Module 6
The Financial System Assignment
a. The Sources and Consequences of Runs, Panics, and Crises
In a market-based economy, the opportunity to succeed is also an opportunity
to fail. New restaurants open and others go out of business. Only 1 in 10 restaurants
survives as long as three years. In principle, banks should be no different from
restaurants: new ones should open and unpopular ones close. But few of us would
want to live in a world where banks fail at the same rate as restaurants. Banks serve
some essential functions in our economy: They provide access to the payments
system, and they screen and monitor borrowers to reduce information problems. If
your favorite restaurant closes suddenly, you can still eat, but if your bank closes, you
lose your ability to make purchases and pay your rent. So while no one suggests that
the government appoint officials to minimize restaurant closings, everyone expects
the government to safeguard banks. Banks’ fragility arises from the fact that they
provide liquidity to depositors. That is, they allow depositors to withdraw their
balances on demand.
If you want the entire amount in your checking account converted into cash,
the process is straightforward and relies on a fundamental promise made by your
bank. All you need to do is visit your bank and request a withdrawal. Upon your
request, the bank teller is obligated to provide you with the full amount of your
checking account balance in cash. This obligation is part of the bank's commitment to
ensure that customers have access to their deposited funds whenever they need them,
without delay or restriction.
This promise of withdrawal on demand is a cornerstone of modern banking,
forming the basis of the trust that depositors place in their financial institutions. It
ensures that individuals and businesses can rely on their bank to provide liquidity
when needed, whether for daily expenses, emergency situations, or significant
purchases. The ability to convert deposits into cash seamlessly is essential for the
smooth functioning of the economy, allowing for the free flow of money and fostering
consumer confidence.
However, for a bank to fulfill this promise, it must maintain sufficient liquid
assets to cover these withdrawals. Liquid assets are those that can be quickly and
easily converted into cash without significant loss of value, such as cash reserves,
government securities, and other highly liquid investments. The bank's ability to meet
withdrawal demands depends on its liquidity management practices, which involve
carefully balancing the amounts of liquid assets held against the potential demand for
withdrawals from customers.
If a bank finds itself unable to meet this promise of withdrawal on demand due
to a shortage of liquid assets, it faces a severe crisis. When a bank cannot provide cash
to depositors upon request, it signals a fundamental failure in its operations and
financial stability. This situation can trigger a loss of confidence among customers,
leading to a bank run where many depositors rush to withdraw their funds
simultaneously. A bank run exacerbates the liquidity problem, as the bank's limited
liquid assets are quickly depleted, making it even harder to meet withdrawal requests.
The inability to meet withdrawal demands can ultimately lead to the bank's
failure. Bank failures can have widespread consequences, affecting not only the
bank's customers but also the broader financial system and economy. To mitigate such
risks, banks are subject to regulatory requirements that mandate maintaining a certain
level of liquid assets relative to their liabilities. These regulations are designed to
ensure that banks can honor their commitments to depositors and maintain stability
even during periods of financial stress.
Moreover, banks engage in various strategies to manage liquidity risk
effectively. These strategies include diversifying their asset portfolios, establishing
lines of credit with other financial institutions, and participating in central bank
facilities designed to provide liquidity support during times of need. By implementing
these measures, banks strive to maintain the necessary liquidity to meet customer
demands and uphold the trust placed in them by their depositors.
In addition to regulatory requirements and internal liquidity management
practices, banks also benefit from deposit insurance schemes provided by government
agencies, such as the Federal Deposit Insurance Corporation (FDIC) in the United
States. Deposit insurance protects a certain amount of customer deposits in the event
of a bank failure, reducing the likelihood of a bank run and enhancing depositor
confidence. This safety net helps to stabilize the banking system and ensures that
individual depositors do not suffer significant losses if their bank encounters financial
difficulties.
In conclusion, the ability of a bank to convert the entire amount in a
customer's checking account into cash on demand is a fundamental aspect of the
banking relationship. This promise relies on the bank's effective liquidity management
and regulatory oversight to ensure that sufficient liquid assets are available to meet
withdrawal requests. Failure to meet this obligation due to insufficient liquid assets
can lead to severe consequences, including bank runs and potential bank failure.
Therefore, maintaining liquidity and depositor confidence is paramount for the
stability and functioning of the banking system.
Banks not only guarantee their depositors immediate cash on demand; they
promise to satisfy depositors’ withdrawal requests on a first-come, first-served basis.
This commitment has some important implications. Suppose depositors begin to lose
confidence in a bank’s ability to meet their withdrawal requests. They have heard a
rumor that one of the bank’s largest loans has defaulted, so that the bank’s assets may
no longer cover its liabilities. True or not, reports that a bank has become insolvent
can spread fear that it will run out of cash and close its doors. Mindful of the bank’s
firstcome, first-served policy, frenzied depositors may rush to the bank to convert
their balances to cash before other customers arrive. In effect, they hope that getting
to the bank early will let them withdraw their “investment” (deposit) at a price above
its true value (the value of the banks’ assets). Such a bank run can cause a bank to fail.
In short, a bank run can be the result of either real or imagined problems. No bank is
immune to the loss of depositors’ confidence just because it is profitable and sound. In
practice, runs often start with shakier banks and then spread to healthier ones as
confidence erodes.
The financial crisis of 2007–2009 is replete with examples of runs on banks
and on the much less regulated shadow banks, which also provide liquidity to the
financial system. The United Kingdom faced its first run on a large bank in more than
a century when, in September 2007, depositors rushed to withdraw funds from
Northern Rock, a major housing lender (see neighboring photos). Meanwhile, the
largest savings bank in the United States, Washington Mutual, failed when depositors
fled in September 2008. That same month, withdrawals from Wachovia Bank—at the
time the fourth-largest U.S. commercial bank—led to its emergency sale. Quiet,
invisible runs on shadow banks were even more dramatic, as they punctuated the
peaks of the financial crisis. In March 2008, short-term lenders and other creditors
stopped lending to Bear Stearns, the fifth-largest U.S. investment bank. The run halted
only when the Federal Reserve Bank of New York stepped in to help the then-second-
largest U.S. commercial bank, JPMorgan Chase, acquire Bear. A similar sudden stop
in private lending led the U.S. government to take over Fannie Mae and Freddie Mac
in September 2008. The financial crisis peaked later that month when a run on
Lehman Brothers—the fourthlargest U.S. investment bank—precipitated its
bankruptcy. Shortly thereafter, losses on Lehman debt compelled a money-market
mutual fund (MMMF) to “break the buck”—that is, to lower its share value below $1;
that fixed value is traditionally promised by all MMMFs so that their customers can
treat their shares as if they were bank deposits.
Fearful that other money market mutual funds (MMMFs) would "break the
buck," which means that the net asset value (NAV) of the fund would fall below the
stable $1 per share mark, investors in those funds quickly began to withdraw their
investments. This panic was fueled by the belief that the promised $1 per share might
exceed the true market value of the fund's underlying assets, particularly in times of
financial instability. Investors were concerned that the assets held by these funds,
often including short-term corporate and government debt, might be worth less than
their face value, leading to losses.
The term "breaking the buck" is critical in the context of money market funds
because these funds are designed to offer a safe, low-risk investment option that
maintains a stable value. For decades, investors had trusted that they could redeem
their shares at any time for $1 each, providing both liquidity and a minimal return.
This assurance made money market funds a popular choice for both individual and
institutional investors seeking a safe haven for their cash reserves.
However, during periods of economic turmoil, the value of the underlying
assets in these funds can fluctuate, sometimes significantly. When the financial crisis
of 2007-2008 hit, it exposed vulnerabilities in the financial system, including the
assets held by money market funds. The collapse of Lehman Brothers in September
2008 was a pivotal moment that triggered widespread panic. One of the prominent
money market funds, the Reserve Primary Fund, held significant amounts of Lehman
Brothers' commercial paper. As Lehman Brothers declared bankruptcy, the value of its
commercial paper plummeted, causing the Reserve Primary Fund to break the buck.
This event sent shockwaves through the financial markets, prompting
investors to fear that other MMMFs might also break the buck. In a bid to protect
their investments, investors rushed to redeem their shares at the promised $1 per share
before the funds could revalue their assets at lower prices. This massive wave of
redemptions created a run on money market funds, exacerbating the liquidity crisis.
The resulting runs on MMMFs had far-reaching implications, undermining a
key component of the U.S. financial intermediation mechanism. Money market funds
play a crucial role in providing short-term funding to corporations, financial
institutions, and governments by purchasing their short-term debt instruments. The
panic-induced withdrawals forced these funds to liquidate assets rapidly, often at fire-
sale prices, to meet redemption requests. This not only reduced the liquidity available
in the financial system but also drove down the prices of short-term debt securities,
further destabilizing the market.
The ripple effects of these runs were felt across the financial system.
Corporations that relied on the short-term funding provided by money market funds
faced difficulties in rolling over their debt, leading to a broader credit crunch.
Financial institutions that used money market funds as a source of liquidity found
themselves under pressure, exacerbating the already strained conditions in the
banking sector.
In response to the crisis, policymakers and regulators took several steps to
restore confidence in the money market fund sector and stabilize the financial system.
The U.S. Treasury Department announced a temporary guarantee program for money
market funds, ensuring that investors would not lose their principal. Additionally, the
Federal Reserve introduced liquidity facilities to support money market funds and
other financial institutions, aiming to ease the liquidity crunch and stabilize the
market.
These interventions helped to calm the immediate panic, but they also
highlighted the need for regulatory reforms to address the structural vulnerabilities in
the money market fund industry. Subsequent reforms included measures to increase
the transparency of fund holdings, enhance liquidity requirements, and implement
mechanisms such as floating NAVs for institutional prime money market funds to
better reflect the underlying value of their assets.
In conclusion, the fear of money market mutual funds breaking the buck led to
a significant wave of redemptions as investors sought to protect their investments.
This panic-induced run on the funds disrupted a critical part of the U.S. financial
intermediation mechanism, exacerbating the liquidity crisis and contributing to
broader market instability. The events underscored the importance of robust
regulatory frameworks and interventions to maintain stability and confidence in the
financial system, especially in times of economic stress.
What matters during a bank run is not whether a bank is solvent, but whether it
is liquid. Solvency means that the value of the bank’s assets exceeds the value of its
liabilities—that is, the bank has a positive net worth. Liquidity means that the bank
has sufficient reserves and immediately marketable assets to meet depositors’ demand
for withdrawals. False rumors that a bank is insolvent can lead to a run that renders a
bank illiquid. If people believe that a bank is in trouble, that belief alone can make it
so. When a bank fails, depositors may lose some or all of their deposits, and
information about borrowers’ creditworthiness may disappear. For these reasons
alone, government officials work to ensure that all banks are operated in a way that
minimizes their chance of failure. But that is not their main worry. The primary
concern is that a single bank’s failure might cause a small-scale bank run that could
turn into a systemwide bank panic. This phenomenon of spreading panic on the part
of depositors in banks (or of creditors to shadow banks like MMMFs) is called
contagion. Contagion was powerful at the peak of the 2007–2009 financial crisis, as
depositors and creditors grew anxious about the well-being of financial intermediaries
around the world.
Information asymmetries are the reason that a run on a single bank can turn
into a bank panic that threatens the entire financial system. What is true for cars is
even truer for banks. Most of us are not in a position to assess the quality of a bank’s
balance sheet. In fact, because banks often make loans based on sophisticated
statistical models, only an expert with knowledge of market conditions and access to
all details about a bank’s assets can estimate their worth. Depositors, then, are in the
same position as uninformed buyers in the used-car market: They can’t tell the
difference between a good bank and a bad bank. And if the cost of withdrawal is tiny,
who wants to keep a deposit in a bank if there is even a small chance that it could be
insolvent? So when rumors spread that a certain bank is in trouble, depositors and
other creditors begin to worry about their own banks’ financial condition.
Concern about even a single bank's stability can trigger a widespread panic,
potentially causing a domino effect that leads profitable banks throughout the nation
to fail. This can culminate in a complete collapse of the banking system, which can
have devastating consequences for the broader economy. The nature of banking, with
its reliance on depositor confidence and liquidity, makes it particularly vulnerable to
such panics. When depositors lose confidence in one bank, it can lead to a bank run
where they rush to withdraw their funds, fearing the bank's imminent insolvency. This
sudden withdrawal of deposits can strain the bank’s liquid assets, forcing it to sell off
assets at fire-sale prices to meet the demands, further exacerbating the liquidity crisis.
The panic does not remain confined to the initially troubled bank. Fear can
spread rapidly to other banks, regardless of their actual financial health. Even
profitable and well-capitalized banks can fall victim to this contagion effect, as
depositors across the banking system begin to question the safety of their funds. The
interconnectedness of banks through the interbank lending market, shared
investments, and common customer bases means that the failure or perceived
weakness of one bank can lead to widespread uncertainty and loss of confidence in
the entire banking sector.
Banking panics and financial crises can indeed stem from false rumors or
misinformation. In an age where information spreads quickly through media and
social networks, rumors about a bank's financial health can cause depositors to act on
incomplete or inaccurate information. For example, a rumor about a bank's liquidity
issues or exposure to bad loans can quickly escalate, leading to a self-fulfilling
prophecy where the panic itself causes the bank to face real liquidity problems. The
Great Depression of the 1930s provides a historical example of how rumors and panic
led to widespread bank runs and failures, despite many banks being fundamentally
sound.
However, banking panics and financial crises can also arise from more
concrete reasons, reflecting underlying issues within the financial system. Structural
weaknesses, such as poor regulatory oversight, inadequate capital buffers, and risky
lending practices, can create vulnerabilities that, when exposed, lead to crises. For
instance, the 2007-2008 financial crisis was precipitated by the collapse of the
housing bubble, which revealed the extensive exposure of banks and financial
institutions to subprime mortgages and mortgage-backed securities. As these assets
plummeted in value, it triggered a cascade of failures and a severe liquidity crunch.
Other concrete reasons for banking panics include economic recessions, which
can lead to a spike in loan defaults and erode banks' capital reserves. For example,
during a severe economic downturn, businesses and individuals may struggle to repay
their loans, resulting in significant losses for banks. If the banks do not have sufficient
capital to absorb these losses, it can undermine their solvency and trigger a crisis of
confidence among depositors and investors.
Additionally, systemic risks such as those posed by large, interconnected
financial institutions can contribute to banking panics. The failure of a major bank or
financial institution can have far-reaching implications due to its interconnectedness
with other banks and the financial system at large. The collapse of Lehman Brothers
in 2008 is a prime example of how the failure of a single institution can precipitate a
broader financial crisis, leading to widespread panic and uncertainty in the banking
sector.
To mitigate the risks of banking panics and financial crises, robust regulatory
frameworks and effective oversight are essential. Regulatory measures such as higher
capital and liquidity requirements, regular stress testing, and the implementation of
resolution mechanisms for failing banks are designed to enhance the resilience of the
banking system. Central banks and regulatory authorities also play a critical role in
maintaining financial stability through monetary policy, lender-of-last-resort facilities,
and coordination with international regulatory bodies.
Deposit insurance schemes are another important tool in preventing bank runs
and maintaining depositor confidence. By guaranteeing a certain amount of deposits,
these schemes reassure depositors that their funds are safe even if their bank
encounters difficulties. This can help prevent the panic-driven withdrawals that can
lead to bank runs and systemic crises.
In conclusion, concern about even one bank can indeed create a panic that
causes profitable banks throughout the nation to fail, leading to a complete collapse of
the banking system. While banking panics and financial crises can easily result from
false rumors, they can also occur for more concrete reasons, such as structural
weaknesses, economic downturns, and systemic risks. Understanding the multifaceted
causes of these crises and implementing robust regulatory measures are essential for
maintaining the stability and resilience of the banking system.
Because a bank’s assets are a combination of loans and securities, anything
that affects borrowers’ ability to make their loan payments or drives down the market
value of securities has the potential to imperil the bank’s finances. The decline of U.S.
housing prices and the resulting wave of mortgage defaults that began in 2006 set the
stage for the crisis of 2007–2009 by lowering the value of assets on the balance sheets
of intermediaries around the world. Recessions— widespread downturns in business
activity—have a clear negative impact on a bank’s balance sheet. When business
slows, firms have a harder time paying their debts. People lose their jobs and suddenly
can’t make their loan payments.
As default rates rise, the financial health of banks begins to deteriorate rapidly.
When borrowers fail to make timely payments on their loans, the value of the banks'
assets—composed largely of these loans—declines. This reduction in asset value has
a direct impact on bank capital, which serves as a cushion against losses. With less
capital, banks find themselves in a precarious position, as regulatory requirements
mandate that they maintain certain capital levels to absorb potential losses and
continue their operations safely.
As the capital levels drop, banks are compelled to take immediate corrective
actions to restore their financial stability. One of the primary measures they adopt is to
contract their balance sheets. This contraction involves reducing the size of their loan
portfolios, which means making fewer new loans and calling in or selling off existing
ones. By doing so, banks attempt to shore up their capital ratios and reduce their
exposure to further defaults and potential losses. However, this tightening of credit
has significant repercussions for the broader economy.
The decline in loan availability means that businesses find it increasingly
difficult to secure the financing they need for investment and growth. Small and
medium-sized enterprises (SMEs), which rely heavily on bank loans for working
capital and expansion projects, are particularly affected. As these businesses face
credit constraints, they are forced to scale back their operations, delay or cancel
expansion plans, and cut back on hiring. This reduction in business investment not
only stifles growth but also contributes to higher unemployment rates as companies
lay off workers or freeze hiring.
The contraction in business activity feeds back into the economy, amplifying
the downturn. As businesses invest less and reduce their workforce, consumer
spending also declines due to lower income and increased job insecurity. This
decrease in consumption further depresses economic activity, creating a vicious cycle
of declining demand, falling production, and rising unemployment. The negative
impact on GDP growth becomes pronounced, pushing the economy deeper into
recession.
Large asset price declines, such as significant drops in real estate and stock
market values, exacerbate the situation. These declines can lead to a severe loss of
wealth for households and investors, further reducing their spending and investment
capacity. When asset prices plummet, the collateral value that borrowers can offer to
secure loans also diminishes. This makes banks even more cautious about extending
credit, as the risk of lending against devalued collateral increases.
In deep recessions, the combination of rising default rates, declining asset
values, and reduced lending capacity can lead to widespread failures of both banks
and shadow banks. Shadow banks, which include non-bank financial institutions such
as hedge funds, investment banks, and money market funds, play a significant role in
providing credit and liquidity to the economy. Unlike traditional banks, shadow banks
are less regulated and often take on higher risks. During economic downturns, the
vulnerabilities of these institutions become apparent, and they may face severe
liquidity shortages and solvency issues.
The failure of banks and shadow banks has far-reaching consequences for the
financial system and the economy. When banks fail, depositors lose confidence in the
safety of their funds, leading to bank runs and further destabilizing the banking sector.
The collapse of shadow banks can trigger a chain reaction of defaults and asset fire
sales, exacerbating the financial turmoil. The interconnectedness of financial
institutions means that the failure of one entity can have a cascading effect,
threatening the stability of the entire financial system.
To mitigate these risks, policymakers and regulators must implement measures
to stabilize the banking sector and restore confidence. Central banks may step in as
lenders of last resort, providing liquidity to troubled banks to prevent bank runs and
ensure that they can meet withdrawal demands. Governments may also implement
fiscal stimulus packages to support businesses and households, boosting demand and
helping to stabilize the economy.
In addition, regulatory reforms aimed at strengthening the resilience of banks
and shadow banks are crucial. These reforms may include higher capital and liquidity
requirements, enhanced risk management practices, and stricter oversight of shadow
banking activities. By ensuring that financial institutions are better prepared to
withstand economic shocks, regulators can reduce the likelihood of widespread
failures and maintain the stability of the financial system.
In conclusion, as default rates rise, the value of bank assets declines, leading to
a drop in bank capital. This reduction in capital forces banks to contract their balance
sheets, resulting in fewer loans being made. The decrease in lending hampers business
investment, which amplifies the economic downturn. Large asset price declines and
deep recessions can lead to the widespread failure of banks and shadow banks, with
severe consequences for the financial system and the broader economy. Effective
regulatory measures and timely interventions are essential to mitigate these risks and
maintain financial stability.
The history of banking in the United States shows clear evidence that
downturns in the business cycle put pressure on banks, substantially increasing the
risk of panics. To see this, we can look at the period from 1871 to 1914, prior to the
creation of the Federal Reserve System. Over those four-plus decades, there were 11
business cycles— booms followed by recessions. Bank panics occurred during seven
of them, five of which were very severe. They often started near the business cycle
peak, when investors began to anticipate a downturn. The next series of severe bank
panics occurred during the Great Depression of the 1930s, when output fell by
roughly one-third. Bank panics usually start with real economic events or their
prospect, not just rumors.3 Financial disruptions can also occur whenever borrowers’
net worth falls, as it does during a deflation. Companies borrow a fixed number of
dollars to invest in real assets like buildings and machines, whose values fall with
deflation. The same applies to households acquiring houses. So a drop inMprices
reduces companies’ and households’ net worth (but not their loan payments). This
decline in net worth aggravates the adverse selection and moral hazard problems
caused by information asymmetries, making loans more difficult to obtain.
If borrowers cannot secure new financing, the repercussions extend far beyond
individual hardships and become a significant drag on the broader economy. Business
investment, which includes expenditures on new equipment, infrastructure, and
expansion projects, will fall sharply. Without access to credit, businesses struggle to
fund these crucial investments, leading to a slowdown in economic growth. Similarly,
residential investment, encompassing the construction of new homes, renovations, and
real estate purchases, will also decline. The inability to obtain financing forces
potential homeowners to delay or forgo purchasing property, which in turn affects
construction companies, real estate agents, and various ancillary industries.
The reduction in both business and residential investment leads to a
contraction in overall economic activity. As businesses cut back on investment, they
also reduce their workforce, leading to higher unemployment rates. Job losses
decrease household incomes, further reducing consumer spending and demand for
goods and services. This reduction in demand forces businesses to cut production,
leading to additional layoffs and a downward economic spiral. The decline in
residential investment has similar effects, as fewer construction projects mean fewer
jobs in the construction sector and related industries.
As economic activity slows, the number of defaults on loans increases.
Businesses facing reduced revenues and consumers dealing with unemployment or
reduced incomes struggle to meet their debt obligations. This increase in defaults
directly impacts banks' balance sheets, as the value of their loan portfolios declines.
When borrowers default, banks not only lose the expected interest income but also
face the potential of having to write off the principal amounts of the loans. This
erosion of asset values weakens the banks' capital positions, reducing their ability to
absorb further losses.
The deterioration of banks' balance sheets exacerbates existing information
problems. In times of financial stability, banks can rely on historical data and
established risk models to assess the creditworthiness of borrowers. However, during
a crisis, the reliability of these models diminishes. Banks become uncertain about the
true financial health of their current and potential borrowers. This uncertainty leads
banks to tighten credit conditions even further, as they become more risk-averse. They
may increase interest rates, demand more collateral, or outright refuse new loans to
businesses and individuals who might have qualified under normal circumstances.
This tightening of credit conditions creates a vicious cycle. As banks restrict
lending, businesses and consumers find it even harder to obtain the financing they
need, leading to further declines in investment and consumption. The resulting
economic contraction leads to more defaults, which further weaken banks' balance
sheets. This adverse feedback loop between financial and economic activity is a key
characteristic of deep crises. The interconnectedness of financial institutions and the
broader economy means that problems in one sector can quickly spread, creating
systemic risks.
A full-blown financial crisis can emerge from this adverse feedback loop. As
banks' balance sheets weaken, they may face liquidity shortages, making it difficult to
meet withdrawal demands from depositors. This can lead to bank runs, where a large
number of depositors simultaneously try to withdraw their funds, fearing the bank's
collapse. If multiple banks experience such runs, the stability of the entire banking
system can be threatened. The crisis can spread to other financial institutions,
including investment banks, insurance companies, and shadow banks, amplifying the
overall financial turmoil.
The collapse of financial institutions during a crisis has severe consequences
for the real economy. When banks fail, the credit intermediation process is disrupted,
making it even harder for businesses and consumers to access financing. The loss of
depositor confidence can lead to a freeze in the credit markets, where even healthy
businesses struggle to secure loans. This credit freeze further depresses economic
activity, leading to deeper recessions and prolonged recoveries.
Governments and central banks play a critical role in managing and mitigating
financial crises. They can implement measures to restore confidence in the banking
system, such as providing emergency liquidity support to struggling banks,
guaranteeing deposits, and recapitalizing banks through direct capital injections.
Central banks may also lower interest rates and engage in unconventional monetary
policies, such as quantitative easing, to stimulate lending and economic activity.
Fiscal policies, including stimulus packages and public investment programs, can help
boost demand and support economic recovery.
In addition to immediate crisis management, long-term regulatory reforms are
essential to prevent future crises. Strengthening the regulatory framework to ensure
that banks maintain adequate capital and liquidity buffers can enhance the resilience
of the financial system. Improving transparency and oversight of shadow banking
activities can reduce systemic risks. International coordination among regulators can
help address the global nature of financial markets and prevent the spread of crises
across borders.
In conclusion, the inability of borrowers to secure new financing leads to a
decline in business and residential investment, reducing overall economic activity and
increasing loan defaults. As defaults rise, banks' balance sheets deteriorate,
compounding information problems and creating a full-blown financial crisis. This
adverse feedback loop between financial and economic activity is a defining
characteristic of deep crises. Effective crisis management and regulatory reforms are
crucial to mitigate the impact of such crises and enhance the stability of the financial
system.
b. The Government Safety Net
First, the government is obligated to protect small investors, many of whom
are unable to judge the soundness of their financial institutions. While competition is
supposed to discipline all the institutions in the industry, in practice only the force of
law can ensure a bank’s integrity. As small investors, we rely on the government to
protect us from mismanagement and malfeasance. Second, the tendency for small
firms to merge into large ones reduces competition, ultimately ending in monopolies.
In general, monopolies exploit their customers, raising prices to earn unwarranted
profits. Because monopolies are inefficient, the government intervenes to prevent the
firms in an industry from becoming too large. In the financial system, that means
ensuring that even large banks face competition. Third, the combustible mix of
liquidity risk and information asymmetries means that the financial system is
inherently unstable. A financial firm can collapse much more quickly than an
industrial company. For a steel corporation, an electronics manufacturer, or an
automobile maker, failure occurs slowly as customers disappear one by one. But a
financial institution can create and destroy the value of its assets in an astonishingly
short period, and a single firm’s failure can bring down the entire system.
Government officials employ a combination of strategies to protect investors
and ensure the stability of the financial system. First, they provide the safety net to
insure small depositors. Authorities both operate as the lender of last resort, making
loans to banks that face sudden deposit outflows, and provide deposit insurance,
guaranteeing that depositors receive the full value of their accounts should an
institution fail. But this safety net causes bank managers to take on too much risk,
leading to the regulation and supervision. This section will examine the unique role of
depository institutions in our financial system. The point is that we need banks. While
they are essential, they are also fragile. This leads to a discussion of the components
of the safety net and the problems it creates. The next section will look at the
government’s responses to these problems.
As the key providers of liquidity, banks ensure a sufficient supply of the
means of payment for the economy to operate smoothly and efficiently. This critical
role and the problems associated with it make banks a key focus of attention for
government regulators. Shadow banks are also major providers of liquidity, and
following their role in the financial crisis of 2007–2009, they also have attracted
intense attention from regulators around the world. We all rely heavily on these
intermediaries for access to the payments system. If banks, MMMFs, and securities
brokers were to disappear, we would no longer be able to transfer funds—at least not
until someone stepped forward to take their place. Other financial institutions—
insurance companies, pension funds, and the like—do not have this essential day-to-
day function of facilitating payments.
Furthermore, because of their role in liquidity provision, banks and shadow
banks are prone to runs. These intermediaries hold illiquid assets to back their liquid
liabilities. In the case of banks, their promise of full and constant value to depositors
is based on assets of uncertain value. The fixed-value shares of MMMFs are like bank
deposits in all but name. The liabilities of other shadow banks are less similar but
have important deposit-like characteristics. For example, repurchase agreements are
usually overnight contracts, so a repo lender can refuse to roll over the loan to a
securities broker at virtually any time, an action similar to a deposit withdrawal. In
contrast, pension funds and insurance companies (and even some hedge funds) may
hold illiquid assets, but their liability holders cannot withdraw funds whenever they
want. Moreover, banks and shadow banks are linked to one another both on their
balance sheets and in their customers’ minds. commercial banking system assets—
which was less than 1 percent of all bank capital. Prior to the crisis, interbank lending
had been substantially greater and represented roughly one-third of all bank capital. If
a bank begins to fail, it will default on its loan payments to other banks and thereby
transmit its financial distress to them. Similarly, MMMFs hold large volumes of
commercial paper, most of which was issued by banks. And (shadow) banks are
among the key repo lenders to securities brokers and hedge funds. Banks and shadow
banks are so interdependent that they are capable of initiating contagion throughout
the financial system.
Other financial institutions also may pose such risks, but these intermediaries
typically are very large and few in number (see footnote 4 regarding the derivatives
exposure of AIG, the largest U.S. insurer when the crisis of 2007–2009 hit). While the
ramifications of a financial crisis outside the system of banks and shadow banks may
be more limited, they are still damaging. As a result, the government also protects
individuals who do business with finance companies, pension funds, and insurance
companies. For example, government regulations require insurance companies to
provide proper information to policyholders and restrict the ways the companies
manage their assets. The same is true for securities firms and pension funds, whose
assets must be structured to ensure that they will be able to meet their obligations
many years into the future.
The best way to stop a bank failure from turning into a bank panic is to make
sure solvent institutions can meet their depositors’ withdrawal demands. In 1873 the
British economist Walter Bagehot suggested the need for a lender of last resort to
perform this function. Such an institution could make loans to prevent the failure of
solvent banks and could provide liquidity in sufficient quantity to prevent or end a
financial panic. Specifically, Bagehot proposed that Britain’s central bank should lend
freely on good collateral at a high rate of interest. By lending freely he meant
providing liquidity on demand to any intermediary that asked for it. Good collateral
would provide assurance of the borrowing institution’s solvency, and the high interest
rate would penalize the borrower for failing to hold enough reserves or easily salable
assets to meet deposit outflows and would promote rapid repayment when funding
conditions normalized.
The existence of a lender of last resort significantly reduces, but does not
eliminate, contagion. The series of three bank panics that occurred during the Great
Depression of the 1930s is one example of the failure of a lender of last resort. While
the Federal Reserve had the capacity and the mandate to operate as a lender of last
resort in the 1930s, it chose not to do so. In effect, policymakers acted as if the “fire”
would burn itself out. Instead, the conflagration spread and intensified. The result was
the worst financial disaster in the 100-plus-year history of the Federal Reserve. There
is another flaw in the concept of a lender of last resort. For the system to work, central
bank officials who approve the loan applications must be able to distinguish an
illiquid from an insolvent institution. But during a crisis, computing the market value
of a bank’s assets is almost impossible, because there are no market prices. (If a bank
could sell its marketable assets in the financial markets, it wouldn’t need a loan from
the entral bank.) Because a bank will go to the central bank for a direct loan only after
having exhausted all opportunities to sell its assets and borrow from other banks
without collateral, its illiquidity and its need to seek a loan from the government raise
the question of its solvency. Officials, anxious to keep the crisis from deepening, are
likely to be generous in evaluating the bank’s assets and to grant a loan even if they
suspect the bank may be insolvent. Knowing this, bank managers will tend to take too
many risks.
In other words, the central bank’s difficulty in distinguishing a bank’s
insolvency from its illiquidity creates moral hazard for bank managers. It is important
for a lender of last resort to operate in a manner that minimizes the tendency for
bankers to take too much risk in their operations. Finally, as we learned in the crisis of
2007–2009, the U.S. lender-of-last-resort mechanism has not kept pace with the
evolution of the financial system. Like many government practices in the financial
arena, the conventional rules for Fed discount lending were (and remain) based on the
legal form of the borrower rather than on its economic function. Some intermediaries
facing sudden flight by their very short-term creditors were not banks—to whom the
Fed usually lends—but shadow banks, which do not normally have access to Fed
loans. Only by using its emergency lending authority—something last done in the
Great Depression of the 1930s—was the Fed able to lend to such nonbank
intermediaries to stem the crisis.
During the turmoil, the Fed utilized this emergency authority repeatedly when
it needed to lend to securities brokers, MMMFs, insurers, other nonbank
intermediaries, and even to nonfinancial firms. Based on this emergency authority, it
developed a variety of new policy tools—including the Primary Dealer Credit Facility
through which the authorities lent directly to nonbank securities dealers—to deliver
liquidity where and when it was needed. While this ad hoc, reactive approach helped
both stem runs and counter their impact, it had limited value in preventing them in the
first place.
Lending to nonbank intermediaries also added massively to the moral hazard
usually associated with the lender of last resort. These intermediaries generally are not
subject to regulation or supervision by the Federal Reserve, and the level of oversight
they received from other agencies was typically less intense and intrusive than that
applied to banks. Accordingly, in the absence of new oversight, the access to central
bank loans granted by the Fed in the crisis will encourage these borrowers to take
greater risks in the future.
Congress’s response to the Federal Reserve’s failure to stem the bank panics of
the 1930s was to create nationwide deposit insurance. The Federal Deposit Insurance
Corporation guarantees that a depositor will receive the full account balance up to
some maximum amount even if a bank fails. Bank failures, in effect, become the
problem of the insurer; bank customers need not concern themselves with their bank’s
risk taking. So long as a bank has deposit insurance, customers’ deposits are safe,
even in the event of a run or bank failure. Here’s how the system works. When a bank
fails, the FDIC resolves the insolvency either by closing the institution or by finding a
buyer. The first approach, closing the bank, is called the payoff method. The FDIC
pays off all the bank’s depositors and then sells all the bank’s assets in an attempt to
recover the amount paid out. Under the payoff method, depositors whose balances
exceed the insurance limit, currently $250,000, suffer some losses.
The second approach, called the purchase-and-assumption method, is more
commonly applied than the payoff method. In a “P&A” transaction, the FDIC finds a
firm that is willing to take over the failed bank. Because the failed institution is
insolvent— on the balance sheet, its liabilities exceed its assets—no purchaser will do
so for free. In fact, the FDIC has to pay banks to purchase failed institutions. That is,
the FDIC sells the failed bank at a negative price. Depositors prefer the P&A method
to the payoff method because the transition is typically seamless, with the bank
closing as usual at the end of the week and reopening on Monday morning under new
ownership. In a purchase and assumption, no depositors, even those whose account
balances exceed the deposit insurance limit, suffer a loss. No private or small public-
sector insurance fund would be able to withstand a run on all the banks it insures—but
the FDIC can. Because the U.S. Treasury backs the FDIC, it can withstand any crisis
that does not undermine the nation’s sovereign credit standing.
We know that insurance changes people’s behavior. Protected depositors have
no incentive to monitor their bankers. Knowing this, bankers take on more risk than
they would normally, because they get the benefits while the government assumes the
costs. In protecting depositors, then, the government creates moral hazard. This is not
just a theory. We can find evidence for this assertion by comparing bank balance
sheets before and after the implementation of deposit insurance. In the 1920s, before
the deposit insurance system was created, banks’ ratio of assets to capital was about 4
to 1. Most economic and financial historians believe that government insurance led
directly to the rise in risk. And that is not the only problem. Government officials are
especially worried about the largest institutions because they can pose a threat to the
entire financial system. Although the failure of a community bank is unfortunate, the
prospect of a large financial conglomerate going under is a regulator’s worst
nightmare. The financial havoc that could be caused by the collapse of an institution
holding more than a trillion dollars in assets is too much for most people even to
contemplate.
What this means is that some intermediaries are treated as too big to fail or too
interconnected to fail. Putting such an institution through the usual mechanism for
resolving a business failure—bankruptcy court—may force the bankruptcy of many
households, firms, and other intermediaries that have contracted with the failed
institution. Thus, too big to fail really means too big or too complex to shut down or
sell in an orderly fashion without large and painful spillovers. Regulators call such an
institution too big to resolve, and the Dodd-Frank law gave rise to a special legal
designation for such a firm: systemically important financial institution (SIFI).
Experience has led the managers of these too-big-to-fail intermediaries to expect
thatMif their institutions begin to founder, the government will find a way to bail them
out. Regulators allowed Lehman Brothers to fail in September 2008, but the painful
financial and economic disruptions that ensued served only to reinforce the
widespread expectation that government will bail out the largest and most
interconnected financial institutions.
A bailout of a failed bank can take many forms. In most cases, the deposit
insurer quickly finds a buyer; otherwise, the government, as lender of last resort,
usually makes a loan to buy time to fashion a solution. Depositors whose balances do
not exceed the insurance limit will be made whole. But in the crisis of 2007–2009,
most of the creditors to banks were protected, not just the insured depositors.
Following the Lehman failure, governments in Europe and the United States
guaranteed all of the liabilities of their largest banks. In particular, they promised that
the holders of new bonds issued by the banks would not incur losses. Without these
guarantees, the evaporation of funding liquidity probably would have led to a rapid
cascade of failures because banks would be unable to fund themselves. In a number of
cases, unlike in a normal bankruptcy, the managers of failing banks also kept their
jobs. During the crisis, governments also recapitalized some intermediaries—that is,
gave them public money in return for partial ownership rights—to prevent a run by
their creditors. In effect, governments declared recapitalized intermediaries to be too
big to fail while they allowed many smaller institutions to go under. In the United
States, for example, the FDIC shut down 297 banks in 2009 and 2010, the largest
number in a two-year period since 1991–1992. In these ways, the government, not the
market, chose the winners and the losers.
Because it undermines the market discipline that depositors and creditors
impose on banks and shadow banks, this too-big-to-fail policy is ripe for reform.
Given the $250,000 insurance limit, a corporation with millions of dollars to deposit
would normally be concerned about the quality and riskiness of the assets a bank
holds. If the bank or MMMF were to fail, the corporation would face significant
losses. Thus, the threat of withdrawal of these large balances restrains the bank or
MMMF from taking on too much risk.7 But for very large banks, the too-big-to-fail
policy renders the deposit insurance ceiling meaningless. In the aftermath of the crisis
of 2007–2009, everyone knew which banks were too big to fail and that the
authorities would support them. With little threat that depositors will flee, bank
managers are inclined to take greater risk than they otherwise would. The too-big-to-
fail policy compounds the problem of moral hazard, encouraging managers of large
banks to engage in extremely risky behavior (and putting small banks at a competitive
disadvantage). During the financial crisis, many shadow banks also received
government bailouts and guarantees that foster moral hazard. Like their bank
brethren, some of the largest shadow banks obtained government support because
their failure was perceived as too costly in a crisis. And the problem is not limited to
the too-big-to-fail class. The U.S. government guaranteed the liabilities of all
MMMFs—most of which are small—in order to halt a run. Whenever the government
provides such a safety net without charging an appropriate fee for it in advance of the
protection, the government creates an incentive for financial institutions to take risks
that can threaten the system as a whole.
Why do government authorities provide this free safety net in a crisis? After
all, they know that some quick-fix policies create bad incentives and impose large
burdens on taxpayers. In the midst of a crisis, however, they must balance the often-
conflicting goals of crisis mitigation and crisis prevention. Frequently, there are no
good choices. Like an emergency room doctor trying to save a dying patient, a
government official will occasionally act to rescue the financial system from urgent
threats that, if left to play out on their own, would lead to an economic catastrophe. Of
course, the taxpayer foots the bill. Naturally, in the aftermath of a crisis, limiting the
unintended consequences of the government safety net is the leading problem facing
regulators. Some argue that toobig-to-fail institutions are simply too big to exist and
that they need to be broken up, removing certain business activities from them in
ways that limit incentives for risk taking. However, that approach does not eliminate
the bad incentives arising from deposit insurance and from the government guarantees
provided to smaller institutions during the crisis. We’ll also discuss how, through a
variety of fees and charges, governments could discourage certain kinds of risk
taking, thereby limiting systemic threats.
c. Regulation and Supervision of the Financial System
Government officials employ three strategies to ensure that the risks created
by theMsafety net are contained. Government regulation establishes a set of specific
rules for intermediaries to follow. Government supervision provides general oversight
of financial institutions. And formal examination of an institution’s books by
specialists provides detailed information on the firm’s operation. As we look at each
of these, keep in mind that the goal of government regulation is not to remove all the
risk that investors face. Financial intermediaries themselves facilitate the transfer and
allocation of risk, improving economic efficiency in the process. Regulating risk out
of existence would eliminate one of the purposes of financial institutions. Consider
also that efforts to tighten regulations on banks may push risk taking somewhere
outside the view of the authorities. The result may not be a safer financial system.
Wary of asking taxpayers to pick up the bill for bank insolvencies, officials
created regulatory requirements that are designed to minimize the cost of such failures
to the public. The first screen, put in place to make sure the people who own and run
banks are not criminals, is for a new bank to obtain a charter. Once a bank has been
chartered and has opened for business, a complex web of detailed regulations restricts
competition, specifies what assets the bank can and cannot hold, requires the bank to
hold a minimum level of capital, and makes public information about the bank’s
balance sheet. As we all know, rules are one thing; enforcement is another. Posting a
speed limit on an interstate highway is just the first step in preventing people from
driving too fast. Unless the police patrol the highways and penalize speeding drivers,
such laws are worthless. The same is true of banking regulations. The best-designed
regulatory structure in the world won’t be worth the paper it’s written on unless
someone monitors banks’ compliance. Government supervisors are the highway patrol
of the banking world. They monitor, inspect, and examine banks and other
intermediaries to make sure their business practices conform to regulatory
requirements.
Banks are regulated and supervised by a combination of the U.S. Treasury, the
Federal Reserve, the FDIC, and state banking authorities. The overlapping nature of
this regulatory structure means that more than one agency works to safeguard the
soundness of each bank. A bank can effectively choose its regulators by choosing
whether to be a state or national bank and whether or not to belong to the Federal
Reserve System. Banks can also change their legal form––say, to become a securities
broker-dealer—leading to yet a different regulator (the Securities and Exchange
Commission) and regulatory framework. If one regulator allows an activity that
another prohibits, a bank’s managers can threaten to switch, or argue that a competitor
who answers to a more permissive regulator has an unfair advantage. The
consequences of such regulatory competition are twofold. First, regulators force each
other to innovate, improving the quality of the regulations they write. But regulatory
competition has a less desirable outcome: It allows bank managers to shop for the
most lenient regulator—the one whose rules and enforcement are the least stringent.
Especially since the repeal of the ban on interstate branching, regulatory agencies
have tried to prevent this outcome. Today state authorities usually defer to the Federal
Reserve, whose supervisors impose uniform regulations on all state-chartered banks.
The Comptroller of the Currency cooperates with the Fed to ensure that national
banks receive similar treatment.
However, the financial crisis of 2007–2009 highlighted cases of “regulator
shopping” that resulted in ineffective oversight. One example was the supervision of
AIG—then the largest U.S. insurer—by the small U.S. Office of Thrift Supervision
(OTS) that also had supervised failed savings banks like Countrywide, IndyMac, and
Washington Mutual. OTS naturally had less experience than other supervisors with
the insurance business—especially with the complex derivatives that AIG sold and
with its business of lending securities. In effect, AIG had chosen its supervisor by
purchasing a small savings bank years earlier. In 2010, the Dodd-Frank Act closed the
OTS—the only regulatory agency that was shut down following the crisis—and
merged it with the Office of the Comptroller of the Currency. The arbitrary and
complex structure of U.S. financial regulators does not stop with the banks. Some
shadow banks—such as securities brokers—are subject to regulation by both the
Securities and Exchange Commission (SEC) and the Commodity Futures Trading
Commission (CFTC). The SEC also regulates MMMFs. Even after the DoddFrank
Act, hedge funds remain lightly regulated: Aside from registering with the SEC, and
fulfilling reporting requirements, they need only act with care (i.e., as a fiduciary).
One long-standing goal of financial regulators has been to prevent banks from
growing too big and powerful, both because their failure might threaten the financial
system and because banks that have no real competition exploit their customers. And
until 1999, banks could not own securities firms or insurance companies. While recent
legislation has changed the banking industry, restrictions on bank size remain. Bank
mergers still require government approval. Before granting it, officials must be
convinced on two points. First, the new bank must not constitute a monopoly in any
geographic region. Second, if a small community bank is to be taken over by a large
regional bank, the small bank’s customers must be well served by the merger.
But government officials also worry that the greater the competition among
banks, the more difficulty banks will have making a profit. Competition reduces the
prices customers must pay and forces companies to innovate in order to survive.
These effects are as true of the market for deposits and loans as they are of the
markets for cars and computers. Competition raises the interest rate bankers pay on
deposits and lowers the interest rate they receive on loans; it spurs them to improve
the quality of the services they provide. Normally we think of these effects of
competition as being positive, but there is a negative side as well. Lower interest
margins and reduced fee income cause bankers to look for other ways to turn a profit.
Some may be tempted to assume more risk—that is, to make loans and purchase
securities that are riskier than advisable, to increase leverage, or to rely excessively on
short-term funding.
There are two ways to avoid this type of moral hazard. First, government
officials can explicitly restrict competition. That is the solution regulators have chosen
in a number of countries; it was also one of the purposes of branching restrictions.9
(Branching restrictions create networks of small, geographically separated
independent banks that face very little competition in their regions.) A second way to
combat bankers’ tendency to take on too much risk is to prohibit them from making
certain types of loans and from purchasing particular securities. The financial crisis of
2007–2009 accelerated the ongoing concentration in the U.S. financial system. When
banks and shadow banks weakened or failed during the crisis, regulators encouraged
other institutions to buy them. JPMorgan Chase, already the second-largest U.S. bank,
acquired both Bear Stearns, the fifth-largest broker, and Washington Mutual, the
largest savings bank. Bank of America, the number one bank in the country,
purchased both Merrill Lynch, the largest broker, and Countrywide, the biggest
housing lender. And Wells Fargo, the fifth-largest commercial bank, took over
Wachovia, the fourth-largest. As of 2018, 36 percent of deposits at U.S. commercial
banks were held in only four banks—Bank of America, Citi, JPMorgan Chase, and
Wells Fargo. Thus, in the process of trying to keep the crisis from deepening by
merging failing banks with the largest ones, authorities made the too-big-to-fail
problem even bigger—in a future crisis, it will be even costlier to allow these swollen
intermediaries to fail. Unless their risk taking is restrained, the protected status of
these megabanks will encourage their managers to take greater risks, increasing the
likelihood of another crisis.
One way to prevent bankers from exploiting their safety net is to restrict
banks’ balance sheets. Such regulations take two forms: restrictions on the types of
asset banks can hold and requirements that they maintain minimum levels of capital.
While banks are allowed to build big office buildings and buy corporate jets for top
executives, their financial assets are heavily restricted. U.S. banks cannot hold
common stock.10 Regulations also restrict both the grade and quantity of bonds a
bank can hold. For example, banks are generally prohibited from purchasing bonds
that are below investment grade, and their holdings from any single private issuer
cannot exceed 25 percent of their capital. The size of the loans they can make to
particular borrowers is also limited. For example, the Federal Reserve requires that
one bank’s exposure to another not exceed 25 percent of the bank’s capital. While
these restrictions on asset holdings are quite detailed, they are really just a matter of
common sense and sound risk management. In effect, regulators are telling bankers to
do what they should be doing already: holding a well-diversified portfolio of liquid,
high-grade bonds and loans.
Minimum capital requirements complement these limitations on bank assets.
Recall that bank capital represents the net worth of the bank to its owners. Capital
serves as both a cushion against declines in the value of the bank’s assets, lowering
the likelihood of the bank’s failure, and a way to reduce the problem of moral hazard.
Capital requirements take two basic forms. The first requires most banks to keep their
ratio of capital to assets above some minimum level, regardless of the structure of
their balance sheets. This approach is equivalent to capping leverage, which is a key
means of taking risk. The second requires banks to finance their activities with capital
in proportion to the riskiness of their operations. The computation is extremely
complicated and the rules change frequently, but basically a bank must first compute
the risk-adjusted level of its assets given the likelihood of a loan or bond default. Then
a capital charge is assessed against that level. Of course, banks face a multitude of
other risks, including trading risk, operational risk, and the risk associated with their
off-balance sheet operations. Regulators require banks to finance their activities with
capital based on assessments of those risks as well. (See Tools of the Trade for a
description of recent changes in capital requirements.)
Many intermediaries are required to provide information, both to their
customers about the cost of their products and to the financial markets about their
balance sheets. Regulations regarding disclosures to customers are responsible for the
small print on loan applications and deposit account agreements; their purpose is to
protect consumers. A bank must tell you the interest rate charged on a loan and must
do so in a standardized way that allows you to compare interest rates at competing
banks. (This regulation is similar to the one that requires grocery stores to show the
price of cheese, peanut butter, or popcorn per ounce, allowing customers to tell which
brand or size is cheapest.) The bank must also tell you the fees it charges to maintain a
checking account—the cost of check clearing, the monthly service charge, the fee for
overdrafts, and the interest rate paid on the balance, if any.
One example of where disclosure is important is the measurement of a bank’s
capital and its leverage (the ratio of assets to capital). In practice, capital turns out to
be quite difficult to compute primarily because assets are challenging to measure.
Measurement problems arise both with a simple unweighted measure of assets and
with the regulatory quantity known as risk-weighted assets. The computation of the
first is complicated by the presence of derivatives on the balance sheet of the bank.
How should you treat the fact that large banks engage in both the buying and selling
of interest rate swaps, among other things? And, because it requires the computation
of the relative riskiness of portfolios of assets that differ across banks, calculating the
level of riskweighted assets is quite difficult as well.
