Abstract
The authors’ empirical evidence is used to show that there is no reasonable capital rule that can protect the financial system in the face of events like 2007–2008: large interconnected banks would need 4 times the amount of capital to avoid default without government aid. They argue that separating deposit-guaranteed banks from investment banking, while maintaining a leverage ratio, is the policy mix supported by empirical evidence. They suggest the best threshold for separation should be derivatives exposure (with no netting) at or above 10%. They compare their own legal separation proposal to the Volcker rule, the UK Vickers rule and to those European proposals that were quietly dropped to please banks. They rebut 5 criticisms of separation proposals and review the 2017 Mnuchin Treasury modification of the Volcker Rule.
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Notes
- 1.
With the elasticities shown in Fig. 6.2, it seems likely that no reasonable cut in leverage would have sufficient impact to offset that of a large rise in derivatives as a share of assets.
- 2.
- 3.
For example, see Ötker-Robe et al. (2011), p. 2.
- 4.
- 5.
See Blundell-Wignall et al. (2013a). The DTD model of equation is first solved as in the appendix to Chapter 6. The DTD is then set to 3.0, and (for maturity of T = 1) target bank capital K* is calculated by solving for the V/D ratio that satisfies that condition for any bank below the critical 3.0 standard deviation threshold: i.e. 3.0 \(\sigma_{t} - \left( {r_{f} - \frac{{\sigma_{t}^{2} }}{2}} \right)\, = \,\log \left( {\frac{{V_{t} }}{{D_{t} }}} \right)\, = \, \propto_{t}\). Given that D = TA − K, where TA is total assets, it is then possible to calculate K* holding σ and V at their original solved values, given the historical observations of TA: \(K_{t}^{ * } = {\text{TA}}_{t} - \frac{{V_{t} }}{{{\text{e}}^{{\alpha_{t} }} }}\). The gap K* − K is then computed for each bank and summed over the system. The idea is to see what ex ante amount of extra capital would be needed, without taking into account any subsequent impact on σ and V that an actual injection of K* − K might have on σ, and other variables.
- 6.
See, for example, OECD (2009).
- 7.
See Blundell-Wignall et al. (2013b).
- 8.
The parent may try to use double gearing if permitted: instead of raising $100 in equity, it borrows half as debt. Debt and equity would be invested as ‘equity’ into the subsidiaries, then the rate of return on equity and the leverage ratio could be doubled versus true equity. It is imperative that the concept of capital to which leverage ratio rules apply should be for equity only.
- 9.
See Brunsden (2017).
- 10.
The OECD views were solicited by the secretariat of the Commission, see UK Government (2011a).
- 11.
Consistent with the Duffie (2012) views.
- 12.
- 13.
An exception is structured finance swaps (ABS swaps). See Warren (2015).
- 14.
For example, banks could not accept that market making was to be moved to a subsidiary.
- 15.
See FINMA (2013).
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Blundell-Wignall, A., Atkinson, P., Roulet, C. (2018). Why Bank Separation Must Complement the Leverage Ratio. In: Globalisation and Finance at the Crossroads. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-319-72676-2_7
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