ERM Symposium Day 3: General Session IV

Last day, penultimate general session!

General Session IV: "Critical Reflections of the Crisis; International Regulatory Experiences and the Way Forward to a More Robust Financial System"

Dr. Colin Lawrence of the Bank of England, Dr. Allan Malz of the Federal Reserve Bank of New York, John Bilson of the Illinois Institute of Technology

Almost everything said during this panel was said before, particularly in General Session II and in Dr. Lawrence's comments during the "Three Lines of Defense" Seminar (Day 1.) Note that I didn't take notes on the very beginning of this panel, nor on the parts that were redundant.

Allan:
Risk spreads - declined since 2009 but not all the way back to historical levels
Market liquidity - continues to be in poor shape
Implied volatilities - at all-time lows
Why hasn't market liquidity improved with these other variables?

John:
Concerned about the behavior of central banks (increasing the money supply.) We are moving toward a period of higher interest rates. "In economics, everything takes a lot longer to happen than you think it would. When it happens, it happens more quickly than you thought it would." We are seeing inflation in the stock market and housing prices as a consequence of this monetary policy (quantitative easing.) Consequently there is a lot of uncertainty in the financial markets. Which countries are doing best coming out of this crisis? Australia and Canada seem to be doing better, with less central bank interference (although there are other influences in those economies.)

Colin:
Commercial bank profitability declines with interest rate compression. If you raise the interest rates, it's not just the central bank rate, it's the expected inflation on top of that. With high interest rates *and* high unemployment, we'll have high impairments. Forbearance, etc., will result in many more challenges for banks unless they change their controls in advance.

Allan:
We need to remain cognizant of the "human risk," because any adjustment we might make may not play out as expected if people react differently than anticipated. Regarding inflation, at least for the moment expected rates seem well-anchored.

What are implications for risk management practices?

Allan:
Obviously risk managers need to be tracking these regulatory changes. Regulators are looking more at risk-weighted assets, but more than that, we're realizing that simply adding more capital resolves a lot of problems very simply.

What about CVaR? In some cases, we see the CVaR is actually lower than the VaR.

Allan: I've never understood why CVaR is set up as being so much better than VaR. You still need a distribution, and the problem with VaR is that we don't know the distribution. It also doesn't resolve the problem on one-size-fits-all regulation.

John:
There's a fiber-optic cable from Chicago to NY that runs in a straight line instead of along the railways like the old one. Access to this cable costs $1M per year, and it saves you 3-1000ths of a second. That shows how big electronic trading is. Computers are making trades before any human even hears or reacts to news.

Colin:
Liquidity issues make VaR not work when you have concentrated assets. It's a fundamental flaw that's been present for a long time.

End General Session IV.