Bailout

The limits of systemic risk regulators

By Felix Salmon

What kind of information will a systemic risk regulator need from banks? Sifma has just commissioned an 86-page study on this question from Deloitte, and the conclusion, though predictable, is sobering:

There is much work to be done, both domestically and globally, in order to address the issue of systemic risks in the financial system… Information gaps are inevitable, however, as noted by the FSB, ?These gaps are highlighted, and significant costs incurred, when a lack of timely, accurate information hinders the ability of policy makers and market participants to develop effective policy responses.?

One of the reasons why Basel II was never fully implemented in the US is that many of the banks here simply don’t have the requisite sophistication to implement it. (In hindsight, this was a good thing.) And worldwide, it’s inevitable that many banks will lack the IT infrastructure needed to be able to give systemic-risk regulators the information they need, especially in a crisis.

You can’t regulate what you can’t measure, and it’s likely to prove impossible, in practice, to get all the world’s biggest banks up and running in terms of reliably reporting all of the information that regulators need, in an easily-tractable and standardized form. Inevitably, regulators are going to end up spending an inordinate amount of time regulating the known knowns rather than the known unknowns, like the economist looking for his keys underneath a lamppost.

As for the unknown unknowns, those you just have to resign yourself to, and hope that size, leverage, liquidity and capital-adequacy restrictions somehow keep them in check. Which is why Basel III is so important. Regulators are important, but rules are too.

Full post as published by Macroprudential on June 25, 2010 (boomark / email).