A blog on financial markets and their regulation
Hard to act against systemic risk
December 24, 2010Posted by on
Richard Bookstaber says in an interview yesterday that it is not difficult to detect systemic risk – the hard part is to take useful action against it:
But I don’t think systemic risk is hard; at least monitoring systemic risk is not difficult. Nobody can hide risk of that magnitude. It’s there to be seen. As I already mentioned, it is taking action that is difficult.
I entirely agree with this assessment. For example, in Indian banking (and many other parts of the financial sector), it is not at all difficult to see that infrastructure finance is a big systemic risk:
- There is a large amount of it.
- There are huge maturity mismatches.
- Infrastructure as the ultimate non tradeable is a bet on the growth of the Indian economy.
- Many of the instruments and techniques are new and many lenders have little prior experience with the sector.
- The central bank has been willing to bend the rules to facilitate expansion of credit to this sector.
- Infrastructure in India is closely bound up with real estate which is implicated in most banking crises.
- No individual bank has any incentive to worry about it because it can count on a bail out – infrastructure is too large and strategically important to be allowed to fail.
In short, it is the classic tail risk mitigated by the high likelihood of a sovereign bailout. It is simply not in the interest of anybody (lender, borrower, regulator or government) to do anything about it.