Compare and contrast the US Volker Rule with the UK Vickers Report in relation to the concept of systemic risk

Compare and contrast the US Volker Rule with the UK Vickers Report in relation to the concept of systemic risk

Introduction

The main purpose of this paper is to make a comparison between the US Volker rule and UK Vickers reports in relation to the concept of systematic risk. One of the specific sections of the Dodd Frank Wall Street Reform and Consumer Protection Act is the Volcker Rule. This rule has been proposed by the American Economist for the purpose of imposing restrictions on the banks of United States for making the speculative investments which do not result in providing benefits to the customers. As per Volcker, these speculative activities are the main contributor of the financial crisis of 2007-2010. This rule is considered as the restriction on the proprietary trading by commercial banks .

On the other hand, UK Vickers report is the final report which has been presented by the UK's independent Commission on Banking. The report has been published in 12th September 2011 by Sir John Vickers; therefore, this report is termed as the Vickers report. The report is comprised of the recommendations about the preferential status for insured deposits, banking operations of the retail banking, insolvency of banks and higher capital requirements of retail banking in United Kingdom. Thus this paper is the comparison between these two on the basis of systematic risks.

Discussion

The financial institutions have the main optimal regulation policy of having the firms which have internalize the costs of systematic risks produced by them. These regulations will provide an outcome of leading to the firms which make decision to be less leveraged and they have the less risky assets. The business of banking involves leveraged intermediation managed by people subject to limited liability and, typically, to profit sharing contracts. This combination is well-known to generate incentives for risk-taking that may be excessive from the perspective of bank creditors. Creditor guarantees such as deposit insurance are known to exacerbate this incentive problem because they weaken creditors' incentive to monitor and discipline management. These issues are magnified in the case of systemically important financial institutions (SIFIs). Owing to their size, interconnectedness, or complexity, the negative externalities emanating from financial distress at SIFIs makes them a source of systemic risk, leading to them being perceived to be too-important-to-fail (TITF) . Consequently, the market implicitly—and often correctly—assumes that apart from explicit deposit insurance, creditor guarantees of a much wider nature would be extended when such firms are threatened by imminent failure. This serves to weaken the mitigating force of market discipline. Prior to the crisis, the high likelihood of public support assumed in a distress situation contributed to the ability of SIFIs to carry thinner capital buffers at lower cost, acquire complex business models, and accumulate systemic risk (Stiroh, 2006, p. 2131). This trend was reinforced by the diversification premium attributed to universal banks by market participants and prudential authorities, ...