| Ten Necessary Steps to Reshape the Global Financial System |
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27/11/2009 16:15 (74 Day 03:07 minutes ago) | |||||
Do you know which is the joke that accountants tell about the balance sheet of banks?: “In the left side there is nothing right, in the right side there is nothing left”.
Unfortunately such a joke has a very negative implication for our economies: if banks do not know the real value of their assets and liabilities they will be reluctant to lend. If there is no lending both consumption and investment (the main components of GDP) will be seriously undermined.
First: completely write off bad assets from the balance sheet of banks. As long as toxic assets remain on the balance sheets credit will remain constrained, and hence the economic recovery will be subdued. Bad assets should be transferred to “bad bank” structures, which should manage the loans for the long term.
Second: recapitalize the remaining “good” banks by injecting fresh pure equity (not preferred or other hybrid capital) until a minimum level of 8% of risk weighted assets. If markets are not willing to inject the money then states should inject it, keeping the potential upside for the tax payer.
Third: central banks should prevent asset bubbles that could produce future credit manias. Their mission should not be constrained to consumer price stability but include asset price stability, preventing “bad bubbles”, the ones that induce excessive credit levels. Hence real estate prices should be monitored and excessive rises be fought with rates increases.
Fifth: prepare a “living will” for a bank and update it monthly in every board meeting. Such a living will should give detailed instructions on what to do in case a bank goes bust. This would reduce the systemic risk which erupted with the failure of Lehman Brothers.
Sixth: Penalize excessive risk taking by the proprietary desks of banks by requiring much more capital if this activity is pursued. This measure should be much more pragmatic than the separation between investment banks and commercial banks.
Seventh: Ban banks from offering buy side and sell side investment services. Choose one of the two and be coherent. This should eradicate the huge conflicts of interest that threat the financial system.
Eighth: Monitor liquidity risk in a bank as seriously as solvency risks.
Ninth: Monitor compensation schemes in systemic relevant actors of banks (top management, chief risk officers, proprietary traders) deferring compensation to mid and long term results.
Tenth: Charge banks with a specific tax and tight capital requirements if their status as “too big to fail” prevents them from failing.
Even though crisis are great moments to make radical shifts in regulation, lobby groups successfully prevent the necessary reforms that are good for the financial system. Reform is needed, not through more regulation (banks are already seriously regulated), but through more intelligent regulation.
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