Economics of Banking Regulation and Supervision

Syllabus

(First Draft)

Hasan Ersel

February 12, 2011

The purpose of these lectures is to discuss the problems associated with banking regulation and supervision from an economic point of view. Therefore the emphasis will be on establishing relations between regulatory/supervisory issues and the economic theory. Recent developments in regulation and supervision in response to 2007+ crisis will be examined in detail.

Lecture I: Financial System and Banking

Do financial intermediaries play a role in a market economy? Why banks do not have any role in an Arrow-Debreu type of economy? Some remarks concerning the historical development of finance.

References

Allen, F. And D. Gale: Comparing Financial Systems, CambridgeMass.: The MIT Press, 2000, Chs. 1-3

Freixas X. & J-C. Rochet: Microeconomics of Banking, Second Edition, CambridgeMass.: The MIT Press, 2008, Ch 1.

Lecture II: The Inherent Instability of the Financial System and Uncertainty

Keynes-Minsky analysis:Instability is closely connected with the dynamism of the system. Control for containing the negative effects of instability: How to stabilize an unstable economy? Regulation and Supervision: The role of the state.The distinction between the macro and micro aspects of financial stability: Price stability (Central banks) and the health of financial institutions, notably banks. (financial regulatory and supervisory authorities).

The Knight-Keynes distinction between risk and uncertainty:What is uncertainty? What is Risk? How risk is measured? What is “fat tail” problem?

References

A) Instability of the Financial System

Allen, F. and D. Gale: Understanding Financial Crisis, Oxford: OxfordUniversity Press, 2007, pp. 1-26.

Minsky, H.: Stabilizing the Unstable Economy, New York: McGraw Hill, 2008. [Originally published by the Yale University Press, 1986],

Minsky, H. : “The Financial Instability Hypothesis”, Working Paper No. 74, The Jerome Levy Economics Institute of BardCollege, May 1992. (will be supplied)

Rochet, J-C.: Why Are There so Many Banking Crisis?, Princeton: PrincetonUniversity Press, 2008.

B) Uncertainty and Risk:

Mandelbrot, B.B. & R.L. Hudson: The (Mis) Behavior of Markets-A Fractal View of Risk, Ruin and Reward, London: Profile Books, 2004. (Popular, recommended)

Lecture III: Microprudential Regulation (Basel I & II)

Historical foundations of financial regulation and supervision:The early US experience. The Basel I framework. Basel II Approach to Financial Regulation: Three pillars of Basel II. From “credit risk” to multiple categories of risk.

References

Dewatripont, H., J-C. Rochet and J. Tirole: Balancing the Banks, Princeton: PrincetonUniversity Press, 2010, Ch. 1.

Freixas X. & J-C. Rochet: Microeconomics of Banking, Second Edition, CambridgeMass.: The MIT Press, 2008, Ch 9.

Tarullo, D.: Banking on Basel,WashingtonD.C.: Peterson Institute for International Economics, 2008. Chs. 2,3 and5.

Lecture IV:The “2007+” Crisis and the Critique of the Existing Regulation

Distinguishing two qualitatively different problems: 1) Failure of self-regulation, i.e. the “deregulation ideology” in the USA and in some European countries. 2) Insufficiency of the microprudential approach. Pro-cyclicality of capital adequacy rules and other issues such as “too big to fail”, shadow banking etc.

References

1) 2007+ Crisis

Cassidy, J. : How Markets Fail, London: Penguin, 2009. (Popular, recommended)

Roubini, N. & S. Nihm: Crisis in Economics, London: Allen Lane, 2010.

Stiglitz, J.E. : Free Fall, New York: W.W. Norton, 2010.

Reinhart, C. and K. S. Rogoff: This Time Different, Princeton: PrincetonUniversity Press, 2009. (Highly recommended)

2) Critique of Existing Regulation

Dewatripont, H., J-C. Rochet and J. Tirole: Balancing the Banks, Princeton: PrincetonUniversity Press, 2010, Ch. 3.

Lecture V: Economic Foundations of Macroprudential Regulations:

How to handle Systemic Risk in Finance? What is macroprudential regulation? Does it require a macrofoundation? What are the institutional aspects of macroprudential regulation? Price stability versus financial stability; should the role and responsibilities of the central bank be broadened? The future of central bank independence; The new Basel III rules: Capital and liquidity requirements.

References

Brunnermeier, M., A. Crockett, C. Goodhart, A.D. Persaud and H. Shin: The Fundamental Principles of Financial Regulation, Geneva Reports on World Economy, 11, ICBM, 2009 (will be supplied)

Davis, E.P. and D. Karim: “Macroprudential Regulation- The Missing Policy Pillar”, Keynote Address at the 6th Euroframe Conference on Economic Policy Issues in the European Union, 12th June 2009. (will be supplied)

Goodhart, C. : “The Role of Macroprudential Supervision”, Paper Presented at the Federal Reserve Bank of Atlanta 2010 Financial Markets Conference, Athens, Georgia, May 12, 2010. (will be supplied)

Hanson, S., A.K: Kashyap and J.C. Stein: “A Macroprudential Approach to Financial Regulation”, Working Paper No. 10-29, The University of Chigago BoothSchool of Business. (will be supplied)

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