as LLPs to avoid your definitions and regulations predicated on their being in those definitions. Regulatory arbitrage is a thing.

    Capital requirements. Where I say that most modern nations do not have capital requirements above 10 per cent (also, of their deposits, not of assets writ large), that does not exclude the possibility that there are less developed countries that also have banks that also have capital requirements that also lack effective enforcement due to lack of state capacity. Perhaps the word modern is unclear, because it can both be interpreted in a temporal and a developmental sense, but I meant the latter.

    Occupation. Regarding your being a law student, you'll be happy to know there's a ridiculous number of lawyers and law students in the GA. Visit the Discord... we have law-related discussions every Thursday (not literally)! I think you'll find yourself at home.

    Definitions and "well-written". When I say that the definitions are wrong, I mean that they do not accord with the generally accepted meaning of those words. I would similarly accept that my definition of the word "secret treaty", excluding pluralisations, is wrong in that it does not mean what most people would expect it to mean, but also that it is hilarious. And on the remark on length, I think that Debtor Voting Rights is a well-written resolution. It does exactly what it is meant to do, precisely and succinctly. I do not adjudge the quality of being "well-written" on length or on my particular grammatical preferences, I adjudge it solely on whether or not the language is precise and accurate. My issue with the well-written-ness of the proposal is its accuracy.

    Drafting. Regarding your remarks here: "why if you had these specific concerns, why you did not address them in this manner" and "It dosen't [sic] seem you had an intention to aid the legislation in being anything better than "poorly written", as you stated, from the get-go". I spent an almost an hour five days ago writing a four-page long response to your proposal. It covered every clause which I thought important, and was generally through. You quoted part of it above. There was a lot more feedback than just that section of the response.

    On 10 April, I came back asking you to run it through a grammar checker. Following that, I then had work at my job where I spent a ton of time talking about bank resolutions. I touch back on the GA every few days and not every few hours. Then, my next post was on the 13th, which was solely confined to the GA Joke thread, and I did not read anything else because I was busy thereafter. The responses here are made towards the specific legislative choices you made in response to those remarks. I've been very critical of the fact that criticism comes out of the woodwork only upon submission (this is especially the case in repeals, where minor errors become massive legality challenges). That simply does not apply here.

    You could say that I did not purposefully maximise the amount of input that I gave to your proposal. You could even say that I missed some things on my first pass through it. I vehemently resent, however, the suggestion that I did not have an intention to give input, or a desire to give input, or purposefully withheld input so to oppose this proposal. I have made my position on the idea of financial legislation in the Assembly quite clear, and have desired to support it writ large. To say the opposite is, in my opinion, absolutely without basis.



    EDIT: The macro prudential concerns, which are the core of the part you quoted supra (and then called squeezing water from a stone), are actually located in my response when it says

    Third, higher capital reserves reduce the quantity of loanable funds. This has three effects: (1) fewer investments are made, meaning that firms and households cannot borrow as much to fund purchases of capital machinery or smooth their consumption; (2) a supply reduction causes there to be higher interest rates, harming people with adjustable rate loans and also increasing the price necessary to make investments profitable, which also reduces the number of investments which have positive net present value; and (3) makes it more difficult for banks generally to survive, biting into all the harms spoken of above (see supra at α).​

    To say those parts weren't addressed is highly economical with the truth.

    Also, these following remarks were not addressed (not an exhaustive list):

    A poor definition. You just told me that financial institutions are depository ones. That's untrue. Pull out a NAICS book and you'll see they're classified under different subsections (52X).
    > I see you complaining that I didn't bring up my belief that your definitions are poor. But I did, right here, and they are poor for the exact same reasons.

    Situational doesn't mean anything here, unless you meant something like "consistent". Moreover, on a structuring level, you should give a list of the actual provisions you want to implement before creating an enforcement mechanism for them. Just put this at the bottom. However that is, jurisdiction is the wrong word, say "empower".
    > This was raised then and was raised again. But in response to your comments above, I would say that you should just get rid of the word because it doesn't seem to do or modify anything. Or substitute case-by-case, if that's what you mean.

     
    Last edited: Apr 14, 2019
  13. TlomzKrano

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    Im worried that this approaches regulations from the wrong angle, but that could vary with my outlook on WA policy making. Some items could use fixing which some longer drafting could have potentially fixed. Furthermore I am concerned that this proposal is slightly rushed. It had a very short drafting period and was never able to enter sponsorship due to submission. Because of that, I am leaning towards against...
     
  14. Bobberino

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  15. Pallaith

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  16. bowloftoast

    bowloftoast Not Just For Breakfast - -

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    Okay, I hear what you're saying, that, as the resolution is written, real estate can't possibly be included. I guess that leaves me wondering why you brought up real estate at all, since mortgages aren't mentioned anywhere in the resolution? On one hand, you've said mortgages fit the given definition of what a lender is, but on the other hand, you're saying that mortgages can't possibly fit the definition because real estate is not currency. I guess I'm unsure what the grievance is?
    Agree, this should have been clarified, and is similar to my concerns about where appeals would be going, since the resolution doesn't make these things clear.
    Your statement was "...(1) What is capital? (2) What counts as a reserve? Is it Tier 1 capital? Tier 2? (3) Why this figure specifically?..." I didn't realize you'd circled back in [3] to his tying the percentage to total deposits.

    Your statement was: "What about areas without deposit insurance which would increase the likelihood of bank default? Should not their reserves be higher?" I took that to mean areas of investment as opposed to physical jurisdictions. Regardless, my thinking is that institutions (and in the greater context, entire economies) should adapt to the fixed limits of the regulations (philosophically too) as opposed to some institutions being emboldened to take greater risk in their investments simply because they are meeting a slightly higher capital requirement.
    That's just me thinking about it in a more holistic sense. Even if an institution is holding a 50% ratio, that doesn't necessarily mean they will have the ability to cover a failed, high-risk investment, and again, people get hurt by that sort of false confidence in their regulations and their institutions. All these theoretical protections continue to serve as little protection at all when the sh*t hits the fan. Someone is always going to find a way to screw things up.
    I'm of the mind that keeping everyone to the same percentage, and discouraging institutional risk-taking behavior as part of a greater, cultural change, the better solution. An ounce of prevention.
    I understand that's not how it works in the model to which you are accustomed, but I don't have a lot of confidence in that model.
     
  17. New Bremerton

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  20. Wonderess

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  22. Imperium Anglorum

    Imperium Anglorum TNPer

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    When you hear the word lender, do you imagine just people who lend only to persons with collateral in the form of currency in a transaction account? I don't. I imagine people who do far more than that: C&I lending, home mortgage lending, commercial paper lending, etc. This gets back to what I said far above saying that the definitions are wrong.

    If the author were to pursue this again (which I eminently recommend, albeit with less haste), it would have been far more useful to say that all persons who possess a depository account are entitled to X, but that's a different proposal.

    This is bad economics. I touched on this on the WALL Discord at length, but, quite simply: There is no good evidence to show that there exists an emboldening effect which would lead to, on balance, more risky bank behaviours. In fact, what we have goes the other way. I'll cite from the FDIC's book, Crisis and Response —

    Most banks that failed or became problem banks did so because of large concentrations, relative to their capital, of poorly underwritten and administered commercial real estate loans and (especially) ADC loans ... In addition, banks’ choice of capital structure mattered: banks that operated with lower levels of capital during the run- up to the crisis failed more often. pp 119–120.

    Capital ratios as of a date well before the start of this crisis are more likely to reflect institutions’ strategic priorities regarding safety, return on equity, and growth and are less likely to reflect factors such as loan write-downs or other operating losses. As indicated in the figure, banks that chose to operate during the midst of the housing boom with lower equity-to-asset ratios were more likely to fail during the crisis. These results probably reflect two factors. First, operating with lower capital reduces an institution’s ability to absorb losses and therefore (all else being equal) makes the institution’s failure during a downturn more likely. Second, operating with lower capital may reflect more emphasis by bank management on achieving aggressive return-on-equity goals, and this emphasis may reflect management’s higher appetite for risk more generally. pp 122–123.
    Moreover, to buttress my case for the inadequacy of required reserve ratios as some kind of silver bullet for banking regulation"

    The reason for the only partial correlation between the indicators and failure or problem-bank status is that the viability of a bank and its resilience during a period of economic stress depend on important bank-specific factors that cannot be evaluated adequately using published financial reports. Among these factors are the quality of loan underwriting and credit administration, risk limits, and internal controls, all of which are specific aspects of bank governance. p 124.​

    Also, I would draw your attention to these figures:

    [​IMG]

    If we are to believe that "some institutions being [are being] emboldened to take greater risk in their investments simply because they are meeting a slightly higher capital requirement" and that this effect makes the financial system more dangerous on balance, then the less capitalised banks should be near or below the Green >10pc line. It's not. Instead, as expected, well-capitalised firms with higher capital buffers fail less frequently than less well-capitalised ones.

    [​IMG]

    More broadly, both these figures show that bank failure is more likely as: (1) leverage ratios go up and (2) the proportion of assets made up by risky loans goes up. The second is extra important, because it shows that the source of the capital which a bank holds is important. If that capital is likely to suffer write-downs, it is comparatively more likely for a bank possessing that capital to fail. The fact that the resolution at vote doesn't address the capital mixture creates perverse incentives for risky firms to find cheap capital which is not as robust to economic shocks.

    On top of this, to address the point which you originally made in your original response: Should risky firms have more capital?

    Why should a firm holding risky assets which have lots of volatility have the same capital requirements as a firm which holds safe assets and makes its money by investing in something like diversified international money market accounts? If the risk of failure is far lower in the latter bank, why should it be held to the same standard as the one that is far more risky? This is basically like saying that even though you drive a modern car with 5-star safety features and auto-braking software, you should have the same insurance rate as some geezer who can barely see driving a Model T. It is profoundly unfair on firms which choose safer more risk-averse strategies.

    The strategies used in Basel and other central bank stress tests deal instead with the ability for a firm to weather shocks given the assets they have. This also has the added bonus of penalising risky firms which have less solid assets by requiring them to have larger capital buffers. Expanding equity is not costless, and therefore, penalises those firms considerably. If a policy like the one you seemed to advocate above were implemented, there would be no marginal deterrent from equity costs to more risky business strategies.

    Some economists actually believe that effect is so considerable that it has led to an undercurrent in the monetary policy literature which believes that stress tests played a part in causing the slow recovery from the last recession by making it more expensive for firms to lend. This also happens to further buttress my claim about monetary policy effectiveness, in that if we increase capital buffers, firms lend less. And we return to the converse claim that I made six days ago: that setting floors on a required reserve ratio lowers the ability for nations to exercise effective monetary policy that would alleviate economic downturns by lowering the cost to lending.
     
    Last edited: Apr 15, 2019
    Sanjurika likes this.
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