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The Financial Stability Board in 2019

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It is a pleasure to be here today at the European Central Bank in my capacity as chair of the Financial Stability Board (FSB) to help celebrate the Journal of Money, Credit and Banking’s(JMCB) 50th anniversary. The broad scope of the JMCB, and the diversity of its scholarship parallels, in some ways, the FSB itself. As we dealt with the global financial crisis, the heads of state and government of the G20 tasked the FSB with identifying and addressing vulnerabilities in the global financial system and developing stronger regulatory and supervisory policies to create a more resilient global financial system in the pursuit of financial stability. Our broad mandate has considerable overlap with the fields that the JMCB covers within its pages. The FSB includes 24 jurisdictions and 73 representatives, including all the members of the G20. Also similar to the JMCB, the FSB is celebrating an anniversary this year, with its creation having occurred 10 years ago. We are a far cry from the JMCB’s 50 years, but I hope that in time our continuing work–and not just our response to the late crisis–will prove valuable enough that we one day merit a similar celebration.

I am especially pleased to speak at this conference today because the FSB welcomes and encourages the participation of the academic community in tackling issues of global financial stability. I would like to see a greater and more direct contribution of academic subject-matter experts to our work. You may have noticed that the FSB sent out a call for nominations last month for academics to advise our work in evaluating post-crisis reforms–in this particular instance, the evaluation that will examine the effects of the too-big-to-fail reform package that the G20 endorsed in 2010 and that the FSB and other standard setters have implemented since then. In our initiatives to examine the consequences of post-crisis reform, the academic community can help advance the field with analytical tools and critical insight.

The financial crisis exposed fault lines in the financial system that had to be addressed immediately, comprehensively, and vigorously. The body of post-crisis regulation that resulted was founded on the work of academics, including important papers published in the JMCB, and involved the energy and efforts of many standard setters, regulators, supervisors, and central banks. It was an exemplary feat of cooperation and coordination, and it has unquestionably made the financial system safer and more resilient.

fintech

Today, the post-crisis reform agenda has been largely completed. Basel III is final, the largest global banks have substantially more capital and liquidity, over-the-counter derivatives markets are safer, and steps have been taken to address the risks of too-big-to-fail institutions. Through greater monitoring and policy measures, the FSB is addressing risks from nonbank financial intermediation. And there has been remarkable progress on the difficult and unglamorous task of establishing workable resolution regimes that are consistent with the FSB’s clearly defined principles. While we must still work to ensure full, timely, and consistent implementation of the agreed reforms, it is time for the FSB to turn more of its energy and attention to the future.

In my time with you today, I would like to do two things. First, I would like to share with you my view on how the work of the FSB must evolve if we are to merit that future celebration and some of the core principles that I think should inform that work. After discussing those principles, I want to focus your attention on some of the work priorities that the FSB will be addressing throughout 2019 and beyond, including nonbank financing, fintech, and evaluating the too-big-to-fail reforms.

Core Principles
Let me turn to the core principles–engagement, rigor, and analysis. These core principles reflect goals that are both inward and outward looking. From within, FSB members have the occasion to reflect on how our work is executed–that is, we must ask ourselves how we can accomplish our mission more effectively, improving the financial sector’s ability to support economic growth without threatening financial stability. Outwardly, we will endeavor to reach out to a greater number of constituents and stakeholders for their input on the important financial stability issues they are encountering. This is also a good time to inform a wider public audience on the nature of our mission in a clear, articulate, and jargon-free manner.

Engagement
As the FSB pivots away from the urgency of post-crisis reform development, it is an opportune time to improve our efforts at effective engagement. Recognizing the wide-reaching effects of its work, the FSB must seek input from a broad range of stakeholders, each of whom brings a different perspective to the issues under consideration. While we are directly accountable to the G20, we are, through the G20, accountable to all of the people affected by our actions. In my view, that means we must engage in genuine, substantial dialogue with all of these stakeholders, to a greater and more effective degree than we have in the past.

To start, we can strengthen the role of the six regional groups that are a part of the FSB organization. In 2011, the FSB established six consultative groups representing large regions of the globe–the Americas, Europe, the Middle East and North Africa, Sub-Saharan Africa, the Commonwealth of Independent States, and Asia. The intent was to expand its outreach program beyond the membership in a systematic manner to better reflect the FSB’s global mission. Each group meets once or twice a year and helps the FSB obtain broader input into its policy development agenda. These groups should be re-engineered to not only promote implementation of international policy initiatives within their respective regions, but also to be in a strong position to keep abreast of developments in financial markets and thus inform FSB policy. We have initiated a study of the operations of the regional groups that will help inform us on ways to upgrade their effectiveness as an outreach and feedback mechanism. I am particularly interested in how we can take lessons learned from this study to move forward with our enhanced engagement.

Engagement outside of the FSB is also very important to our mission. We currently engage with businesses, institutions, market participants, and academics on much of our FSB work. For example, we have in the past conducted public consultations on FSB policy recommendations, albeit sometimes with very short timetables. We have now established an expectation that public consultation will be at least 60 days. We need to give the public adequate time to comment on FSB proposals, which can, at times, be quite complex.

Beyond public consultation, we must convene more meetings with the private sector and academic community to build a more robust and meaningful dialogue. For example, we kicked off the work we have undertaken at the behest of the Japanese G20 Presidency to study differences in regulatory environments and market conditions across jurisdictions that may have financial stability implications–often referred to as “market fragmentation”–by hosting a workshop with key stakeholders and academics. This was quite successful, and I look forward to such interactions being the rule. In addition, we need to improve our interaction and cooperation with other standard-setting bodies, such as the Basel Committee, the Committee on Payments and Market Infrastructure, the International Association of Insurance Supervisors, and the International Organization of Securities Commissions (IOSCO). While we have worked together in the past, we all owe it to the global community to seek out opportunities for improved cooperation and engagement.

To improve FSB transparency, we will be taking a number of important steps. For example, on February 12, 2019, the FSB published a comprehensive work program on its website for the year ahead.1 This is the first time in the FSB’s history that the work program was disseminated publicly. Over the term of my chairmanship, I will continue to look for steps that will allow all stakeholders to have a more open window into the FSB’s decisionmaking process and products. I believe improved transparency into the FSB process is critical to our mission. I’m reminded of Lord Hewart’s famous–and oft-quoted–remark concerning the importance of jurisprudence to the public: “Not only must justice be done; it must also be seen to be done.” We should be able to apply this concept to the field of global financial standard setting.

Rigorous Vigilance
The second principle I would like to discuss concerns how we assess and mitigate vulnerabilities in the global financial system. The post-crisis reforms addressed the fault lines that led to the crisis and the contagion effects felt around the world, but they will never replace the need for vigilance. If we are not rigorously vigilant, we still risk another crisis. What we need are forward-looking methodologies that use the most advanced analytical tools to spot vulnerabilities well in advance before they lead to widespread financial distress and economic costs. Here the academic community can continue to contribute with cutting-edge and robust modeling techniques.

We can only mitigate financial vulnerabilities if we identify them accurately and in a timely manner. As such, the FSB’s Standing Committee on Assessment of Vulnerabilities under the leadership of FSB Vice Chair Klaas Knot of the Dutch National Bank will be directing a considerable amount of energy to developing a cutting-edge framework for the identification and assessment of financial vulnerabilities. Again, the principles of transparency and engagement will shape the work of the group. It is important that a wide spectrum of financial participants be brought into the process, from banks and nonbank financial institutions to financial regulators to national authorities and multilateral standard-setting bodies and the broad academic community. This task is essential to the mission of the FSB; financial developments move at a rapid pace, and being able to quickly and accurately assess vulnerabilities is essential if we are to take action to prevent future crises.

Analysis
Finally, the FSB members must employ a critical eye toward the effects of the regulations that have been put in place. Many of the reforms have been in place long enough for them to be evaluated. We can judge whether reforms are having their intended effects and making the financial system more resilient. Are any regulatory reforms causing unintended, adverse effects? Can we achieve the same, strong level of financial resilience with reforms that are more efficient, simple, transparent, and tailored? The FSB must champion efficient and effective regulation in order to maintain public support for the progress we have made.

Key Pieces of the FSB’s Work Plan
Now I would like to turn to three prominent issues on the FSB’s agenda in 2019. I will start with two relatively new issues that continue to evolve and grow in sophistication: nonbank financing and fintech, and then I will turn to the important work we are beginning on evaluating the effects of reforms aimed at ending too big to fail.

Fintech
I will loosely define fintech as technology-enabled financial innovation that results in material changes to the provision of financial services. As is often the case when technological innovation meets established business, fintech has attracted a great deal of attention, ranging from utopian claims to hostile skepticism. Claims about fintech’s promise abound: it has the power and potential to reduce economic inequality, increase financial inclusion, and boost economic growth. Through the introduction of new methodologies, greater information curation, and reduction in processing costs, fintech could potentially reduce financial volatility and vulnerabilities.

We are already seeing significant changes to how many people around the world obtain financial services. For example, in Kenya, a mobile payments technology has introduced mobile wallets to millions of people, many of whom never had a bank account. In the United States, the largest mortgage provider is an online lender. In China, a technology firm started the world’s largest money market fund.

Yet, alongside this growth in fintech, as my predecessor as FSB chair emphasized, we as regulators must ensure that as we maximize the potential benefits in the development of fintech we minimize the potential risks and costs. The FSB monitors and analyzes the financial stability implications of financial innovation as part of our mandate to identify and address vulnerabilities in the global financial system. Let me outline two areas that we have started to examine in greater detail: the potential effects from the entry of large technology firms into financial services and the potential effects from the growth in decentralized financial technologies.

Over the last decade, the world has witnessed an explosion of large technology firms that are weaving themselves into our daily lives: for example, Facebook, Amazon, Apple, Tencent, and Baidu. Some of these firms are increasingly providing some financial services, such as payments, credit, insurance, and asset management. Their involvement can support financial services broadly. For example, their technology may increase speed and efficiency, and the ubiquity of their presence in our lives may allow them to offer financial services in a more convenient way or at lower cost to consumers. Further, as they are only dipping their toes into the edges of the financial services water, the effects they have on the provision of financial services could grow enormously if they were to dive in.

Looking at the technologies that underlie some of the recent innovative financial products, we see a move toward decentralization–that is, a movement toward technologies that connect financial market participants directly without an intermediary. The potential areas of impact are broad: settling interbank payments; verifying and reconciling trade finance invoices; executing, enforcing and verifying the performance of contracts; and keeping an audit trail to deter money laundering.

Both the potential entry of large, established technology companies into financial services and the ability of technology to decentralize financial transactions raise a number of issues, some of which may touch on financial stability. Technological innovation offers the promise of a substantially more efficient financial system. But new systems, processes, and types of businesses will bring with them novel fragilities. We continue to be responsible for ensuring that the financial system be sufficiently resilient that businesses and households worldwide need not fear the collapse of the system that serves their needs.

These are open questions that need to be addressed, and because they touch on issues of financial stability, the FSB is putting significant resources into understanding these potentially important developments. To be clear, we are not trying to oppose innovation, because innovation, including fintech, offers the world many potential benefits. As the group charged with ensuring financial stability, however, we have to work to ensure that we can reap the benefits offered by these new technologies without harming financial stability. We hope to offer some answers to these questions in the coming years and to do so in line with the principles I outlined earlier. We will address the questions with discipline and analytical rigor in a way that incorporates the views of the public and key stakeholders and that results in answers that are practical and intelligible.

Nonbank Financial Intermediation
The second issue I would like to discuss is nonbank financing. Since the global financial crisis, nonbank financing has grown relatively rapidly, in both its absolute size and its relative importance in intermediating credit. In the jurisdictions that the FSB closely monitors, nonbank financial assets are just under 50 percent of total global financial assets, a share that has grown by close to 5 percentage points since 2009. Nonbank financial intermediation (the artist formerly known as “shadow banking”) provides a valuable alternative to bank financing and helps to support real economic activity. Accordingly, the shift within the financial system toward nonbank financing represents a welcome increase in the diversity of the sources of lending to both firms and households.

Even though the core of the financial system is much more resilient than before the global financial crisis, with strengthened bank capital and liquidity requirements, nonbank financing has been a source of systemic risk. Nonbank financing often features high leverage, maturity and liquidity mismatches, opaque structures, and concentrated holdings of risky assets. Nonbank financing can also lead to lower lending standards, bidding up the price of risky assets and sending an encouraging signal to credit underwriters. All of these channels played a role in the recent global financial crisis. More recently, new forms of interconnectedness between nonbank financial firms and the banking system have emerged that could, in some scenarios, act as channels for domestic and cross-border amplification of risks.

Given these potential risks, and the large–and increasing–role for nonbank financing, we need to monitor closely its development. Is the growth of nonbank financing altering the existing market structures? Are there new vulnerabilities in the financial system? How will nonbank financing develop?

To answer these important questions, the FSB is progressing on three related tracks. First, the FSB produces an annual report that outlines the developments in nonbank financing, detailing the global trends and potential risks. Second, the FSB promotes the resilience of nonbanks through the development of a range of policies to address systemic vulnerabilities where they arise, while not impeding the growth of sustainable nonbank financing models. In this way, we hope to promote resilient nonbank financial intermediation. The FSB, working alongside other standard-setting bodies such as the Basel Committee and IOSCO, is monitoring the implementation of these policies. Finally, knowing it is arrogant to expect that we got everything right the first time around, it is imperative that we start analyzing the effectiveness of the policies that have been implemented. How should we alter our policies? Have we modelled the risks from nonbank financing accurately? Have we missed a crucial new source of systemic risk? These are all questions that we must ask ourselves.

Evaluation of Too-Big-To-Fail Reforms
The third issue that I would like to raise is the problem of “too big to fail”–that is, the perception by investors that some institutions will receive support from their governments if they become distressed. This weakens market discipline and allows such firms to become even larger, more leveraged and more complex. To address this challenge, the FSB and other global standard setters developed a framework and a set of policy measures intended to reduce the moral hazard risks posed by systemically important financial institutions. These measures are intended to make the financial system more resilient, for example through higher capital and liquidity requirements, while simultaneously allowing these institutions to fail without causing disruption to critical services, such as payments. A key element of the FSB’s policy measures to address too big to fail is its total loss absorbing capacity standard. Under this standard, the FSB introduced a bail-in (in contrast to a bailout) strategy that necessarily employs a gone concern or post-failure loss-absorbing and recapitalization capacity for the set of global systemically important banks.

Crucially, by raising resolution standards, we have improved the potential for non-disruptive bank failure. The implementation of these standards is most advanced in the banking sector, especially for the largest globally important banks. The FSB established crisis management groups, collections of supervisors who monitor resolution plans of the firms. At the same time, we must be conscious that we have not actually tested the failure of a large bank in the marketplace–surely a good thing!

Standing over a decade on from the start of the financial crisis, we must ask ourselves, how effective have we been at reducing the problem of too big to fail? Have we achieved our objective to reduce or eliminate the problem? Have we introduced new unintended risks to the financial system or costs to other financial market participants?

To start answering these important questions, as part of its broader effort to evaluate the effects of reforms, the FSB is launching an evaluation of the effects of these too-big-to-fail reforms. We intend to bring analytical rigor to these questions, and we recognize that the academic community has undertaken much work in this area. As a result, we will draw extensively on academic advisors during all phases of the work we are undertaking. I also encourage other experts in this field to look closely to the consultative document that will be coming from the study next year. We welcome the input as we undertake the study of this signature issue from the crisis.

Conclusion
Let me conclude by reiterating some of the broad themes I intended to convey today. First, I touched on some of the key principles that I hope will guide the FSB work while I am chair. Those principles include expanded engagement with a broad range of stakeholders and experts, rigorous and careful examination of financial vulnerabilities that may threaten our financial system, and analytical examination of past reforms to ensure that they are making the financial system as resilient as it can be in the most efficient manner possible.

Second, I shared some of the key questions we are working on relating to the rise of large technology firms in the financial sector and decentralized financial technologies, the growing importance of the nonbank financial sector, and our burgeoning efforts to look at how well we have addressed too big to fail, the signature issue of the recent financial crisis.

Moving forward there will surely be additional issues to address and areas to examine.a During my time as chair of the FSB, I hope to make progress not only on the areas I have outlined but on a range of forward-looking issues and continue to demonstrate the value of the FSB. International standard-setting bodies serve an important role within our global financial sector, and I look forward to the FSB advancing our progress and work in these areas.

Basel III monitoring results published by the Basel Committee

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  • Changes in minimum required capital from fully phased-in final Basel III remain stable for large internationally active banks compared with end-2017
  • All banks continue to meet initial Basel III minimum and target CET1 capital requirements
  • All banks in the sample reported Liquidity Coverage Ratios (LCRs) that met or exceeded the final 100% minimum requirement

The Basel Committee today published the results of its latest Basel III monitoring exercise, based on data as of 30 June 2018. Through a rigorous reporting process, the Committee regularly reviews the implications of the Basel III standards for banks, and has been publishing the results of such exercises since 2012. The report sets out the impact of the Basel III framework that was initially agreed in 2010 as well as the effects of the Committee’s December 2017 finalisation of the Basel III reforms. However, it does not yet reflect the finalisation of the market risk frameworkpublished in January 2019.

Data are provided for a total of 189 banks, including 106 large internationally active banks. These “Group 1” banks are defined as internationally active banks that have Tier 1 capital of more than €3 billion, and include all 29 institutions that have been designated as global systemically important banks (G-SIBs). The Basel Committee’s sample also includes 83 “Group 2” banks (ie banks that have Tier 1 capital of less than €3 billion or are not internationally active).

The final Basel III minimum requirements are expected to be implemented by
1 January 2022 and fully phased in by 1 January 2027. On a fully phased-in basis, the capital shortfalls at the end-June 2018 reporting date are €30.1 billion for Group 1 banks at the target level. These shortfalls are more than 70% smaller than in the end-2015 cumulative QIS exercise, thanks mainly to higher levels of eligible capital. For Group 1 banks, the Tier 1 minimum required capital (MRC) would increase by 5.3% following full phasing-in of the final Basel III standards relative to the initial Basel III standards. This compares with an increase of 3.2% at end-2017.

The increases in both shortfalls and the change in MRC over the last six months are driven partly by a higher market risk contribution; this does not yet reflect the finalisation of the market risk framework published in January 2019, which is expected to offset the increases to some extent. By excluding all revisions to the market risk framework, the current end-June 2018 data show increases in Tier 1 MRC of 1.7%, 1.5% and 8.3% for Group 1 banks, G-SIBs and Group 2 banks, respectively, compared to 1.7%, 1.2% and 5.3% six months earlier.

The initial Basel III minimum capital requirements were fully phased in by 1 January 2019 (while certain capital instruments can still be recognised for regulatory capital purposes until end-2021). On a fully phased-in basis, data as of 30 June 2018 show that all banks in the sample continue to meet both the Basel III risk-based capital minimum Common Equity Tier 1 (CET1) requirement of 4.5% and the target level CET1 requirement of 7.0% (plus any surcharges for
G-SIBs, as applicable). In addition, applying the 2022 minimum requirements for total loss-absorbing capacity (TLAC), six out of 24 G-SIBs reporting TLAC data have a combined incremental TLAC shortfall of €68 billion as at the end of June 2018, compared with €82 billion at the end of December 2017.

The monitoring reports also collect bank data on Basel III’s liquidity requirements. Basel III’s Liquidity Coverage Ratio (LCR) was set at 60% in 2015, increased to 90% in 2018 and continued to rise in equal annual steps to reach 100% in 2019. The weighted average LCR for the Group 1 bank sample was 135% on
30 June 2018, compared with 133% six months earlier. For Group 2 banks, the weighted average LCR remained almost stable at 180%. All banks in the sample reported an LCR that met or exceeded the final 100% minimum requirement.

Basel III also includes a longer-term structural liquidity standard: the Net Stable Funding Ratio (NSFR). The weighted average NSFR for the Group 1 bank sample remained stable at 116%, while for Group 2 banks the average NSFR increased slightly to 119%. As of June 2018, 96% of the Group 1 banks and 95% of the Group 2 banks in the NSFR sample reported a ratio that met or exceeded 100%, while all banks reported an NSFR at or above 90%.

Joachim Wuermeling: What will pass, what will still be around, and what will come? The prospects for Germany’s banking sector

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Ladies and gentlemen,

I, too, would like to warmly welcome you all to this year’s Bundesbank banking symposium. Today is a premiere for me, since it is the first time that I have the honour of hosting this event.

I would like to use this opportunity to tell you what I see, in my capacity as a banking supervisor, and what the Bundesbank sees as the key challenges facing Germany’s banking sector at the moment and in the medium term. Although acute problems tend to keep us busy on a day-to-day basis, I mainly want to identify prospects with you here today. Let me put the question like this: imagine we meet here again in five years’ time – which of today’s challenges will still be on our agenda?

Germany Stock Exchange

Germany Stock Exchange

Looking more to the future makes particular sense in 2019, because what we are currently experiencing is a turning point. The focus over the past decade has primarily been on learning the regulatory and supervisory lessons from the financial crisis. Now this ambitious set of reforms is largely drawing to a conclusion, in the shape of the European banking package and the implementation of the final piece of Basel III. It will admittedly take a few more years to put everything into practice, but there is not much more in the pipeline for the time being. That’s why, for me, 2019 is also a year for staking out new topics – or, to use business-speak, for “agenda-setting”.

And that is why I feel we now need to look more at issues which will shape the future – such as structural change in financial markets, digital transformation and the evolution of the economic and political setting for you and for us.

I would therefore like to organise my introduction in three sections.

  • First, what will pass? These are the topics which are still very important today, but will probably be a thing of the past in five years’ time.
  • Second, what will still be around? These are the issues which we are still some way from overcoming.
  • And third, what will come? These are the topics I expect to grow in importance and to occupy us even more than they do today.

2 What will pass?

Let’s kick off with the issues that will pass – that is, the topics which are keeping us busy right now, but will hopefully be yesterday’s news at the Bundesbank’s 2024 symposium. There are three areas I see here.

First, five years from now, will we still be talking about the regulatory reforms enacted in the wake of the financial crisis? I don’t think so. I’m very confident that we will have wrapped up and implemented most of the regulatory projects and grown quite accustomed to operating within the new framework.

The final pieces are just being added to the regulatory puzzle. As things stand at present, the EU’s banking package will be signed off before the elections to the European Parliament in May, thus implementing the components of the 2010 Basel III package. The leverage ratio and the net stable funding ratio, or NSFR, will be established as binding minimum requirements going forward. Another initiative which is in the process of being implemented is the Basel Committee’s new rules for market risk – the Fundamental Review of the Trading Book (FRTB).

The total loss-absorbing capacity provisions incorporated into the banking package will provide tailwinds for derisking in the banking union. This doesn’t mean that risk reduction has been concluded yet, of course. But it makes me optimistic that the remaining risks are also being addressed with the determination and commitment they deserve in Europe’s banking union.

However, this leaves one fairly major item for the Bundesbank which we likewise need to wrap up over the coming years. I’m talking about the important subject of proportionality – that is, the matter of easing overly severe operational burdens for small, non-complex institutions.

This is an area in which we have succeeded over the past two years to forge a common understanding at the European level. For instance, the banking package now includes a definition of “small, non-complex institutions” – these are institutions with total assets of €5 billion or less which also satisfy a number of qualitative criteria.

That means we have successfully addressed the basic issue of the regulatory importance of proportionality and its implementation. The foundations have been laid for easing the burden on institutions precisely in areas where the administrative effort is disproportionate to the supervisory gains.

The second topic which is on the finishing straight is implementation of the package finalising Basel III in Europe, which has been agreed for the beginning of 2022. So the end of the “Basel marathon” is within our sights.

A comprehensive impact study is under way. Thank you to all the institutions which participated in this arduous exercise. The investment will pay off. You see, the new Commission that will be assembled after the European elections will table a draft bill based on the findings from this impact study.

But if we really want to put this reform agenda to bed once and for all, we will have to implement all the global agreements, without exception. Two thoughts spring to mind here. First, this opportunity to strengthen banking sector resilience is one we should not squander. Second, by unrestrictedly implementing the Basel standards (which are, of course, non-binding in legal terms) we need to rule out for ourselves any pretext which allows others to deviate from the rules. Otherwise, a project that has been achieved with a great deal of time and effort – and is unique in terms of global economic regulation – will be at stake. Particularly in light of the dangers to multilateralism, we need to be committed advocates of global standard-setting – in our own interests and for the common good – including in the way we put these standards into practice.

I’ll be the first to concede that for some institutions, these reforms will put more work on their plates. Just take the output floor, which is having a clear impact on a number of larger institutions running riskier business models. That said, the necessary adjustments are doable, and they’re warranted, too, in light of these institutions’ risk profiles.

And for many institutions, the additional capital requirements introduced by the reforms are in any case on the low side – for smaller and medium-sized banks they come to 5.7% on average. Some institutions will even see their capital requirements decline.

Let’s turn to the third topic that will pass. In all likelihood, the United Kingdom will, at least in five years’ time, no longer be a member of the European Union; and London – this is something I firmly believe, unlike others – will no longer perform the role it plays today for the EU as a financial centre.

On the continent, credit institutions and other financial agents will have expanded their operations and interconnected their activities to such an extent that they will be taking on essential functions currently performed out of the City – from wholesale banking to clearing operations. You will need to be ready for this.

The new capabilities and the new agents will drive another wave of structural change in markets and competition in the German financial markets, above all here in Frankfurt. That’s something you will need to prepare for.

The transition won’t be easy – but as a financial market we’re better prepared than other sectors. You, just like the legislators in Berlin, Brussels and Strasbourg, and we, the European and national supervisors, have seen to that. Five years from now, we will hopefully no longer be tearing our hair out over short-term transitional problems.

3 What’s here to stay?

Ladies and gentlemen, in my view, three major issues will still be with us five years hence:

  • Robust earnings in competitive markets;
  • Consolidation and cooperation;
  • Digital financial technology (fintech).

Let’s begin with earnings. Fierce competition in Germany’s banking sector combined with slim margins have been a perennial topic for many years now – particularly given the low interest rates. And things are not going to change in a hurry. That, too, is something you will need to prepare for.

Let me be totally frank here: your business model also needs to function when interest rates are low. Judging by your 2018 balance sheets, I can see that many of you, though not all, have been diligently doing your homework.

You can expect monetary policy – which came under intense fire again recently due to the repercussions for banks – to remain geared exclusively to the goal of price stability. Forgive me for saying it, but you cannot expect policymakers to take account of the earnings prospects of certain economic agents, even if we do see the side effects, of course.

Altogether, though, there’s no reason to constantly speak ill of Germany’s banking market. The institutions are robust, their portfolios are solid, and they are well capitalised. Or, as “The Banker” wrote recently, Germany’s market is characterised by “liquidity strength [and] strong asset and funding structures”.

These qualities make us the envy of others, and that’s something we can even be a little proud of. As a supervisor, let me say that as long as enough capital can be built up, earnings aren’t everything.

If I may say so as a Bundesbanker taking a bird’s eye view, diversity – and thus the fierce competition – provides rich rewards for the economy as a whole, even if it is making life difficult for you. “The three-pillar system has served the country pretty well,” is how “The Economist” recently summarised Germany’s situation.

It is thanks to you that the supply of credit and other bank products and services to the real economy has run smoothly ever since the upswing started in 2009. To put an even finer point on it, you could say that although Germany’s banking sector gets funny looks in some quarters, it has been a veritable godsend for the country’s economy.

But still, profitability remains a perennial challenge. Not every institution has sound earnings potential – and this needs to be improved. No one should pretend they can’t challenge key aspects of their business model.

And that’s why consolidation – which is my second point in this section – will also remain on the agenda. Mergers can be a powerful tool for absorbing hefty administrative expenses. And they have been deployed, frequently, for decades now. The number of credit institutions in Germany has been declining steadily since the early 1990s, dropping from nearly 4,500 in 1991 to around 1,800 today. And that number will dwindle further still. But mergers are not the only consolidation tool. Far too little attention is paid to the efficiency gains that have already been tapped in Germany by centralising individual elements of the value-added chain – and are still there to be tapped. This can be done within institutions, in groups of institutions, by forging cooperations or outsourcing operations to third parties, and even across borders.

There remain a great many opportunities for you to seize here, especially if you put innovative technologies to use. Innovative forms of collaboration among standalone institutions are often more worthwhile than mergers between traditional institutions. This is a trend which we supervisors want to support by designing our outsourcing rules accordingly.

Like other sectors of the economy, the banking sector also experiences waves of structural change. Mergers and acquisitions are one manifestation of such processes. Last year alone, 53 banks merged in Germany. Many of you will have initiated and implemented transactions of this kind and can report from your own experience on how much effort and skill is needed to produce a successful outcome. Further mergers are probably on the cards, and the options are currently the subject of intense public debate.

Owing to recent events, I feel it is important today to say that we supervisors are neutral when it comes to bank mergers. We may monitor such processes, but we certainly do not initiate them. You are aware of that, but perhaps there are some sections of the public arena which are not.

The initiatives for mergers and acquisitions and their design are matters for the management of the institutions and their owners. Supervisors only come into play when we are presented with a plan. The law states that mergers require the approval of the supervisory authorities, whose job it is to check whether the new institution satisfies the regulatory requirements now and in the future. That calls for a sound and sustainable business model. The assumptions and projections made in the business plans presented to us will therefore be subjected to thorough analysis.

As in all banking supervisory matters, you and, of course, the direct stakeholders in particular can count on our constructive and critical involvement. You see, banking supervisors can only play a constructive role if they are inquisitive and analytical – in keeping with their duty towards the institutions and society as a whole.

We have a commitment to society and the general public to preserve stability, solidity and security in the consolidation process. As in the past, this is a commitment we will also take very seriously in future mergers.

However, what mergers cannot resolve is a more deeply seated challenge facing the German banking market: the liquidity surplus. A bank needs to invest these funds it is unwilling to pay us the negative interest rate of 0.4%. Competition is therefore fierce, and it wouldn’t get any easier with only half as many institutions in the marketplace.

Ladies and gentlemen,

Let me move on to my third topic, which is not digitalisation but digital transformation. Because what lies ahead of us over the next few years is more than just a few fancy apps. We can barely grasp the sheer momentum of the digital change which will transform the world, and it’s certainly impossible to overstate its impact.

Five years from now, fintech players won’t be like creatures from outer space, but linked organically with traditional institutions. Furthermore, whole new dimensions look set to open up. Who today can predict the possibilities that blockchain, BigTech and changes in customer behaviour can bring?

This has a consequence which is not at all new but can blow up into something dramatic: business models not only have to be revised and updated, but sometimes have to be taken back to the drawing board. And they have to be capable of being constantly retooled.

Transformation impacts on us as well, in our function as supervisors. If you, the supervised institutions, fundamentally overhaul your business model, working methods and thus your risk profile, we need to ask ourselves whether our prudential toolkit and practices are still fit for purpose. Not to block, or slow the pace of, transformation. In fact, the opposite is true. We want to enable you to harness the opportunities offered by the innovative technologies without endangering the hard-won stability. To achieve this, we need to engage in greater dialogue so that we can better grasp what’s happening in the digital world and thus respond to developments in a more purposeful manner.

4 What lies ahead?

Let us now look a bit further into the future. What concern me now are topics that are certainly well known today, but whose medium and long-term importance, I feel, will be greater than many anticipate, and will still be making smoke come out of our ears in 2024. Allow me to cite three topics from a wide range of areas.

The first topic is actually more of a textbook example, but it always tends to be brushed under the carpet when times are good: cyclical risk. A long period of strong growth and low interest rates is behind us. It doesn’t take a prophet of doom to tell you: this won’t last.

The problem is this, though: it is precisely in times when the economy is booming that the probability of things turning sour in future is cast aside all too easily. However, there is no doubt that in these years where the economy has been “fat” and interest rates have been “lean”, vulnerabilities have been accumulating in the German financial system.

An unexpected – or unexpectedly strong – economic downturn could simultaneously expose vulnerabilities in multiple areas. Rising losses from credit defaults and heightened risk provisioning would mean falling values of assets and loan collateral. Losses would eat into banks’ available capital buffers. Banks would also have to hold more capital in order to meet regulatory or market requirements. Over the short term, banks would attempt to achieve these goals by constraining lending. This could further amplify a cyclical downswing.

I’ll be the first to concede that the interrelationships I’ve just described are “old hat” to you. Yet I still believe it’s important to highlight the vulnerabilities. After all, even though the medium-term outlook for economic growth is currently not all that bad, that can change sometime. Now is therefore the time to take precautions.

It helps that banks have already built up buffers – thanks in no small part to stricter regulation. Currently, the low interest rate environment is creating competitive incentives, particularly in commercial banking and commercial real estate finance, to ease credit standards. I expect market participants, for all the investment pressure they are facing, to show a certain degree of discipline so as not to worsen the quality of their portfolios as a whole.

It is important, then, for you not to let up in your efforts to keep strengthening your buffers and thus to boost the financial system’s overall immune system.

We at the Bundesbank have our eyes clearly trained on the outcome of these efforts, including where the regular review of the deployment of macroprudential buffers is concerned.

Ladies and gentlemen, when looking into the future, we should also detect entirely new sources of risk as early as possible – those that do not show up in historical data. One example I am thinking of is the risks of climate change.

Such risks were at the core of last year’s symposium. The topics of green finance and sustainable finance have picked up an enormous amount of steam at all levels since then. I would particularly like to draw your attention to the report of the Network for Greening the Financial System (NGFS) group, which will be published on 17 April 2019. You might be aware that the Bundesbank is one of the NGFS’s founding members. The topic is not a “flash in the pan”, and now is the time for you to take it seriously.

Flag EU with flags of countries - members of European Union

Flag EU with flags of countries – members of European Union

As a risk, for one thing. For physical and transitory risk can be the source of credit risk, market risk and operational risk. To a point, this is uncharted territory, and I am aware of the difficulties relating to data and methodology. There is still a lot of knowledge and methodological expertise that needs to be collected. However, that is no excuse for putting off addressing climate risk.

For another, you should view green finance as an opportunity. It is also about acquiring market share – about who is able to meet the growing demand for sustainable financial services. Some countries are making great strides – examples I am thinking of include China and the United Kingdom. The EU needs to make sure it doesn’t fall behind on this score.

That’s why we expressly welcome the initiatives which Brussels has put forward here, and why the Bundesbank is an active participant in this debate. We are, however, keeping a very close eye on ensuring compliance with the principle of risk orientation. This is a test that any new regulation in the field of sustainable finance has to pass.

But another thing is clear: not every proposal floated at the European level in the past few months is fully baked and ready to be served up to the real world. For this reason, institutions and associations also need to play their part in greening Europe’s financial sector.

Shaping, and taking the long view, are also at the heart of my third and last point: designing the European financial centre post-Brexit.

I am convinced that we need a European strategy to deepen and modernise the internal market for financial services. Our objective should be an interconnected European financial market which not only spurs competition internally but is also a global force to be reckoned with.  I’m hoping for a financial ecosystem which is spread out over several sites and in which national, regional and local specialisation is possible, yet where actors and services are part of a single, interconnected market.

Such an internal market would be able not only to close the gaps created by London’s departure: such a joint financial centre would also help keep significant financial flows under European supervision and enable us to ensure the protection of financial stability thanks to our high supervisory standards.

All these considerations on what comes beyond the capital markets union during the next European legislative period need to be priority issues which the second panel will discuss after lunch.

Basel III

5 Moulding the future

Ladies and gentlemen,

Albert Einstein is credited with saying that “I’m more interested in the future than in the past, because the future is where I intend to live.”

A change of perspective towards the future can help us to put into perspective the numerous challenges facing banks and savings banks now. Out of the many pertinent topics, I have touched upon nine.

Some topics that are still the subject of lively debate today might be self-evident five years down the road – think of Basel III.

Other topics which are already on the agenda today will not be nearly as easy to consign to history – think of structural change and digital transformation.

And other topics, in turn, deserve even more attention than they have been getting thus far – think of climate change and the design of the European financial centre.

As Willy Brandt put it: “The best way to predict the future is to create it.” The future won’t just happen – all of us in this room can shape it if we confront it at an early stage.

I am expecting this day to provide much impetus for dealing with the future. In closing, let me say that I am looking forward to a rich and rewarding symposium and to many inspiring discussions here in the auditorium and outside in the lobby about how, through common action and joint dialogue, we can shape the future of banking and finance in a way that benefits everyone here and in the wider community.

Basel Committee discusses policy and supervisory initiatives and approves implementation reports

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The Basel Committee on Banking Supervision met in Basel on 27-28 February to discuss a range of policy and supervisory issues, and to take stock of its members’ implementation of post-crisis reforms.

At its meeting, the Committee:

  • took note of the implementation status of margin requirements for non-centrally cleared derivatives. The Committee will publish in March a joint statement with the International Organization of Securities Commissions to clarify certain implementation aspects of the margin requirements framework;
  • reiterated its support for reforms of interest rate benchmarks and approved a work plan to look at the interactions with supervisory requirements;
  • agreed to publish high-level supervisory expectations related to crypto-assets in light of the high degree of risks associated with such exposures. These expectations will be published in March;
  • discussed the use of different practices among jurisdictions to proportionately apply the Basel Committee‘s global minimum prudential standards, and agreed to publish a summary of these practices in March;
  • reviewed the assessment reports on the implementation of the Net Stable Funding Ratio and large exposures standards in Brazil and India. Publication of these reports is expected in the coming months; and
  • reviewed the follow-up reports and actions by member jurisdictions on the implementation of certain Basel III standards. These will be published in March.

Basel III

The Committee also discussed its work programme for evaluating the impact of its post-crisis reforms. The programme includes planned evaluations related to cross-cutting policy issues, the countercyclical capital buffer framework and the global systemically important banks framework. Committee members also discussed issues related to sovereign risk.

The next meeting of the Basel Committee is tentatively scheduled for 19-20 June 2019.

The Basel Committee on Banking Supervision (BCBS) is a committee of banking supervisory authorities that was established by the central bank governors of the Group of Ten countries in 1974. It provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide. The Committee frames guidelines and standards in different areas – some of the better known among them are the international standards on capital adequacy, the Core Principles for Effective Banking Supervision and the Concordat on cross-border banking supervision.The Committee’s Secretariat is located at the Bank for International Settlements (BIS) in Basel, Switzerland. The Bank for International Settlements (BIS) hosts and supports a number of international institutions engaged in standard setting and financial stability, one of which is BCBS. Yet like the other committees, BCBS has its own governance arrangements, reporting lines and agendas, guided by the central bank governors of the Group of Ten countries. 

Sabine Lautenschläger: Risks to banks – from inside and out

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Ladies and gentlemen,

It is a pleasure to be here today! And not only because it allows me to escape the cold German winter, but also because this meeting allows us to share views from opposite ends of the world – views from Asia and Australia and views from Europe.

The crisis has shown how important it is to do just that. How important it is to be aware of what’s going on elsewhere, of how closely markets and market participants are interconnected. After all, a crisis that breaks out on one side of the globe can quickly spread to the other.

So, being aware is one thing. But the crisis forced us to go further; it forced us to join forces – not only in overcoming problems as they arose, but also in revamping the regulatory and supervisory framework afterwards. This happened at the global level – Basel III – and at the regional level.

In Europe, policymakers went further than anywhere else. At the height of the crisis, they decided to set up a banking union. The first step was to take banking supervision from the national to the European level. So, in 2014, the ECB became responsible for supervising banks in the euro area.

Has this worked out? I still remember that, back in 2014, I heard quite a few critical voices. Not everyone believed that European banking supervision would actually work. Four years later, this has changed. European banking supervision has been set up, it is running smoothly, and it contributes to making banks safer and sounder.

But it was quite some job, I can tell you. I remember the early days, when we were just a handful of people sitting in a half-deserted building in Frankfurt.

I remember how we began to hire staff – around 1,000 – for the ECB, and how we began to bring together the supervisors in national authorities, supporting them in adopting the new European supervisory approach.

I remember the comprehensive assessment we carried out on the banks that we would later supervise. We were like a start-up; we still are, in fact. We are constantly innovating, learning and growing together as a European team of supervisors.

And this European aspect is crucial. As European supervisors, we can take a higher vantage point; we can see and act across borders. As a national supervisor at the Federal Financial Supervisory Authority and the Deutsche Bundesbank, I supervised 20 large banks – all from Germany. In the SSM, we supervise around 120 large banks from across the euro area. You can imagine the greater depth of insight that we gain.

We benchmark all these banks against their peers; by comparing them we can more easily spot new trends, new risks and new vulnerabilities. We can clearly distinguish the nodes and links of the European banking sector. And see what works and what doesn’t – both on the banking and the supervision side.

Let me give you just one example. It’s no secret that European banks have a profitability problem. In analysing this problem, we benefited a great deal from our cross-country perspective. We could identify a number of banks that constantly outperform their peers, and we could assess the factors behind their success. This would not have been possible if we had looked only at a national sample of banks.

But now that I have lavishly praised the concept of European banking supervision, let’s turn to the banks and the risks they face.

Risks from the outside – the economy, geopolitics and technology

And there are plenty of risks. Plenty of risks that interact in complicated ways. So, for brevity’s sake, I won’t address all the risks that exist but will focus on just a few. I will start with one of the issues that has, unfortunately, become a hallmark of the euro area banking sector: non-performing loans, or NPLs.

In early 2015, significant institutions in the euro area held almost €1 trillion worth of bad loans on their balance sheets and the aggregate NPL ratio stood at 7.5% on average. This average, however, masks big differences: NPL ratios ranged from around 1.5% in Luxembourg to more than 45% in Greece.

The banks therefore had a heavy burden to carry. After all, NPLs require special care and so tie up management resources. They also pose a higher risk of losses, require provisions, tie up capital and affect lending. Their effect on lending is what makes NPLs a problem that reaches beyond the banks.

The euro area economy mostly relies on banks as a source of credit – much more so than many other economies. This is particularly true for small and medium-sized enterprises, which form the backbone of the economy. In the EU, SMEs account for more than 50% of value added and more than 60% of employment. Altogether, 99% of all enterprises are small and medium-sized.The three most important sources of financing for SMEs are bank loans, leasing and credit lines.So they do rely heavily on banks.

This makes them somewhat vulnerable. In crises, banks tend to charge higher premiums when lending to SMEs. And, as an ECB study shows, this premium is in turn partly driven by the amount of NPLs on a bank’s balance sheet.3 The more NPLs a bank holds, the less it lends to the economy.

So, it was clear from the start that NPLs were not just a problem for banks and their supervisors. Other national and European authorities had to act as well.

As for us supervisors, dealing with NPLs is a core task! We benefited from our European point of view, from being free of national traditions. We drew, for instance, on the experience of countries such as Ireland which had already successfully dealt with NPLs.

And we were able to compare and draw lessons from the different legal and judicial environments in 19 countries. Building on all these insights, we developed a harmonised European supervisory approach for tackling NPLs. This was not easy, though, as we met with considerable pushback.

But we nevertheless moved ahead. After first taking stock, we pursued a two-pronged approach from 2015 onwards: first, directly addressing legacy NPLs; second, preventing new NPLs from piling up.

On this basis, we devised a harmonised approach that rests on three pillars.

The first pillar is qualitative guidance to banks on how to develop and implement strategies to reduce NPLs. These strategies should contain targets for reducing NPLs at the portfolio level over a three-year horizon. But our guidance simply outlines best practices in devising the strategies and lists tools for implementing them. As no two banks are alike, each bank needs to pursue an individual strategy and meet individual reduction targets. It goes without saying that we diligently monitor their progress.

The second pillar is a quantitative addendum to this guidance, in which we specify our supervisory expectations for the provisioning of new NPLs. These expectations depend on the extent to which NPLs are secured. For fully unsecured exposures and unsecured parts of partially secured exposures, we expect banks to achieve 100% coverage within two years after a loan has been classified as non-performing. For secured NPLs, the limit is seven years.

The third pillar is a framework to address the stock of NPLs. Within this framework, we formulate, for each bank, our expectations regarding the provisioning of legacy NPLs, bearing in mind the general expectations on provisions that I just outlined.

Our assessment of each bank’s implementation of our qualitative and quantitative guidance is part of our bank-specific Supervisory Review and Evaluation Process, or SREP for short.

At the same time, an action plan to tackle NPLs was developed at the political level. This plan set out the need for action in three areas: first, banking supervision; second, insolvency and debt recovery frameworks; and third, secondary markets for distressed debt.

And since 2015, we have made real progress in bringing down the level of NPLs. The volume of NPLs has declined by almost €400 billion since that year. The average NPL ratio now stands at just over 4%, around €600 billion in absolute terms. So things are improving significantly, but there is still some way to go.

NPLs are among the biggest challenges facing banks in the euro area; it is essential that banks complete the clean-up of their balance sheets as long as the sun is shining.

But banks and supervisors cannot focus solely on the past, on legacy assets. We must also look to the future and watch out for the risks that are still beyond the horizon or just appearing on the horizon.

While I have just praised the banking union as a major step towards a united Europe, one country is about to take a step in the opposite direction. Brexit is about to happen – or so it seems. The official date for the United Kingdom to leave the European Union is 29 March 2019. As of today, however, it is still unclear how this will happen – if it happens at all. The worst scenario would be a Brexit without any agreement between the United Kingdom and the EU on their future relationship.

Despite all the uncertainty, one thing is clear: Brexit will change the shape of the European banking sector. In the first place, the large number of banks that are located in the United Kingdom and do business in the EU will have to find new ways of accessing the European market after Brexit.

And this is relevant for us supervisors, of course. Over the past two years, we have clearly set out what we expect from banks relocating to the euro area. We have published information on our website; we have talked about the issue in interviews and speeches; and we have had intense discussions directly with the banks. We have urged and pushed them to prepare for all potential outcomes of the political process. At present, most banks relocating to the euro area have made reasonable progress in preparing their move.

But it’s not just banks located in the United Kingdom that will be hit by Brexit. Euro area banks rely, for instance, very much on central counterparties, or CCPs, in the United Kingdom to clear derivatives. With Brexit, they might lose access to these services, and this might disrupt their business and the markets, and in turn threaten financial stability. The European Commission has acknowledged the problem and plans to take temporary measures to preserve access. While this is certainly good news, it is merely a stopgap. There is no time to relax; there is just a little more time to prepare.

Now, Brexit at least offers an opportunity to think about CCPs and concentration risk in more general terms. The market for clearing is highly concentrated. While I do see the benefits in terms of efficiency, I also see the risks. And this is something we definitely need to discuss.

I have now focused on two challenges that are more or less European: NPLs and Brexit. There are, of course, many more challenges, and these affect banks not only in Europe but worldwide.

There are geopolitical uncertainties, for instance. It seems that nationalism and, thus, protectionism, is on the rise. In the long run this will hurt the economy and everyone will be worse off, including those who appear to benefit from protectionist measures at first glance; the current trade tensions are a case in point.

Then there are financial market risks. Interest rates are low and liquidity is still abundant and cheap, but these conditions will not last forever; there is the risk of a snapback in markets.

At the same time, technological progress might change the business of banking and the structure of the sector. This could be an opportunity; but it may also be a risk if banks fail to adapt.

Risks from the inside – governance, culture and ethics

Ladies and gentlemen, banks have to deal with many risks these days. And while it seems that the risks have grown, it should be clear that risks are an inherent part of a bank’s business. In fact, what distinguishes a good bank from a bad bank is how it deals with risk.

And in this regard, the enemy all too often comes from within. After all, banks are managed by people. And people make mistakes from time to time; they are often biased when taking decisions under uncertainty and some people have skewed ethics. The result can be bad risk management or even outright misconduct. Neither is acceptable and each can damage the reputation of a bank, drive away its customers and diminish its capital. Each can bring down a bank and harm others.

For policymakers, issues of misconduct can bring additional challenges. Money laundering is a good example. Recent cases have shown that it often reaches across borders and requires different authorities to act. In Europe, national authorities are in charge of anti-money laundering, AML for short. The ECB has no AML mandate, but as European banking supervisors we also have to take relevant risks into account. We do so, for instance, when we assess acquisitions of qualifying holdings, or when we assess whether banks’ managers are fit for their jobs.

Prompted by the recent scandals, European policymakers have now taken several initiatives, one of their aims being to strengthen the cooperation between national AML authorities and European banking supervisors.

For instance, new European legislation provides that the ECB and national AML authorities exchange relevant information. To better integrate findings from national AML authorities in prudential supervision, ECB Banking Supervision is setting up an AML coordination function which will have three main roles: to handle interactions with national AML authorities, raise supervisors’ awareness about money laundering risks in banks, and be a centre of expertise on prudential AML topics.

But AML is just one example. More generally, good governance, with the right checks and balances in place, can keep such problems from emerging. Governance has been neglected by regulators and supervisors for far too long. I see it as a crucial topic for the years to come.

For European banking supervision, governance is a key issue – and has been from the very beginning. The quality of a bank’s governance is one of the four pillars of our SREP. How could we judge a bank to be safe and sound without assessing its governance framework?

As part of our SREP, we also assess the banks’ risk appetite frameworks, their RAFs. We look at whether banks are fully integrating the policies, processes, controls, systems and procedures set out in their RAF into their decision-making processes and their risk management. We also assess whether their RAF is aligned with their business plans, strategies, capital planning and remuneration schemes. Easier said than done, as I’m sure you know.

We do not look at banks in isolation. As I just mentioned, benchmarking is a key supervisory tool. We carry out horizontal analyses on a host of issues, including governance, which was the subject of a thematic review we published in 2016.

However, all of this is still work in progress – for supervisors and for banks. That banks are not yet where they should be becomes clear when we look at the recent scandals in the headlines: money laundering, tax evasion, manipulation of rates and prices – you are no doubt familiar with these cases. They are not confined to a single region, nor to a single bank. While good governance can take banks a long way in behaving responsibly, we have to dig deeper.

Ultimately, ethical behaviour is either helped or hindered by a bank’s culture. So we do not want to see a culture that tolerates misconduct or even encourages it. But it is not in a supervisor’s power to shape a bank’s culture. Ultimately, the onus is on the banks and their stakeholders to bring about a cultural shift.

The first step is to understand that staying in business for the long term is more important than ramping up profits in the short term. In that sense, a good reputation is worth more than a dodgy deal – no matter how much profit that deal promises.

Shareholders, too, should focus more on the sustainability of a bank’s business model, and thus their investment, and less on receiving as high a dividend as possible in the short run.

This understanding is only the first step. The culture of a bank is shaped both ways, top-down and bottom-up. The management of a bank plays an important role in setting the tone and defining expected behaviour. But this is not enough. When it comes to culture, action speaks louder than words. Staff will take the behaviour of management as a cue of what is acceptable and what not. Managers have to lead not only by words but by example.

Incentives are another important point. Staff will know which behaviour earns them a bonus or gets them promoted. That’s why European banking supervisors assess remuneration schemes, including the extent to which integrity matters in promotions. More generally, integrity is one of the five criteria we apply when conducting fit and proper assessments of potential bank managers.

And this is key. Culture tends to be self-perpetuating, because people with certain values tend to hire people who hold the same values. Breaking this cycle is difficult, but necessary. But simply hiring people with different values and perspectives will not suffice. They then must be encouraged to speak up – to call foul when necessary. Here, we supervisors can help again. The ECB has set up a breach-reporting mechanism through which whistle-blowers can share information with us. Last year, we received more than 120 reports, an increase of about 40% from 2017.

So, there are things that can be done, but we should not expect miracles. Culture is a sticky thing that tends to change very slowly. I am sure it will keep us busy for some time to come.

Conclusion

Ladies and gentlemen,

This is it; this is how the banking world looks from a European point of view. Banks have become more resilient over the past years, but they still face a number of risks and challenges. Some of these risks and challenges are indeed European, but some are global in scope. And a number of risks are universal in the sense that they emerge from within a bank: weak governance, bad risk management, unethical behaviour. So plenty of work lies ahead for banks and supervisors.

But for now, I am looking forward to listening to you, and to discussing our thoughts and ideas.

Thank you for your attention.

Joachim Wuermeling: Banking regulation and the benefits of international cooperation – Basel III and beyond

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Ladies and gentlemen,

Welcome to the “Gold Room” of the Konrad Adenauer Foundation. I am honoured to welcome you all – your attendance today surely makes this lunch a golden opportunity to exchange ideas and perspectives on the future of transatlantic and international cooperation.

We are probably all having quite difficult conversations in our jurisdictions at the moment about what transatlantic cooperation – and what international cooperation – can do to achieve a prosperous economy over the coming years and decades. How can cooperation support the goals of prosperity, stability and progress?

My personal view is this: our prosperity hinges heavily on the interdependencies of our economies. That’s what makes cooperative frameworks that create reliability and trust so important.

Take banking regulation as an example – here we have a fairly successful track record of international cooperation: the Basel Committee of Banking Supervision is a semi-formal network of supervisors from currently 28 jurisdictions.

Since 1974, regulators in the Committee have been developing international minimum standards and guidelines to harmonise the supervision of internationally active banks.

Even though its standards are only non-binding agreements, these are typically implemented in more than 100 countries.

During its 45 years of international cooperation, the Basel Committee has achieved a lot:

  • It ensures a clear-cut separation of work and cooperation between home and host supervisors, so that the activity of international banks cannot fall through the cracks.
  • It fosters the continuous exchange between supervisors and thereby helps build mutual trust.
  • The Basel minimum standards reduce the opportunity for regulatory arbitrage.
  • And in the process, they reduce the likelihood of a regulatory race to the bottom.

I like to think of Basel as an example of the value of international cooperation.

And as such, the Basel Committee was crucial as a forum to make sure that regulatory reforms after the financial crisis were developed in international accord.

The final pieces of this international reform effort were achieved with the Committee finalising the Basel III standard. The Basel III package, which includes reforms developed between 2009 and 2019, will make internationally active banks safer in the future.

And yet I would like to bring one sobering fact to your attention: since the Basel Committee started its work, financial crises have not become fewer but more frequent.

How can that be? One reason is regulatory loopholes that emerge due to financial innovation – this calls for a confident, strong supervision in the face of new developments that are not covered by international standards.

But another source of weakness of the international Basel standards is insufficient implementation.

I was recently discussing with my staff the implementation of Basel III in the EU. At some point, the discussion turned to the less than optimal experiences with the previous Basel standards. Some pointed out that the US did not implement the Basel II standard in full, despite having pushed for it in the first place. That led to the question how complete the implementation could be if other jurisdictions simply cherry-picked.

But then I saw two colleagues whispering and laughing – and I asked what it was about. One of them, quite reluctantly, explained that it may be true that Basel II implementation in the US diverged from what the EU had hoped for – but that it was the EU which had been found to be materially non-compliant with the Basel III standard. The room suddenly fell silent.

Finally, someone asked: will it be different this time around?

The purpose of this tale is not to blame and shame. My concern is rather to highlight where we are right now in terms of finalising regulatory reform after the financial crisis – and that the system of national implementation does not favour full implementation.

So where are we? We are getting closer, we can already make out the finishing line. But the last leg of national implementation is a steep upward climb.

Without reaching the last milestone, Basel III would lose dramatically in value in terms of financial stability.

What we need is complete implementation, nothing less: all internationally active banks – be they American, European, Asian or from any other region – need to be subject to these minimum standards – otherwise we have failed to achieve a truly international compact.

Does this mean that, in future, every community bank should apply internal models to estimate its risk of credit valuation adjustment in derivative positions?

Of course not. International cooperation would reach beyond what is sensible. The Basel rules are highly complex and call for big compliance departments – something that is beyond the reach of a community bank business model, for example.

That’s why smaller institutions which are not internationally active should be subject to less complex rules.

And that’s why the US and the EU have begun to reduce operationally burdensome rules for such institutions – a path that we are pursuing further, within the Basel Committee as well as in national implementation.

However, we should not take this too far. For example, I am concerned about tendencies in both the EU and the US to exclude from key regulations internationally active mid-sized banks. The last crisis erupted not only due to what large banks did, but also because of the activities at mid-sized banks.

International cooperation can serve us well. In banking regulation, cooperation can contribute to building a safer banking system. As Basel III has been finished by the Basel Committee, the focus will now shift towards evaluation and implementation monitoring. Though, some topics have to be kept on the agenda of the Basel Committee. One example is the regulation of sovereign exposures in times of historically high sovereign debt levels and rising interest rates worldwide. There is a considerable reputational risk for the Basel Committee if it ignored the sovereign risk issue.

Furthermore, new risks are emerging and will determine the Basel Agenda. I am thinking of climate risks in banks’ balance sheets or risks stemming from crypto assets as well as new players like BigTechs expanding to banking business. Those examples also show that risks and stakeholders can’t be grasped within national borders which shows very clearly that there is no alternative to international cooperation.

However, international cooperation can only work if national politics are able to overcome the tendencies towards less than full implementation.

International cooperation does not cause national responsibility to vanish.

Thank you for your attention – I look forward to our discussion.

Basel III Monitoring Results Published by the Basel Committee

by Leave a Comment Filed Under: Regulatory Annoucements Tagged: , , , , , , , ,

Bank of International Settlements - BIS

  • Fully phased-in final Basel III capital shortfalls more than 70% lower for large internationally active banks compared with end-2015
  • All banks continue to meet initial Basel III minimum and target CET1 capital requirements

The Basel Committee today published the results of its latest Basel III monitoring exercise based on data as of 31 December 2017. The Committee established a rigorous reporting process to regularly review the implications of the Basel III standards for banks, and has been publishing the results of such exercises since 2012. For the first time, the report sets out the impact of the Basel III framework that was initially agreed in 2010 as well as the effects of the Committee’s December 2017 finalisation of the Basel III reforms.

Data have been provided for a total of 206 banks, including 111 large internationally active banks. These “Group 1” banks are defined as internationally active banks that have Tier 1 capital of more than €3 billion, and include all 30 banks that have been designated as global systemically important banks (G-SIBs). The Basel Committee’s sample also includes 95 “Group 2” banks (ie banks that have Tier 1 capital of less than €3 billion or are not internationally active).

The final Basel III minimum requirements are expected to be implemented by 1 January 2022 and fully phased in by 1 January 2027. On a fully phased-in basis, the capital shortfalls at the end-2017 reporting date are €25.8 billion for Group 1 banks at the target level. This is more than 70% lower than in the end-2015 cumulative QIS exercise and driven mainly by higher levels of eligible capital.

For Group 1 banks, the Tier 1 minimum required capital (MRC) would increase by 3.6% following full phasing-in of the final Basel III standards relative to the initial Basel III standards. Compared with the previous cumulative QIS (based on end-2015 data), the impact on MRC has increased from -0.5% to 1.7%, excluding the effect of market risk to make the two studies comparable. The differences are partially driven by more conservative assumptions for the implementation of the revised operational risk standards in some countries.

Basel III monitoring results published by the Basel Committee

Basel III monitoring results published by the Basel Committee

The initial Basel III minimum capital requirements are expected to be fully phased in by 1 January 2019 (while certain capital instruments could still be recognised for regulatory capital purposes until end-2021). On a fully phased-in basis, data as of 31 December 2017 show that all banks in the sample continue to meet both the Basel III risk-based capital minimum Common Equity Tier 1 (CET1) requirement of 4.5% and the target level CET1 requirement of 7.0% (plus any surcharges for G-SIBs, as applicable). In addition, applying the 2022 minimum requirements for total loss-absorbing capacity (TLAC), eight of the G-SIBs in the sample have a combined incremental TLAC shortfall of €82 billion as at the end of December 2017, compared with €109 billion at the end of June 2017.

The monitoring reports also collect bank data on Basel III’s liquidity requirements. Basel III’s Liquidity Coverage Ratio (LCR) was set at 60% in 2015, increased to 80% in 2017 and will continue to rise in equal annual steps to reach 100% in 2019. The weighted average LCR for the Group 1 bank sample was 133% on 31 December 2017, compared with 134% six months earlier. For Group 2 banks, the weighted average LCR was 180%, up from 175% six months earlier. Of the banks in the LCR sample, 99% of the Group 1 banks (including all G-SIBs) and all Group 2 banks in the sample reported an LCR that met or exceeded 100%. All banks reported an LCR at or above the 90% minimum requirement that will be in place for 2018.

Basel III also includes a longer-term structural liquidity standard: the Net Stable Funding Ratio (NSFR). The weighted average NSFR for the Group 1 bank sample was 116%, while for Group 2 banks the average NSFR was 118%. As of December 2017, 97% of the Group 1 banks (including all G-SIBs) and 95% of the Group 2 banks in the NSFR sample reported a ratio that met or exceeded 100%, while all banks reported an NSFR at or above 90%.

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