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Preparing for the Next Financial Crisis




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ISBN 9781138594708
December 28, 2020 Forthcoming by Routledge
304 Pages 5 B/W Illustrations

 
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Book Description

The ramifications of the Global Financial Crisis, which erupted in 2007, continue to surprise not only the general public but also finance professionals, economists and journalists. Faced with this challenge, "Preparing for the Next Financial Crisis" goes back to basics. The authors ask: what do theory and empirical observations tell us about the causes and the consequences of financial crisis and instability? In what has become an increasingly complex financial world, what lessons can we learn from economic policies, which have been implemented, and research, which has developed extremely rapidly in recent years, so as not to repeat past mistakes?

In this comprehensive review of the literature, which is both complete and balanced, the authors highlight the points of consensus among economists and policy makers. They assess the capacity of economic policies and institutions in limiting the cost of financial instability. In conclusion, they ask if the financial system has become safer, in the light especially of the Covid-19 Global Crisis. Ten years after the GFC crisis, this is a timely review of the reform agenda, the progress made and the areas where further changes need to be made to address new risks and challenges.

Olivier de Bandt, who holds a PhD from the University of Chicago, is an economist and researcher associated with the University of Paris-Nanterre. He is an associate editor of the Journal of Financial Stability. Françoise Drumetz and Christian Pfister are also economists. They teach the Financial Stability course in the Sciences Po School of Public Affairs (Paris).

 

Table of Contents

1. Notions

FINANCIAL STABILITY

FINANCIAL FRAGILITY, LIQUIDITY AND LEVERAGE

DEFINITIONS

THEORETICAL UNDERPINNINGS

THE DIAMOND AND DYBVIG MODEL

SUBSEQUENT DEVELOPMENTS

SAFE ASSETS

BUBBLES AND CONTAGION

What is a bubble?

Contagion or financial integration?

MORAL HAZARD AND TOO BIG TO FAIL

MORAL HAZARD AND TIME CONSISTENCY

ORIGIN OF MORAL HAZARD

CONSEQUENCES OF MORAL HAZARD FOR FINANCIAL STABILITY

CONCENTRATION OF THE FINANCIAL INDUSTRY AND TBTF

FINANCIAL CONCENTRATION

TBTF

SYSTEMIC RISK

DEFINITION OF SYSTEMIC RISK

SOURCES OF SYSTEMIC RISK

BANKING ACTIVITIES

ASYMMETRIC INFORMATION AND AMPLIFICATION EFFECTS

INTERCONNECTIONS

MACROECONOMIC SHOCKS

FINANCIAL MARKETS

EXPOSURES

ASYMMETRIC INFORMATION

PAYMENT SYSTEMS

2. Financial Cycles and Crises

FINANCE AND GROWTH

FINANCE MATTERS FOR GROWTH

TOO MUCH FINANCE HARMS GROWTH

FINANCIAL CYCLES

MEASURING FINANCIAL CYCLES

DRIVERS OF FINANCIAL CYCLES

SECURITIZATION

DEFINITION

RATIONALE

VULNERABILITIES

SHADOW BANKING

DEFINITION

Rationale

Vulnerabilities

PREDICTING FINANCIAL CYCLES

CRISES

EMPIRICAL APPROACHES

THEORETICAL APPROACHES

RECENT DEVELOPMENTS

3. International Dimensions of Financial Stability

A GLOBAL FINANCIAL CYCLE?

DEFINITION OF GLOBAL FINANCIAL CYCLES

DO GLOBAL FINANCIAL CYCLES EXIST?

THE "SAVINGS GLUT" VIEW

THE "GLOBAL BANKING" VIEW

THE EURO AREA CRISIS AND FINANCIAL FRAGMENTATION

A COMPETITIVENESS CRISIS, A SOVEREIGN DEBT CRISIS, A BANKING CRISIS

FINANCIAL FRAGMENTATION

– INTERNATIONAL CAPITAL FLOWS AND FINANCIAL STABILITY IN EMERGING COUNTRIES

BENEFITS AND CHALLENGES OF FINANCIAL GLOBALISATION

POLICY OPTIONS TO ABSORB THE IMPACT OF INTERNATIONAL CAPITAL FLOWS

4. Incentives

MOTIVES AND MODALITIES OF A PUBLIC INTERVENTION

WHY INTERVENE?

NORMATIVE APPROACH

POSITIVE APPROACH

HOW TO INTERVENE?

SETTING OF CONSTRAINTS

CONSTRAINTS ON PRODUCTION PROCESSES

CONSTRAINTS ON ACTIVITIES

ACTING ON INCENTIVE SCHEMES

WHAT WORKS BEST?

MARKET DISCIPLINE AND TRANSPARENCY

CREDIT RATING AGENCIES

ACCOUNTING STANDARDS

VALUATION AT HISTORICAL COST OR AT FAIR VALUE

PERVERSE INCENTIVES?

DISCRETION

INCREASED VOLATILITY OF EARNINGS AND SHORTTERMISM

PROCYCLICALITY

NEGATIVE FEEDBACK LOOP BETWEEN BALANCE SHEET AND FUNDING CONSTRAINTS

CORPORATE GOVERNANCE IN FINANCIAL INSTITUTIONS

SPECIFICITY OF FINANCIAL CORPORATE GOVERNANCE

IMPORTANCE OF GOVERNANCE

TAXATION

FINANCIAL TRANSACTIONS TAX

MOTIVES

EMPIRICAL STUDIES AND MEASURES RECENTLY ADOPTED

FINANCIAL ACTIVITIES TAX

MOTIVES

IMPLEMENTATION

TAX DESIGN

USE OF THE PROCEEDS

COMPENSATION LEVEL AND STRUCTURE OF COMPENSATION

DATA

INTERPRETATION

SUGGESTED INTERVENTION

MEASURES ADOPTED

5. Constraints

INSTITUTIONS

DEPOSIT INSURANCE

BENEFITS AND COSTS OF DEPOSIT INSURANCE

BENEFITS

COSTS

DEVELOPMENTS IN DEPOSIT INSURANCE SYSTEMS SINCE THE GFC

LIMITATIONS OF THE SCOPE OF FINANCIAL ACTIVITIES

BENEFITS AND DRAWBACKS OF UNIVERSAL BANKING

BENEFITS OF UNIVERSAL BANKING

DRAWBACKS OF UNIVERSAL BANKING

SEGMENTATION AND LIMITATION OF BANKING ACTIVITIES

BANKING REFORMS IN THE s AND s

THE DEREGULATION OF THE s AND s

MEASURES TAKEN OR PROPOSED SINCE

STRICT LIMITATION OF RISKY ACTIVITIES (VOLCKER RULE)

ISOLATION OF RETAIL BANKING ACTIVITIES (VICKERS RULE)

OTHER PROPOSALS

ISSUES RELATED TO REGULATION OF THE SHADOW BANKING SYSTEM

PRACTICES IN FINANCIAL MARKETS

SHORT SELLING

THEORY

EMPIRICAL EVIDENCE

REGULATION

HIGHFREQENCY TRADING

PRESENTATION

CONCERNS

MARKET LIQUIDITY

NEGATIVE FEEDBACK LOOPS

EXCHANGETRADED FUNDS

REUSE AND REHYPOTHECATION OF COLLATERAL

FINANCIAL MARKET INFRASTRUCTURES

ROLE

BENEFITS AND COSTS

RISK MANAGEMENT

CONCERNS

RISK CONCENTRATION AND INTECONNECTEDNESS

RISK TRANSMISSION

SUPERVISION AND DEFINITION OF STANDARDS

OTHER MEASURES PROPOSED

6. Capital and Liquidity Standards

COSTS AND BENEFITS OF CAPITAL AND LIQUIDITY REQUIREMENTS

MAIN ISSUES

IMPACT ON FINANCIAL INTERMEDIATION

CAPITAL REQUIREMENTS

LIQUIDITY REQUIREMENTS

IMPACT ON OUTPUT AND CREDIT SUPPLY

REDUCTION IN THE COST OF CRISIS

REDUCTION IN THE PROBABILITY OF CRISIS

REDUCTION IN THE LOSS OF OUTPUT

EXPECTED IMPACT OF REGULATORY CHANGES

DIFFERENCES IN APPROACH

DIFFERENCES IN ASSESSMENT

BASEL I, BASEL II, AND PROCYCLICALITY

BASEL I

BASEL II

MAIN FEATURES OF BASEL II

PILLAR I

PILLAR

PILLAR

CRITICISMS ADDRESSED TO BASEL II

RISK OF PROCYCLICALITY

DEFINITION OF REGULATORY WEIGHTINGS

BASEL III

RISKWEIGHTED CAPITAL RATIOS

THE STRENGTHENING OF QUALITATIVE REQUIREMENTS FOR CAPITAL

THE STRENGTHENING OF QUANTITATIVE REQUIREMENTS FOR CAPITAL

CREDIT RISK

MARKET AND COUNTERPARTY RISK

LEVERAGE RATIO

ARGUMENTS IN FAVOR OF THE RETURN TO A SIMPLE MEASURE

IMPLEMENTATION AND IMPACT

LIQUIDITY RATIOS

LIQUIDITY COVERAGE RATIO TO REGULATE LIQUIDITY AT A ONEMONTH HORIZON

PURPOSE AND DEFINITION

NUMERATOR AND DENOMINATOR

NET STABLE FUNDING RATIO TO REGULATE MATURITY TRANSFORMATION

OBJECTIVE AND FORMULA

NUMERATOR AND DENOMINATOR

IMPLEMENTATION AND FURTHER IMPACT

INTERACTIONS ACROSS REGULATORY REQUIREMENTS

OBJECTIVES AND CONSTRAINTS OF BANKING SUPERVISION

ROLE OF BANKING SUPERVISION

FORMS OF INTERVENTION OF BANKING SUPERVISION AUTHORITIES

OFFSITE SUPERVISION

BANKING SECTOR DEVELOPMENTS HAVE IMPACTED SUPERVISION PRATICES

THE WAY PRUDENTIAL SUPERVISION OPERATES HAS PROFOUNDLY CHANGED

INFORMATION AND COMMUNICATION TECHNOLOGIES HAVE CHANGED THE DAILY WORK OF SUPERVISORS

ON SITE INSPECTIONS

ASSESSMENT OF PILLAR II REQUIREMENTS

FINANCIAL STABILITY DEPENDS ON EFFECTIVE PRUDENTIAL SUPERVISION

THE SOLVENCY II DIRECTIVE FOR INSURANCE IN EUROPE

NEW QUANTITATIVE PRUDENTIAL RULES

A NEW ACCOUNTING FRAMEWORK TO ASSESS THE SOLVENCY OF INSURANCE AND REINSURANCE COMPANIES

NEW PRUDENTIAL REQUIREMENTS

QUALITATIVE REQUIREMENTS HAVE BEEN STRENGTHENED

IMPLEMENTATION AND PRELIMINARY ASSESSMENT OF IMPACT

IMPLEMENTATION OF SOLVENCY II REGULATION

PRELIMINARY ASSESSMENT OF THE IMPACT OF SOLVENCY II REGULATION

THE VOLATILITY OF PRUDENTIAL BALANCE SHEETS

DIFFERENCES ACROSS COUNTRIES WITH THE LONG TERM GUARANTEE PACKAGE

THE ASSESSMENT OF THE "BEST ESTIMATES" OF TECHNICAL PROVISIONS

THE REVIEW OF SOLVENCY II

7. Crisis Management and Resolution of Financial Institutions

DEFINITION OF FINANCIAL CONTRACTS

BAIL OUT

VOLUNTARY EXCHANGE

CONTINGENT CAPITAL

THRESHOLD

CONVERSION RATE

INTERNAL BAILIN

OBJECTIVES

IMPLEMENTATION

SCOPE

TRIGGER

– IMPACT ON FINANCING COSTS

LIMITATIONS

CONTAGION RISK FROM BAILIN AND THE NEED TO EXCLUDE RETAIL DEPOSITS

HIGHER LEGAL COSTS

SPILLOVER RISK

RESOLUTION OF FINANCIAL INSTITUTIONS

NEW OBJECTIVES

RESPOND TO CRISIS SITUATIONS BY GIVING POWERS TO A RESOLUTION AUTHORITY

THE RESOLUTION AUTHORITY

EARLY DETECTION

INTERVENTION POWERS

GENERATE FINANCIAL RESOURCES WHILE PROTECTING PUBLIC FINANCE BY INVOLVING THE PRIVATE SECTOR

DIFFERENCES BETWEEN EU AND US

ASSESSMENT OF RESOLUTION REFORMS

EFFECTIVENESS

IMPACT

CROSS BORDER RESOLUTION

CALIBRATION OF TLAC

OBJECTIVES OF TLAC

REQUIREMENTS

IMPACT

TRANSPOSITION IN EU: MREL

8. Macroprudential Policy

OBJECTIVES

THE ROLE OF MACROPRUDENTIAL POLICY

THE NEED FOR A MACROPRUDENTIAL APPROACH

ENDOGENEITY OF FINANCIAL RISKS

NEED FOR A COMPREHENSIVE APPROACH

FAILURE OF REGULATION

THE COMPLEMENTARY ROLE BETWEEN MICRO AND MACROPRUDENTIAL POLICY

THE DEFINITION OF THE FINAL OBJECTIVE

INDICATORS

INDICATORS OF THE FINANCIAL CYCLE

TYPES OF INDICATORS

RELEVANCE OF INDICATORS

MEASUREMENT OF SYSTEMIC RISK

MEASURES AVAILABLE

INSTITUTIONS

MARKET INFRASTRUCTURES

INDICATORS FOR MEASURING INTERCONNECTIONS IN BANKING NETWORKS

SYNTHETIC INDICATORS

ASSESSMENT

BENEFITS AND DRAWBACKS OF BALANCE SHEET DATA WITH RESPECT TO MARKET DATA

LEADING OR COINCIDENT INDICATORS

CONTAGION VERSUS SHOCK TRANSMISSION

ROLE OF STRESS TESTS

MAIN PRINCIPLES OF STRESS TESTS

PURPOSE OF STRESS TESTS

IMPLEMENTATION OF STRESS TESTS

STRENGTHS AND WEAKNESSES OF STRESS TESTS

INTERMEDIATE OBJECTIVES AND INSTRUMENTS

A PLURALITY OF INTERMEDIATE OBJECTIVES AND INSTRUMENTS

INTERMEDIATE OBJECTIVES

MACROPRUDENTIAL INSTRUMENTS

CYCLICAL INSTRUMENTS

Provisioning modes

Restrictions on the distribution of dividends

Countercyclical capital buffer

Instruments specific to real estate market and credit distribution

Concentration limits from a macroprudential standpoint

Macroprudential instruments in the field of insurance

STRUCTURAL INSTRUMENTS

Capital buffer on systemic financial institutions

Systemic Risk Buffer

Instruments to increase the resilience of market infrastructures and oversight of OTC derivative contracts

Regulation of the shadow banking sector

EFFECTIVENESS AND LIMITS

PRINCIPLES OF EVALUATION OF INSTRUMENTS

APPLICATIONS

QUESTIONS RELATED TO THE IMPLEMENTATION OF MACROPRUDENTIAL POLICIES

COMMUNICATION AND RESPONSIBILITY

INTERNATIONAL COORDINATION

STATISTICAL INFORMATION NEEDS

9. Economic Policies and Financial Stability

MONETARY POLICY

LEVERS AND CONSTRAINTS IN CRISIS SITUATIONS

LENDER OF LAST RESORT

RELATIONSHIP WITH FISCAL POLICY

INTERACTIONS BETWEEN MONETARY POLICY AND FINANCIAL STABILITY

HAS MONETARY POLICY BEEN A SOURCE OF FINANCIAL INSTABILITY?

INTERACTIONS BETWEEN MONETARY POLICY AND MACROPRUDENTIAL POLICIES

WHICH CONSEQUENCES FOR THE STRATEGY AND THE CONDUCT OF MONETARY POLICY?

FISCAL POLICY

A TWOWAY LINK BETWEEN FISCAL POLICY AND FINANCIAL STABILITY

HOW CAN THE LOOP BE LOOSENED?

STRUCTURAL POLICIES

TAX POLICY

TAX POLICY AND HOUSING

TAX POLICY AND DEBT FINANCE

HOUSING POLICY

COMPETITION POLICY IN THE FINANCIAL SECTOR 

10. Institutions

GENERAL ISSUES

ARCHITECTURE

DO WE NEED ONE OR MORE SUPERVISORS?

WHAT ROLE FOR THE CENTRAL BANK?

THEORETICAL ARGUMENTS

EMPIRICAL ARGUMENTS

GOVERNANCE

CAPTURE AND THE REVOLVING DOOR

INDEPENDENCE AND RESPOSIBILITY

INDEPENDENCE AS A CREDIBILITY FACTOR

ACCOUNTABILITY AS A COMPLEMENT TO INDEPENDENCE

INTERNATIONAL ASPECTS

INSTITUTIONS

GROUPS OF COUNTRIES

INTERNATIONAL MONETARY FUND

SURVEILLANCE

FINANCIAL ASSISTANCE

BANK FOR INTERNATIONAL SETTLEMENTS AND ASSOCIATED INSTITUTIONS

EXTENSIVE REFORMS OR IMPROVEMENTS TO THE EXISTING FRAMEWORK?

COMPREHENSIVE REFORMS

PROVISION OF LIQUIDITY

REGULATION

IMPROVEMENTS TO THE EXISTING FRAMEWORK

CHANNELS AVAILABLE TO COUNTRIES

PRIVATE SECTOR INVOLVEMENT

COOPERATION

EUROPEAN ASPECTS

ECONOMIC ASPECTS

RISK POOLING

THE ISSUANCE OF EUROBONDS

THE PATH TAKEN

ENACTMENT OF RULES

ACADEMIC RECOMMENDATIONS

FINANCIAL SYSTEM ASPECTS

THE EUROPEAN SYSTEM OF FINANCIAL SUPERVISION

BANKING UNION

THE SINGLE SUPERVISION MECHANISM

THE SINGLE RESOLUTION MECHANISM

A EUROPEAN DEPOSIT INSURANCE SCHEME

11. Emerging Risks and New Challenges

THE GLOBAL COVID CRISIS OF

THE SECOND GLOBAL CRISIS OF THE TWENTYFIRST CENTURY?

THE SANITARY CRISIS

THE LIQUIDITY CRISIS (MARCH APRIL )

CONSEQUENCES FOR FINANCIAL INSTITUTIONS

POTENTIAL LONG TERM FINANCIAL STABILITY CONSEQUENCES OF THE CRISIS

POLICY RESPONSES

FISCAL AND MONETARY POLICIES

PRUDENTIAL REGULATION

RESPONSES BY MARKET AUTHORITIES

RESPONSES BY INTERNATIONAL AND EUROPEAN INSTITUTIONS

NEW RISKS

CYBER RISK

DEFINITION

COSTS

POLICIES

CRYPTOASSETS

DEFINITION

RISKS AND RESPONSES

CLIMATE CHANGE RELATED RISKS

DEFINITION

POLICY RESPONSES

NEW CHALLENGES

THE FEEDBACK LOOP BETWEEN INEQUALITY, FINANCIAL STABILITY AND POPULISM

INEQUALITY AND FINANCIAL STABILITY

INEQUALITY AND MACROPRUDENTIAL POLICIES

POPULATION AGEING, SOVEREIGN DEBT AND FINANCIAL STABILITY

COMPLEXITY IN BANKING AND FINANCE

DEFINITION

IMPLICATION OF COMPLEXITY FOR FINANCIAL STABILITY

EVOLUTION OVER TIME AND POLICY RESPONSES

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Author(s)

Biography

Olivier de Bandt, who holds a PhD from the University of Chicago, is an economist and researcher associated with the University of Paris-Nanterre. He is the Director of Research at the Prudential Supervision Authority, Banque de France and Associate Professor at University of Paris Ouest Nanterre La Defence. He is an associate editor of the Journal of Financial Stability.

Françoise Drumetz and Christian Pfister are also economists. They teach the Financial Stability course in the Sciences Po School of Public Affairs (Paris).