The workshop was opened by two keynote lectures by Jean-Charles Rochet and Jon Danielsson. They proved to be extremely valuable as a constant guideline and background for the lively debates during the workshop. Jean-Charles Rochet from Toulouse asked "Why are there so many banking crises?" and gave some highly inspiring answers. Reviewing recent crises episodes, he pointed out that the modern form of bank runs are silent runs, professional investors sopping to renew their deposits. He argued that credibility problems are central to the understanding of financial fragility and discussed the weaknesses of current regulatory arrangements and the limitations of various reform proposals. In particular, he considered attempts to strengthen market discipline by introducing minimum requirements for subordinated debt. As an important result, he pointed out that subordinated debt may be well-suited in normal times and in a framework without regulatory distortions. However, in an environment characterized by coordination failures and credibility problems, any mechanism based on market discipline is likely to be hazardous. Rochet therefore concluded that the single most important issue is to guarantee independence and accountability for banking authorities. The difficult task is to commit that tough governments fully expropriate managers and shareholders in case of failure.
Jon Danielsson from LSE discussed likely consequences of explicitly considering the underlying risk of an institution in capital regulation. He convincingly explained how risk-based regulation may perversely increase financial risk, both for individual institutions and the entire banking system, and may hence promote financial instability due to the endogenous nature of risk. As an example, he pointed out how feedback loops may increase the potential for procyclicality. He furthermore argued that Basel ignores important incentive problems that may lead banks to reduce the intensity and quality of their risk management. Danielsson finally criticized the proposals faith in the ability of statistical models to accurately measure risk without recognizing recent methodological advancements, e.g. non-linear dependence. He doubted that the risk- iness of a financial institution cannot be represented by a single number.
Misa Tanaka from Nuffield College Oxford and Jan Wenzelburger from Bielefeld tackled the important problem how to incorporate adequately banking regulation in macroeconomic models. Tanaka analyzed capital adequacy regulation in a static general equilibrium model of the monetary transmission mechanism. She demonstrated that monetary policy may loose part of its impact in situations with a poorly capitalized banking sector. She furthermore showed that Basel II is likely to create a sharper loan contraction during recessions. She suggested that regulatory forbearance may be used as a tool to mitigate these undesirable effects of Basel II. Jan Wenzelburger showed how dynamic general equilibrium models of a banking sector subject to repeated macroeconomic shocks can add to our understanding of optimal banking regulation. In an overlapping generations framework, he demonstrated that rather extreme measures may be necessary to avoid a banking collapse or a consumption trap.
Stéphanie Stolz and Cornelia Holthausen presented two papers on a hotly debated institutional issue, namely the question of international conflict and cooperation in regulation and supervision. After discussing potential sources of international conflict, Stolz presented a model showing that a national supervisor/regulator will not adequately internalise costs caused to other economies by hazardous banking behaviour in her jurisdiction. She concluded that the current European system of international cooperation has to be extended and proposed to centralize responsibilities at the ECB-based banking supervision committee. Cornelia Holthausen studied incentives for information exchange between national regulators dealing with a multi-national banking firm. She showed that international divergence of interests might distort closure decisions and allow the bank to engage in regulatory arbitrage by allocating its assets strategically.
Marc Quintyn from the IMF finally complemented the discussions on institutional aspects of banking regulation, highlighting the close relation between supervisory and regulatory independence and financial stability. His insights into the reality of banking regulation in developing and emerging markets stimulated another lively debate. The first day was closed by Gabriela Mundaca who analyzed "Moral hazard effects of bailing out under asymmetric information". Claudio Borio from the Bank for International Settlements in Basel opened the second day with his keynote lecture. He argued strongly in favor of a macro prudential approach for regulation. He addressed many issues raised on the first day, in particular the adequate mix of market- and policy-induced discipline, the role of incentive-based regulation and the adequate measurement of risk. He stressed the need to calibrate prudential standards with respect to the marginal contribution of an institution to system-wide macro risk and expressed his confidence in the development of improved measurement techniques. He pointed out that there is a high demand for analytical and empirical research to sharpen the macro-prudential perspective and to develop the tools to address them.
The last three papers asked how Borio's policy agenda can be implemented in practice, discussing important issues from an applied perspective as well as empirically. Giovanni Majnoni from the the World Bank discussed the role of Loan Loss Provisioning during economic slowdowns. He presented econometric evidence that banks tend to delay provisioning for bad loans until the point when cyclical downturns have already set in, possibly magnifying the impact of the economic cycle on banks' income and capital. He also reported considerable differences in patterns followed by banks around the world. In the next presentation, Lieven Baele took up a topic that was constantly raised during the conference, namely the role of market discipline in the supervisory process. An important precondition for more market discipline is to gather information about whether bank's stock prices are a potentially useful indicator of financial distress. Baele contributed to this issue by analyzing the effects of diversification and capitalization on bank credit risk, using stock returns of a large sample of banks within a multi-factor model.
Finally, Martin Summer presented an inspiring tool for macro-prudential risk management. After developing an econometric framework for the assessment of the risk of interbank credits on the level of the entire banking system, he reported interesting results from applying his framework to a cross section of individual bank data. At the end of the conference, Gerhard Illing thanked all presenters and discussant for their stimulating contributions. The best papers of the conference will be published in a special volume of CESifo Economic Studies.
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