Procyclical versus Countercyclical Policy Effects on Financial Markets

8/3/2019 Procyclical versus Countercyclical Policy Effects on Financial Markets

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Study prepared or theAnthony . Clu Fund

Prepared by

William A. Longbrake

and Clifford V. RossiJuly 2011

Procyclical versus Countercyclical Policy Effectson Financial Services


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Procyclical versus Countercyclical Policy Effectson Financial Markets1

William A. Longbrake and Cliord V. Rossi2

July 2011

1 The authors would like to thank the Trustees of the Anthony T. Cluff Fund for their support on this project. The views and conclusions expressed in this study and any errors and omissions are solethose of the authors.

2 William A. Longbrake is Executive-in-Residence at the Robert H. Smith School of Business, University of Maryland; Clifford Rossi is Executive-in-Residence and Tyser Teaching Fellow, Robert Smith School of Business, University of Maryland.


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Procyclical versus Countercyclical Policy Effects on Financial Markets i

Foreword Alex J. Pollock

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Procyclical versus Countercyclical Policy Effects on Financial Markets iii

Table of Contents

Executive Summary ......................................................................................................................................... 1

Introduction ....................................................................................................................................................... 3

Procyclicality and Countercyclicality ............................................................................................................. 5

Fostering Long-term Sustainable Growth While Simultaneously Managing Risk Taking ..........................6

Short Description of the Five Procyclical Policies, Rules and Governance Mechanisms ........................10

Loan Loss Reserving Accounting Rules and Supervisory

Implementation of Regulatory Policy .............................................................................................................10

Regulatory Capital Requirements ..................................................................................................................10

Liquidity Requirements ..................................................................................................................................11

Deposit In surance Premiums .......................................................................................................................11

Fair Value Accounting Rules ..........................................................................................................................11

Loan Loss Reserve Rules and Practices .......................................................................................................13

Procyclicality of Regulatory Capital Requirements ......................................................................................19

Procyclical Effects of Liquidity Requirements ..............................................................................................23

Deposit Insurance Premiums ..........................................................................................................................27

Fair Value Accounting RulesProcyclicality Impacts and Potential Remedies .......................................31

Conclusions and Policy Recommendations ..................................................................................................37

References ........................................................................................................................................................41


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Procyclical versus Countercyclical Policy Effects on Financial Markets 1

Executive Summary

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1. Coordination.Regulatory and rule-setting bodies should develop coordinated and com-

prehensive strategies that address and mitigate procyclical impacts among these ve policies

and practices.

2. Accountability. Regulatory and rule setting bodies should be accountable or developing

rules, policies and governance mechanisms and taking actions designed and intended to

mitigate the potential or procyclical impacts to occur and exacerbate nancialcrises.

3. Loan Loss Accounting Rules.Te Financial Accounting Standards Board should con-

tinue to work with the International Accounting Standards Board to develop loss reserving

rules based on expected loss methodology with the intent o mitigating procyclical impacts

o current loss reserving rules.

4. Supervisory Implementation of Loss Provisioning Regulatory Policy.

Regulatory agencies and accounting standards setting bodies should coordinate loss reserv-

ing accounting rules and regulatory guidance.

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5. Regulatory Capital Requirements.

Regulators should study the potential consequences o the proposed Basel III capital requirements

or lending and economic growth during the phased implementation period.

Te Basel Committee on Banking Supervision and U.S. regulators should not impose a countercy-

clical capital buer as part o the Basel III guidelines until a concrete methodology is developed or

determining the appropriate size and the conditions that should trigger implementation and phase-

in o a capital buer. Also, urther analysis should be conducted on the benets and consequenceso implementing such a requirement to determine whether it would likely have a countercyclical

impact or whether it would have other unintended consequences.

Explore the efcacy o developing orms o contingent equity capital or bail-in debt i a

predetermined triggering event occurred.

6. Liquidity Requirements.Te Basel Committee on Banking Supervision and U.S. regu-

lators should evaluate potential signicant unintended consequences o the two proposed

required liquidity ratios and should either revise the ratios to mitigate such consequences or

should eliminate explicit requirements and replace them with supervisory guidelines and

rely on central bank liquidity acilities in times o extreme illiquidity.

7. Deposit Insurance Premiums. Te FDIC should use the discretion provided by the

Dodd-Frank Act to propose and then implement a countercyclical deposit insurance pricing

mechanism that stabilizes premiums charged over the entirety o the cycle.

8. Fair Value Accounting Rules.

Te U.S. Financial Accounting Standards Board (FASB) and the International Accounting

Standards Board (IASB) should continue to work toward harmonizing US and interna-

tional air value accounting (FVA) principles and in doing so should be attentive to miti-

gating potential procyclical impacts.

Fair value accounting (FVA) principles should be revised to avoid contributing to ampli-

cation o nancial crises.

FASB should consider whether revised accounting rules or determining other than tem-

porary impairment or held or investment nancial instruments (FAS 115) should be

incorporated into FAS 157 or available or sale nancial instruments.

In times o acute nancial markets distress, FASB, Financial Stability Oversight Council

and regulators o nancial services companies should consider implementing actions that

could lessen or decouple the link between FVA losses and margin calls and risk manage-

ment practices that trigger orced asset sales based on FVA results.

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INTRODUCTION

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Figure 1. Commercial Loans: Net Respondents Reporting Higher Spreads in Loan Rates Over Funding Costs

Source: Federal Reserve Underwriting Survey, 2011.

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1 Ben Bernanke, Speech at the Federal Reserve Bank of Chicago Conference of Bank Structure and Competition, May 7, 2009.


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PROCYCLICALITY and COUNTERCYCLICALITY

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FOSTERING LONG-TERM SUSTAINABLE GROWTHWHILE SIMULTANEOUSLY MANAGING RISK TAKING

Risk taking is fundamental to

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Regulation of Financial Services Firms and Failure Resolution

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Loan Loss Reserves and Capital Requirements

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SHORT DESCRIPTION OF THE FIVE PROCYCLICALPOLICIES, RULES and GOVERNANCE MECHANISMS

Loan Loss Reserving Accounting Rules and Supervisory Implementation of Regulatory Policy

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2 Federal Reserve Board, The Supervisory Capital Assessment Program: Overview of Results, May 7, 2009. The$185B additional capital wasassociated with 10 of the 19 banks examined under SCAP.


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LOAN LOSS RESERVE RULES AND PRACTICES

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3 Financial Accounting Standards Board, Summary of Statement No. 114: Accounting by Creditors for Impairment of a Loan, September 2003 andFinancial Accounting Standards Board, Summary of Statement No. 5: Accounting for Contingencies, March 1975.


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Figure 2. Loss Estimates Derived Using Incurred and Expected Loss Methods

Procyclicality of Loss Reserves The Historical Record

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4 Clifford Rossi, Anatomy of Risk Management Practices in the Mortgage Industry: Lessons for the Future, Research Institute for Housing AmericaMay 2010.


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Figure 3. ALLL and Provision Trends 2000-2010

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Figure 4. Provisions/Total Income 2000-2010 (%)

Source: FDIC Call Report Data.

Differing Regulatory PerspectivesF

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5 Office of the Comptroller of the Currency, Comptrollers Handbook, Allowance for Loan and Lease Losses, 1998, p. 136 John Dugan, Loan Loss Provisioning and Procyclicality, Remarks before the Institute of International Bankers, March 2, 2009.


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each assets credit impairment in an average period and is the historical long-term average

specic provision for each asset type. The key driver of the statistical model is the relationship

in brackets. That is, if the specic provision in a given period is less than the average historical

specic provision, then the general provision is increased by that difference. In this way, there is

a natural mean reversion-like component to the statistical model that mutes the uctuation in thereserve over different parts of the economic cycle.

Balla and McKenna found that in 2006, a period just prior to the emergence of the nancial crisis,

Spanish banks had ratios of ALLL to nonperforming loans well above those of U.S. banks during

the same period 255% vs. 176%.8 In other words, Spanish banks in general maintained higher

levels of reserves heading into the crisis than did their U.S. counterparts. While some portion

of this difference between banks must be attributable to factors specic to Spanish banking at

that time, the signicantly higher coverage ratios of Spanish banks using dynamic provisioning

suggests that such methods do moderate to some extent the procyclicality of the incurred-loss

reserving methodology.

As a further test of the effect of dynamic provisioning on banks, Balla and McKenna conducted

a simulation, based upon the Spanish statistical provisioning model shown above, using repre-

sentative parameters for U.S. banks. The model was tested for the period 1993-2008. It shows

that reserves would have begun building starting in 1993. They found that applying the statistical

provisioning model in the 5-year buildup phase, banks would have had a ratio of reserves to total

7 Anne Beatty and Scott Liao, Regulatory Capital Ratios, Loan Loss Provisioning and Pro-cyclicality, white paper, October 15, 2009.8 Eliana Balla and Andrew McKenna, Dynamic Provisioning: A Countercyclical Tool for Loan Loss Reserves, Economic Quarterly, Richmond Fed,

Vol. 95, No. 4, Fall 2009, pp. 403-404.


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loans that was more than double their actual ratio for the same period. Another result from this

work was that during the recessions of 2001 and 2008-2009, the use of statistical provisioning

would have resulted in declines in provisions, which is exactly opposite to what actually occurred

during these years. Since the statistical provision is a negative adjustment to the income state

ment, during recessionary periods, prots of nancial services rms wind up being higher than

they would be applying the incurred loss method. One inference from this result is that banks

which rely on such a statistical provisioning methodology could conceivably be in a better posi

tion to maintain lending during difcult times and moderate their lending during boom periods.

Developments Subsequent to the Financial Crisis of 2007-2009

In the aftermath of the nancial crisis, reductions in loan-loss reserves accounted for a substantia

portion of reported earnings for many nancial services companies during 2010, conrming the

procyclical pattern of loss provisioning. According to Harry Terris, Jamie Dimon, JPMorgan

Chases chief executive, asserted skepticism during his companys earnings call about swings in

reserve positions as credit deteriorates and recovers, as he did the previous quarter. Its a silly

post-cyclical thing we go through, putting them all up and take them all down, he said.9

During the nancial crisis, many nancial institutions began to implement the expected loss

reserving model, even though in so doing it conicted with the incurred loss methodology pre

scribed by FAS 5. These changes brought reserving practices into closer alignment with the loss

estimation methodology embedded in the Basel II capital requirements framework. Bank regula

tors were supportive of these changes and the SEC has neither endorsed nor objected.

More recently, FASB and the International Accounting Standards Board (IASB) drafted a pro

posal that would permit the expected loss concept to be applied to loss reserving. Details of how

the expected loss concept should be applied have yet to be worked out.

Thus, there has been some progress in adopting practices that should reduce the procyclicality of

loss reserving in the future, but until accounting rules are explicitly revised, uncertainty will remain

9 Harry Terris, Channel From Loss Reserves to Bottom Line, American Banker, November 10, 2010.


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PROCYCLICALITY OF REGULATORY CAPITALREQUIREMENTS

Financial services firms targeted for S C A

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Basel II Capital Framework

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10 B.S. Bernanke and C.S. Lown, The Credit Crunch, Brookings Paper. Econ. Act. Vol. 2, 1991, pp. 205248.11 Rafael Rapullo, Jesus Suarino and Carlos Trucharte, Mitigating the Procyclicality of Basel II, CEPR Discussion Paper 7382, 2009.12 Michael B. Gordy and Bradley Howells, Procyclicality in Basel II: Can We Treat the Disease Without Killing the Patient? Journal of Financial

Intermediation, 2006, 15, pp. 395-417.


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Table 1. New Basel Capital Standards as of September 2010

Source: BIS Press Release on Basel III, May 2009.

13 Bank for International Settlements, Group of Governors and Heads of Supervision announces higher global minimum capital standards, PresRelease, September 2010


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Higher Minimum Capital Ratios, More Stringent Risk Weights and Limitations onQualified Capital Instruments

Higher minimum capital ratio requirements applicable over the entirety of the economic cycle,

more stringent risk weights and limitations on qualifying capital instruments will collectively

result in reduced credit extension simply because nancial institutions will be unable to leverage

the size of their balance sheets to the same extent as in the past. Most covered nancial services

rms expect to reduce the size of their balance sheets through sale of assets, particularly sales of

those with signicant increases in risk weights.

If securitization markets were healthy, negative impacts on credit extension might be limited

through the sale of assets to other investors not similarly restricted by higher capital require-

ments; however, new risk retention requirements could well offset this potential benet. While

reduced credit creation could slow economic growth, this negative outcome would be offset (per-

haps more than offset) by a lower propensity for speculative asset bubbles to develop during the

expansion phase of the cycle and a diminished probability of insolvency of individual nancial

institutions during the contraction phase of the cycle. Clearly, higher minimum capital require -

ments will diminish the amplitude of cycles, both during the expansion and contraction phases.

What is less clear is whether the result will be neutral to potential economic growth over the

entirety of the cycle or whether the higher requirements will stunt innovation, risk taking andgrowth. If the latter turns out to be the case, then the countercyclical policy of requiring higher

capital ratios will result in diminished economic welfare.

There is another risk if capital requirements are set too high and that is one of potential leakage

of lending activity to less regulated or unregulated credit providers. Leakage contributed to the

explosion of subprime debt and to the magnitude of the housing bubble. While the Dodd-Frank

Act provisions have closed many of the legal and regulatory loopholes that permitted leakage, the

history of dynamic nancial markets in a market economy is that there is always ample incentive

to nd ways to minimize required capital and increase leveraged returns. Capital requirements

that are too high will simply increase the incentives to nd such avoidance alternatives while at

the same time weakening the competiveness of regulated nancial institutions.

Capital Conservation Buffer

The Bank for International Settlements (BIS) has issued a consultative document that discusses

several options for specifying the countercyclical capital buffer.14 The leading approach to

establishing a countercyclical capital buffer features a variable requirement dependent upon a

conditioning variable to determine the speed at which the buffer would be built or released as

economic conditions change. A credit-to-GDP (CtGDP) factor has been identied as a leading

candidate for such a capital requirement. It is dened as real aggregate credit growth divided

by GDP and is intended to reect the fact that credit demand and supply are usually positively

related with economic growth. The BIS asserts that historically higher ratios are associated withsubsequent nancial crises. The BIS further adjusts the ratio by its long-term historical trend and

uses this CtGDP gap as the basis for establishing the ramp up in the countercyclical capital target.

The specic recommendation for the buffer is as follows and is graphically shown in Figure 5:

14 Bank for International Settlements, Countercyclical Capital Buffers: Exploring Options, BIS Working Papers 317, July 2010.


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Figure 5. Countercyclical Capital Buffer Proposal

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15 Rafael Repullo, Countercyclical Capital Buffers: A Critical Assessment of the Basel Proposal, CEPR Conference on the Future of RegulatoryReform, London, 4 October 2010


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PROCYCLICAL EFFECTS OF LIQUIDITYREQUIREMENTS

Asevere liquidity crisis accompanied ,

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Loss of Liquidity and Central Bank Responses During the 2007-2009 Financial Markets Crisis

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16 This TED spread is often used as a measure of market liquidity. Spread data from Bloomberg as reported by Barth, Li, and Phumiwasana, TheU.S. Financial Crisis: Credit Crunch and Yield Spreads, White Paper, Auburn University, 2009.

17 Franklin Allen and Elena Carletti, The Role of Liquidity in Financial Crises, Prepared for the 2008 Jackson Hole Symposium, August 21-23, 2008on Maintaining Stability in a Changing Financial System.

18 Allen and Carletti, 2008, p. 4.


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C j

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Figure 6. Bank Underwriting Trends Consumer Loans

Source: Federal Reserve 2011 Underwriting Survey.

Figure 7. Bank Underwriting Trends Commercial Loans

Source: Federal Reserve 2011 Underwriting Survey.


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Proposed Changes to Liquidity Requirements to Reduce Individual Firm Loss ofLiquidity and Market Contagion During Times of Financial Crisis

In the response to the recent crisis, efforts to preempt a future liquidity crisis have emerged in

such proposals as the introduction of two liquidity ratios as part of the proposed Basel III capital

rules. The Liquidity Coverage Ratio is designed to ensure adequate short-term (30-days) liquid-

ity for banks. Specically, the ratio is dened as the stock of high quality liquid assets divided

by net cash outows over a 30-day time period. The ratio cannot fall below 100%. Included

in the determination of cash outows during a liquidity stress scenario are multiple rating down-

grades of the rm, a signicant run-off in retail deposits, loss of unsecured wholesale funding

sources and increases in market volatilities of assets such that they trigger posting of additional

collateral and or haircuts, among other actions. This liquidity ratio requirement is proposed to

become effective starting in January 2015.

The second ratio, Net Stable Funding is designed to ensure ample liquidity over an extended

period of time (i.e., over 1 year). The numerator of the ratio is computed using bank capital,

preferred stock with a maturity greater than 1 year, and liabilities over 1 year multiplied against

certain weights for the stability of the funding (referred to as ASF factors). The denominator is

dened to be the sum of assets held by the bank including off-balance sheet equivalent items

multiplied by specic factors designating the quality of stable required funding (RSF factors).As in the Liquidity Coverage ratio, the Net Stable Funding ratio cannot be less than 100%. This

liquidity ratio requirement is proposed to become effective starting in January 2018.

Research Studies

Various theories describing the provision of liquidity for nancial institutions exist. Allen and

Carletti present a model where customers provide a measure of liquidity to banks via deposits

and that banks must carefully manage two kinds of liquidity risk; 1) a rm-specic risk associ -

ated with the withdrawal prole of depositors for the institution, and; 2) an aggregate liquidity

exposure reecting the systemic impacts to banks generally as market conditions amplify or

reduce the demand for liquidity. Due to market imperfections, liquidity risks cannot be easilyhedged away and hence inefciencies in the provision of liquidity occur, which give rise to

such conditions as cash-in-the-market-pricing. This phenomenon can greatly affect even high

quality assets at times when liquidity is constrained causing the prices of these assets to fall

well below their intrinsic values. This can lead to other major negative effects on markets such

as nancial fragility where small shocks amplify declines in asset prices as well as contagion

effects as was evident during the crisis.

Allen and Carletti examine the evidence for why markets for interbank lending during the 2007-

2009 period contracted so much. Their research reveals that rather than banks being unwilling

to lend to other banks, banks engaged in liquidity hoarding. Based on this nding, Allen and

Carletti believe that the role of the interbank markets is to provide a mechanism to address bank-specic liquidity risks and that, if under conditions that prevailed in 2007-2009, banks become

concerned about the aggregate liquidity risk exposure in markets generally, they will increase

their liquidity levels and hence address their rm-specic risk so that contractions in interbank

markets impose little overall risk to their nancial stability.

Berger and Bouwman provide additional insight into the role of liquidity on nancial markets

over a number of nancial crises.19 In this study the authors examined bank data over a period

19 Allen Berger and Christa Bouwman, Financial Crises and Bank Liquidity Creation, white paper, October 2008.


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from 1984-2008, developing a measure of liquidity creation for banks. Using this measure, they

analyzed the changes in aggregate liquidity during nancial crises. They found that nancial

crises are typically preceded by increases in aggregate liquidity, which during the 2007-2009

crisis may have been fed by a relaxation in credit standards. This nding, they suggest, might

reverse the direction of causality between liquidity creation and nancial fragility. Typically, it

is theorized that nancial fragility would require banks to raise liquidity levels, but in the case of

the ndings above the authors believe that abnormally high levels of liquidity, such as preceded

the recent nancial crisis, may have been a precursor to nancial fragility. They also found thawhile the levels of liquidity declined somewhat during the crisis they remained at levels abnor

mally high relative to historical levels.

Implications of Research for Proposed Changes in Liquidity Requirements

W B ? R

- -

B B - -

,

, . T

.

A

- ,

M,

. I

, , (F R)

. T F R

2007-2009 F R

.

Reaction of Financial Services Firms to Basel III Liquidity Proposal

T A B J B, JPM C

L C R x

, ,

- . A .20

20 Donna Borak, New Fight Brewing Over Basel III, This Time Over Liquidity Requirements, American Banker, June 2, 2011.


34/49


DEPOSIT INSURANCE PREMIUMS

he financial crisis led to

2008 2. I , FDIC B I F (BIF)

- . T FDIC -

BIF

. B D-F A (DFA),

1.35% S 30, 2020

. T FDIC, , (DFA

1.50% ). W BIF x, FDIC

, .

DFA z FDIC

. I

, DFA

. T ,

x - .

Table 2. Failed and Problem Banks 2005-2010

Failed Banks 2010 2009 2008 2007 2006 2005

Number of Firms 127 235 25 3 0 0

Total Assets 83,282$ 104,665$ 169,709$ 371,945$ -$ -$

Problem Banks

Number of Firms 860 1254 252 76 50 52Total Assets 379,230$ 748,713$ 159,405$ 22,189$ 8,265$ 6,607$

Source: FDIC Quarterly, Vol. 4, No. 4, 2010


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Procyclicality of Deposit Insurance Assessments

P DFA , ,

. T

F 8 9. D 2007-2009

1980 1990, BIF . N

, BIF ,

1935. A .

F, , F 9

. I

,

Figure 8. Bank Insurance Fund Reserve Balance and Ratio: 1935-2010

Source: FDIC Quarterly, 2011

Figure 9. Deposit Premium Trends: 1935-2010

Source: FDIC Quarterly, 2011.


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Positive Correlation Among Procyclical Rules, Policies and Governing MechanismsAmplifies Their Combined Adverse Effects

T , x

; ,

. P z

-

.21 P

x . S,

- -

. I , P -

,

.22 T

- ,

, .

Proposals to Reduce the Procyclicality of Deposit Insurance Premiums

A P -

FDIC (N

DFA ; , FDIC, x -

, ). W

, . C -

- . I P

-- -

. I 1987-1996 , P

-

FDIC . I

, P , .

M , J, M U

.23 T -

-- .

T -

, P.

Dodd-Frank Act Amendments and FDIC Discretion

O FDIC - .

DFA .

T . 3

21 George G. Pennacchi, Risk-Based Capital Standards, Deposit Insurance and Procyclicality, Journal of Financial Intermediation, Vol. 14, 2005,pp. 432-465.

22 George G. Pennacchi, The Effects of Setting Deposit Insurance Premiums to Target Insurance Fund Reserves, Journal Financial ServicesResearch. Vol. 16 (2/3), 1999, pp. 153180.

23 Robert Jarrow, Dilap Madan, and Haluk Unal, Designing Countercyclical and Risk Based Aggregate Deposit Insurance Premia, White paper,Kakamura Corporation, 2006.


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x. P ( CAMEL

) j .

T FDIC j

,

. T 60

j.24 I j

, 2%. A FDIC

- x .

I , x, DFA

. D

x 1.35%,

FDIC .., 2.0% FDIC -- . T FDIC

, ,

. A FDIC ,

1.35% . W

. A, FDIC

. I ,

, x

, x .

E -

I ;

, BIF

.

Table 3. Total Initial and Base Assessment Rates

Source: FDIC Quarterly, 2011

24 Lee K. Davidson and Ashley M. Carreon, Toward a Long-term Strategy for Deposit Insurance Fund Management, feature article, FDIC QuarterlVol. 4, Issue 4, 2010, pp. 29-37.


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FAIR VALUE ACCOUNTING RULES PROCYCLICALITYIMPACTS AND POTENTIAL REMEDIES

Considerable debate occurred during and

(FVA) . O

, x

, ,

. F x, S 1 14

, z z 2008, +9.1%

-21.8% 10 14 x .25

Fair Value Diverges from Probable Long-Term Realizable Value in Illiquid Distressed Markets

O FVA -

. S, x ,

z , z . T

, ,

, (

x ),

x .

F - . D

, .26 M,

A C , FVA

z . H, , S, FVA .

Impacts of Fair Value Accounting in Benign Economic Times

A FVA x 2007-2009 ,

FVA

. R, A C,

FVA, , 1980

1990 FVA .

H, FVA x . W -

, x ,

x

. x ,

. L, ,

25 Sanders Shaffer, Fair Value Accounting: Villain or Innocent Victim: Exploring the Links Between Fair Value Accounting, Bank Regulatory Capitaland the Financial Crisis, Federal Reserve Bank of Boston, Working Paper No. QAU10-01, January 31, 2010, p. 14.

26 Alicia Novoa, Jody Scarlata and Jose Sole, Procyclicality and Fair Value Accounting, IMF Working Paper, WP/09/39, March 2009, p. 3.


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. T

,

FASB Fair Value Accounting Rules FAS 157 and Levels 1, 2 and 3

FASB

-- (HFI), -- (AFS), ,

. T z . I HFI ,

, z . H, HFI j

j --- (OI) - j

FAS 115

S j x ,

.

I AFS , , FAS 157

,

x . F

. I

L 1 . L 2

. L 3 --

I , (CDS) z

(CDO),

L 3 FVA .

L 1, 2 3 FVA, N . F 10-12.

Figure 10. Change in Level 1 Assets: Q1/2007-Q1/2008

Source: Novoa et al.


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D 2007-2009, L 1 L 2 x

x M S. B ,

L 3 x . B A L

1 2007 x 70% 50%, . N , N

. , ( F 13) L 2 x

L 2 L 3 .






41/4934

Proposals to Moderate Procyclical Effects of Fair Value Accounting

A FVA . T

AFS HFI ,

AFS HFI FVA ,

, , ,

R HFI

z.27 A, HFI j

OI . C

. S L 2

FVA. A ,

, x

.

Figure 13. Level 1, 2 and 3 Allocations of US and Foreign Banks (Percent)


A FVA j

FVA -

FVA . A

FVA- .

27 Novoa et al., p. 13.


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Research Studies

S FVA N

. T x FVA ; ,

, . T

: ; FVA

, , FVA; FVA

. T

, , . F, N .

, FVA

. F,

FVA , ,

. H,

.

Recent Developments

O FVA, , ,

, , ,

z

FVA x FVA

. I , FASB x FVA

. B

, L 3

FAS 157, FASB .

H, FAS 115 OI

. I A 2009, FASB z HFI

,

. L

- z -

. T

z j . T , , z

, x z-

HFI . B j

j ,

x

. T OI x

FVA


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Policy Implications

FVA . T

; -

. A FVA -

FVA

. A , j

FVA . F

FVA

.


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CONCLUSIONS AND POLICY RECOMMENDATIONS

his paper focused on describing j

, ,

. T 2007-2009 j . T -

, , ,

, .

T

. M,

. I

,

, .

P z , -

j. H, , z

, ,

, ,

. A,

-

,

, 2007-2009 .

Policy Recommendations

Coordination.Regulatory and rule-setting bodies should develop coordinated and compre-hensive strategies that address and mitigate procyclical impacts among these ve policies and

practices. F ,

. A x -

. T

-

. T D-F A (DFA) F S

O C (FSOC), -

. I

,

x , -

.

Accountability. Regulatory and rule setting bodies should be accountable or developing

rules, policies and governance mechanisms and taking actions designed and intended

to mitigate the potential or procyclical impacts to occur and exacerbate nancial crises.

R x

-

. T FSOC x -

, ,


45/4938

. FSOC

.

Loan Loss Accounting Rules.Te Financial Accounting Standards Board should continue

to work with the International Accounting Standards Board to develop loss reserving rules

based an expected loss methodology with the objective o mitigating procyclical impacts

o current loss reserving rules. T FAS 5,

. T j

. T

x

, -

. I ,

, ,

.

Supervisory Implementation of Loss Provisioning Regulatory Policy.

Regulatory agencies and accounting standards setting bodies should coordinate lossreserving accounting rules and regulatory guidance.A

x

.

Regulatory agencies should implement countercyclical examination and supervisory pro-

cedures. W -

, -

. T G A O,

, j-

x .

Regulatory Capital Requirements.

Regulators should study the potential consequences o the proposed Basel III capital

requirements or lending and economic growth during the phased implementation

period. B II 2007-2009 . F, x

. S,

,

-

. O

B III . A

x . F

, . T

B III . I , ,

. B B III

x - , -

. S

- .


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T j

, - .

Te Basel Committee on Banking Supervision and US regulators should not impose a coun-

tercyclical capital buer as part o the Basel III guidelines until a concrete methodology is

developed or determining the appropriate size and the conditions that should trigger imple-

mentation and phase-in o a capital buer; also, urther analysis should be conducted on

the benets and consequences o implementing such a requirement to determine whetherit would likely have a countercyclical impact or whether it would have other unintended

consequences. A ,

.

Explore the efcacy o developing orms o contingent equity capital or bail-in debt

which would automatically convert into common equity i a pre-determined triggering

event occurred. T -

- .28 R

, . B

(SIFI) . F -

, -

,

. F,

- ,

. U.S.

- .

Liquidity Requirements.Te Basel Committee on Banking Supervision and U.S. regulators

should evaluate potential signicant unintended consequences o the two proposed required

liquidity ratios and should either revise the ratios to mitigate such consequences or should

eliminate explicit requirements and replace them with supervisory guidelines and rely oncentral bank liquidity acilities in times o extreme illiquidity. W

, -

x -

. A

-

. T B C B S

. S, x-

, , . A

.

Deposit Insurance Premiums.Te FDIC should utilize the discretion provided by the Dodd-

Frank Act to propose and then implement a countercyclical deposit insurance pricing mecha-

nism that stabilizes premiums charged over the entirety o the cycle. A

28 Editor at Large, Think the Basel III Rules Are Sewn Up? Think Again, American Banker, February 3, 2011.


47/4940

,

z . S P

- .

Fair Value Accounting Rules.

Te U.S. Financial Accounting Standards Board (FASB) and the International

Accounting Standards Board (IASB) should continue to work toward harmonizing USand international air value accounting (FVA) principles and in doing so should be

attentive to mitigating potential procyclical impacts.

Fair value accounting (FVA) principles should be revised to avoid contributing to amplica-

tion o nancial crises. T FVA

. FVA

. F A S 157

. L 1

. H,

, L 1 - . U, -

FVA

. FVA -

-

. A

x . S j, -

F S O C (FSOC)

F A S B (FASB) j.

FASB should consider whether revised accounting rules or determining other than tem-

porary impairment (OI) or held or investment nancial instruments (FAS 115)

should be incorporated into FAS 157 or available or sale nancial instruments.

In times o acute nancial markets distress, FASB, FSOC and regulators o nancial

services companies should consider implementing actions that could lessen or decouple

the link between FVA losses and margin calls and risk management practices that trigger

orced asset sales based on FVA results. P, OI

FSOC

FASB .

T x ,

. U

. P z ,

j. H, z

, ,

. M,

- .


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References

A, F E C, T R L F C, P 2008 JH S, A 21-23, 2008 M S C F S.

B, E A MK, D P: A C L LR, E Q, R F, V. 95, N. 4, F 2009.

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R, J F S R. V. 16 (2/3), 1999.

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The Anthony T. Cluff Research Fund designs, approves, and funds research on issues affecting the

financial services industry and related public policy. The results of these studies inform and educate

opinion leaders and policymakers.

Procyclical versus Countercyclical Policy Effects on Financial Markets

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