That means being attentive to exchange-traded derivatives and to cash markets, whether on or off-exchange, and perhaps especially to the short-term financing markets. Where firms are concerned, we have learned to focus on maturity transformation and leverage. For markets, it is, perhaps, not quite so straightforward. In the case of intrafinancial system markets, we are interested in whether they produce chains of cumulative maturity transformation and leverage, and how transparent that is. With end-user markets, we are also interested in whether they are driven by strongly procyclical forces; whether they are especially liable to generate assets whose risks are mispriced or obscure; whether demand is dominated by leveraged investors and traders. We are interested in whether they can crater – becoming illiquid or even closing – under stress. And in whether there are ready substitutes. If not, intermediation can become impeded and end-users deprived of valuable services. Across all of these concerns, the underlying factors may be either structural or cyclical. And they go wider than the traditional focus of securities regulators on the integrity of transactions in public “end user” markets. In practice, the components of individual markets give us a list of things to focus on. A list that goes well beyond firms: products and their distribution in primary markets; the rules of the game and infrastructure for trading, including the role of market makers; the infrastructure for post-trade clearing and settlement; and asset management practices. Especially for “end-user markets”, these are subjects typically associated with securities market regulation not with mainstream microprudential supervision.
The key to progress was the joint recognition by market regulators and supervisors that earlier identification of credit losses is consistent both with financial statement users’ needs for transparency regarding changes in credit trends and with the prudential objective of safety and soundness.19 In the other direction, bank supervisors have typically insisted on the vital confidentiality of the information they receive, while securities regulators emphasise transparency. One could argue that, in many countries, the bank supervisors have done too well in this debate. That was brought home to me some years ago when, in a previous existence at the Bank of England, my then team realised that we could analyse large and complex firms most easily using disclosures made under SEC rules. As announced last week in the joint Bank of England/FSA document on how the future Prudential Regulation Authority will approach banking supervision, we plan in the future to publish prudential returns to the extent possible. Shadow banking and the prudential perimeter My second point about firms concerns shadow banking, defined to mean non-bank firms or structures that replicate the monetary and/or credit services of banks in some way, involving maturity transformation and/or leverage20. 18  See Recommendation 19, FSB Report on Implementing OTC Derivatives Reforms (2010); and the recommendations of the FSB’s Data Gaps and Systemic Linkages Group.