Poszar, Z (2014), ‘Shadow banking: the money view’, Office of Financial Research Working Paper No.14–04. Tirole, J (1988), The theory of industrial organization, MIT Press. BIS central bankers’ speeches  5  Chart 1: Higher capital requirements and market concentration(a) In an oligopolistic market, assume banks that invested first have a higher market share and are more profitable for a given level of costs than the banks that invested second. Higher capital requirements push the profits of the banks with smaller market shares below the fixed cost, causing them to exit, while the profits of banks with larger market shares remain above the fixed cost and they remain in the market. The market becomes more concentrated. Profit (excluding fixed cost) Higher capital requirements increase marginal costs  Banks with large market share Banks with smaller market share Fixed cost Marginal cost (a) The chart is drawn based on the Stackelberg-Spence-Dixit model described in chapter 8.2 in Tirole (1988). 6  BIS central bankers’ speeches  Chart 2: A bank substitutes investment in a lower-risk-weighted asset for investment in a higher-risk-weighted asset when the risk weight for the higher-risk-weighted asset increases A bank chooses a portfolio of assets where its indifference curve is tangent to its risk-based capital constraint. An increase in the risk weight on the higher-risk-weighted assets relative to the risk weight on the lower-risk-weighted assets induces a bank to decrease its investment in the higher-risk-weighted assets and increase its investment in the lower-riskweighted assets.

c.  The Financial Stability Board has agreed minimum haircuts 7 in order to limit the leverage that non-banks can obtain through borrowing cash against private sector securities. These haircut floors have deliberately been set at “backstop” levels designed to prevent excess in times of market exuberance while allowing room for prudent firms to do their own risk management. d.  The US authorities have taken steps to strengthen the tri-party infrastructure. The reforms are not yet complete. One important missing ingredient is data collection to monitor market trends more closely. For example, the authorities need to understand the composition of the collateral being used across key financial markets in order to identify concentrations. The financial crisis showed the risks associated with a market-wide margin call when widely-used collateral is subject to an unexpected common price shock. Data is also needed to track the terms of transactions, including maturity and haircuts. One interesting idea is for regulators to run exercises in which they ask prime brokers to calculate portfolio haircuts against archetypal leveraged portfolios. The aims would be both to track any loosening in market-wide standards over time and to spot outlier dealers that require lower haircuts than their competitors. These significant regulatory reforms will have consequences for the behaviour of dealers and investors in securities financing markets. Some market participants may seek ways around the new regulations: for example, there has been talking about dealers “renting” balance sheet from other market participants or establishing off-balance sheet financing vehicles.