Financial Reforms, Obama style.

This is the ninth in a series of articles on the financial reforms sought to be implemented by the Obama Adminstration in U.S.A.

C.  Strengthen capital and other prudential standards applicable to all Banks and BHCs:   The Treasury is expected to play a key role in the reassessment of the extant regulatory capital requirements, for Banks as well as BHCs including new Tier I FHCs by leading a working group with federal financial regulatory agencies and outside experts.   December 31st, 2009 is the deadline for submission of it’s report by the working group.

What the working group will review:

1. The present capital requirements and their adequacy.
2. To assess and evaluate capital requirements in relation to the multifarious activities of the firms including trading assets, and structured credit products.
3. To make a comprehensive review of the capital requirements, including the composition of the capital, scope of risk coverage in relation to the firms’ activities, exposures, etc.
4. To make it incumbent on Banks and BHCs to hold a higher level of capital in favorable economic times, in order to take care of capital requirements during stressed times.
5. The working group will study the feasibility of Banks and BHCs issuing contingent capital instruments that would take care of at least a part of their capital requirements by automatic conversion of the underlying instruments into common equity under stressful economic conditions.
6. Purchase of tail insurance by Banks and BHCs against macroeconomic risks is another idea to be examined.
7. Investments and exposures that expose the Banks and the BHCs to a higher level of risk like trading positions, equity investments, credit exposures to low quality firms and persons, and other such exposures to be subject to higher capital requirements.
8. A simpler and more transparent system of leverage for Banks and BHCs would be considered to support risk based capital measures.

Banks and BHCs would, in general, be subject to a risk-based capital rule covering the entire gamut of their businesses, and subject to assessment of their capital adequacy relative to their various exposures and applicable across the firms.   The idea behind this is to ensure that the changes that are sought to be brought about in the supervison and regulation of financial firms is better than the extant ones, that could not prevent the present crisis.

                                                                                  To be concluded.

Financial Reforms, Obama style.

This is the eighth in a series of articles on the financial reforms sought to be implemented by the Obama Adminstration in U.S.A.

Consolidated supervision of Tier I FHCs:  The present crisis has exposed the weaknesses  in the present supervisory systems.   Arising out of this, it was decided to have one consolidated supervisor and regulator for all Tier I FHCs, with a thorough understanding of the operations and activities of each firm.  

Therefore, the Gramm-Leach-Bliley Act (GLB Act) is to be done away with to facilitate the process of having a sigle supervisor and regulator as pointed out earlier.

In order to ensure transparency in the process of supervision and regulation, the Federal Reserve would have the right to examine any Tier I FHC and it’s subsidiaries, including those having a primary supervisor.   The Fed Reserve would consult with the primary supervisor and the Treasury, before initiating any corrective action against the Tier I FHC for any omissions and commissions.

The fundamental issue to be addressed in the process of supervision and regulation is to take an overall view of the Tier I FHCs, rather than concentrate on individual firms.   Even though individual firms may not appear to pose a threat to the system, when combined with the shortcomings of all such firms, a different picture may emerge.   Therefore, holistic approach should be adopted that assesses and evaluates the combined risk posed by the Tier I FHCs, and their arms to the system.   In other words, the consolidated supervision of a Tier I FHC should be macroprudential in focus.

One of the most important decisions to emerge from the review of the financial system and the proposed reforms is in regard to the scope and role of the Fed Reserve System.   Several new responsibilities would be given to the Fed Reserve, while it’s existing role in consumer protection would be reduced.

The Fed Reserve is expected to give it’s recommendations for a change in its charter and activities by October 2009.   This would be done in consultation with Treasury and external experts in order to get the perspectives and ideas of those not connected with it.

                                                                                         To be concluded.

Financial Reforms, Obama style.

This is the seventh in a series of articles on te financial reforms sought to be implemented by the Obama Administration, in U.S.A.

Tier I FHCs would be subject to more robust and conservative regulation as compared to other FHCs.   The rationale for this is the potential of their causing systemic failure in the event of their own failure.   Conversely, it was also felt that imposing onerous regulatory requirements on them could stunt their long term growth.   Hence a balance needs to be achieved between these two concerns.

Accordingly, Tier I FHCs would be required to meet certain higher standards on the following parameters:

1. Capital Requirements:  Stressful economic and financial conditions would be the backdrop against which this requirement would be judged for Tier I FHCs.   They would be required to hold capital at a level to ensure comfort in times of distress.   At any rate, they would have to have capital above prudential minimum capital requirements.   The firms’ capital planning practices and market based indicators of their credit quality would be assessed as part of the process to recommend the optimum level of capital.
2. Prompt Corrective Action:  There will be no dilly dallying when it comes to taking corrective action against Tier I FHCs in the event of a decline in their capital levels.
3. Liquidity standards:  The risk management practices of Teir I FHCs should incorporate liquidity risk management.   Liquidity stress scenarios should be worked out against which the firm should conduct stress tests, both short term and long term, institution- specific, as also market-wide scenarios, and for on and off balance sheet exposures. 
4. Overall risk management:  Tier I FHCs should identify and provide for risk management across the spectrum of their activities, especially firm-wide risk concentrations.
5. Market discipline and disclosure:  Appropriate disclosures in regard to capital adequacy, risk profile, and risk management capabilities should be made by Tier I FHCs.
6. Restrictions on non-financial activities:  The non-financial acitivity restrictions applicable to the BHCs would also be applicable to those BHCs that do not control a insured depository institution.
7. Rapid resolution plans:  Every Tier I FHC would be required to have a contingency plan ready to resolve any problem faced by it under stressful conditions.   These plans should be regularly updated and revised as often as needed.

                                                                                                    To be concluded.

Financial Reforms, Obama style.

This is the sixth in a series of articles on the financial reforms sought to be implemented by the Obama Adminstration in U.S.A.

Identification of Tier I FHCs:   The following are the criteria to determine if a financial firm is qualified to be called a Tier I FHC:

1. What impact the failure of the firm would have on the stability and well-being of the financial system, and the economy, as a whole.
2. The combination of the size, leverage, and the extent of the firm’s dependance on short-term funding.
3. The importance of the firm as a source of financing to households, businesses, and governments, local and state, and also as a source of liquidity for the financial system.
4. The Federal Reserve would consult Treasury in identifying the Tier I FHCs.
5. However, The Fed would have the discretion to consider factors other than those mutually agreed upon with the Treasury in the above exercise.
6. The reasons for this discretion given to the Fed is to enable it to monitor and counter innovative approaches of the firms to escape regulatory processes.
7. Firms might route transactions outside of their Balance Sheets to escape the eyes of te regulators.   Hence flexibility given to the Fed is justified.
8. The identification process of the Tier  I FHCs would include an analysis of  the systemic importance of the firms under stressed economic conditions.
9. Such analysis should include the result of the firm’s failure on other such firms, on payment, clearing and settlement systems, and availability of credit in the economy.
10. Where the subsidiary of a firm is subject to supervision by other federal agencies, the Fed must consult them before subjecting the parent to Tier I FHC regulation.
11. Classification of Tier I FHC should be a regular exercise.
12. The Council would have the authority to recommend the designation of a firm as a Tier I FHC to the Fed.
13. The Fed would have access to necessary and relevant information from financial firms, as well as other regulators to determine their classification as Tier I FHCs.
14. The Fed would have authority to examine firms crossing the laid down threshold limits to determine their ability to threaten financial stability.
15. However, the Fed would itself operate within limits laid down for it, and not overdo its act.

                                                                                     To be concluded.

Financial Reforms, Obama style.

This is the fifth in a series of articles on the financial reforms solught to be implemented by the Obama Administration, in U.S.A.

In order to promote robust supervision and regulation of the financial firms, the Administration proposed the creation of a Financial Services Oversight Council(Council).   That apart, it also promoted a proposal to Implement heightened, Consolidated Supervision and Regulation of all Large, Interconnected, Financial Firms, which is discussed below:

1. Tier I FHCs(Financial Holding Companies), that is, financial firms whose combination of size, leverage, and interconnectedness is big enough to cause instability in the markets, if they failed, would be subject to vigorous, consolidated supervision and regulation.   This would be applicable irrespective of the firm owning an insured depository institution.
2. The U.S. Government acknowledged the fact that the unexpected and sudden failure of such financial giants like the AIG had a devastating effect on the markets.
3. These big firms were ineffectively regulated in spite of their critical importance to the financial system.
4. Such ineffective supervision allowed these firms to operate with less than the required level of capital and liquidity.
5. These firms did not have the inherent strength to withstand the financial crisis, and went under.
6. Lax supervision encouraged these firms to own depository institutions that were not classified as “Banks” under the Bank Holding Companies Act, thereby escaping more vigorous supervision.
7. The Federal Reserve Board would be invested with the authority and accountability for consolidated supervision and regulation of the Tier I FHCs.
8. A single regulator for the Tier I FHCs is considered necessary to avoid confusion and to bring about consistency in regulation.
9. The Fed Reserve will consult the Council in setting material prudential standards for the Tier I FHCs.
10. The Fed Reserve would be expected to focus on the entire sprectrum of the firm’s activities and not adopt a narrow approach to regulation like a functional regulator would.
11. The Fed Reserve should go beyond the issue of the safety and soundness of te Bank subsidiary, and take cognizance of the activities of the firm as a whole, and take steps to counter the risks to the system in the event of it’s failure.

                                                                                     To be concluded.

Financial Reforms, Obama style.

This is the third in a series of articles on the proposed financial reforms sought to be implemented by the Obama Administration, in U.S.A.

The Obama Administration, in it’s proposals to Congress, to overhaul the U.S. financial system, seeks to set up new institutions to imporve the process of regulation of financial firms.   They are discussed below:

Creation of Financial Oversight Council:   This Council would :

1. Facilitate information sharing and coordination among the various federal agencies engaged in the task of financial regulatioin.
2. To identify emerging risks from the big market players by identifying them, and exposing such activities as are likely to put the system in jeopardy.
3. To facilitate discussion among the agencies charged with the responsibility of regulating the markets.   To enable and encourage joint analysis of various issues on the financial regulatory policy issues, and to come up with well-informed, consistent and practical responses to emerging trends, etc.
4. Some of the major areas where this Council is expected to contribute are in regard to policy development, rule making, examination, reporting requirements, and enforcement actions.
5. To provide a forum to sort out overlapping responsibilities, and cross cutting issues, among the various federal agencies, that often leads to confusion and gaps in monitoring and supervision that firms are ever ready to exploit.
6. Classification of firms having such a combination of size, leverage, and interconnectedness, as to cause market disruptions and even crashes, as Tier I FHC.
7. The authority and jurisdiction of all the regulatory bodies to be drawn up to avoid overlap and confusion.
8. To access information from any firm which in the opinion of the council is necessary to assure itself in regard to the threats posed by it to the financial system.

                                                                                                     To be concluded.

Financial Reforms, Obama style.

This is the third in a series of articles on the proposed financial reforms sought to be implemented by the Obama Administration, in U.S.A.

Having identified four of the major weaknesses related to the financial system, and its regulation, the Administration came up with several proposals to tackle them.   Among them:

1. A new financial regulatory body to be established to promote vigorous and consistent regulatory standards for all financial institutions.   Further, similar kind of financial institutions would be subject to same regulatory standards.   Special efforts would be made to prevent gaps, loopholes, and arbitrage opportunities.
2. Another proposal is for creation of the Financial Services Oversight Council (Council), to act as a facilitator for policy implementation, resolution of disputes, and to identify and plug loopholes.   Further it would be responsible for identifying emerging risks in firms and market activities.   This Council would be headed by the Treasury, and include heads of the principal federal financial regulators, and have a permanent staff.
3. The Federal Reserve would be revamped to emerge as a new avatar with responsibility to supervise all the companies that own a Bank.   It would be a single point of reference for matters of supervision related to Bank Holding Companies (BHCs).  
4. The Federal Reserve would be the authority to oversee and regulate the activities of all the large interconnected firms whose failure could threaten the very stability of the system.   The Administration is determined to ensure that none of the firms is able to escape oversight of their manipulative market activities.
5. The bigger the firm, stricter the supervision.   This is the new mantra of the Administration, that wants firms that are big enough to cause systemic failures, be subjected to more a more robust supervisory regime, to ensure they stay within the bounds of law.
6. As a single point of consolidated supervision, the Federal Reserve would have better control on it’s own functioning and perform more effectively.  
7. A key concept sought to be promoted in the new system is to compel firms to internalize costs of their blunders, that would otherwise be passed on to the unsuspecting tax payers, and society at large.

                                                                                      To be concluded.

Financial Reforms, Obama style.

This is the second in a series of articles on the financial reforms sought to be implemented by the Obama administration, in U.S.A.

The Obama Administration identified the following as some of the reasons for the financial cirsis, and what it intended to do about it.

Capital Requirements:  The capital and liquidity requirements possessed by the firms, especially the big ones, were very low.   They were not adequate to meet their actual requirements.   Regulators appear to have been complacent in not insisting on the firms to have much higher levels of capital and liquidity in sync with their trading assets, high risk loans, and off-balance sheet exposures.

Further the regulators did not envision bad times for the firms, and recommend higher capital levels during good times to tide over the bad ones.   Regulators did not exhibit the foresight required of them to plan for critical situations, when liquidity would not be easy to obtain and maintain.

Systemic Risks:  Regulators did not apply their mind to the risks of large, interconnected firms causing damage to the financial system, if they failed.   It was quite surprising that an important issue like systemic risks did not attract the attention of the regulators enough to take steps to prepare for the worst.

Fragmented supervision:  Multiplicity of regulatory agencies played into the hands of rouge firms that took advantage of the confusion and the loopholes in the system to get away with murder.   Overlapping responsibilities played havoc with the regulatory processes, making it ineffective, letting the firms have a field day.

Insufficient Government Oversight:  Investment Banks, among the most profligate market operators, and consequently, the first to first under the impact of the market crash, were not subjected to sufficient Government oversight.   Similarly, Mutual Funds found themselves in such a vulnerable position as to invite runs on them.   And there was no supervision worth the name of the hedge funds and similar operators.

                                                                                                   To be concluded.

Financial Reforms, Obama style.

This is the first in a series of articles on the financial reforms sought to be implemented by the Obama administration, in U.S.A.

The sweeping reforms of the U.S. financial system proposed by the Obama administration, may be compared to the sweeping electoral victory of Obama in the American elections.   The U.S. financial system may never have faced the prospect of such tectonic changes in it’s long history.

If approved by the Congress, it could lead to certain fundamental changes in the way American financial and securities markets function.   And it is anyone’s guess how the system would fare with Big Brother watching over them 24*7.

What the Administration proposes:  The reform package seeks a complete overhaul of the system, leaving no area of concern untouched.   Some of the things the Administration would like to do are:

Promote robust supervision and regulation of financial firms:

In a frank admission of past sins, the Obama Administration conceded to facts that led to the financial crisis:

1. Risks were there for all to see, but they were allowed to build up.
2. Market booms, while inflating the prices of assets, particularly housing, concealed the poor standards of underwriting for the related loan portfolios.
3. Indiscriminate methods of market operations had made financial firms, including the largest ones, highly leveraged.
4. These firms came to depend excessively on unstable sources of short term funds.
5. Firms went on merrily accumulating risks in their balance sheets and off it, as well.
6. Risk management systems did not get the due importance in conducting business operations.
7. The boom and bust cycle weakened the markets and the system.
8. Availability of short term credit lulled the firms into a false sense of security, and they did not prepare themselves for a rainy day.
9. As a consequence, when the crisis came, which was inevitable, firms were caught napping.
10. Firms reacted to the crisis, typically by reducing lending therey depriving households and businesses of much needed credit.
11. The supervisory apparatus was not equipped to deal with a crisis this big.
12. In spite of regulatory exercises being a routine prior to the crisis, they failed to prevent the market crash, because of their inadequacies.

                                                                                                        To be concluded.

P

The Chinese Economy chugs along.

At one time, China was a source of mystery and awe for its ancient culture and civilization for the West.   It is, even now.   But apart from the culture and civilization part, China is now being looked upon as a stabilizer of international financial markets, badly hit by the recession.

China is one of the few large economies, that have not been much affected by the economic downturn.   It is alive and kicking, though not vigorously, as earlier.   The Chinese establishment must be commended for its swift response to the crisis, and the prompt steps taken by it, to retain public confidence in the economy, and to bring it back on track.   Of course, being a communist country and not answerable to anyone helps.

The Chinese Government initiated a stimulus package of nearly USD 600.00 billion to counter the recession, by increasing domestic spending.   This strategy seems to be working, at least for the present.   With the stimulus package doing the trick, the Chinese economy is expected to grow by about 6.50% in the current year, as figures released by the World Bank suggest.

Ironically, this is good news for the West.   Notwithstanding their aversion to the Communist regime, and its repressive policies, the West, nevertheless looks up to China to stabilize a badly bruised international financial system, and to hold the fort for some time, so that their own economies could bounce back to good health.   They look up to China to contribute to a stable world economy, that would provide them an opportunity to get their act together, and put their own house in order again.  

However, it’s not roses all the way for China.   It’s exports have certainly dipped on account of falling demand for its goods and services in the countries hit by the recession.   Unemployment is on the rise.   But domestic demand is said to be north-bound.

Overall, it’s a choppy economic scene that the Chinese have to negotiate and come out on top of.   That would require all the skill and dexterity that the Chinese possess.   But the big question is at what cost this would be achieved.

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