12 April 2008

The Financial Stability Forum Meets the Bowery Boys

Financial Stability Forum Report to the G7 April 7/08 (PDF)

"...the balance sheets of financial institutions are burdened by assets that have suffered major declines in value and vanishing market liquidity. Participants are reluctant to transact in these instruments, adding to increased financial and macroeconomic uncertainty.

To re-establish confidence in the soundness of markets and financial institutions, national authorities have taken exceptional steps with a view to facilitating adjustment and dampening the impact on the real economy. These have included monetary and fiscal stimulus, central bank liquidity operations, policies to promote asset market liquidity and actions to resolve problems at specific institutions. Financial institutions have taken steps to rebuild capital and liquidity cushions.

Despite these measures, the financial system remains under stress. While national authorities may continue to consider short-term policy responses should conditions warrant it, to restore confidence in the soundness of markets and institutions, it is essential that we take steps now to enhance the resilience of the global system.

To this end, the FSF proposes concrete actions in the following five areas:

• Strengthened prudential oversight of capital, liquidity and risk management.
• Enhancing transparency and valuation.
• Changes in the role and uses of credit ratings.
• Strengthening the authorities’ responsiveness to risks.
• Robust arrangements for dealing with stress in the financial system."


Executive Summary

Strengthened prudential oversight of capital, liquidity and risk management

Capital requirements:

Specific proposals will be issued in 2008 to:
• Raise Basel II capital requirements for certain complex structured credit products;
• Introduce additional capital charges for default and event risk in the trading books of banks and securities firms;
• Strengthen the capital treatment of liquidity facilities to off-balance sheet conduits.

Changes will be implemented over time to avoid exacerbating short-term stress.
(Special challenge: banks have been using SIVs extensively to blow off the Basel II requirements as they had been. What good will raising them do? - Jesse)


Supervisory guidance will be issued by July 2008 for the supervision and management of liquidity risks.
(Yeah it can wait. Its only the heart of the crisis. - Jesse)

Oversight of risk management:

Guidance for supervisory reviews under Basel II will be developed that will:
• Strengthen oversight of banks’ identification and management of firm-wide risks;
• Strengthen oversight of banks’ stress testing practices for risk management and capital planning purposes;
• Require banks to soundly manage and report off-balance sheet exposures;

Supervisors will use Basel II to ensure banks’ risk management, capital buffers and estimates of potential credit losses are appropriately forward looking.
(Here's a teaspoon and a feather-duster, go clean that Augean Stable. - Jesse)

Over-the-counter derivatives:

Authorities will encourage market participants to act promptly to ensure that the settlement, legal and operational infrastructure for over-the-counter derivatives is sound.
This sounds like sending a copy of MISS MANNERS to Al Capone. -Jesse)

Enhancing transparency and valuation

Robust risk disclosures:
• The FSF strongly encourages financial institutions to make robust risk disclosures using the leading disclosure practices summarised in Recommendation III.1 of this report, at the time of their mid-year 2008 reports.
• Further guidance to strengthen disclosure requirements under Pillar 3 of Basel II will be issued by 2009.
(Sixtieth Rule of Ferengi Acquisition: Keep Your Lies Consistent. - Jesse)

Standards for off-balance sheet vehicles and valuations:
Standard setters will take urgent action to:
• Improve and converge financial reporting standards for off-balance sheet vehicles;
• Develop guidance on valuations when markets are no longer active, establishing an expert advisory panel in 2008.

Transparency in structured products:

Market participants and securities regulators will expand the information provided about securitised products and their underlying assets.
(The core of the problem is that the risk management models these jokers have been using have some whoppers of assumptions in them, and are essentially grounded in foo-foo dust. But let's do more of it and it will get better. - Jesse)

Changes in the role and uses of credit ratings

Credit rating agencies should:
• Implement the revised IOSCO Code of Conduct Fundamentals for Credit Rating Agencies to manage conflicts of interest in rating structured products and improve the quality of the rating process;
• Differentiate ratings on structured credit products from those on bonds and expand the information they provide.

Regulators will review the roles given to ratings in regulations and prudential frameworks.

Strengthening the authorities’ responsiveness to risks

• A college of supervisors will be put in place by end-2008 for each of the largest global financial institutions.
(College! Cool! We'll be Animal House. Ben can be Dean Wurmer. Aw, everyone wants to be Bluto. The Board wants to dance wif yo dates. Road Trip!! - Jesse)

Robust arrangements for dealing with stress in the financial system
• Central banks will enhance their operational frameworks and authorities will strengthen their cooperation for dealing with stress.
(Group yoga sessions? - Jesse)