This Week in Basel - February 10

A weekly roundup of news and information eminating from and related to the Bank for International Settlements (BIS) in Basel, Switzerland.*

Basel Committee 101

Like just about everyone else in the world, BIS General Manager Jaime Caruana isn't too sure what US President Donald Trump has in mind for the stance US representatives will adopt in the now paused "Basel IV" negotiations of the Basel Committee on Banking Surpervision. In fact, Trump's known disdain for global regulatory accords coupled with a seemingly uninformed letter sent from US Rep. Patrick McHenry, R, N.C., to Federal Reserve Chairwoman Janet Yellen that labeled the mere participation of the US in negotiations with entities like the Basel Committee and the Financial Stability Board as “unacceptable,” raise the spectre of the the US withdrawing entirely from the Basel Committee. Amid such uncertainty, Caruana thought it important to explain how international financial regulatory reforms actually work.

“Perhaps it would good to clarify that these rules are just agreements. ... It is the national supervisors that discuss these rules and later each regulation is passed through the democratic process in each of the countries. This has always been the case and will continue to be the case.”

Caruana might have been looking to simply calm the rhetoric, but he also might have given the Trump adminstration a playbook. After all, Trump is known for agreeing to business deals and then backing out when the terms or finances don't end up working out in his favor. Should Trump decide to send negotiators to continue the "Basel IV" talks, it is hard to believe they will march back to the US and seek stringent implementation and enforcement if the accord does not end of favoring the US.

Trust Data? Caruana Says Just Do It

The BIS knows data. Big data, little data, common data, obscure data … the BIS does it all. The main reason the BIS does data so well is because central banks, financial institutions and various other entities around the world share their data with the BIS. Jaime Caruana, the General Manager of the BIS, shared his thoughts on the history of how financial crises spawn increased data sharing.

However, Caruana believes the acquisition and sharing of data is not always enough to ensure financial stability.

"Better statistics alone do not make international finance safe. We also need to struggle to escape the popular models that prevent us from recognizing the build-up of vulnerabilities. Getting all the right dots in front of you does not really help if you do not connect the dots.

Right now, I worry that even though we have data on aggregate debt, we are not properly connecting the dots and we are underestimating the risks, particularly when the high levels of debt are aggravated by weak productivity growth in many countries. And the standard of evidence for precautionary action has to be the preponderance of evidence, not evidence beyond a shadow of doubt. Waiting for fully compelling evidence is to act too late."

Caruana’s comments advance the conversation and spawn some key questions: Why does it a take a crisis to spur increased data sharing? How long does the uptick in data sharing usually last? Have we already reached a point where the momentum behind the data-sharing response to the financial crisis of 2007-09 has receded?

On Cash Hoarding and Fire Sales

Anyone interested in whether asset managers should be subjected to regulatory stress tests will want to read this working paper from Hyun Song Shin and Ilhyock Shim of the BIS and Stephen Morris from Princeton University. Their research suggests “cash hoarding is the rule rather than the exception” when global bond mutual funds face times of market stress.

"There is ongoing discussion of the scope for improving liquidity risk management practices of the asset management sector. One area of discussion has been on the usefulness of system-wide stress testing that incorporates the impact of collective selling by funds on the resilience of financial markets (see FSB, 2015 and 2016). For both firm-level and system-wide stress testing exercises, our results suggest that a stress scenario would ideally include the possibility of cash hoarding."

The authors’ call for the inclusion of cash hoarding in any stress test scenario is admirable. However, the political winds don’t appear to be blowing in the direction of stress tests becoming a reality for asset managers any time soon.

Do commodities booms always have to spell doom for some countries?

Commodities booms in smaller, less economically diverse countries can end up being a bad thing in the long run; a very bad thing. The culprit in this phenomenon – known as the “Dutch Disease” – is the flow of capital away from a nation’s more fundamental industries toward said commodity. That results in systemic problems once the commodity boom fades. (Hello Brazil … How are you doing Venezuela?)

Enrique Alberola-Ila of the BIS and Gianluca Benigno from the London School of Economics assert there are things countries can do to make sure the bust isn’t so brutal.

"From a normative point of view, policies of capital account management which would limit international borrowing and lending in the adjustment following a commodity shock could be welfare enhancing for our small commodity exporter economy. Similarly, fiscal instruments such a stabilization fund or a tax where commodity revenues could accrue and be redirected to traded goods sector would also reduce the drive towards de-industrialization and improve welfare."

That all sounds well and good, but the companies driving a commodities boom usually have the undivided attention of policymakers and the last thing those companies want to hear is talk of a tax on their spoils.

TWIB Notes

  • Sharon Donnery, Deputy Governor of the Central Bank of Ireland, thinks it would be a good idea if Europe implemented standards for the resolution of non-performing loans.
  • Dealers aren't loving the backtesting desk-level internal models put forth by the BIS in a recent FAQ about the Fundamental Review of the Trading Book
  • Andreas Dombret, member of the Executive Board of the Deutsche Bundesbank, has stared bravely into the abyss of FinTech and decided regulators still have a role to play in policing markets amid a rapid wave of innovation. Dombret gets extra credit for resisting the urge to mention "blockchain" even once ... Bravo! 


*This Week in Basel is not affiliated in any way with the Bank for International Settlements. There is just a ton of interesting news related to the the BIS, so I like to write about it.