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How to Avoid Another Financial Crisis Central European Perspective

This article discusses the key factors and policies necessary to prevent another financial crisis from a Central European perspective. Topics covered include monetary policy, fiscal stabilization, structural reforms, free capital flow, and a good business climate.

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How to Avoid Another Financial Crisis Central European Perspective

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  1. How to Avoid Another Financial CrisisCentral European Perspective Andrzej Raczko

  2. Reputable monetary policy (independent central bank) • Long-term fiscal stabilization • Structural reforms boosting international competitiveness (labor market) • Free float of capital • Good business climate • Domination of private financial sector

  3. Accumulation of huge global imbalances (exchange rate rigidity) • Ample liquidity (global saving glut) • - „negative experience” from former financial crisis – growing F/X reserves of central banks, • - corporate saving, • - high commodity prices and financial accumulation (oil countries) • Low interest rates (easy monetary policy in the USA) • Widespread growth of price assets (housing bubble) • Low personal saving in the USA

  4. Liquidity risk (excessive leverage) • Wholesale financial market development • Interaction betweenmark-to-market pricing andliquidity

  5. „Too big to fail” • Micro prudential policies • Reduction of pro-cyclicality (amplitude of credit cycles) • Automatic countercyclical mechanism vs. discretionary interventions • Scope of banking operations (the Volcker’s Rule) • Systemic important institution (requirements and costs) • Taxation of banking sector • Consumer protection law • Bank capital • Liquidity • Risk management • International cooperation

  6. Liquidity • International cooperation • Risk management • Trading book capital • Securitization risk weights • Improvement of guidance on management and supervision • Compensation system • Concentration of risk • Principles of cooperation (G-20, FSB – Standard Setters, BIS, IMF, EU) • Supervisory colleges • EU attempts to strengthen supervision

  7. New framework – proposals • Quality and transparency of capital base • Reduction of Basel II build-in pro-cyclicality • Counter cyclical capital buffer • Capital conservation buffer • Leverage ratio • Forward looking provisioning • New liquidity measures

  8. Hedge funds • Revision of Code of Conduct Fundamentals • Differentiated ratings on structured products • Conflict of interests • Minimum standards • Systemic monitoring

  9. Accountancy standards • Standardization of products • Integrated clearing system • Alternative approach to mark-to-market system • Transparent standards for off-balance sheet vehicles

  10. Emerging market countries • Originate-to-distribute model • Collateralized Debt Obligation (securitization) • Structured Investment Vehicle (SIV) • OTC market and wholesale financing system • Abrupt outflow of foreign saving • Long-term assets denominated in foreign currency • Finance innovation (F/X options)

  11. Quality and transparency of capital base • Fair competition (based on risk not reputation) • Hybrid capital (subordinated debt in foreign currency) • Subsidiary vs. branch model • Reform of Basel II • Risk weights(standardized vs. internal rating-based approach) • Pro-cyclicality (F/X sensitivity) • Counter cyclical capital buffer • Flexibility of automatic stabilizers definition

  12. Capital conservation buffer • Specific risks - role for domestic supervisor • Leverage ratio • Domination of standardized approach • Forward looking provisioning • System based on domestic risk assessment • New liquidity measures • Phasing-in mechanism

  13. European Systemic Risk Board • Domination of central banks (monetary policy vs. financialstability function) • Early warning system (practical solution?) • Communication (via non-binding recommendations) • European System of Financial Supervisors (ESFS) • Structure (built on Lamfalusy structures) • Sectoral vs. national supervisors (balance of powers)

  14. European Supervisory Authorities • Single rule book (binding technical standards) • Interpretation of regulations • Mediation (even addressing individual financial institution) • Colleges of Supervisors • Supervision of cross-border groups (day-to-day supervision) • European systemic institutions

  15. Crisis resolution • Cross-border insolvency • Selection of institutions (financial viability criterion?) • Models of resolution („bad” bank, guaranty of price of assets, transfer of assets) • Pan-European Deposit Guarantee Scheme • Structure (domestic vs. Pan-European) • Coverage (cross-border operation) • Funding (ex-ante contribution) • Membership (compulsory) • Fiscal responsibility of last resort • Potential arbitrage (subsidiary vs. branch)

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