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How much financial strength information do central banks need?

How much financial strength information do central banks need?. by Claudio Borio* Head of Research and Policy Analysis Bank for International Settlements, Basel Presentation for Norges Bank Conference on “Banking Crisis Resolution – Theory and Policy” Oslo, 16-17 June 2005 Norway.

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How much financial strength information do central banks need?

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  1. How much financial strength information do central banks need? by Claudio Borio* Head of Research and Policy Analysis Bank for International Settlements, Basel Presentation for Norges Bank Conference on “Banking Crisis Resolution – Theory and Policy” Oslo, 16-17 June 2005 Norway * The views expressed are those of the author and not those of the BIS

  2. Introduction: CBs and crisis resolution • Information needs vary with role … • CB is just one player in broader safety net • roles do differ considerably • … but one role in common: emergency liquidity assistance (ELA) 2

  3. Three questions about ELA • How do CB approaches differ? • What are the implications for information needs? • What are the key challenges/trade-off?

  4. Highlight three points • Absence of supervisory functions raises dilemmas for CBs in ELA • Should pay more attention to ELA and market distress • International issues loom large

  5. Structure of remarks • Why is question so relevant today? • Clarify the definition of ELA • Examine the information needs for • ELA to institutions • ELA to markets • Raise some issues about the international dimension

  6. Why ask now? • Incipient trend towards loss of supervisory responsibilities • CBs one step further removed from source of information • Changing nature of liquidity demands • from “bank runs” to “market runs” • market distress can have systemic implications • this has implications for information needs

  7. Definition of ELA • Economic literature: ELA to … • D1: market as a whole (Thornton) • D2: individual institutions (Bagehot) • In practice it can be hard to draw the line between • liquidity to the market and to individual institutions • ELA and monetary policy implementation • My definition: requires … • … liquidity shortage that threatens or accompanies insolvency risks plus • … operation outside normal conditions (terms/collateral) plus • D1: no concern with possible failure of counterparty receiving funds • D2: concern with possible failure of counterparty receiving ELA

  8. ELA to institutions: 3 stylised types of CB • Type 1 (“prudent micro-prudential”) • ELA if and only if solvent but illiquid • Type 2 (“prudent macro-prudential”) • ELA like type 1 plus only if systemic risk • Type 3 (“never say never”) • ELA not ruled out if insolvent but systemic

  9. ELA to institutions: information requirements • Two kinds: • financial strength of institutions (1 + 2) • evaluation of systemic risk (2 + 3) • Prudential information necessary (1 + 2 + 3) but not sufficient (for 2 + 3) • system-wide distribution of exposures • behavioural responses • Need to combine prudential information with payment & settlement system and market functioning information  not easy!

  10. ELA to institutions: choices of CBs without supervisory functions • Stylised choices: • rely on supervisor’s information • develop independent information • Without necessary tools, (b) is hard • Also raises interesting question • What if the CB judgement differs from supervisor’s?  de facto loss of discretion

  11. ELA to institutions: credibility issues • (1) and (2): credibility depends crucially on existence of alternative mechanisms to address systemic risk, without ELA • (2): credibility depends on ability to resist likely political economy pressures • issue of small versus large institutions

  12. ELA to markets: what information? • Case 1: • clear that purely operational problems (eg. Y2K, 9/11) • Lend freely/possibly cut interest rates • need to go outside normal operational criteria depends on • surplus collateral • number and type of facilities • number of counterparties • eg. US vs euro area

  13. ELA to markets: what information? • Case 2: • concerns about potential insolvency (eg. LTCM) • Key questions • need for more targeted action? • does CB have sufficient knowledge/leverage/legal powers to act?  may require coordination with supervisors

  14. ELA and the international dimension • Two specific additional concerns • one further step removed from information • misalignment of incentives? eg. • systemic in host but not at home • Implications • host CB in difficult position • coordination desirable, how hard in practice?

  15. Reference • Borio, C (2004): “Market distress and vanishing liquidity: anatomy and policy options”, BIS Working Papers, no 158, July.

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