Is the Bank Too Big to Fail? Is it Too Big to Exist?

1. IF BANK IS TOO BIG TO FAIL IS IT TOO BIG TO EXIST ? Prof. dr hab. Jan Szambelańczyk

2. Background • Insolvency problems are moving over from financial institutions to national states. • Globalization and modern financial architecture reduce national markets immunity. • Public trust and financial institutions credibility are diminishing. • Social perception of bankers professionalism has collapsed. • The idea of EU and common market benefits is politically jeopordized. • Next financial crisis will be even worse– says Nouriel Roubini Prof. dr hab. Jan Szambelańczyk

3. Before Lehman Brothers After Lehman Brothers If it would be 10 ? Prof. dr hab. Jan Szambelańczyk

4. Evaluation • Regulators, who are supposed to understand and prevent actionsthat spur systemic risk, failed. Too many became „captured” by thosethey were supposed to be regulating. • After 2008, as a result of global financial crisis,concept of safety network and concept of deposit guartantee schemehave changed significantly. • Excluding home and host country issues, DGS concept is nationaly orientedwhile internationalization (foreing investment & transborder operarations)creates transnational and new problems. Prof. dr hab. Jan Szambelańczyk

5. After the year 2008 • in search of safety • regulations tends to: • secure stability by: • >capital standard • rigid regulation • > investor protectionExpectation:S T A B I L I T Y • Before the year 2008 • in search of optimumbetween stability & efficiency • regulations aimed at: • market transparency • ≥ competitiveness • investor protectionIntention:Sustainable growthSide-effect: • C R I S I S Prof. dr hab. Jan Szambelańczyk

6. Characteristic for Poland • Up to now, toutef proportion gardees, Poland has not been significantly affected by global financial crisis. • Polish DGS (BFG - Bank Guarantee Fund) has not experienced TBTF doctrine in practice. • Very high share of FDI in Polish banking sector (4 out of 5 in Top-5; 8 out of 10 in Top-10) makes it potentially sensitive to ‘external’ shocks and endengered ‘internal’ stability. Prof. dr hab. Jan Szambelańczyk

7. ‘Too Big to Fail’ concept • Refer to institutions whose sole failure due to their size or interconnections to other institutions would create an unacceptable risk to the rest of the system. • Means any entity that has grown so large that its failure would have a catastrophic effect on the stability of either the financial system or economy without substantial government assistance. • Even if individual banks are SMALL, if they engage in correlated behaviour – using the same models – their behaviour can fuel systemic risk. Prof. dr hab. Jan Szambelańczyk

8. Simplified analogy Big power plant failure leds to a massive cascade of power outagess that spread across large areas of the country,leaving tents of millions withoutelectricity. Lessons from the study of cascades dynamics, in complexsystem:- the most demaging incidents areimpossible to anticipate with anyconfidence. Financial markets experienced a different kindof cascade („global financial blackout”).How banks, acting independently, collectivelymanaged to put trillions of $ at risk withoutbeing detected? The risk was invisible because it was „systemic”!Financial systems are far mor complex but main problem of systemic risk is the same:- risk managers are supposed to assess their owninstitutions’ exposure (ceteris paribus),- in a crisis conditions change unpredictable,despite of applied stress tests. The solution may be to make the system less complex. [Adapted from Duncan Watts] Prof. dr hab. Jan Szambelańczyk

9. ‘To big to exist’ idea • If the global financial crisis has demonstrated that: • - markets do not automatically controll systemic risk, • - economic policy, monetary policy, regulatory policy didn’t protect against financial crisis but even - to some extend - stimulate risk • one should ask what kind of intervention is needed ? • Complexity of the answer, but in the first place includes principle:„if a financial institution is TBTF it shouldn’t be allowed to grow so large” • However F.S. Mishkin says:„You can’t put that genie in the bottle again”. Prof. dr hab. Jan Szambelańczyk

10. A few propoposals • Gradually implementing ‘Too big to exist”. • Greater regulatory scrutiny and higher capital requirements for financial institutions that create ‘systemic’ threats. • Legal segmentation of financial market stimulating institutional diversification. • Impose fees on giant banks to encourage them to operate more carefully. • Design incentive system including a principle of delated income (f.e. basedon received not on expected revenue). • Making all executives and directors personally liable for abuse in financialreporting, deception or excessive risk-taking with insured deposit. • Rearrange external audit of financial institution (payment made by financial institution to supervision in advance, supervision body nominates/selects auditor,auditor fees payment within 1-2 year delay according to report quality). Prof. dr hab. Jan Szambelańczyk

11. Thank you !