Mario Draghi: The transatlantic relationship in an era of growing
economic multipolarity
Keynote speech by Mr Mario Draghi, Governor of the Bank of Italy and Chairman of the
Financial Stability Board, at the Peterson Institute for International Economics - Bruegel
Conference, Washington DC, 8 October 2010.
* * *
Let me start by thanking [Fred, the IIE, Bruegel] for inviting me to this policy debate on
regulatory reform and transatlantic relations. The issues on the conference agenda are highly
topical and present challenges for international policy makers.
Just as is the case for tackling the problem of global climate change - another important
topic on your agenda - achieving a more stable and resilient global financial system requires
coordinated action at the global level. The US and Europe have strong joint interests in this
and are critical to progress. But so are the growing weight of countries beyond these
continents, and they have come to play an increasingly important role in shaping global
outcomes.
In my remarks I will first review what we have achieved so far in terms of financial reforms.
I will then turn to important challenges still ahead of us. And I will conclude with thoughts on
international policy coordination and the role of the FSB.
Achievements so far
We have come a long way towards strengthening the financial system since this crisis
began, reflecting an unprecedented amount of international co-ordination in achieving
consistent reforms. While issues remain to be resolved, in Europe, in the US and elsewhere,
we are, collectively, fundamentally reshaping the framework for systemic financial oversight.
Let me note some examples:
- First, top-down, system-wide oversight arrangements are being put in place at
national, regional and international levels. These arrangements are designed to
deliver more encompassing surveillance, with broadened macro-prudential
perspectives, and better mechanisms for triggering action on identified risks.
Examples are the European Systemic Risk Board and related arrangements, the US
Financial Services Oversight Council, the IMF-FSB Early Warning Exercise, and the
establishment of the FSB itself.
- Second, major jurisdictions have overhaulied their regulatory and supervisory
structures to strengthen responsiveness to risks, improve coordination and close
gaps. The FSB is in many ways the international manifestation of these efforts;
- Third, the regulatory perimeter is being expanded. Major jurisdictions have finalized
or will shortly finalize legislation that establish regulation and oversight over the OTC
derivatives markets, hedge funds and credit rating agencies. In each of these areas,
principles for what regulation should achieve have been internationally agreed and
implementing regulation is being closely coordinated;
- Fourth, we have put in place cross-border oversight and contingency planning for
the largest and most complex global financial institutions, each of which now have
functioning core supervisory colleges and crisis management groups.
At the level of the essential regulatory policies to buttress financial stability, let me recall:
- that with Basel III, we have a fundamentally revised global bank capital framework
which will establish stronger protection through improved risk coverage, more and
higher quality capital, a counter-cyclical buffer and a constraint on the build-up of
banking sector leverage;
- Second, as part of Basel III, we will for the first time have a global liquidity standard
for banks that will promote higher liquidity buffers and constrain the maturity
mismatching that created the condition for this crisis;
- Third, as I will describe later, we are making progress in developing a policy
framework and tools to roll back the moral hazard risks posed by institutions that are
TBTF;
- Fourth, we have eliminated the perverse incentives that pervaded securitization,
including the scope for leverage to develop in opaque off-balance sheet vehicles
through changes to accounting standards and regulatory and prudential rules;
- Fifth, we are establishing central clearing of standardised contracts in the OTC
derivatives markets and a OTC global trade repository is now in operation;
- Fifth, we have developed a series of supervisory tools to raise standards of
governance, risk management and capital conservation at financial institutions. In
this context, let me note that:

we are making good progress with accounting standard setters towards
expected loss provisioning regime for credit losses, which will dampen
procyclicality and align accounting and prudential objectives in this key area; and

principles and standards have been issued to better align compensation
systems with prudent risk-taking. The standards give supervisors powers to
restrain compensation structures and the level of pay-out to conserve capital
in the firm. As we move to raise capital levels, we will encourage supervisors
to use these powers.
I have been selective in my enumeration. But the point I want to leave with you is that we
should not underestimate what has been accomplished. Each of the above areas are difficult
in their own right. That we have been able to progress global policy development and
implementation on such a broad front, while fighting a very serious financial crisis, is
something that has never happened before.
So, the direction in which we are moving internationally is encouraging. But important issues
remain. And it is political resolve that will determine whether we accomplish the credible and
robust reforms that our citizens rightly demand, yet preserve the enormous advantages of an
internationally integrated financial system.
Addressing TBTF
Addressing the "too-big-to-fail" (TBTF) problem is perhaps the most challenging remaining
legacy of the crisis. Basel III will greatly strengthen banking system resilience, but it does not
address this problem.
The FSB has assessed a broad range of policy options in this area and will present its
recommendations to the G20 in November.
It is important to recognise that SIFIs vary widely in structures and activities and that the
nature and degree of the risks they pose also differ. Some are large, complex highly
integrated global financial institutions with activities spanning a range of sectors. Others may
have a global customer base but are simpler commercial banking operations. Yet a third
category is entities that are large at a domestic or regional level but nonetheless globally
interconnected through wholesale funding markets.
Whatever their nature, SIFIs have two things in common: that their uncontrolled failure would
cause significant systemic disruption and that we, as authorities, cannot at present resolve
them in an orderly fashion without use of public funds. The framework we have agreed to
address SIFIs is therefore based on four necessary pillars.
First, we must radically improve our capacity to resolve SIFIs without disruptions to the
financial system and without taxpayers' support. Effective resolution regimes must advance
the goals of both financial stability and market discipline. This means they need to be able to
impose losses on shareholders as well as creditors while ensuring continuity of essential
financial functions. All countries should have a Dodd Frank style regime in place. In addition,
we need to acquire additional resolution tools. The bail-in of debt holders holds significant
attractions both from the perspective of correcting creditor incentives and protecting tax
payers. But the legal issues associated with the bail-in in group structures and in a
crossborder context are non-trivial.
Moreover, to be effective backstops in dealing with global firms, national resolution regimes
need to converge towards common standards. And these need to be supplemented by
cross-border cooperation arrangements underpinned by national law that provides both
mandate and capacity for resolution authorities to cooperate. Legislative changes will be
needed in many countries to enable this. Lastly, "living wills" will be mandatory for major
firms. These will include assessments of firm resolvability. Supervisors will have the power to
require changes to a firm's structure to improve its resolvability.
Second, the loss absorption capacity of systemic firms should reflect their role in the global
financial system and their potential contribution to systemic risk. Even with the best possible
resolution tools, the failure of a major global firm would cause significant damage. This
reinforces the importance of strengthening the resilience of major global firms. Higher loss
absorption capacity for SIFIs than the minimum agreed Basel III standards, especially for the
largest globally operating SIFIs, therefore are at the core of our recommendations. A credible
process of peer review will be established to challenge the policy choices made within each
jurisdiction and to ensure that measures applied on a country-by-country and SIFI-by-SIFI
basis are consistent and mutually supportive.
The third area is strengthened oversight and supervision. Senior line supervisors have drawn
a frank assessment of weakness leading up to this crisis. These weaknesses were not
present in equal amounts everywhere, but there is scope for improvements all around. Our
recommendations in this area have been developed with the IMF. One set is focused on the
mandates, independence and resourcing of supervisors. Another is on improved methods
and practices to proactively identify and address risks.
Fourth, we will be setting out higher robustness standards for core financial infrastructure.
These infrastructures - including for central counterparties - are themselves sources of
systemic risk were they to malfunction or fail.
This is a complex project which will unfold over a number of years. It will need to be
consistently implemented in all major countries to maintain a level playing field, avoid
regulatory arbitrage and effectively address the risks to the overall system. The already
established FSB framework of country and thematic peer reviewing process will address
improved resolution frameworks and more intensive supervision In addition for SIFIs with the
potential to create damages at a global level we will establish a mutual policy review process
that will review and challenge the national policies towards major global SIFIs.
Ahead of us, other issues still require attention:
- So far, most of our attention has been on strengthening the resilience of the banking
system, and rightly so. Yet, the shadow banking sector remains a large part of our
financial systems, less regulated, but nonetheless significant in the credit
intermediation and maturity transformation, and subject to runs in damaging ways.
- We need to make frameworks for macro-prudential policies and systemwide
oversight operational. We will be sharing approaches for surveillance, powers to
obtain information and modalities for action on identified risks. The FSB will
coordinate approaches where an international regulatory response is needed. We
will be working with the BIS and the IMF to build principles for effective
macroprudential policies.
Lastly, the FSB is developing arrangements to broaden the involvement non-members in its
work at early stages of policy development. We will be setting up regional arms of the FSB.
Each regional group will be co-chaired by an FSB member and a regional non-member who
will attend FSB Plenary meetings.
Conclusions
Let me conclude. Three things have been important in making the progress we have on
reforms:

First, the sheer seriousness of the crisis, and the recognition that, in a globally
integrated system, we all sit in the same boat;

Second, the readiness in the official community to agree objectives and timelines for
substantial reform, including through the G20 process; and

Third, the establishment of mechanisms, such as the FSB, to hasten the policy
development needed to meet these objectives.
I am quite confident that, with these, we will be able to achieve globally consistent rules that
will lastingly increase the resilience of the financial system and the real economy and deliver
the level playing field that a global system needs.