The Turner Review A regulatory response to the global banking crisis March 2009 [...]... efficiency and market rationality 1.1 The global story: macro trends meet financial innovation At the core of the crisis lay an interplay between macro-imbalances which had grown rapidly in the last ten years, and financial market developments and innovations which have been underway for about 30 years but which accelerated over the last ten to 15, partly under the stimulus of the macro-imbalances Macro-imbalances... regulatory response in a clear analysis of the causes of the crisis This chapter presents that analysis in four sections: • The global story: macro-imbalances meet financial innovation • The UK specific story: rapid credit growth, significant wholesale and overseas funding • Global finance without global government: fault lines in the regulation of cross-border banks • Fundamental theoretical issues: market... reliance on sophisticated maths The increasing scale and complexity of the securitised credit market was obvious to individual participants, to regulators and to academic observers But the predominant assumption was that increased complexity had been matched by the evolution of mathematically sophisticated and effective techniques for measuring and managing the resulting risks Central to many of the. .. book assets & capital 2007: examples Market risk capital requirement as % trading assets Trading assets as % of total assets Trading / market risk capital as % total capital requirements Bank 1 0 4% 34% 11% Bank 2 0.4% 28% 7% Bank 3 0.1% 57% 4% Bank 4 1.1% 27% 7% Source: BIS Estimates from Bank Annual Reports • In addition, however, the years running up to the crisis saw the rapid growth of off-balance... with macroeconomic imbalances, helped create an unsustainable credit boom and asset price inflation • Those characteristics then played a crucial role in reinforcing the severity of the financial crisis and in transmitting financial system problems into real economy effects • The shock to the banking system has been so great that its impaired ability to extend credit to the real economy has played and... complexity of the mathematics used to measure and manage risk, moreover, made it increasingly difficult for top management and boards to assess and exercise judgement over the risks being taken Mathematical sophistication ended up not containing risk, but providing false assurance that other prima facie indicators of increasing risk (e.g rapid credit extension and balance sheet growth) could be safely ignored... (stripping out all intra financial system assets and liabilities) and observe the maturity mismatch between the consolidated assets and liabilities This is an impossibly difficult task The large increase in long-term mortgage debts, however, makes it almost certain that a large increase in aggregate maturity transformation has occurred: only if this increase had been matched by an increase in long-term assets... major role in mortgage lending since the creation of Fannie Mae in the 1930s and had been playing a steadily increasing role in the global financial system and in particular in the American financial system for a decade and a half before the mid-1990s But from the mid-1990s the system entered explosive growth in both scale and complexity: • with huge growth in the value of the total stock of credit securities... with particularly rapid growth of overnight repos • And, particularly in the US, mutual funds increasingly performed a bank-like form of maturity transformation They have held long-term credit assets against liabilities to investors which promise immediate redemption And in many cases they have made implicit or explicit promises not to ‘break the buck’ i.e not to allow capital value to fall below the. .. was the concept of Value-at-Risk (VAR), enabling inferences about forward-looking risk to be drawn from the observation of past patterns of price movement This technique, developed in the early 1990s, was not only accepted as standard across the industry, but adopted by regulators as the basis for calculating trading risk and required capital, (being incorporated for instance within the European Capital . of Fannie Mae in the 1930s and had been playing a steadily increasing role in the global financial system and in particular in the American financial system. and market rationality. 1.1. The global story: macro trends meet financial innovation At the core of the crisis lay an interplay between macro-imbalances