Archive for August 7th, 2009

Iceland Capital Control Lifting Strategy

August 7, 2009

As I pointed earlier, Iceland plans to undo the capital controls it imposed after crisis shattered its economy. However, it was to declare its strategy for the same later.

It has now released a strategy doc for the same. It is a useful read on why they were imposed, what kind of controls were imposed and way out now. To cut it short, first it plans to lift controls on capital inflows, then on longer term outflows and finally on short term outflows.


Romer answers critiques and says fiscal stimulus is working

August 7, 2009

Christina Romer knows how to answer her critiques and does it really well. 

Recently, there was criticism that Obama plan was too small. The plan was based on a Romer study in Jan 2009 which said if Obama fiscal plan goes through unemployment would be around 8%. Where as it is currently at 9.5%. So, econs criticise Romer report & Obama fiscal stimulus to be weak. To this In her recent speech, she says:

Here, I can’t resist pointing out the fallacy in a common critique. Throughout the spring, I frequently heard people say: “The unemployment rate is even higher than you all predicted without stimulus. That means the policy isn’t working and may actually be making things worse.” Even leaving aside the fact that we were always very clear that there was tremendous uncertainty about what would happen to the economy, that argument is – to quote a recent New York Times editorial – just plain “silly.”5 To understand why, let me give you an analogy. Suppose you go to your doctor for a strep throat and he or she prescribes an antibiotic. Sometime after you get the prescription, and maybe even after you take the first pill, your fever spikes. Do you decide that the medicine is useless? Do you conclude the antibiotic caused the infection to get worse? Surely not. You probably conclude that the illness was more serious than you and the doctor thought, and are very glad you saw the doctor and started taking the medicine when you did.

That was exactly the situation with the economy. It is true that the U.S. and world economies went down much faster last fall and winter than we, and almost all other forecasters, expected. The revised GDP statistics show that the actual decline in GDP growth in the third and fourth quarters of last year was about twice as large as the preliminary estimates we had at the time indicated. And, the rise in the unemployment rate has been exceptionally large, even given the large fall in GDP that we now know occurred.  The fact that the economy deteriorated between January when we were doing our forecast and the end of March simply reinforces how crucial it was that we took action when we did.

🙂 She had answered her critiques equally well previously.

Her talk focuses on Obama’s fiscal stimulus plan and says it is working and the results are there for all to see. The numbers have started improving and the confidence is improving. What is even surprising is the recent Q2 GDP and unemployment numbers though negative, show the sharpest rise from Q1 to Q2 in the last 25 years!!

She also looks at fiscal stimuls in other countries and US states and finds that recovery is sharpest in those countries/states where fiscal stimulus is highest.

She also tells you about this website:  which provides you details of the Obama fiscal stimulus plan:

I know that some believe that the government can never do things well. But this program really is a model of efficiency and transparency. The website provides an honest and thorough accounting of what is getting done. The biggest problem so far occurred when a blogger misinterpreted an entry and reported that we had spent a million dollars for two pounds of ham. It turns out it was for 760,000 pounds of ham (in two-pound packages) that went to food banks and soup kitchens – a pretty good value at about $1.50 a pound. I can tell you that the Vice President is a man on a mission and is determined that every dollar will go out quickly and to the high-value projects it was designed for.

Great stuff. It also provides a rich refernce list on impact of fiscal stimulus on the economy.

A look at dynamic provisioning in Spanish Banks

August 7, 2009

World Bank has started releasing short research notes on various policy issues in this crisis. Its 7th note in the series is on Dynamic Provisioning System at Spanish Banks.

Spain developed this much discussed provision tool which was counter-cyclical in nature. It was a system which meant banks provisions increased in good times and declined in bad times. So, as this crisis struck the interesting q was what happened in Spain? Did the new tool help its banks? Was its banking system safe?

This note begins with explaining the dynamic provision system.  Has it helped in this crisis? The note says:


They account on average for about 10 percent of the net operating income of banks. That is why bankers initially were not in favor of dynamic provisions. At the end of 2007 the total accumulated provisions (close to 75  percent were general provisions) covered 1.3 percent of the total consolidated assets of Spanish deposit institutions, at a time that capital and reserves represented 5.8 percent of those assets.

Spanish banks had accumulated a significant buffer to cover incurred losses, a buffer that they have now started to draw down as individual loan losses have begun to mount in parallel with the deterioration in the economy. The buffer was never intended to be permanent. Instead, it is meant to be used in periods such as the current one, when problem loans and specific provisions are surging. By being drawn down, dynamic provisions fulfill their anticyclical purpose.

There is no guarantee, given the depth of the current crisis, that the amounts provisioned will be enough to cover the loan losses that banks are facing. Nevertheless, dynamic provisions have contributed to the stability of the Spanish financial system and allowed Spanish banks to deal with the crisis from a much better starting point.

It does not explain in details but says it worked. What is also interesting is the point that banks resisted this move but has helped them in the end.

On reading the document, I recalled RBI also raised provisions in its Annual Monetary Policy Statement 2006-07. It increased provision and risk weights for real estate loans:

 185. The Committee on Banking Sector Reforms (Chairman: ShriM. Narasimham) had recommended that, as a prudential measure, a general provision of about one per cent of standard assets of banks would be appropriate and should be implemented in a phased manner. The Mid-term Review of October 2005 increased the provisioning requirement on standard assets, with the exception of direct advances to agricultural and SME sectors, from 0.25 per cent to 0.40 per cent of the funded outstanding on portfolio basis. To ensure that asset quality is maintained in the light of high credit growth, it is proposed:

• to increase the general provisioning requirement on standard advances in specific sectors, i.e., personal loans, loans and advances qualifying as capital market exposures, residential housing loans beyond Rs.20 lakh and commercial real estate loans from the present level of 0.40 per cent to 1.0 per cent. As hitherto, these provisions would be eligible for inclusion in Tier II capital for capital adequacy purposes up to the permitted extent.

Operational guidelines in this regard would be issued separately.


(l) Risk Weight on Exposures to Commercial Real Estate


186. In July 2005, the Reserve Bank had increased the risk weight on exposures to commercial real estate from 100 per cent to 125 per cent. Given the continued rapid expansion in credit to this sensitive sector, it is proposed:

• to increase the risk weight to 150 per cent.

This was also not liked by the banking industry then. However, bankers ended praising  Dr Reddy as global crisis hit Indian economy.

Again the issue is not about having more counter-cyclical capital regulations as is being said now. Infact, I have read numerous papers on how the current banking capital system is pro-cyclical and could cause much damage. However, it didn’t move much beyond writing academic papers and discussions. As the crisis hit we again see the same suggestions of reducing procyclicality, macroprudential supervision etc etc.

The real lesson is not having more of these but how do we push these countercyclical capital regulations in good times? How do central bankers/ financial market regulators ignore the banks resistance/criticism to pass such measures? This to me is the real challenge- getting people who want to regulate.  


Great finance minds blogging

August 7, 2009

I came across this new blog – Finance: Facts and Follies . The Bloggersare all who’s and who of financial economics – Ross Levine, Asli Demirguc-Kunt, Thorsten Beck, Patrick Honohan, Jarry Caprio etc etc. It is a wow list. These economists are not the usual financial economists who just work on asset prices , efficiency etc. Instead they have done tons of work on finance sector from a policy perspective.

The initial blog posts are a great read already. I hope they carry on blogging.

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