By Karamjeet Paul (Published by American Banker/BankThink September 25, 2014)
The financial services industry is often caught in a debate about whether it faces too much regulation or not nearly enough. This is a valid topic of discussion. But it distracts from another, even more critical matter: regulations in the aftermath of the most recent financial crisis have failed to effectively address the root problem that caused so many bank failures.
A couple of weeks ago, during the New York Fashion Week, seeing glamorous models at the Lincoln Center Plaza brought to mind the beauty of models. Unfortunately, the conversation at a meeting soon after actually highlighted the ugliness of models.
At that meeting, frustrations were evident that regulators are always complaining that, despite the beauty of their sophistication, bank models underestimate the capital regulators believe is needed to support risk at financial institutions, and thus can lead to ugliness in times of financial crises similar to the crash of 2008.
By Karamjeet Paul
For the first time in history, regulators are requiring financial institutions to have a specific amount of liquid assets on hand to withstand a 30-day run by creditors and depositors, should a sudden crisis strike again. This is a right step to keep the system from freezing as happened in 2008.
However, will focusing on liquidity prevent what can devastate institutions in crises as experienced by Bear Stearns, Lehman and Wachovia? No, it will not, because institutional liquidity problems in crises are caused by a more fundamental factor.
By Karamjeet Paul
Those calling for higher capital requirements for banks have the right objective of making financial institutions and the system stronger (everybody agrees with that objective). However, their proposals to increase capital don’t receive support from everyone because their approach is not a proven one.
In a New York Times article on August 10, 2014, “When She Talk, Banks Shudder,” Prof. Anat Admati of Stanford University was quoted as offering an analogy of what’s wrong with banks today: “My comparison is to speed limits. Basically what we have here is the market has decided nobody else should be driving faster than 70 miles an hour and these are the biggest trucks with the most explosive cargo and they are driving at almost 100 miles an hour.”
Perspectives on Sustainability of Financial Institutions In Financial Crises
reflections on regulation, law and public policy
Karamjeet Paul
Sustainability Management 