Bank of England's Paul Tucker wants regulators to set margin requirements

The Bank of England's Paul Tucker called for regulators to have the ability to set margin requirements on transactions in the shadow banking system.  Reuters reports that Mr. Tucker would like this ability to cool down the markets when they overheat.

In theory, regulators need to have a complete toolkit for taking away the punch bowl so the party doesn't get out of hand.

In practice, as demonstrated in the late 1990s by the US Fed, regulators are not going to use this authority.

Readers might recall in the late 1990s, the equity markets were experiencing a bubble.  A bubble whose magnitude could have been greatly diminished by the Fed.  

The Fed had and still has the right to change stock margin requirements under Regulation T.  Had the Fed raised stock margin requirements, as Mr. Tucker points out, it would have cooled down the market.

However, the Fed did not raise stock market requirements.  It did not for several reasons including 1) it is hard to recognize a bubble and hence the event that would trigger the need for raising margin requirements and 2) the believe that it could clean up the mess after the equity bubble popped.

Supervisors should have powers to demand more collateral on financial transactions in order to cool down overheated markets, Bank of England Deputy Governor Paul Tucker said on Friday. 

He and other regulators from across the world are looking at how to rein in the multi-trillion dollar "shadow-banking" sector which handles credit and leverage outside traditional banking....

The best way to rein in the "shadow-banking" system is by making it transparent.

This is easily accomplished by requiring ultra transparency.

"The authorities should be able to step in and set minimum haircut or margin levels for the collateralised financing markets, or segments of them," Tucker told a European Commission conference on regulating shadow banks.... 

The European Commission will propose EU-wide shadow bank regulation next year after a global regulatory body, the Financial Stability Board (FSB), completes work on policy recommendations for world leaders by November when G20 leaders meet. 

The FSB, of which Tucker is a member, said in an interim report on securities lending and repos on Friday there was a lack of transparency, potential risks from firesales of collateral assets, and insufficient rigour in collateral valuation and management practices.

Adopting ultra transparency addresses all of these issues.

For example, the potential for a fire sale of collateral is greatly reduced when the holder of the collateral can independently assess the risk of the borrower.  Based on this independent assessment, the holder of the collateral will require bigger haircuts well before regulators would think to step in.