by Beck, Ioannidou, Perotti, Sánchez, Suarez, Vives:Three policy proposals (amendments to liquidity requirements, enhancements to supervision policy, and recognition of funding fragilities in the computation of Pillar 2 requirements) could be implemented quickly...
The banking turmoil in March 2023 was the most significant system-wide banking stress event since the global crisis. This second column in a two-part series discusses policy options to adjust bank regulatory and supervisory frameworks, considering pros and cons. Some options (such as narrow banking or full deposit insurance) appear impractical or too costly, while others require further analysis. Three policy proposals (amendments to liquidity requirements, enhancements to supervision policy, and recognition of funding fragilities in the computation of Pillar 2 requirements) could be implemented quickly to increase bank stability relative to liquidity risk.
In this column, we discuss, from an academic perspective, a range of possible policy options that were mentioned in the aftermath of the banking turmoil in March 2023. Our starting point is a full and sound implementation of Basel III global standards. We order the policy options into two categories (Figure 1). The first category includes options that could be further considered without major structural changes to the current regulatory and supervisory framework, and which might be implemented as adjustments within the margins of discretion of Basel III. The second category includes those with policy options that would entail a deeper structural transformation of the institutional setup or of the banking industry.
Figure 1 Policy options to address bank funding vulnerabilities
In this column, we discuss, from an academic perspective, a range of possible policy options that were mentioned in the aftermath of the banking turmoil in March 2023. Our starting point is a full and sound implementation of Basel III global standards. We order the policy options into two categories (Figure 1). The first category includes options that could be further considered without major structural changes to the current regulatory and supervisory framework, and which might be implemented as adjustments within the margins of discretion of Basel III. The second category includes those with policy options that would entail a deeper structural transformation of the institutional setup or of the banking industry.
Figure 1 Policy options to address bank funding vulnerabilities
Source: Beck et al. (2024).
In the following paragraphs, we briefly describe each category. Beck et al. (2024) offer a more detailed account of each policy, paying specific attention to (i) how each policy option affects the allocation of potential gains or losses across agents, (ii) the implications of each option for risk-taking, (iii) the effectiveness of each option in reducing bank funding fragility, and (iv) the likely impact of each option on the cost of intermediation. For related discussions on policy lessons from the 2023 banking turmoil, see Dewatripont et al. (2023) and Acharya et al. (2024).
Policy options entailing a fine-tuning of existing regulation and supervision
First, the bank runs in the US in March 2023 provided evidence of the increased speed with which deposits can move across banks and the role of social media and digital payment channels in accelerating these runs. They also showed that concerns about triggering runs lead to regulatory forbearance as supervisors are reluctant to act in a timely manner. Timely intervention by microprudential authorities would require increased frequency of reporting by banks of their liquidity positions, which is currently on a monthly basis in the EU (with the possibility for the microprudential supervisor to increase the reporting frequency on an ad hoc basis). Further granularity of the supervisory information related to the concentration of uninsured funding would also be useful. Moreover, the fact that the last published capital ratios of Silicon Valley Bank and Credit Suisse remained above the regulatory minima, at a time when they were failing, suggests the need to incorporate market-based information into the (confidential) supervisory assessment of banks and as input to timely intervention.
Second, a consequence of the striking speed of the runs observed in March 2023 relates to the way the risk of deposit outflows is considered in the computation of the Liquidity Coverage Ratio (LCR), even if the LCR is not designed to cover all tail events. Currently, the LCR is computed assuming outflow rates of 3% and 10% for stable (i.e. insured) and less stable (i.e. uninsured) household deposits respectively over a period of 30 days, while outflow rates for corporate deposits are estimated in the range from 5% to 40%. In addition, in view of the vulnerability stemming from the concentration of uninsured depositors, regulators and supervisors could consider introducing concentration limits on the funding side (for uninsured deposits or similarly flighty liabilities), similarly to the large exposures regime. Another measure to ensure a timely recognition of distress would require that all debt securities qualifying as liquid assets be measured at fair value in the financial statements. While this would not affect the LCR calculation, it seems illogical to classify some securities as ‘held-to-maturity’ for accounting purposes and at the same time consider them as available to cover sudden liquidity needs.
In the following paragraphs, we briefly describe each category. Beck et al. (2024) offer a more detailed account of each policy, paying specific attention to (i) how each policy option affects the allocation of potential gains or losses across agents, (ii) the implications of each option for risk-taking, (iii) the effectiveness of each option in reducing bank funding fragility, and (iv) the likely impact of each option on the cost of intermediation. For related discussions on policy lessons from the 2023 banking turmoil, see Dewatripont et al. (2023) and Acharya et al. (2024).
Policy options entailing a fine-tuning of existing regulation and supervision
First, the bank runs in the US in March 2023 provided evidence of the increased speed with which deposits can move across banks and the role of social media and digital payment channels in accelerating these runs. They also showed that concerns about triggering runs lead to regulatory forbearance as supervisors are reluctant to act in a timely manner. Timely intervention by microprudential authorities would require increased frequency of reporting by banks of their liquidity positions, which is currently on a monthly basis in the EU (with the possibility for the microprudential supervisor to increase the reporting frequency on an ad hoc basis). Further granularity of the supervisory information related to the concentration of uninsured funding would also be useful. Moreover, the fact that the last published capital ratios of Silicon Valley Bank and Credit Suisse remained above the regulatory minima, at a time when they were failing, suggests the need to incorporate market-based information into the (confidential) supervisory assessment of banks and as input to timely intervention.
Second, a consequence of the striking speed of the runs observed in March 2023 relates to the way the risk of deposit outflows is considered in the computation of the Liquidity Coverage Ratio (LCR), even if the LCR is not designed to cover all tail events. Currently, the LCR is computed assuming outflow rates of 3% and 10% for stable (i.e. insured) and less stable (i.e. uninsured) household deposits respectively over a period of 30 days, while outflow rates for corporate deposits are estimated in the range from 5% to 40%. In addition, in view of the vulnerability stemming from the concentration of uninsured depositors, regulators and supervisors could consider introducing concentration limits on the funding side (for uninsured deposits or similarly flighty liabilities), similarly to the large exposures regime. Another measure to ensure a timely recognition of distress would require that all debt securities qualifying as liquid assets be measured at fair value in the financial statements. While this would not affect the LCR calculation, it seems illogical to classify some securities as ‘held-to-maturity’ for accounting purposes and at the same time consider them as available to cover sudden liquidity needs.
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