Andreas Dombret: International coordination to enforce regulatory
reform
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at the Salzburg Global Seminar "Financial regulation - bridging global
differences", Salzburg, 16 August 2012.
* * *
1. Introduction
Ladies and gentlemen,
To cut to the chase: International collaboration between regulators has never been so
challenging - and yet never has collaboration been so important.
Let me explain.
2. Financial sector reform - time to slow down?
The regulatory community is currently facing enormous pressures. The sovereign debt crisis
has given a fresh impetus to calls to water down or delay regulatory reform. Some argue that
the ongoing uncertainty in financial markets and the weak global economy are good reasons
to ease up on regulatory pressure. They say the financial sector is being asked to do too
much too soon, and regulators should slow the speed of adjustment.
Yet I see it as more a case of "too little, too late": If there is a reproach to be made, it is that
regulatory progress has not been faster. The sovereign debt crisis, which is not least driven
by systemic problems in some countries' banking systems, underscores the urgent need to
make the financial system more resilient. Relying on financial markets' self-regulation will not
do, I am afraid. We must deliver on our promise and extend regulation and oversight to all
systemically important financial institutions, instruments and markets.
To deliver this promise, close international collaboration is essential. Given the truly global
financial system, "going it alone" is no longer a viable option. It will only lead to the migration
of business and to regulatory arbitrage, undermining not only the integrity, efficiency and
orderly functioning of financial markets, but ultimately undermining financial stability.
3. International consistency versus one-size-fits-all
The crisis has clearly demonstrated that countries cannot successfully regulate their financial
markets and firms in isolation. Capital flows do not stop at geographical borders; quite a
number of financial institutions operate globally. Therefore, an internationally coordinated
regulatory response is imperative. To be successful, reforms must be implemented at least at
the major financial centres.
International cooperation is not an end in itself, however. Instead, I suggest to measure its
value by the extent to which it provides financial stability. While adopting a robust, common
set of rules is essential, it is neither practical nor desirable to fine-tune all details of financial
regulation internationally. As the characteristics of each country's financial system differ,
sometimes significantly, I do not think it to be appropriate to apply completely identical rules
to every country or region. We must strike the right balance between providing a workable
level playing field and at the same time providing sufficient flexibility for the peculiarities of
national financial systems. The leitmotif for financial regulation ought to be international
consistency, one-size-fits-all.
not
A uniform set of rules and regulations would deprive us of the benefits of international
regulatory competition. By this, I do not mean competition where countries are undercutting
each other with ever laxer, but also ever more risky regulation. This would be equivalent to a
race to the bottom as we would invite market players to arbitrage across divergent national
regimes.
By regulatory competition, I mean assessing the merits of regulatory approaches and
measures undertaken by other countries and, if deemed appropriate, adopting these
approaches and measures. In short - learning from one another. For instance, in the USA,
the Federal Deposit Insurance Corporation, FDIC for short, has gained an extensive wealth
of experience in resolving failing financial institutions. In my opinion it would be careless for
European authorities not to draw on the knowledge of their US colleagues when
implementing their own resolution regimes.
4. Need for international cooperation
The work to develop a new regulatory framework for the international financial system is
slowly but surely nearing completion. An example of what has been achieved through
intensive cooperation is the new regulatory standard for bank capital and liquidity, commonly
known as "Basel III", or the comprehensive policy framework for dealing with systemically
important financial institutions, SIFIs for short.
Yet, we can not at all be satisfied with what has been achieved. While rule-making at the
global level is a necessary condition for financial stability, it is by no means a sufficient
condition. Rather, for the agreed reforms to be effective, they have to be translated into
national laws and regulations. This must be done in a globally consistent manner and
according to agreed timelines. Here, we must significantly step up our efforts and cooperate
as closely as possible. Otherwise, we risk failing.
Let me illustrate this with three examples.
4.1 Solving the too-big-to-fail problem
Solving the too-big-to-fail problem will, without a doubt, constitute the litmus test of financial
sector reform. The aim is clear: Taxpayers should not again be stuck with the tab for financial
institutions' failures. To achieve this, we must return to a founding principle of social market
economy: individual responsibility. Those who take risks must also face the consequences.
The possibility of losses and even default is a constitutive element of any functioning market
- and financial markets can not and must not be an exception to this.
Therefore, we have to find ways of resolving financial institutions, however large, complex,
interconnected or internationally active, without causing systemic disruptions. Obviously this
demands international cooperation. National resolution regimes are stretched to their limits
when it comes to globally operating SIFIs. To borrow the well-known line from Mervyn King,
the Governor of the Bank of England: "Global banking institutions are global in life but
national in death". In the past, if internationally active banks ran into trouble, national
supervisors regularly ring-fenced their assets. Banking groups were broken up or rescued as
separate entities along national boundaries. This led to systemic distortions and considerable
costs to taxpayers.
Against this background, the Financial Stability Board has developed, and the G20 have
adopted, a new international standard for resolution regimes, known as the Key Attributes of
Effective Resolution Regimes for Financial Institutions.
I very much welcome this development. The Key Attributes represent a major step forward,
for the first time stipulating at the global level main features that national resolution regimes
should include. Yet, following their adoption by the G20, the Key Attributes must now be
implemented consistently across borders. Here, a great deal of work remains to be done.
The Key Attributes have to be transposed into legislation which, naturally, has to be much
more concrete than the international standard.
The necessity of close cooperation is further underscored by the fact that the European
Commission has recently published its legislative proposal for an EU framework for bank
recovery and resolution. It is of utmost importance to ensure consistency between the two
frameworks. Otherwise we risk unnecessary inconsistencies and, consequently, new
problems in the event of financial institutions becoming distressed.
4.2 Monitoring and regulating the shadow banking system
The so-called shadow banking system can serve as another prime example for the need for
close cooperation. Firstly, there is the immediate threat of regulatory arbitrage, as stricter
rules imposed on banks via Basel III as well as the rules for SIFIs set incentives for activities
and risks to be pushed from the core of the financial system outward to the periphery.
Secondly, the fluid, evolutionary nature of the shadow banking system is a reminder to us not
to focus solely on risks which have come to light during the current crisis. We have to be
flexible enough to capture future developments as well. To ensure this, exchanging
information across jurisdictions on a regular basis is crucial.
better
Regarding monitoring, a lot has already been achieved. The FSB set out
recommendations which now have to be implemented by national authorities. Additionally,
the FSB has committed to conduct annual global monitoring exercises to assess global
trends and risks in the shadow banking system.
Regarding better regulation, work at the international level is ongoing to examine potential
gaps and inconsistencies of the existing framework. Several working groups are currently
developing proposals on possible regulatory measures. An integrated set of policy
recommendations will be presented by the end of this year. These recommendations will
then have to be implemented at national level, calling, once again, for close international
cooperation to ensure consistency.
4.3 Enhancing compensation practices
Reforming compensation practices in the financial sector shall serve as my final example.
Asymmetries in remuneration systems in terms of risk and reward led to short-termism and
excessive risk-taking. They also contributed to the large, in some cases extreme absolute
levels of compensation, leaving firms with less capacity to absorb losses as risks
materialised.
Good work should be rewarded with good money. Yet to be good, work has to be sustainable
and responsible. To safeguard financial stability, remuneration systems in the financial sector
must be better aligned to long-term value creation as well as prudent risk-taking, including
through malus or clawback arrangements. The Principles for Sound Compensation Practices
and their Implementation Standards developed by the FSB are both helpful and welcomed
guidelines to this effect.
To address the concerns of firms and improve cross-border supervisory cooperation, the
FSB established its Bilateral Complaint Handling Process in early 2012. This mechanism
enables national supervisors to bilaterally report, verify and, if necessary, address specific
compensation-related complaints by financial institutions that derive from level playing field
concerns.
Yet, it will take a lot of stamina and endurance to achieve lasting change in behaviour and
culture within the financial sector. The organised manipulation of LIBOR is just one
cautionary example for this. While progress has been made in implementing the FSB
Principles and Standards, more work is necessary to ensure a level playing field in the
market for highly skilled employees. Sustained commitment and close cooperation of
supervisory authorities therefore remain essential.
5. Intensified implementation monitoring
The success of financial sector reform crucially depends on the timely and globally consistent
implementation of agreed policies. As major reforms to address risks and strengthen
regulation across the financial system have been adopted, it is becoming increasingly
important to ensure that countries live up to their commitments. By means of peer pressure
and transparency, we have to make sure that the measures necessary to improve the
stability of the financial system are actually put into practice.
A number of steps to ensure effective and timely implementation of internationally agreed
reforms have already been taken. The results of numerous monitoring exercises are
summarised by the FSB in regular scoreboards and public progress reports to the G20. In
order to enhance the effectiveness of implementation monitoring, the FSB and important
standard setting bodies have jointly established a Coordination Framework for
Implementation Monitoring. In addition, the FSB monitors the implementation and
effectiveness of international financial standards and policies via its peer review programme.
Peer reviews are an important tool to promote consistency, enabling FSB members to
engage in dialogue with peers and share lessons and experiences. It is necessary to
continue on this path.
6. Closing remarks
Allow me to summarise:
Firstly, ongoing stress in the financial system and a weak economic recovery in many
countries is no excuse to weaken our commitment to financial sector reform.
Secondly, today's interconnected financial markets cannot effectively be regulated nationally.
Close international cooperation is warranted.
Thirdly, we must strike the right balance between achieving a level playing field and providing
sufficient flexibility for the peculiarities of national financial systems.
Finally, rigorous implementation monitoring will be indispensable. As the old saying goes:
Trust, but verify.