For immediate release: April 29, 2009
Global Regulatory Changes Needed for Financial Stability, Says Dallas Fed Report
DALLAS—The chances for financial crises could be reduced if new standards for liquidity and leverage complement existing rules on bank capital, according to the April issue of the Federal Reserve Bank of Dallas’ Economic Letter.
In “Seeking Stability: What’s Next for Banking Regulation?” research economist Simona E. Cociuba finds that routine links between financial institutions create risks that aren’t addressed by the Basel II accord, the framework used by regulators to measure capital and set minimum standards for international banks.
U.K. mortgage lender Northern Rock, the first bank to fail during the current crisis, is an example of the risks created by those links, Cociuba states. Though the bank complied with its capital requirements, Northern Rock was highly leveraged and vulnerable to reductions in funding.
During the summer of 2007, as short-term credit markets froze up, banks began to hoard liquidity. The resulting freeze in the wholesale markets left Northern Rock unable to finance its assets.
“Under a different regulatory scheme, Northern Rock might not have experienced the run that led to its collapse,” Cociuba writes.
Liquidity rules would seek to enhance banks' stability with assets that can be readily sold to raise capital in an emergency, Cociuba says. Leverage rules would limit the amount of debt that banks can take on during booms.
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