Policymakers were alarmed at how opaque and complex securitised products collapsed in value as the credit crunch began unfolding from mid-2007, despite being highly rated. This sparked huge writedowns by banks that shattered investor confidence.
“In a scheme analogous to the hierarchy controlling the availability of pharmaceuticals, the safest securities would, like non-prescription medicines, be available for purchase by everyone,” BIS, which acts as a forum for the world’s central banks, said in its annual report.
“Next would be financial instruments available only to those with an authorisation, like prescription drugs; another level down would be securities available only in limited amounts to pre-screened individuals and institutions, like drugs in experimental trials,” the BIS said. “Finally, at the lowest level would be securities that are deemed illegal.”
A new instrument would be rated or an existing one moved to a higher safety category only after successful tests. “Such a registration and certification system creates transparency and enhances safety… This will mean that issuers bear increased responsibility for the risk assessment of their products,” BIS said.
Access to some products is already restricted in some countries, such as to hedge funds. Policymakers are tightening financial rules in a process spearheaded globally by the Group of 20 industrialised and emerging market countries.
BIS endorses many of the pledges the G20 made in April such as the need to monitor all parts of the financial market, particularly system-wide risks, to limit tendencies to amplify rather than counter the prevailing trend, and to insist on the clearing of off-exchange traded derivatives.
Policy interventions should combine outright bans with regulations that bump up the cost of risky activities, it said.
BIS goes a step further than the G20 by suggesting shifting off-exchange traded instruments onto exchanges. “The primary advantage of taking this step is that it ensures price transparency with less reliance on market-makers,” BIS said.
It proposed a bespoke “systemic capital charge” on each bank to reflect the risk it posed to the wider financial system as well as a minimum leverage ratio, another regulatory tool other policymakers have aired.
BIS also backed calls for all financial institutions to have a bankruptcy contingency plan.
The G20 wants banks to build up buffers of capital during good times for tapping when markets turn sour, thereby lessening the likelihood of more taxpayer funded bailouts.
BIS said one difficulty was knowing when banks should start building up a buffer, which would make lending more costly, and when reserves can be tapped to promote lending. “Yet another problem with implementing a countercyclical charge is that it is not ‘one size fits all’,” BIS said. Central bankers also needed to adopt a more “activist stance” to booms in both credit and asset prices.
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