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Darrell Duffie on Effect New Regulations Have on Financial Stability

Posted by
Anita Belitz Krasniqi
Monday, February 1, 2016 - 13:45

In a recent interview, Darrell Duffie, Professor of Finance at Stanford University and currently SFI Visiting Professor @EPFL, provided an insight into the effects new regulations regarding the use of collateral may have on banking activities.

"I don't think that the new regulations requiring massive new amounts of collateral are going to increase financial instability. In fact, I think it will reduce concerns about a financial crisis.

The problem however, is that in some cases the demands are extremely high, to the point that some market efficiency or liquidity will be lost. I think it's an appropriate trade-off on average.

I think the regulators, on average, have it right, but in one area in particular, I think they have it wrong. And that's in the area of supplementary leverage ratio which essentially requires that banks have the same amount of capital for a risk-free position as they have for a risky position. And that's causing the supply of liquidity in markets like treasury repo, or bond repo to be suppressed, relative to what it should be. So, there's a mistake there that could be corrected." Click on the full interview below:


And related to this issue, Darrell Duffie goes on to talk about bond market concerns, he says:

"It's very interesting if you look back in history, in the late 19th century, the bond markets were actually more liquid than equity markets, but we scroll ahead a hundred years and we're looking at a bond market which is very illiquid relative to equity markets. The turnover in treasury markets per day is about one tenth that of equities, and the turnover in corporate bonds is about one one-hundredth of that in equities, so it's a very illiquid market and we wouldn't expect it to have the same kind of bid-ask spread or depth that equity markets have. But there are a number of concerns here. One is how do we bring ultimate investor-buyer to trade directly with ultimate investor-seller? Right now that's very limited on electronic trading platforms that are quite small. Most of the trade goes through the major dealers, and these dealer banks are not anxious to give up territory in this area.

I was recently an expert on a $1.6 billion settlement against the major dealers for reducing competition in the credit-default-swap market. And the dealers are simply not interested in ceding territory to all-to-all anonymous trade."