Redefining and Containing Systemic Risk

Abstract

Official definitions of systemic risk leave out the role of government officials in generating it. Policymakers' support of creative forms of risk-taking and their proclivity for absorbing losses in crisis situations encourage opportunistic firms to foster and exploit incentive conflicts within the supervisory sector. To restore faith in the diligence, competence, and integrity of officials responsible for managing the financial safety net, reforms need to rework incentives in the government and financial sectors. The goal should be to align the incentives of private risk managers, accountants, credit-rating firms, and government supervisors with those of ordinary taxpayers. This article describes a series of complementary ways of advancing toward this goal. The most important steps would be to measure regulatory performance in terms of its effect on the loss exposures that the safety net passes through to taxpayers and to require institutions that benefit from the net to produce information that would support this effort. This entails estimating the explicit and implicit safety-net benefits individual institutions receive and issuing extended-liability securities whose prices would improve the accuracy of these estimates.

The implication of banking competition: Evidence from African countries

“…Caminal and Matutes (2002) show that concentration banking system reduces credit rationing and larger loan, and therefore increase the bank failure. Kane (2010) and Rosenblum (2011) suggest that larger banks receive public guarantees which generate moral hazard and encourage them to take more risk. Schaeck et al (2009) conclude that more competitive market, as measured by the Panzar and Rosse (1987) (H-statistic), would reduce the risk and reinforce the bank stability.…”

Tracking Variation in Systemic Risk at Us Banks During 1974-2013

“…It is not necessary to sort out the causal origins of the crisis to see that the systemic risk of U.S. financial institutions increased dramatically during this period, and was aggravated by ad hoc and inconsistent policy responses (Kane, 2010). Authorities initially offered massive liquidity support to troubled banks and began to lower interest rates.…”

Missing elements in US financial reform: A Kübler-Ross interpretation of the inadequacy of the Dodd-Frank Act

“…Missing from his catalog is evidence of the moral fiber and passion for serving the interests of the nation's citizenry that are needed to overcome the nasty political pressures that force unpracticed officials into scary games of chicken that the financial industry seems always to win. Kane (2010) argues that complete and authentic financial reform must include an operational definition of systemic risk and more detailed mission statements and oaths of office for regulatory personnel. Ideally, mission statements and oaths ought to espouse five duties that a conscientious supervisor ought to be willing to agree that government personnel owe to the community that employs them: Envisions a $150 billion resolution fund from the biggest financial firms, which would be tapped in order to unwind a failed institution Resolution authority was adopted, but advance funding was abandoned Numerous more-arcane differences existed between the bills, including the ways in which they address capital requirements (i.e., permissible leverage), risk-retention for securitized loans, credit-rating firms, executive compensation, preemption of state consumer protection laws (the Senate would have allowed more preemption leeway), and restrictions on interchange fees (which seems to have created more visible ex post pushback than any other single provision in the Act).…”

“…As a way to improve accountability, Kane (2010) and others (Levine, 2009;Lo, 2009) propose to separate the supervisory function of diagnosing systemic risk from that of containing it. The DFA takes a potentially important step in this direction.…”

“…Kane (2010) proposes to divide responsibilities for collecting and processing data on safety-net benefits into at least three pieces. The first segment would task managers of financial firms with estimating and reporting to their primary regulators (on the same quarterly basis that firms publish other data) interval estimates of the value of the safety-net benefits their firm receives.…”