Posted by: Dirk | January 31, 2008

How to increase supervision in the financial sector

The FT reports that Spain has been largely unaffected from the fallout created by the financial crisis:

According to Mr Ortiz, several years ago a clutch of Spanish banks discretely approached the Spanish central bank and asked permission to do what other international banks were doing at the time – namely set up networks of SIVs.

However, Madrid took a dim view of this and demanded that Spanish banks post an 8 per cent capital charge against SIV assets. That essentially killled the business stone dead by removing incentives to create these creatures.

SIVs – structured investment vehicles – are used by banks to ‘get rid’ of risky investments. The risk dumped at the SIV is not in the books of the bank then, which means that the overall position of risk taken by the bank seems lower than it actually is. This is an advantage under Basel I (and II) rules and benefits the bank. However, financial risk is then hidden away and the regulators don’t know where it is. In times of crisis this becomes a problem.

In case of a liquidity crisis, SIVs do not have access to central bank money – banks do. So the problem is that the central bank could save a bank, but not a SIV (unless the bank takes it back on its own books, which however will harm the bank). Today, in the middle of a solvency crisis, we can also see that banks don’t trust each other because they know some banks must have hidden SIVs which are big liabilities. Inter-bank lending has declined. This is bad for the economy. Maybe the Spanish central bank got a thing right when almost everybody else (including Germany) liberalized the financial sector in order to enhance the position of national banks.

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