Monday, January 19, 2009

A comprehensive failure of regulation

There has been a comprehensive failure of every one of the three pillars of regulation: disclosure to ensure market discipline, adequate capital and effective supervision, says an article in FT.

The author used public domain data in October 2007 to estimate losses for banks. He says he came up with estimates that turned out to be pretty accurate. For Citigroup, for instance, the form 10 Q statement filed with SEC by the bank showed that Citibank’s tier one (equity) capital at the end of the third quarter of 2007 was $92.3bn and the subprime exposure accounted for 242 per cent of tier one capital! Neither market analysts nor regulators used the data to form a coherent picture of the full magnitude of the crisis- so much for market efficiency.

As for regulation and capital adequacy, all the banks that failed were compliant with Basel II. Which clearly means that Basel II is simply not upto the job of containing risks exposed by the sub-prime crisis.

Finally, bank supervision proved inept. In January 2008, the IMF estimated bank losses at $1 trillion. But it took the collapse of Lehman for regulators to wake up to the enormity of the crisis and respond to it.

Clearly, we will need a radical rethink of the entire regulatory architecture. Here's one disconcertingly radical thought: perhaps, as in the Indian banking system, it would be in the interest of systemic stability to have some component of the banking system owned by the state.


Anonymous said...

Your radical thought endorsed by Krugman (, Willem Buiter ( and Felix Salmon (

T T Ram Mohan said...

Anonymous, about your earlier query, the FT had carried stories about possible changes at the top at Citigroup. As for the references you have sent on public ownership, what I am taking about is such ownership on a permanent basis, not a temporary cure.


Anonymous said...

Not sure how permanent public ownership ownership of some banks reduces the systemic risk posed by private ownership. It might at the most change the type of risk. Greed and risk taking will be replaced by bureaucracy, political interference,... Which I think is equally bad or even worse in the long run.