## CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

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### Introduction and reform impetus
- Global financial crisis prompted major regulatory overhaul after widespread market dislocation and persistent output and employment effects.
- Between 2007 and 2008, 24 countries experienced banking crises; output today remains below its precrisis trend in 85 percent of these countries (October 2018 World Economic Outlook).
- 2009 G20 leaders agreed a regulatory reform agenda to establish stronger globally consistent rules.
- Chapter focus: progress, remaining gaps, and emerging risks with emphasis on advanced and large emerging market economies addressed by the FSB and BCBS.

### Causes of the crisis and precrisis failings
- Immediate trigger: correction in U.S. house prices starting in 2006.
- Deep causes and vulnerabilities:
  - Procyclical rise in leverage and inadequate capital quality and quantity.
  - Reliance on off-balance-sheet SPVs and securitization to expand lending without commensurate capital increases.
  - Rudimentary stress-testing frameworks that underestimated tail risks.
  - Low provisions for losses entering the crisis, leaving capital buffers strained.
  - Increased leverage in the nonbank financial sector via expanded securitization and structured-product leverage (including CDOs and CDO-squared securities).
- Supervisory, governance, and market-discipline failures:
  - Weak governance and light supervision allowed expansion of risk without adequate oversight or buffers.
  - Implicit guarantees and “too-important-to-fail” perceptions eroded market discipline.
  - No identification of systemically important financial institutions and no special mechanisms for their resolution precrisis.
  - Failure of Lehman Brothers precipitated severe market panic and required coordinated policy actions (capital injections and deposit guarantees).

### Enhancing capital, reducing leverage, and addressing procyclicality
- Basel III objectives: “more and better-quality capital,” wider risk coverage, a non-risk-based leverage ratio, constraints on banks’ internal models, and additional capital cushions (countercyclical capital buffer and capital conservation buffers) plus systemic bank surcharges.
- Implementation status (Regulatory Consistency Assessment Programme as of March 2018, 19 assessments):
  - 15 compliant,
  - Indonesia, Korea, and the United States largely compliant,
  - European Union (grouping nine Basel member jurisdictions) materially noncompliant.
- G-SIB compliance: all jurisdictions hosting G-SIBs, including the EU, found compliant with G-SIB standards.
- Capital outcomes:
  - Global median common-equity-to-asset ratio has increased by more than 2 percentage points since 2010.
  - By 2017, all ratios were significantly higher than before the crisis.
  - Part of the increase reflects de-risking of bank assets (movement away from assets with higher regulatory risk weights).
- Countercyclical measures and provisioning:
  - Countercyclical capital buffer (CCyB) intended to be activated in booms and released in downturns; at end-2017, some BCBS jurisdictions had not set the CCyB above zero despite relatively large credit gaps.
  - Brazil and Mexico prescribe expected-loss provisioning; IFRS 9 required beginning in January 2018; FASB in the United States does not require this for listed companies until 2020.
  - Capital conservation buffer broadly introduced; progress on the leverage ratio more gradual.
- Evidence on procyclicality:
  - Regression of real quarterly bank credit growth on real GDP growth showed significant precrisis procyclicality in a 61-country sample and decline to nonsignificant postcrisis.
  - Country-level: declines in procyclicality in 60 percent of sample countries and in slightly more than half of BCBS countries.
  - Bank-level: leverage shifted from slightly procyclical precrisis to slightly countercyclical postcrisis (subsample with banks in Canada and the United States).

### Liquidity, funding, and currency risks
- New liquidity standards:
  - Liquidity coverage ratio (LCR): stock of liquid assets to withstand 30-day stress; implementation beginning in 2015.
  - Net stable funding ratio (NSFR): manage maturity mismatch up to one-year horizon; implementation beginning in 2018.
- Implementation outcomes:
  - All Basel member countries have implemented the LCR and undergone RCAP assessments indicating consistency.
  - NSFR implementation more demanding; some jurisdictions have not issued draft proposals; others have drafts with open deadlines for conclusion.
- Liquidity and funding trends:
  - Liquidity buffers have, on average, grown since the crisis.
  - Banks’ holdings of cash and government securities as a share of total assets have increased.
  - Recent LCR reporting shows levels well above 100 percent and increasing since 2014.
  - Banks’ reliance on wholesale funding trending downward since the crisis.
  - Internationally active banks domiciled outside the United States continue to rely on U.S. dollar funding, including through foreign exchange swaps.
- Money market and repo reforms:
  - U.S. institutional money market funds moved toward mark-to-market valuation for less liquid assets; boards can use liquidity charges and suspended redemptions.
  - Europe: most money market funds moved toward floating valuation; exceptions for those investing in government debt; regulations include potential redemption gates and liquidity charges.
  - Triparty repo reforms in the United States increased transparency about haircuts and reduced intraday credit risks.

### Nonbank sector leverage and shadow banking
- Insurance sector:
  - Improved solvency frameworks in some jurisdictions (notably Solvency II in the EU), but a globally consistent approach still under development.
  - Riskier insurance businesses wound down postcrisis.
- Asset managers and nonbank leverage:
  - Measurement of leverage in asset managers is difficult; limited information with some evidence of increase.
  - Consolidated supervision has reduced leverage in some nonbank institutions but remains incomplete in many jurisdictions, enabling regulatory arbitrage.
- Shadow banking monitoring and reform:
  - FSB established typology and framework; IOSCO issued recommendations on liquidity mismatch, leverage within investment funds, operational risk, and securities lending.
  - Proposed remedies: reporting, monitoring, risk management, stress testing, and deeper liquidity buffers.
  - Progress limited to date; data timeliness and granularity and cross-border interconnection information remain priorities.
  - Securitization reforms require originator retention; implementation ongoing and not yet forcefully in place in many jurisdictions.

### Systemic institutions, supervision, and market structure
- Identification and mitigation of systemic firms:
  - G-SIB methodology and list are an important success; G-SIBs subject to systemic capital surcharge since 2016.
  - Many countries adapted G-SIB methodology for D-SIBs with varied approaches.
- Supervisory coordination and crisis preparedness:
  - Supervisory colleges and crisis management groups deployed for G-SIB host jurisdictions to exchange information; FSAPs report increasing sophistication but call for more open communication.
- Capital buffer increases:
  - G-SIBs increased regulatory capital ratios by 5 percentage points or more.
  - Other institutions increased regulatory capital ratios by 1 percentage point.
- Concentration and competition:
  - Three-bank concentration ratio has shown a moderate but sustained decline since 2000.
  - Median ratio of G-SIB bank assets to GDP across 13 host countries declined by 0.4 percentage point; that of D-SIBs declined by 0.1 percentage point over 39 countries.
  - Asset-to-GDP ratio of G-SIBs declined in 8 host countries and declined for D-SIBs in 19 countries.
  - Despite concentration declines, competition measures have not improved: both the Lerner index and the Boone indicator have markedly increased in recent years.
- Market perceptions of government support:
  - Support ratings sharply lower today than before the crisis for stand-alone banks.
  - Example market measure: euro area implicit subsidy reached 194 basis points at end-2011 and is now slightly less than 18 basis points.

### Stress testing and supervisory practices
- Stress testing became central to supervision after the 2009 U.S. Supervisory Capital Assessment Program.
- Limitations persist:
  - Resilience often tested to only a single scenario.
  - Estimated bank losses generally less than historical experience.
- Nevertheless, stress testing is now used by almost all supervisors of sophisticated banking systems.
- Supervisory reorganizations around Basel implementation noted in jurisdictions such as the United Kingdom and the euro area.

### Resolution frameworks and loss-absorption capacity
- FSB Key Attributes of Effective Resolution Regimes adopted as benchmark.
- TLAC standard for G-SIBs (phased implementation for institutions classified as G-SIBs before end-2015):
  - 16 percent of risk-weighted assets beginning January 2019
  - 18 percent beginning January 2022
- Jurisdictional implementation:
  - Canada, Sweden, Switzerland, the United Kingdom, and the United States have incorporated TLAC requirements into domestic rules; the EU and Japan have issued policy proposals.
  - Significant amounts of TLAC-eligible securities have been issued; many G-SIBs meeting the January 2019 requirement.
  - Banks in emerging markets granted longer adjustment periods; Chinese G-SIBs have not yet sold TLAC-eligible debt.
- Recovery and resolution planning:
  - All G-SIBs have established recovery plans; resolution plans being finalized.
- Remaining gaps:
  - Less progress on resolution regimes for systemic nonbanks (insurers, FMIs).
  - National bank resolution regimes often have significant weaknesses and are not fully aligned with the Key Attributes.
  - Cross-border resolution impediments include confidentiality constraints on information sharing and group structures that hinder orderly resolution.
  - Recommendations: strengthen crisis management groups for systemic nonbanks and CCPs; improve funding sources for resolution periods.

### Data gaps and the Data Gaps Initiative (DGI)
- Postcrisis data shortfalls led to the G20 Data Gaps Initiative (DGI) launched October 2009.
- DGI phases:
  - First phase (2009–15): capture buildup of financial-sector risk, cross-border connections, vulnerability monitoring, improved communication.
  - DGI-2 (launched September 2015): regular collection and dissemination of reliable statistics; action plans for 20 recommendations by 2021; emphasis on linkages across sectors.
- Achievements:
  - SDDS Plus launched February 2012 targeting economies with systemically important financial sectors.
  - Most G20 economies now report the seven FSIs expected from SDDS Plus adherents: 
    - (1) regulatory Tier 1 capital to risk weighted assets;
    - (2) regulatory Tier 1 capital to assets;
    - (3) non-performing loans net of provisions to capital;
    - (4) non-performing loans to total gross loans;
    - (5) return on assets;
    - (6) liquid assets to short-term liabilities;
    - (7) residential real estate prices.
  - Frameworks developed for credit default swap reporting, securities statistics, and a global systemically important banks data hub at the BIS.
- Remaining DGI priorities through 2021:
  - Compilation of government finance statistics beyond central government;
  - Sectoral accounts including shadow banking details;
  - Sharing of granular data.
- Data priorities remain central to cross-border cooperation and systemic risk monitoring.

### Policy recommendations and areas to complete
- Complete outstanding elements of global reform agenda:
  - Implement solvency frameworks for insurers, the leverage ratio, and outstanding liquidity items.
  - Intensify supervision of systemic institutions.
- Strengthen macroprudential oversight:
  - Ensure accountability and willingness to act in a timely manner.
  - Develop cross-border cooperation in data sharing and systemic risk oversight.
- Corporate governance and compensation:
  - Reinforce board accountability and corporate cultures to restrain excessive risk taking.
  - Clarify enforceability of malus and clawback provisions to avoid contractual circumvention.
- Resolution reforms:
  - Continue implementing Key Attributes-consistent regimes, improve cross-border coordination, and address impediments to resolvability.
- Shadow banking and nonbank intermediation:
  - Consider activity-based regulation, macroprudential tools for nonbanks, and closing data gaps.
- Address unintended consequences of reforms:
  - Design policies to mitigate bank–sovereign feedback loops and avoid excessive sovereign bond holdings by banks.
  - Ensure CCPs have solid capital and liquidity buffers and adequate resolution frameworks; consider central bank liquidity provision to solvent systemic CCPs under extreme circumstances.
- Fintech and cybersecurity:
  - Support fintech for innovation and inclusion while safeguarding system stability.
  - Develop supervisory capabilities for cybersecurity; supervisors often lack dedicated units and face skills shortages.
- Correspondent banking withdrawals:
  - Address consequences for financial stability and inclusion; reassess regulatory perimeter where risk migrates to nonbanks.

### Conclusion and forward view
- Ten years on, substantive progress in capital, liquidity, and systemic oversight is clear, and vulnerabilities related to derivatives and wholesale funding have been reduced.
- Gaps persist in macroprudential frameworks, systemic risk monitoring, data, resolution regimes for nonbanks, and cross-border cooperation.
- Emerging and intensifying risks include concentration in CCPs, growth of nonbank credit intermediation without matched regulation, rapid fintech development with evolving risk understanding, and rising cybersecurity threats.
- Regulators and supervisors must remain vigilant, resist reform fatigue and rollbacks, and be prepared to act—especially in periods of low interest rates and subdued volatility when risks tend to rise.

*International Monetary Fund | October 2018 — CHAPTER 2 (excerpt provided)*

### Introduction

### Introduction

### Reform impetus and scope
- The global financial crisis led to a major overhaul of financial regulation, driven by widespread dislocation in financial markets and abrupt and persistent consequences for growth and unemployment.
- Between 2007 and 2008, 24 countries experienced banking crises, with output today remaining below its precrisis trend in 85 percent of these countries (October 2018 World Economic Outlook).
- The Group of Twenty (G20) leaders agreed a regulatory reform agenda in 2009 to establish stronger globally consistent rules.
- This chapter, with 10 years of hindsight, examines progress toward regulatory reform, remaining gaps, and emerging risks; it focuses primarily on advanced and large emerging market economies addressed by the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS).

### What went wrong before the global financial crisis
- Immediate trigger: correction in U.S. house prices starting in 2006.
- Deeper causes: accumulation of structural financial vulnerabilities during the preceding housing boom that amplified losses beginning in 2007 and propagated through global financial markets through at least 2012.
- Key vulnerabilities identified:
  - Procyclical rise in leverage and inadequate capital quality and quantity.
  - Reliance on off-balance-sheet special purpose vehicles (SPVs) and securitization to expand lending without commensurate capital increases.
  - Rudimentary stress-testing frameworks that underestimated tail risks (for example, widespread house-price declines).
  - Low provisions for losses at banks entering the crisis, leaving capital buffers strained.
  - Increased leverage in the nonbank financial sector via expanded securitization and structured-product leverage (including collateralized debt obligations and CDO-squared securities).

### Leverage, capital, and prudential failures
- High leverage combined with poor loss-absorbing capacity of some regulatory capital instruments (so-called Tier 2 instruments) undermined resilience; some such instruments required dividend payments even as institutions failed.
- Bank capital proved insufficient and unreliable when conditions deteriorated.
- Insurance-sector business models (for example, monoline insurers) shifted, indicating a need for new approaches to risk management and solvency.

### Liquidity and funding risks
- Bank funding shifted toward short-term and uninsured market-based sources, enabling aggressive lending growth but increasing liquidity and maturity transformation.
- Off-balance-sheet vehicles relied almost exclusively on short-term market funding such as asset-backed commercial paper (ABCP).
- Complex products used as collateral raised liquidity risks: falling house prices reduced the value of mortgage-backed securities and complex assets, while opacity led to confusion about underlying value and impaired market clearing.
- Examples of market stress:
  - Northern Rock (United Kingdom) faced liquidity pressures from reliance on short-term market funding.
  - AIG (United States) suffered massive losses and margin calls after selling default protection on structured securities.
- Exchange rate risk increased through practices such as posting U.S. mortgage-related securities as collateral for U.S. dollar funding and using cheap short-term foreign deposits to fund domestic lending; currency mismatches of borrowers made loan portfolios vulnerable to currency fluctuations.

### Size, interconnectedness, and systemic risk
- Large, complex, and interconnected institutions (for example, Lehman Brothers, Bear Stearns, Dexia) posed regulatory and supervisory challenges across home and host jurisdictions.
- The size and opaqueness of these institutions amplified moral hazard and “too big to fail” perceptions.
- Insurers and monoline insurers played key roles in the asset-backed securities market by selling default protection, increasing cross-market linkages.
- Interconnectedness rose via common exposures to mortgage-related securitized products and OTC derivatives, including credit default swaps.
- In most countries, no single macroprudential authority had a consolidated view of cross-sector risk migration or sufficient powers and tools to contain systemic risk.

### Supervision, market discipline, and corporate governance failures
- Supervision proved inadequate for increasingly complex financial systems and systemic risk.
- Compensation practices and corporate governance encouraged excessive risk taking; market discipline and self-regulation failed to restrain incentives.
- The originate-to-distribute model weakened originators’ incentives to maintain loan quality when loans were securitized and sold.

*Source: https://www.imf.org/-/media/files/publications/gfsr/2018/oct/ch2/doc/ch2.pdf*

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### Causes of the Crisis and Precrisis Failings
- Securitization and sale of loans to third-party investors "weakened incentives for sound credit underwriting."
- Investors "accepted ratings assigned to these products without much scrutiny."
- "Implicit guarantees" eroded market discipline and distorted incentives toward risk taking, exemplified by government-sponsored enterprises in the United States and "too-important-to-fail" institutions.
- Governance at many large financial institutions was "too poor to understand or control these risks."
- A preference for "relatively light supervision allowed this expansion of risk without adequate oversight or buffers."
- The absence of viable resolution frameworks for large complex financial institutions compounded problems: "There had been no identification of systemically important financial institutions" and "no special mechanisms for their resolution."
- The failure of Lehman Brothers "initiated one of the worst stages of the crisis as fears of counterparty risk turned into panic."
- Policymakers were forced to take coordinated actions to inject capital and issue deposit guarantees in several countries.

### The Regulatory Agenda Launched After the Crisis
- At the 2009 G20 summit, the international regulatory community convened to overhaul the regulatory and supervisory framework with goals to:
  - "enhance capital buffers and reduce leverage and financial procyclicality,"
  - "contain funding mismatches and currency risk,"
  - "enhance the regulation and supervision of large and interconnected institutions,"
  - "improve the supervision of a complex financial system,"
  - "align governance and compensation practices of banks with prudent risk taking," and
  - "overhaul resolution regimes of large financial institutions."
- The IMF contributed through multilateral and bilateral surveillance, including the Financial Sector Assessment Program (FSAP), Article IV missions, and Global Financial Stability Reports (GFSRs).
- Analysis in this chapter is based on information on the largest banks in 80 countries—35 advanced economies and 45 emerging market economies—and assesses statistical significance of trends.

### Enhancing Capital, Reducing Leverage and Financial Procyclicality
- The BCBS created a global framework (Basel III) focused on "more and better-quality capital," increasing permanence and loss absorption of banks’ capital.
- Basel III addressed capital definition and composition by:
  - widening risks being covered,
  - balancing risk-based measures with a new non-risk-based leverage ratio, and
  - constraining capital relief from banks' use of their own models to calculate risk weights.
- Basel III added capital cushions: the "countercyclical capital buffer and capital conservation buffers," and "capital surcharges for systemic banks."
- The BCBS completed a review of regulatory treatment of sovereign exposures "without changes to existing rules."

### Implementation and Progress on Basel III Capital Standards
- "Implementation of the Basel III capital agreement has advanced largely as planned."
- As of March 2018, under the Regulatory Consistency Assessment Programme (RCAP), of 19 assessments:
  - 15 were "compliant,"
  - Indonesia, Korea, and the United States were "largely compliant,"
  - The European Union (grouping nine Basel member jurisdictions) was "materially noncompliant."
- All jurisdictions hosting global systemically important banks (G-SIBs), "including the EU, were found compliant with the G-SIB standards."
- "Many non-BCBS countries have also implemented some parts of the Basel III capital agenda."
- Capital buffers increased notably after the crisis:
  - The global median common-equity-to-asset ratio "has increased by more than 2 percentage points since 2010."
  - "By 2017, all ratios were significantly higher than before the crisis."
- Part of the increase in regulatory capital ratios resulted from banks moving away from assets with higher regulatory risk weights ("de-risking of bank assets").
- FSAP surveillance identified areas for improvement, noting that jurisdictions hosting the majority of banking assets are "deemed compliant or largely compliant," while "materially noncompliant ones host a small but non-negligible fraction of banking assets."
- Common reasons for noncompliance include:
  - "political pressures against enforcing regulatory agreements,"
  - "structural features of economies (such as the widespread presence of small- and medium-sized enterprises in the EU),"
  - and time needed to internalize adequate powers and readiness to use them.

### Reducing the Procyclicality of Leverage and Use of Macroprudential Tools
- The main countercyclical capital tool is the countercyclical capital buffer (CCyB):
  - "This buffer should be activated to lean against the accumulation of systemic risks during periods of financial exuberance, and be released when the cycle turns."
- At the end of 2017, "some BCBS jurisdictions had not set the CCyB above zero, despite relatively large credit gaps."
- Outside BCBS, "the use of CCyB has been sparing" for reasons including:
  - reliance on other microprudential or macroprudential tools,
  - concerns about disintermediation,
  - and shifts in accounting rules.
- Forward-looking provisioning is being adopted:
  - Brazil and Mexico "prescribe that loan loss provisions be recognized based on expected losses."
  - The International Accounting Standards Board (IASB) introduced IFRS 9, "required beginning in January 2018."
  - The Financial Accounting Standards Board (FASB) in the United States "does not require this for listed companies until 2020."
- Other tools used to limit procyclicality include the capital conservation buffer and the leverage ratio; "the capital conservation buffer has been introduced very broadly, but progress in the leverage ratio has been more gradual."
- Some countries use caps on credit growth; such caps "have been used primarily in emerging markets."

### Evidence on Procyclicality and Targeted Sectoral Tools
- Procyclicality of bank credit has declined:
  - A regression measure (real quarterly bank credit growth on real GDP growth, both detrended) indicated "significant procyclicality" precrisis in a sample of 61 countries, then declined and became "nonsignificant" postcrisis.
  - Country-level estimates show declines in procyclicality of credit in "60 percent of the sample countries, and in slightly more than half of BCBS countries."
  - Bank-level analysis suggests "leverage has gone from being slightly procyclical in the precrisis period to slightly countercyclical in the postcrisis period" (subsample contained banks in Canada and the United States).
- Sectoral countercyclical tools have been deployed mainly for household real estate risks:
  - Tools include higher risk weights for housing loans with higher loan-to-value ratios, loan-to-value caps (sometimes differentiated), debt-service-to-income ratios, and caps on debt-to-income metrics.
  - "Debt-service-to-income ratios" require extensive borrower information and have been used in several countries, particularly in Europe and Asia.
  - "Debt-to-income ratios have been used more sparingly."

### Stress Testing and Supervisory Practices
- Stress testing "has become a central component of bank supervision."
- Microprudential stress testing existed precrisis but spread widely after the U.S. Supervisory Capital Assessment Program in 2009.
- Limitations remain: resilience is often tested to "only a single scenario" and estimated bank losses are "generally less than historical experience."
- Despite limitations, "stress testing is now used by almost all supervisors of sophisticated banking systems" and supervisory practices in jurisdictions such as the United Kingdom and the euro area "have been reorganized around Basel implementation."

### IMF Role and Technical Assistance
- The IMF has played "a critical role in facilitating implementation of the regulatory reform agenda" through surveillance and technical assistance.
- A "fundamental IMF role in the reform agenda has been through its technical assistance activities."

*International Monetary Fund | October 2018*

### 1. Total Credit-to-GDP Gap in BCBS Members and CCyB Rates

### 1. Total Credit-to-GDP Gap in BCBS Members and CCyB Rates

### Leverage in the nonbank sector
- Solvency frameworks and regulation for insurance companies have been improved in some countries and regions (most notably, implementation of Solvency II in the EU), but a globally consistent approach is still under development.
- Many of the riskier businesses in which insurance companies became involved have been wound down since the crisis as focus on systemic risk in the insurance sector increased.
- The FSB’s 2014 framework for haircuts on non–centrally cleared securities-financing transactions constrained securities financing; final or draft rules have been issued in many jurisdictions (BCBS 2017).
- Consolidated supervision has helped reduce leverage of some nonbank financial institutions, but it has not been fully implemented in many jurisdictions, facilitating regulatory arbitrage within financial groups.
- Measurement of leverage in asset managers is difficult and information is limited, with some evidence pointing to its increase (see Chapter 1 of the April 2018 GFSR).

### Containing funding mismatches and addressing liquidity and currency risk
- Two regulatory liquidity ratios emerged from the crisis:
  - Liquidity coverage ratio (LCR): concept of holding a stock of liquid assets to withstand a high degree of stress for a 30-day period; implementation beginning in 2015.
  - Net stable funding ratio (NSFR): managing potential mismatch between asset and liability maturities up to a one-year horizon; implementation beginning in 2018.
- All Basel member countries have implemented the LCR and undergone Regulatory Consistency Assessment Program assessments indicating consistency with the agreed-on Basel framework.
- Implementation of the NSFR has proved more demanding; while it should have been implemented by January 2018, some jurisdictions have not issued draft proposals and others have drafts with open deadlines for conclusion.
- Outside BCBS membership, there has been interest in adopting Basel III liquidity standards.

### FSAP findings on liquidity risk and stress testing
- FSAP assessments (2012–2018) show wholesale funding remains important in various jurisdictions; a broad review of liquidity risks is still necessary.
- Some jurisdictions have introduced liquidity stress testing using horizons beyond the 30-day LCR and highly granular supervisory data, but FSAP risk analysis identified instances where stress-testing techniques warranted further development.
- Without adequate stress-testing tools and insights, liquidity metrics might be misleading.
- FSAP also identified instances where the banking community, shielded by benign market conditions, has been slow to develop risk management skills.

### Liquidity buffers and reliance on wholesale funding (key statistics and trends)
- Liquidity buffers have, on average, grown since the global financial crisis.
- Banks’ holdings of cash and government securities (considered highly liquid) have increased as a share of total assets.
- Recent reporting of the LCR shows levels well above 100 percent and increasing since data became available in 2014.
- Holdings of government securities have risen in many countries, which could signal persistence of links between banks and sovereigns.
- Banks’ reliance on wholesale funding has been trending downward since the crisis.
- Internationally active banks domiciled outside the United States continue to rely on U.S. dollar funding, including through foreign exchange swaps, for their global dollar lending.

### Nonbank liquidity and foreign currency risks
- New valuation guidelines for money market mutual funds have reduced run risks:
  - U.S. institutional money market funds investing largely in less liquid corporate debt or municipal bonds have moved toward a mark-to-market basis, reducing incentives for investor runs.
  - Boards of money market funds can take measures such as liquidity charges and suspended redemptions to address potential run risks.
- In Europe, most money market funds have moved toward floating valuation, with exceptions for those investing in government debt; European regulations have included potential redemption gates and liquidity charges.
- IOSCO has contemplated additional guidelines for money market funds.
- U.S. reforms to the triparty repo market (greater transparency about haircuts, rules to reduce collateral risk, new clearance procedures to reduce intraday credit) have reduced potential run risks.
- Many countries have applied measures to contain foreign exchange risk; these include macroprudential-style measures such as reserve requirements differentiated by currency and higher risk weights for foreign exchange loans.
- Examples of targeted measures:
  - Central and Eastern Europe deployed a wide range of tools to contain risks for foreign exchange–denominated mortgages.
  - Korea imposed leverage caps on banks’ positions in foreign exchange derivatives and a levy on nondeposit liabilities denominated in foreign exchange, with shorter-term deposits attracting a higher charge than long-term ones.

### Enhanced regulation of large and interconnected institutions
- Identification of systemic firms and imposition of stricter requirements have been central to postcrisis reforms.
- Agreement on criteria and a list of G-SIBs (developed by the IMF with FSB and BIS) is an important success of the reform agenda; G-SIBs are identified using indicators of size, interconnectedness, lack of readily available substitutes, global activity, and complexity.
- Supervisory judgment allows authorities to nominate banks for inclusion on the publicly disclosed list.
- G-SIBs have been subject to a systemic capital surcharge since 2016.
- A list of global systemically important insurers has been developed but not published; work on capital standards for systemic insurers is experiencing delays.
- Many countries adapted the G-SIB methodology for domestic systemically important banks (D-SIBs); approaches vary by jurisdiction.

### Supervisory colleges, crisis management, and data improvements
- Supervisory colleges and crisis management groups have been deployed for G-SIBs’ host jurisdictions to exchange information and views on supervisory issues and crisis preparedness.
- FSAPs trace increasing confidence and sophistication of supervisory exchanges, but continued progress and more open communication remain priorities.
- G-SIBs and systemic institutions have increased capital buffers:
  - Postcrisis increase in capital buffers has been particularly substantial for G-SIBs, which have increased their regulatory capital ratios by 5 percentage points or more.
  - Other institutions increased regulatory capital ratios by 1 percentage point.
- Banking system concentration:
  - Moderate but sustained decline in the three-bank concentration ratio observed since 2000 continued.
  - Size of systemic institutions relative to the economy has been declining or remaining stable in most countries, including those in the BCBS.
  - Median ratio of G-SIB bank assets to GDP across 13 host countries declined by 0.4 percentage point; that of D-SIBs declined by 0.1 percentage point over 39 countries.
  - Asset-to-GDP ratio of G-SIBs declined in 8 host countries and declined for D-SIBs in 19 countries.
- Despite concentration trends, measures of banking competition have not improved:
  - Both the Lerner index (a measure of banking sector markups) and the Boone indicator (a measure of elasticity of profits to marginal costs) appear to have markedly increased in recent years.

### Data gaps and the Data Gaps Initiative
- A data hub for G-SIBs, contemplated in the Data Gaps Initiative, has been set up at the Bank for International Settlements, providing supervisory authorities in major jurisdictions the ability to contribute to and access a common database on risk exposures and interconnectedness across systemically important financial institutions, markets, and jurisdictions.
- Two key areas needing further progress:
  - Increasing the granularity of data accessible to international financial institutions.
  - Increasing access to aggregate data by national macroprudential authorities.

### Intensifying supervision and regulatory focus
- Postcrisis guidance emphasized intense scrutiny and the will and ability of supervisors to act; revised sectoral standards require timely and effective supervision rather than regulations alone.
- Supervisory approaches have been refreshed to examine systemic institutions more rigorously:
  - Examples: United States’ Comprehensive Capital Analysis and Review; Brazil’s segmentation/tiering of institutions; euro area supervision predicated on systemic significance; Russia centralizing supervision of systemic banks.
- FSAPs have recommended continued enhancements in supervisory approaches and cross-border cooperation.

_International Monetary Fund | October 2018 — Chapter 2 (excerpt provided)_

### 1. Postcrisis Differences across Countries and Banks

### 1. Postcrisis Differences across Countries and Banks

### Banking concentration and competition
- Postcrisis period defined as 2010–17; differences measured as coefficients of a post–global financial crisis (GFC) dummy variable; solid bars indicate statistical significance at the 10 percent level.
- Finding: Concentration within the banking sector has fallen slightly, although competition has not picked up.
- Competition measures described:
  - Lerner index: measure of bank markups (output prices minus marginal costs) estimated from a translog cost function; higher value = lower competition; expressed in percentage points by multiplying the Lerner index by 100.
  - Boone indicator: competition measure based on elasticity of bank profits to marginal cost; a more negative value is consistent with greater competition.
- Panel data and medians are referenced across countries in the sample; GFC shaded in figure.

### Supervisory intensity and resource adequacy
- Concern: supervisory intensity and adequacy often found insufficient in several jurisdictions.
- Jurisdictions explicitly noted with concerns about resources for supervisors: China, the Netherlands, Sweden, Switzerland, and the United Kingdom.
- Aggregate finding: one-quarter of the postcrisis FSAPs of systemic jurisdictions expressed concerns that the right balance of supervisory resources was not being devoted to systemic institutions or that supervision of them was not sufficiently intense.
- Additional risk: factors identified in a number of jurisdictions could compromise the independence of supervisory authorities.

### Expanding the regulatory perimeter and shadow banking
- Basel III closed loopholes used to game Basel I and II via off-balance-sheet vehicles; new rules on treatment of special purpose vehicles reduced profitability of using them for capital arbitrage.
- Liquidity framework now considers volatility of different funding sources, increasing scrutiny of bank use of nonbank financing.
- United States example: investment banks moved toward traditional banking licenses after the crisis, bringing them within a more tightly regulated perimeter.
- Shadow banking and market-based finance monitoring expanded:
  - The FSB established a typology and broad framework for regulation; IOSCO published recommendations on liquidity mismatch, leverage within investment funds, operational risk, and securities lending.
  - Proposed remedies: reporting, monitoring, risk management, stress testing, and deeper liquidity buffers.
  - Implementation: some jurisdictions have implemented measures, but regulatory advances remain limited to date; efforts to improve timeliness and granularity of data and cross-border interconnection information should continue.
- Securitization framework overhauled: originators must retain part of the original structure; implementation still in progress and not yet in force in many jurisdictions; retention rules need to adequately align securitization sponsors’ incentives.
- OTC derivatives migration and FMIs:
  - Pittsburgh G20 Summit target: report OTC contracts to trade repositories and clear all standardized OTC contracts on CCPs by end-2012.
  - Important progress achieved; buffers at most CCPs deemed systemic have been strengthened (including liquidity support and financial buffers).
  - Central banks in Europe provide, under strict criteria, liquidity support to CCPs; in the United States, the Federal Reserve allows CCPs to open and maintain accounts but not to access routine intraday credit.

### Macroprudential authorities and powers
- Most countries instituted systemic oversight authorities postcrisis; in most cases the role assigned to the central bank (Figure 2.7, panel 1).
- Examples:
  - United Kingdom: central bank oversees prudential supervision.
  - Mexico: Financial System Stability Council with nine members including finance ministry, central bank, deposit insurance agency, and prudential supervisors.
  - United States: Financial Stability Oversight Council.
  - China: Financial Stability and Development Committee.
- Designation and mandates vary; some countries (e.g., Brazil and Canada) share macroprudential responsibilities without an explicit macroprudential mandate.
- Powers vary greatly (Figure 2.7, panel 2):
  - Hard powers: examples include the United States’ FSOC power to designate systemic financial institutions and subject them to enhanced supervision; Monetary Authority of Singapore has the full range of macroprudential tools.
  - Semi-hard powers: comply-or-explain mechanisms.
  - Soft powers: informing relevant agencies and the public of potential risks and advising on policy steps (example countries: United States, Russia, South Africa).
- Many macroprudential authorities still lack sufficient powers and tools; this remains an area needing attention.

### Governance and compensation
- Banking supervision scope extended to corporate governance; Basel Core Principles became more demanding on governance.
- Postcrisis reviews: more than half of the FSAPs in 25 systemic jurisdictions between 2011 and 2018 identified gaps, deficiencies, or weaknesses in corporate governance in the financial sector.
- Progress:
  - By 2017, most jurisdictions had regulations addressing compensation packages in the financial sector.
  - FSB stocktaking found most major banks recognize board responsibility for appropriate risk taking; many jurisdictions require independent directors to chair key board committees.
  - Examples by 2018: Single Supervisory Mechanism thematic reviews in euro area; Russian authorities empowered with relevant legislation; Brazilian supervisory agency intensified supervisory processes.
- Compensation reform issues:
  - Almost all major FSB member jurisdictions have substantively implemented principles for sound compensation practices and their implementation standards.
  - Legal enforceability of malus and clawback provisions remains unclear.
  - Risk that compensation contracts can be reengineered to circumvent such clauses and regenerate excessive risk-taking incentives.
- Swing pricing: in the United States, measures to institutionalize swing pricing were introduced by the Securities and Exchange Commission in 2016 and have reportedly been adopted by all large asset management firms; compliance across the industry is expected by the end of 2018.

### Resolution frameworks and loss-absorption capacity
- Crisis exposed inadequate resolution frameworks and moral hazard from implicit government support.
- FSB Key Attributes of Effective Resolution Regimes adopted as benchmark for resolution authorities.
- Progress:
  - Many jurisdictions with G-SIBs introduced nearly all bank resolution powers advocated by the Key Attributes.
  - IMF has worked via FSAPs and technical assistance to improve predictability, effectiveness, and transparency of regimes.
  - Total Loss-Absorbing Capacity (TLAC) standard adopted to ensure G-SIBs maintain liabilities to absorb losses and recapitalize failing firms.
    - TLAC phased implementation for institutions classified as G-SIBs before end-2015:
      - 16 percent of risk-weighted assets beginning January 2019
      - 18 percent beginning January 2022
    - Several FSB member jurisdictions (Canada, Sweden, Switzerland, the United Kingdom, and the United States) have incorporated TLAC requirements into domestic rules; others (the EU and Japan) have issued policy proposals.
    - Significant amounts of TLAC-eligible securities have been issued; many G-SIBs meeting the January 2019 requirement.
    - Banks in emerging markets granted longer adjustment periods; Chinese G-SIBs have not yet sold TLAC-eligible debt.
  - Recovery plans: all G-SIBs have established recovery plans; resolution plans are being finalized.
- Remaining gaps:
  - Less progress in strengthening resolution regimes for systemic nonbanks (insurers, FMIs).
  - National bank resolution regimes often have significant weaknesses and are not fully aligned with the Key Attributes.
  - Impediments to resolvability include group structures that hinder orderly resolution and inadequate loss-absorption capacity at non–G-SIBs.
  - Cross-border resolution challenges: confidentiality impedes information sharing; greater coordination and planning needed for cross-border resolution of G-SIBs; crisis management groups should be established for systemic nonbanks such as insurers and CCPs.
  - Initiatives underway to improve funding sources for resolution periods.

### Market perceptions of government support and implicit subsidies
- Changes in banks’ ratings and market prices indicate a perceived reduction in the likelihood of government support and bailouts for banks, especially the largest ones.
- Support rating: sharply lower today than before the crisis for stand-alone banks (which could only receive extraordinary support from the government).
- Market measure of implicit subsidy (difference between a “fair value” CDS spread and observed CDS spread on bank bonds):
  - Example: euro area implicit subsidy reached 194 basis points at the end of 2011 and is now slightly less than 18 basis points.
- Overall: market signals suggest a lower perceived likelihood of bailouts since the crisis, but concerted efforts remain necessary to achieve resolution reform objectives, especially cross-border issues.

*Source: ch2 - 1. Postcrisis Differences across Countries and Banks (PDF chapter).*

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD

### Complete the Global Regulatory Reform Agenda
- Incomplete aspects of the global regulatory agenda should be fully implemented, including:
  - solvency frameworks for insurers
  - the leverage ratio
  - outstanding items on the liquidity agenda
- Continue to intensify supervision, particularly of systemic institutions.
- Macroprudential oversight and policy tools are improving; key challenges are:
  - ensuring accountability and willingness to act in a timely manner
  - further developing cross-border cooperation in data sharing and systemic risk oversight
- Corporate governance reforms should:
  - ensure cultures of excessive risk taking can be reined in
  - hold boards accountable for doing so
  - confront difficult issues such as compensation and the use of credit ratings
- Resolution frameworks:
  - should continue to be implemented consistent with the Key Attributes
  - should be improved for systemic entities, particularly cross-border institutions such as banks
- Improvements in oversight and regulation of shadow banking should continue:
  - FSB (2017a) finds aspects of shadow banking that contributed most to the global financial crisis generally no longer pose financial stability risks
  - new forms of shadow banking and market-based finance outside the prudential regulatory perimeter, such as asset managers, may be accumulating systemic risks with potential spillovers to banks
  - this is particularly true in many emerging markets, including China, where shadow banking has grown rapidly, albeit from a small base
- Policy and regulatory options to reduce shadow banking risks could include:
  - activity-based (as opposed to entity-based) regulation
  - development of macroprudential tools for nonbanks
  - closing data gaps (see Chapter 3 of the April 2015 GFSR)

### Address the Consequences of the Postcrisis Regulatory Agenda
- After 10 years, an evaluation of the effectiveness and efficacy of the reforms is appropriate.
  - The regulatory reform agenda increased resilience but might come at some cost to efficiency; supervisors can start taking stock and fine-tuning measures.
  - The FSB has started this assessment process through dedicated working groups; the IMF is leveraging the FSAP to conduct assessments where adequate data exist.
  - Example: the recent Peru FSAP used microeconomic data to evaluate the impact of higher capital requirements on lending, finding only small transitory effects.
- Policies aimed at addressing bank–sovereign links should be designed holistically:
  - Banks’ government bond holdings are still large.
  - Sovereign bonds play a prominent role as safe and liquid assets in the new liquidity regulations, often receive favorable treatment in capital regulations (often with a risk weight of zero), and are exempted from concentration limits.
  - The bank–sovereign interconnection can create a negative feedback loop where a banking or sovereign crisis reduces the value of government bonds, further deepening declines in banks’ asset values and affecting sovereign bonds.
  - Dell’Ariccia and others (2018) argue that improving balance sheets of banks and sovereigns is key, and that policies discouraging excessive sovereign bond holdings can improve financial stability and market efficiency, emphasizing design to minimize procyclical effects.
- Risks related to central counterparties (CCPs) and derivatives:
  - The 2009 G20 mandate to centrally clear all standardized derivatives contracts through CCPs reduced counterparty risk and leverage but concentrated credit risk within CCPs.
  - A failure of a CCP to absorb losses could amplify adverse aggregate shocks.
  - Margin calls and haircuts tend to rise as the financial cycle worsens, potentially leading to procyclicality.
  - Important regulatory actions include ensuring CCP capital and liquidity buffers are solid, establishing adequate resolution frameworks that consider cross-country nature, and using macroprudential tools where appropriate.
  - Provision of central bank liquidity to solvent and systemic CCPs could be considered under extreme circumstances to safeguard financial stability (Wendt 2015).
- Correspondent banking withdrawals:
  - In countries affected by a withdrawal of correspondent banks, authorities should address possible consequences for financial stability and inclusion.
  - The reform agenda, along with money-laundering rules and other factors, may have contributed to reassessment of correspondent banking relationships affecting access for residents of some countries.
  - In some cases this has led to migration of risks to nonbanks, requiring reevaluation of the regulatory perimeter; in others, authorities should step in to support financial inclusion.
  - The IMF has assisted affected countries via FSAPs and technical assistance.
- Resist reform fatigue and rollback pressures:
  - As memories of the global financial crisis fade, fatigue with ongoing implementation is rising and pressures to roll back the agenda are increasing.
  - Supervisory oversight of major banks and supervisory intensity, especially onsite and for systemic banks, should not be weakened.

### Confront New Risks
- Fintech and cybersecurity:
  - Financial technology (fintech) encompasses big data, automation of loan processing, distributed ledger technology, and new lending and electronic trading platforms.
  - Fintech is still small but has grown rapidly (IOSCO 2017; Figure 2.9, panel 5).
  - The regulatory challenge is to support fintech’s contribution to innovation, efficiency, and inclusion while safeguarding against risks that could amplify shocks to the financial system (FSB 2017b).
  - Cybersecurity risks: increasing reliance on information technology and interconnectedness pose financial stability risks.
    - Direct costs of cybersecurity events could be large and indirect costs, such as reputational risk, further raise the stakes (Kopp, Kaffenberger, and Wilson 2017; Bouveret 2018).
    - Supervisors must engage with financial institutions to develop identification, response, and recovery capabilities; supervisors often lack dedicated units and face skills shortages.
- Shadow banking and nonbank intermediation:
  - Assets of conventional banks have stagnated while nonbank institutions have gained ground.
  - Banks’ interconnections with nonbank institutions can be large in some countries.
  - In many countries, the bank–sovereign nexus remains strong.
- Systemic importance of CCPs:
  - The systemic importance of central counterparties is growing rapidly and counterparty concentration is an emerging vulnerability.
- Cyber risk vulnerabilities and fintech investments:
  - Global fintech investment backed by venture capital has expanded rapidly.
  - Cyber risk vulnerability severity varies by industry and sector.

### Conclusion
- Ten years after the onset of the global financial crisis, progress is clear, but the reform agenda must be completed.
  - Implementation of measures for capital, liquidity, and systemic oversight have been successful; vulnerabilities related to derivatives and wholesale funding have been reduced.
  - The FSAP has supported and evaluated implementation of these reforms in both FSB and non-FSB economies.
  - Gaps remain across a range of areas, including macroprudential frameworks, systemic risk monitoring, data, and cross-border cooperation.
  - Bank compensation practices and the use of credit rating agencies are thorny issues requiring consolidation of existing progress and possibly new thinking.
- Regulators and supervisors must remain vigilant and ready to act:
  - Risks of rollback, waning multilateralism, and regulatory fatigue are real and could undermine progress.
  - New risks are emerging as the financial system adapts to new regulations and structural change: concentration in CCPs, growth of nonbank credit intermediation without matched regulatory monitoring, rapid fintech development with still-developing knowledge of risks, and increased cybersecurity risks.
  - No regulatory framework can reduce the probability of crisis to zero; regulators should remain humble and vigilant, particularly during periods of low interest rates and subdued volatility when risks tend to rise.

*Source: International Monetary Fund | October 2018 — CHAPTER 2 REGuLATORY REFORM 10 YEARS AFTER ThE GLOBAL FINANCIAL CRISIS: LOOkING BACk, LOOkING FORWARD*

### Box 2.1. The IMF’s Role in the Global Regulatory Reform Agenda

### Box 2.1. The IMF’s Role in the Global Regulatory Reform Agenda

### Background: data shortfalls revealed by the global financial crisis
- Lack of timely and reliable data hindered policymakers’ ability to detect emerging risks and imbalances during the global financial crisis.
- The problem was emphasized by the IMF in March 2009 (Johnston and others 2009) and widely supported by the international community.
- Key gaps identified: financial sector data for detecting the buildup of risk, cross-border interconnections, financial linkages of global systemically important financial institutions, sectoral accounts, and national balance sheets.
- In October 2009, the G20 finance ministers and central bank governors endorsed the G20 Data Gaps Initiative (DGI). The initiative is led by the Financial Stability Board Secretariat and IMF staff.

### DGI phases and objectives
- First phase (2009–15): 
  - Aim: better capture the buildup of risk in the financial sector, improve data on connections within the international financial network, monitor vulnerability of domestic economies to shocks, and improve communication of official statistics.
- Second phase (DGI-2), launched in September 2015:
  - Focus: implementation of the regular collection and dissemination of reliable and timely statistics for policy use.
  - Introduced action plans that set out specific targets for the implementation of its 20 recommendations by 2021.
  - Increased emphasis on linkages across economic and financial sectors to assess risks, interconnections, and spillovers within and across economies.
  - Aims to improve cooperation, communication, and sharing of data.

### Main achievements to date
- The DGI led to the development of the IMF’s Special Data Dissemination Standards (SDDS) Plus, launched in February 2012, targeting economies that have systemically important financial sectors.
- Most of the G20 economies now report the seven financial soundness indicators (FSIs) that are expected from adherents to the SDDS Plus, and work is well advanced to initiate collection of FSI measures beyond simple averages (for example, median, skewness, quartiles) to provide information on tail risks, concentration, and shifts in risk distribution.
- A framework for reporting credit default swaps was developed and implemented, and new international guidance was developed for securities statistics.
- A framework for the collection and sharing of data on global systemically important banks was established and reporting of such data to the International Data Hub is progressing.
- All G20 economies report their international investment positions quarterly and core Coordinated Portfolio Investment Survey data semiannually.
- Most of the G20 economies disseminate residential property price indices.

### Remaining work through 2021 (DGI priorities)
- Address key remaining data gaps:
  - compilation of government finance statistics beyond the central government;
  - sectoral accounts, including details on shadow banking activities;
  - sharing of granular data.

### Linkages with broader regulatory reforms
- The DGI has been a key component of the financial sector reform agenda.
- By contributing to a better understanding of trends and volatility of capital flows, DGI data are also related to the G20 work on international financial architecture.
- Global regulatory reforms such as Basel III and the work on the Legal Entity Identifier support the DGI by contributing to the robustness of various data frameworks (that is, security-by-security and cross-border exposures of nonbank corporations).

### The seven FSIs expected from SDDS Plus adherents
- (1) regulatory Tier 1 capital to risk weighted assets;
- (2) regulatory Tier 1 capital to assets;
- (3) non-performing loans net of provisions to capital;
- (4) non-performing loans to total gross loans;
- (5) return on assets;
- (6) liquid assets to short-term liabilities;
- (7) residential real estate prices.

*Prepared by Florina Tanase and Evrim Bese Goksu.*

*Source: GLOBAL FINANCIAL STABILITY REPORT—A DECADE AFTER ThE GLOBAL FINANCIAL CRISIS: ARE WE SAFER, International Monetary Fund | October 2018 — Box 2.1.*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2018/oct/ch2/doc/ch2.pdf_