Axel A Weber: Banking regulation
Keynote speech by Professor Axel A Weber, President of the Deutsche Bundesbank, at the
9th Munich Economic Summit, Munich, 30 April 2010.
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1. Introduction
Ladies and gentlemen
The financial crisis, though in its third year now, still presents us with a great many
challenges. Nevertheless, while the number of challenges has not decreased, their nature
has changed. With the stabilisation of markets and the onset of recovery, the focus has
shifted from managing the current crisis to preventing future crises. And a cornerstone of this
attempt to create a more stable financial system is the reform of banking regulation. As the
field of banking regulation is highly complex and involves a host of technical details, I will limit
myself to a brief overview of the current state of the reform process, highlighting some critical
points. However, I am sure that the ensuing panel discussion will provide us with an
opportunity to elaborate on some of the more technical details.
2. Micro- and macroprudential aspects of regulation
Any attempt to create a more stable financial system should begin with the individual bank -
that is, on the microprudential level of regulation. The relevant regulatory framework on this
level are the Basel II rules, which have been implemented by a large number of countries. As
the crisis revealed some shortcomings of the Basel II framework, the G20 commissioned the
Financial Stability Board to work towards a reform of the current rules. A first set of relevant
measures was published in the summer of 2009 as a direct reaction to the subprime crisis.
Among others, these measures include stricter capital requirements for market risk and
securitisation as well as heightened risk management requirements. Additional proposals
were put forward in December 2009. Aiming at enhancing the resilience of the banking
sector, major elements of these proposals include a new liquidity standard as well as a
revised definition of capital. In the course of the current year, the relevant measures will be
calibrated on the basis of a comprehensive impact study and be finalised by the end of 2010.
Although the envisaged reforms will strengthen the existing rules, they will not change their
underlying principles. In essence, the Basel II framework seeks to limit banks' risk-taking
behaviour by making it more expensive and thus less attractive. Against this backdrop,
recent proposals to prohibit certain risky activities altogether pursue a more radical course.
One fundamental problem of such an approach is that the complete prohibition of certain
activities is a very far-reaching market intervention, especially since these activities do not
necessarily have zero economic value-added. Contrary to the Basel II approach, the penalty
imposed on risky activities would become infinite. Thus, given the inherent trade-off between
the efficiency costs of intervention and its benefits, a reformed Basel II framework might
provide a more balanced solution. This is also the case with regard to the introduction of an
additional tax for the banking sector. Even though such a tax could be useful in recouping
some of the costs of the crisis, it is an inferior instrument in terms of internalising the effects
of risky activities on financial stability. Hence, the reform of the Basel II framework is rightly
given preference by regulators and should be implemented with priority by policymakers.
Regardless of its actual design, the general objective of regulation on the microprudential
level is to have a first line of defence by reducing the likelihood of individual bank failures.
However, given our globalised and interconnected world and the interdependence of
financial institutions and markets, even the failure of a single institution might lead to
systemic disruptions. Thus, it is necessary to complement a strengthened microprudential
regulation with a macroprudential stance which as a second line of defence takes into
account the stability of the financial system as a whole. One major aspect of macroprudential
regulation would be the treatment of systemically important financial institutions. Although the
revised Basel II framework is part of a solution to this problem, broader reforms are
necessary. These might include capital surcharges for systemically important institutions,
better resolution regimes as well as a stronger market infrastructure.
Regarding the reform process itself, we have to bear in mind that the decisions we are about
to make will shape the global financial system for years to come. Thus, accuracy is more
important than speed, and we have to be careful not to implement oversimplistic solutions.
Regarding the required complexity of regulatory measures, potential interactions have to be
taken into account, as otherwise the danger of unintended consequences will grow. At the
same time, the cumulative effect of new measures has to be considered, which makes
thorough impact assessments of the intended consequences necessary. We are, of course,
aware of the fact that a slow pace of reform increases regulatory uncertainty for market
participants. But up to now, policy development has proceeded according to agreed and very
ambitious timelines, reducing the uncertainty as far as possible.
3. International cooperation and harmonisation
Another factor that increases the complexity of the reform process is the need for
international cooperation in order to move to a regulatory level playing-field. Due to the
ongoing process of globalisation and the emergence of internationally active banks,
international harmonisation of regulation has become essential in safeguarding the stability
of the financial system. The general case for a stronger harmonisation of regulation could be
made by imagining a globalised and interconnected world where national rules prevail. In
such an environment, internationally organised banks could easily avoid national regulations
by shifting business activities across borders. Via this process of regulatory arbitrage they
would be able to comply only with the lowest standards and thus endanger the stability of the
financial system. At the same time, this behaviour would put those banks at a disadvantage
which are not internationally organised. A level playing-field as the basis for fair competition
would not exist. Furthermore, nationally fragmented regulatory frameworks would hamper
cooperation between home and host supervisors of international banks and thus lower the
effectiveness of regulation. Hence, attempts to put the reform of regulatory frameworks on an
international footing are fully warranted, even though this adds an additional layer of
complexity to the process.
4. Conclusion
Ladies and gentlemen
The financial crisis has taught us three very broad lessons. We have to strengthen regulation
on the microprudential level, complement it with macroprudential supervision and ensure
international harmonisation and cooperation. Although we have already come a good
distance, we have to sustain the political will to stay the course. As we are now hopefully
entering better times, there is a certain danger that some major issues on the reform agenda
might fall prey to dwindling commitment and political interests. However, this must not be
allowed to happen, as only a coordinated and harmonised effort will enable us to ensure
financial stability and thus pave the way for steady and sustainable global development.
Thank you for your attention.