"Restructuring Failed Financial Firms in Bankruptcy: Learning from Lehman" Free Download
Yale Journal on Regulation, Forthcoming

MARK J. ROE, Harvard Law School
STEPHEN ADAMS, Harvard University - Law School - Alumni

Lehman Brothers’ failure and bankruptcy is widely thought to have deepened the 2008 financial crisis whose negative effects the real economy is still experiencing. Yet, while financial regulation has changed in hopes of avoiding another crisis, bankruptcy rules such as those that governed Lehman’s failure, have not been changed at all. When Lehman failed, it lost considerable further value when its contracting counterparties terminated their financial contracts with Lehman. Hit by broad termination, Lehman’s overall value to its creditors degraded beyond the immediate losses that caused its downfall, and then, along with AIG’s failure several days later, the broad termination involving Lehman further deeply disrupted financial markets in the United States, and indeed the world. Lehman’s financial portfolio was thought to be running a paper profit of over $20 billion when it filed, and is said to have lost up to $75 billion as a result of the post-filing liquidation by Lehman’s counterparties of their deals with Lehman. How such a vast shift can occur, whether bankruptcy can ameliorate the problem (yes), and whether bankruptcy law has been updated since the financial crisis to handle the problem (no) are the subjects of this paper.

For bankruptcy to handle a systemically important financial institution successfully, it must market the institution’s financial contracts’ portfolio, which current bankruptcy law prevents. Moreover, regulatory and bankruptcy authorities need authority to sell the portfolio along product market lines, which they lack. Such authority is needed, first, to preserve its overall portfolio value, and, second, to break up and sell a very large portfolio that could not be sold intact in the aggregate, as the most systemically difficult portfolios are embedded in the world’s largest financial institutions and cannot readily be sold intact. Bankruptcy is the best and first place to put that authority. And, from a systemic perspective, bankruptcy needs to be able to dismantle a large failed portfolio, rather than sell it intact to a larger institution, a typical but undesirable solution here. Lastly, although regulatory and other conditions have changed since the financial crisis, making the bankruptcy target a moving one, the bankruptcy target deserves more consideration today, rather than less, because it is a reachable target without the complexities and uncertainties of new alternatives now in motion. Bankruptcy, however, has not been fixed and updated since the financial crisis, leaving the financial system at risk that, if a major financial institution failed and could not be otherwise resolved, the same difficulties would again arise as arose during the 2008-2009 crisis and the failures of Lehman and AIG.

"Trends in the Polish Banking System's Liquidity Risk Measured by Basel III Standards" Free Download

BLAZEJ KOCHANSKI, Gdansk University of Technology - Faculty of Management and Economics

Basel III liquidity proposals are still "work in progress" as new versions of regulations appear, but general shape of two major new liquidity ratios (short term LCR – liquidity coverage ratio and medium-term NSFR – net stable funding ratio) seems to be established. In the paper LCR and NSFR measurement in time is proposed to assess changes in systemic liquidity risk in Poland.

Estimations of two Basel ratios for years 1996-2012, based on the data on aggregate banking system from National Bank of Poland, reveal that both ratios gradually deteriorated throughout most of this period. The ratios stabilized in 2008 – probably a combined result of banks' reaction to financial crisis abroad and new regulations.

It seems that on average Polish banks can meet Basel's liquidity requirement. However, reverse stress test for LCR uncovers that currently an average Polish bank would withstand a run-off of no more than 20% retail deposits – while fifteen years earlier similar stress test would show that banks were able to endure even 60% run-off rate. Also, "net cash capital" surplus present in the system at the beginning of the analysed period has practically disappeared, even if favourable Basel weights for mortgage loans are taken into account.

"The Risk-Taking Channel of Monetary Policy – Exploring All Avenues" Free Download
Bank of Portugal Working Papers 2 | 2014

DIANA BONFIM, Banco de Portugal
CARLA SOARES, Bank of Portugal

It is well established that when monetary policy is accommodative, banks tend to grant more credit. However, only recently attention was given to the quality of credit granted and, naturally, the risk assumed during those periods. This article makes an empirical contribution to the analysis of the so-called risk-taking channel of monetary policy. We use bank loan level data and different methodologies to test whether banks assume more credit risk when monetary policy interest rates are lower. Our results provide evidence in favor of this channel through different angles. We show that banks, most notably smaller banks, grant more loans to non-financial corporations with recent defaults or without credit history when policy interest rates are lower. We also find that loans granted when interest rates are low are more likely to default in the hiking phase of the interest rate cycle. However, the level of policy interest rates at the moment of loan concession does not seem to be relevant for the ex-post probability of default of the overall loan portfolio.

"Data Intensive Technologies for Financial Regulatory Systems" Free Download

ROY S FREEDMAN, Inductive Solutions, Inc., NYU Polytechnic School of Engineering

We briefly review three U.S. regulatory initiatives in the context of data intensive technologies. We compare the conventional data warehouse approaches versus the newer approaches based on exploiting parallel computation, from data appliance to the open source “big data? approaches. Several existing financial applications are reviewed and implementation tradeoffs are discussed. The goal is to help regulators understand these technologies and to help technologists understand the new financial regulatory initiatives.

"Substituted Compliance: An Alternative to National Treatment for Cross-Border Transactions and International Financial Entities" Free Download
Georgetown Journal of Law & Public Policy, Vol. 13, 2015

LILY D. VO, Columbia Law School

The recent trend toward globalization of financial markets has resulted in a growing need for effective U.S. policies with respect to foreign banking organizations that conduct business with U.S. persons or within U.S. territory. These foreign financial entities typically fall within the jurisdiction of both the U.S. and their home countries.

Due to concerns that excessively risky activities of foreign entities could adversely affect U.S. markets, the Dodd-Frank Act defaults toward the National Treatment Model, mandating that all foreign entities within U.S. jurisdiction comply with U.S. regulations in addition to their home country regulations. However, the Dodd-Frank approach creates problems due to variations in financial regulations among jurisdictions — U.S. regulations are often redundant or in conflict with the entities’ host country rules. This article therefore recommends that U.S. agencies develop a policy that would: permit efficient transactions with jurisdictions that previously had conflicting regulations; reduce costs associated with complying with duplicative regulations; and minimize the risk of contagion to U.S. markets.

This article will evaluate several potential regulatory frameworks for international entities — specifically harmonization, minilateralism, mutual recognition, and outcome-based substituted compliance — in the areas of entity registration; prudential standards, such as capital adequacy and liquidity; and transaction requirements, such as margin. Substituted compliance is a policy in which international financial institutions with operations in the U.S. could be deemed in compliance with U.S. law and regulations by complying with their host countries’ regulations, provided that the regulations in the host country are declared to be "equivalent" to their U.S. counterparts. If correctly implemented, substituted compliance could be the most effective framework for achieving the desired policy objectives in the areas of entity registration and over-the-counter derivative transactions. However, despite the benefits of substituted compliance, this article recognizes the lack of viability of substituted compliance with respect to prudential requirements until U.S. regulators have increased confidence in foreign regulators’ abilities to control contagion. This article suggests potential reforms that could provide such confidence.


About this eJournal

This eJournal distributes working and accepted paper abstracts covering regulatory and legal aspects of national and international financial institutions. The eJournal welcomes research that deals with legal aspects of depository institutions including banks, credit unions, trust companies, and mortgage loan companies. Topics also include regulation of insurance companies, brokers, underwriters, and investment funds.

Editors: G. William Schwert, University of Rochester, and Rene M. Stulz, Ohio State University (OSU)


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Advisory Board

Regulation of Financial Institutions eJournal

Max L. Heine Professor of Finance and Vice Director, New York University (NYU) - Salomon Center, Max L. Heine Professor of Finance, New York University (NYU) - Department of Finance

Professor of Finance and Dykema Professor of Business Administration, University of Michigan, Stephen M. Ross School of Business

Morgan Stanley Investment Management

Joseph E. Boettner Professor, Temple University - Risk Management & Insurance & Actuarial Science, Harry J. Loman Professor Emeritus, University of Pennsylvania - Insurance & Risk Management Department

Merton H. Miller Distinguished Service Professor of Finance, University of Chicago - Booth School of Business, National Bureau of Economic Research (NBER)

Robert R. McCormick Distinguished Service Professor of Finance, University of Chicago - Finance

Professor of Finance, New York University - Stern School of Business

Bank of America Professor of Managerial Leadership, Washington University in St. Louis - Olin Business School

Co-Founder, Chairman, Managing Director and Integrity Officer, Social Science Electronic Publishing (SSEP), Inc., Jesse Isidor Straus Professor of Business Administration, Emeritus, Harvard Business School, Research Associate, National Bureau of Economic Research (NBER), Fellow, European Corporate Governance Institute (ECGI)

Washington Mutual Endowed Chair in Innovation Professor of Finance, University of Washington - Michael G. Foster School of Business

Professor of Business Administration, University of Pittsburgh - Finance Group

University of Illinois at Chicago - Department of Finance

President, Federal Reserve Bank of Philadelphia, National Bureau of Economic Research (NBER)

Duke University - Fuqua School of Business

Sterling Professor of Law, Yale Law School

Distinguished University Professor of Finance and Statistics, University of Rochester - Simon Business School, National Bureau of Economic Research (NBER)

Everett D. Reese Chair of Banking and Monetary Economics, Ohio State University (OSU) - Department of Finance, National Bureau of Economic Research (NBER), Fellow, European Corporate Governance Institute (ECGI)

Erwin H. Schell Professor of Management, Massachusetts Institute of Technology (MIT) - Sloan School of Management