Prudential bank regulation: present and future
Speech given by
Vicky Saporta, Executive Director for Prudential Policy, Bank of England
Westminster Business Forum Keynote Seminar: Building a resilient UK financial sector
-
next steps for prudential regulation, structural reform and mitigating risks
4 July 2018
I would like to thank Matthew Willison for working with me on this speech. Thanks are also due to
Thom Adcock, Omar Ahmed, Dana Andreicut, Tamiko Bayliss, Stuart Dossett, Orlando Fernandez
Ruiz, Mariana Gimpelewicz, Marc Hinterschweiger, Alex Holmes, Antoine Lallour, Jack Leslie,
Damien Lynch, Sinead
O'Leary-Barrett, Sam Miller, David Murphy, Santosh Pandit,
Thomas Papavranoussis, Rajan Patel, Joshua Plank, Jakob Schedlbauer, Jon Sepanski,
Dominic Shaw, Jonathan Smith, Ruth Smith, Anthony Veal, and Sam Woods for contributions and
comments.
Introduction
I am pleased to be here today to give this speech. The Westminster Business Forum has a fascinating
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agenda from policy priorities for UK manufacturing, to the development of FinTech, even the future of the
UK space industry! And your roots are in Parliament, which gives the Bank of England its objectives to
maintain monetary and financial stability.
Today is also a special day for me personally.
Exactly two years ago, on 4 July 2016, I was appointed in my current role as Executive Director for
Prudential Policy.
As only 10 days had passed from the EU referendum, I was anticipating that I would be spending significant
amounts of my time thinking about how to approach prudential policy during a period of uncertainty over the
UK's future relationship with the EU.
I had not anticipated, however, that the finalisation of Basel III, which at the time was expected to be agreed
by the Group of Central Bank Governors and Heads of Supervision in January 2017, would be delayed by
another 11 months, during which time a number of people would doubt whether it would be finalised at all.
But on 7 December 2017, Basel III was finalised.
This is a major milestone for regulators globally, including the Bank of England, which has been at the
forefront of prudential reforms internationally. Not only because it signals the continuation of a cooperative
approach to standard setting for internationally-active banks, but importantly, because it puts in place the
final elements of the reforms to banking regulation agreed since the crisis.
What has been achieved?
The scale of these reforms has been remarkable: between the start of 2009 and December 2017, when
Basel III was finalised, the Basel Committee on Banking Supervision published 47 standards.1 To put that in
context, in the preceding twenty-year period, between the time Basel I was agreed in 1988 and the crisis, the
-
Basel Committee had published less than half of that number 21 standards.
The reforms have also touched a wide range of different aspects of bank regulation. As well as extensive
changes to risk-weighted capital requirements, the Basel Committee has published standards for a leverage
ratio requirement, liquidity requirements and large exposures limits.
1
the publication type 'Standards'. Where a standard was published in the
This is a count of publications by the Basel Committee of
period and subsequently superseded by another standard within the same period both standards are counted.
In the United Kingdom, we have also developed a range of domestic reforms reflecting the importance of the
banking system as a share of our economy.2
These reforms range from the development and implementation of a new institutional framework for
macroprudential policy to deal with threats to financial stability, to the design of microprudential remuneration
rules that better align risk-taking incentives with variable pay, to the Senior Managers and Certification
Regime aimed at improving individual accountability at PRA-authorised institutions.
We have also undertaken structural reform to protect retail payments and lending to households and
businesses from shocks to other parts of banking groups specialising in serving wholesale customers.
We are well on track to deliver structural reform in January 2019, including higher capital buffers for
ring-fenced banks. Yesterday, the PRA issued for consultation proposals to implement leverage ratio
requirements and buffers for ring-fenced banks whose groups are required already to meet leverage ratio
3
requirements on a consolidated basis, and to reflect these higher leverage buffers in group capital. These
proposals are in line with the Bank's leverage ratio policy statement published in 20154
and the statement of
policy on the systemic risk buffer framework from 2016.5 These proposals mark the end of the policy
development cycle on this flagship reform since the crisis.
Complementing these domestic structural reform measures, policymakers both here and internationally have
put in place resolution regimes to end too-big-to-fail. Jon Cunliffe has recently discussed developments in
this policy area.6
A lot has been said about the progress made through these international and domestic reform agendas in
so I will not dwell more on this topic here. Suffice to say that UK banks'
strengthening financial resilience7,
ratios of high-quality capital to risk-weighted assets are on average over ten percentage points higher than
2
UK banks' assets are close to 400% of UK GDP.
3
See 'UK leverage ratio: applying the framework to systemic
ring-fenced bodies and reflecting the systemic risk buffer, Prudential
Regulation Authority Consultation Paper 14/18,
https://www.bankofengland.co.uk/prudential-regulation/publication/2018/uk-leverageratio-applying-the-framework-to-systemic-rfbs-and-reflecting-the-srb.
4
See 'Implementing a UK leverage ratio framework', Prudential Regulation Authority Policy Statement PS27/15,
https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/policystatement/2015/ps2715.pdf?la=en&hash=5DBB377CD051FA67D16BCA1662DBE696682AF56B.
5
See 'The PRA's approach to the implementation of the systemic risk buffer',
https://www.bankofengland.co.uk//media/boe/files/prudential-regulation/statement-of-policy/2016/the-pras-approach-to-the-implementation-of-the-systemic-risk-buffersop.pdf?la=en&hash=6954AC9765597EB5598414171D90C25982A144CE.
6
'Central clearing and resolution - of the lessons of Lehmans', 5 June 2018,
learning some
https://www.bankofengland.co.uk//media/boe/files/speech/2018/central-clearing-and-resolution-learning-some-of-the-lessons-of-lehmans-speech-by-joncunliffe.pdf?la=en&hash=954FF2E62AA3A5AB6ADCDEA88188FB6697F9B0CD.
7
'What a difference a decade makes', a speech by Mark Carney,
E.g., see
'Ten years on: lessons from Northern Rock, a speech
https://www.bankofengland.co.uk//media/boe/files/speech/2017/what-a-difference-a-decademakes.pdf?la=en&hash=CA8F77C4F518DCFB8C697C03704773370C82326D,
by Jon Cunliffe,
https://www.bankofengland.co.uk/-/media/boe/files/speech/2017/ten-years-on-lessons-from-northernrock.pdf?la=en&hash=9543F1499C211A505206615DA86C8C88D7988365, 'The revolution is over. Long live the revolution!', a speech
by Sam Woods,
and 'Rethinking financial stability', a
https://www.bankofengland.co.uk/-/media/boe/files/speech/2016/the-revolution-is-over-long-live-therevolution.pdf?la=en&hash=C5A74C42F5129D9505A8FA27B211BE2404C71351, speech by Andy
Haldane,
https://www.bankofengland.co.uk/-/media/boe/files/speech/2017/rethinking-financialstability.pdf?la=en&hash=C6F5991F2DD69E1C84610B0EBE51FB03F5F62E61
crisis (Chart 1). And UK banks' buffers of liquid assets have increased by
they were prior to the over 40
percent since 2010 (Chart 2).
Basel III finalisation
Turning back to last December's Basel III package, it is important to remember the aim of these reforms.
was to reduce excessive variability of banks' assets, and in doing so making banks'
Their aim risk-weighted
risk-based capital ratios more transparent and comparable.8
This excessive variability is caused by the fact banks' internal models can generate widely
different risk
weights for very similar assets. When the Basel Committee asked banks to calculate risk weights using their
internal models for hypothetical portfolios of assets banks reported very different risk weights. The ratio of
highest to lowest risk weights was as high as 2.3 for a hypothetical portfolio of trading book exposures (and
even higher for individual asset classes in the banking book).9 To put that in context, against the same
portfolio of exposures, one bank might be holding £100 of capital whereas another one might be holding
£230.
This risk weight variability could reduce the stability of the banking system by impairing the link between risk
and capital at the level of the system. It means banks with similar portfolios will not be equally resilient.
It also means that banks with the same ratios of capital to risk-weighted assets actually display different
levels of resilience. Consequently, excessive risk weight variability makes banks' capital ratios less
comparable and less transparent reducing the market's confidence in them. This is what happened during
the crisis; investors lost confidence in regulatory measures of capital and started constructing their own.
To accompany this speech, I include a paper co-written with Marc Hinterschweiger and Tobias Neumann
that presents detailed analysis of the issue of risk sensitivity in capital regulation.10
Here, I would like to highlight two things from this work.
First, the evidence supports the hypothesis that more granular and risk-sensitive measures reduce incentives
for banks to take on more risk ("risk shift", in the jargon). In the paper, we compare mortgage lending of UK
banks using internal ratings based (IRB) models to UK banks using less risk-sensitive standardised
approaches after the implementation of Basel II in 2007. (Basel II was the reform that allowed banks to use
their much more granular and risk-sensitive internal models to assess capital for mortgages and other credit
8
See https://www.bis.org/press/p171207.htm.
9
See https://www.bis.org/publ/bcbs240.pdf and https://www.bis.org/publ/bcbs256.pdf.
10
Hinterschweiger, Neumann, and Saporta (2018), 'Risk sensitivity and risk shifting in banking regulation', Bank of England
Financial
Stability Paper No.44,
https://www.bankofengland.co.uk/financial-stability-paper/2018/risk-sensitivity-and-risk-shifting-in-bankingregulation
exposures.) We show that after the introduction of Basel II, UK banks that used internal models increased
their lending to less risky mortgage borrowers and decreased their lending to risky borrowers, relative to
"standardised" approach. Put differently, more granular
banks on the less complex and less risk-sensitive
risk-sensitive approaches appeared to have led to less risking up, exactly as the architects of Basel II
intended.
Second, we show that simpler measures of capital adequacy can do better than more risk-sensitive
measures in discriminating between failing and surviving banks. Indeed, there is now a body of literature
that suggests that the leverage ratio did better than the more risk-sensitive Basel I ratio in discriminating
between weak and strong banks in the global financial crisis.
The paper also offers explanations on why this may be the case.
The first reason is statistical.
measures tend to be less "biased", that is
More complex and risk-sensitive on average their predictions are
closer to the real risk. But notice the emphasis on the words "on average". Any model, including a zero bias
model, can predict different results depending on the sample used. And the more complex the model, the
"model variance", other
more parameters involved and the greater the statistical variability in results or,
factors being equal.
To reduce this model variance one needs large and high quality data sets. For low probability events, such
as defaults on loans to highly-rated large corporations or to low-LTV mortgages, the data requirements
become even larger. And when data requirements are too large, the paper shows that simple but wrong
(biased) models can outperform correct (unbiased) but complex models, precisely due to the large statistical
variability (Charts 3, 4).
The second reason is behavioural.
Financial participants adapt their behaviours to the policy environment they face by finding ways to take on
12
- "regulatory arbitrage".11,
the same risk but using up less required capital so-called
A balance therefore needs to be struck between the need to allow for more risk-sensitive and complex
measures to discourage risk shifting and the need to best trade off model bias and model variance, while
being less vulnerable to arbitrage.
11
A well-known example of such behaviour is the use of securitisation and innovative forms of credit enhancement under the Basel I risk
(1999), 'Capital requirements and bank behaviour: the impact of the Basel Accord', Basel Committee on
weights (see Jackson, P
Banking Supervision Working Paper No.1, https://www.bis.org/publ/bcbs_wp1.pdf).
12
Such behaviour is, of course, not limited to the financial system, or in fact to humans: even dolphins have been observed
'gaming the
rules'
(https://www.theguardian.com/science/2003/jul/03/research.science)!
This is precisely what the final elements of the Basel III package seek to achieve. The package reaffirms the
role of internal models as a primary means of guarding against risk shifting. It also firms up an international
leverage ratio regime (borrowing a number of elements from the UK regime13) while also, and more
controversially, introducing an aggregate output floor calibrated at 72.5% of standardised risk weights to
guard against excessive risk-weight variability.
in addition
By introducing the output floor to the leverage ratio, model variance will be constrained at a wider
set of banks. The leverage ratio acts as a break to debt-funded asset growth focussed on low risk-weighted
assets (RWAs) (Chart 5). It binds for banks that specialise such assets, e.g. repo, clearing services, and
low-LTV mortgages.
On the other hand, the output floor affects banks for which the leverage ratio is not binding yet nonetheless
might be exposed to model risk, for example banks that are active in a range of asset classes but their
internal models tend to systematically produce results that are significantly lower than the RWAs based on
standardised approaches.
The Basel Committee will continue to monitor closely the implementation of the Basel III standards, which
will include the impact on risk-weight variability.14
What is next?
The finalisation of Basel III signals that the wave of regulatory reform following the Global Financial Crisis is
now over. You should not expect a lot of further reform to bank regulation, particularly regulations regarding
banks' capital and liquidity.
The focus of regulators, both in the UK and internationally15, is pivoting towards three things:
 Completing the implementation of the post-crisis reforms - e.g. the Basel III finalisation package and
the reforms contained in CRD V and CRR Il;

Making adjustments to the framework in response to new risks;
 Making adjustments to the framework in response to unintended consequences.
13
For instance, a leverage ratio buffer for global systemically important banks (G-SIBs) that is based on the level of the risk-weighted
GSIB buffer. There are some differences between the Basel leverage ratio regime and the UK regime but the amounts of Tier 1 capital
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major UK banks need under each are broadly similar see Box 3 in the June 2018 Financial Stability Report,
https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2018/june2018.pdf?la=en&hash=9D057C7302B80EF57D634020F50C6F46D782904C.
14
See https://www.bis.org/press/p171207.htm.
15
See the letter from the Financial Stability Board chair to G20 Finance Ministers and Central Bank Governors, 18 March 2018,
http://www.fsb.org/wp-content/uploads/P180318.pdf.
Remaining policy development
As mentioned, you should not expect a lot more reform. But there will be some further policy development to
finish the job we started 10 years ago.
For example, having implemented the Liquidity Coverage Ratio (LCR) back in 2015, we are polishing our
Pillar 2 liquidity framework. This has not been adapted since the FSA introduced a new liquidity regime in
2010. Pillar 2 liquidity is intended to capture liquidity risks faced by banks that are not captured by the
Pillar 1 LCR.
Earlier this year we published a Statement of Policy on Pillar 2 liquidity.16 And we are now considering the
appropriate calibration of overall liquidity requirements, covering both Pillar 1 and Pillar 2. This analysis will
inform a further consultation paper in due course.
Importantly, the Bank is taking further steps to ensure the public can have confidence that banks in difficulty
can be resolved without disruption to the provision of financial services to the economy. The Bank intends to
consult at the end of this year on the details of a framework for assuring that banks are resolvable.17
Implementation
Given the large number of reforms that have been agreed, it should not be surprising to hear that there
remains quite a lot of implementation still to do.
The reforms which finalise Basel III are due to be implemented between 2022 and 2027. The Bank supports
a full, timely, and consistent implementation of these reforms.18
As the Financial Policy Committee explained late last year, we remain committed to implementing robust
prudential standards in the UK, irrespective of the particular form of the UK's future relationship with the
EU.19 This will require maintaining a level of resilience as least as great as that currently planned, which
itself goes over and above what is required by international baseline standards.
16
Prudential Regulation Authority Statement of Policy, February 2018,
https://www.bankofengland.co.uk/-/media/boe/files/prudentialregulation/statement-of-policy/2018/pillar-2-liquidity-sop.pdf?la=en&hash=2963466309B077C9E5FFD64EC4BBAABE26699FD7.
17
speech by Jon Cunliffe, 'Central clearing and resolution - learning some of the lessons of Lehmans', 5
See the previously referenced
June 2018,
https://www.bankofengland.co.uk/-/media/boe/files/speech/2018/central-clearing-and-resolution-learning-some-of-thelessons-of-lehmans-speech-by-jon-cunliffe.pdf?la=en&hash=954FF2E62AA3A5AB6ADCDEA88188FB6697F9B0CD.
18
See the Communique of Finance Ministers and Central Bank Governors, on which the Bank sits, March 2018,
https://g20.org/sites/default/files/media/communique_-_fmcbg_march_2018.pdf.
19
See page II of the executive summary of the Financial Stability Report November 2017,
https://www.bankofengland.co.uk//media/boe/files/financial-stability-report/2017/november2017.pdf?la=en&hash=F6D65F714A7DC28394BC4FCC9909CCD39E28AD10.
Other reforms that form part of Basel III, as well as other elements of the post-crisis regulatory framework,
will be implemented as part of the forthcoming new Capital Requirement Directive and Regulation. These
are likely to be implemented in around 2020-21.
Table 1 sets out the pipeline of policies to be implemented.
New risks
Turning now to the identification and handling of new risks.
Regulators must avoid the temptation to keep on fighting the last war while failing to recognise other, new
risks.
The last war was mainly focussed on the inadequacy of bank's capital and liquidity, the inadequacy of
frameworks to tackle too big to fail, and the lack of individual accountability. And these issues are and will
continue to be important in any future prudential regulatory regime.
But the world has also changed since.
As my colleague, Lyndon Nelson, has recently set out, technology is transforming the payments and banking
industry and, together with opportunities, it brings with it new risks.20 And his answer to fighting this new war
was that PRA-regulated firms need to be on a WAR footing; that is, they should be able to withstand, absorb,
and recover from operational shocks.
latest Financial Stability Report published last week sets out the Financial Policy Committee's approach
The
to establishing standards for the resilience of the delivery of vital financial services to cyber incidents.21
And, tomorrow, the PRA, the Bank in its capacity of supervising financial market infrastructures, and the FCA
will be publishing a discussion paper on operational resilience.
Dynamic adjustments
As set out earlier, the reforms that were agreed following the crisis were remarkable in scope. They have
delivered a much more financially resilient system, both in the United Kingdom and globally.
20
See a speech by Lyndon Nelson, 'Resilience and continuity in an interconnected and changing world', 13 June 2018,
https://www.bankofengland.co.uk/-/media/boe/files/speech/2018/resilience-and-continuity-in-an-interconnected-and-changing-worldspeech-by-lyndon-nelson.pdf?la=en&hash=3DFD465DE00C545FA39255384DD660AF7B0C8A9F.
21
See Box 1, p.40 of
https://www.bankofengland.co.uk/-/media/boe/files/financial-stability-report/2018/june2018.pdf?la=en&hash=9D057C7302B80EF57D634020F50C6F46D782904C.
Furthermore, some of the reforms were put in place quickly. They were also developed concurrently.
Therefore it would be flabbergasting if the reforms did not have some unintended consequences.
Unintended consequences might arise from the way regulations interact with each other. Because reforms
were developed at the same time, some interactions may not have been identified as policies were
negotiated.
I referred to one type of unintended consequence already. Banks will seek ways to lower regulatory
requirements even in ways that do not actually reduce the risks they face ('regulatory arbitrage').
Plus, the financial system will evolve over time. New products, market practices, and especially technologies
are going to emerge; some of these might create new risks that were unforeseen when the post-crisis
reforms were developed.
As unintended consequences come to light and new risks emerge regulators may need to make changes to
regulation over time, what I am going to refer to as 'dynamic adjustments'.
Being open to making such adjustments does not mean undermining the objectives behind the post-crisis
regulatory framework or changing the level of resilience in the banking system regulations are aiming for.
On the contrary, it is by making dynamic adjustments that we can ensure the regulatory framework continues
to deliver on the reforms' objectives and ensures that the resilience that policy makers injected into the
system post-crisis endures.
To ensure this is the case we will need to follow a set of principles to guide us towards when it is appropriate
to make dynamic adjustments.
Principles for making dynamic adjustments
What might these principles look like? Here are my current thoughts.
Principle 1: decisions about dynamic adjustments should be made with reference to the objectives of the
original regulation and/or of regulators.
For the Bank, prudential regulation is relevant to a number of our primary and secondary objectives: most
the PRA's microprudential objectives and the FPC's macroprudential objectives, but also the
obviously
MPC's monetary policy objectives given the role banks play in the monetary transmission mechanism.
Principle 2: decisions about dynamic adjustments should be evidence-led.
Decisions about whether or not to make an adjustment will be made on the basis of a careful weighing up of
evidence of benefits and costs. In doing this we need to bear in mind that regulatory costs will often be
easier to quantify than the financial stability and safety and soundness benefits. And depending on the case
we may need to look beyond the banking system to capture all of the costs and benefits. For instance,
unintended consequences of bank regulation might be felt not in the banking sector but in financial markets,
financial infrastructures, and other parts of the financial system.
Principle 3: we should aim to match a dynamic adjustment to the problem that has been identified.
If we identify an unintended consequence of a particular regulation we should first seek to adjust that
regulation to deal with the consequence. Similarly with any new risks that emerge. For instance, if a new risk
that is identified is threatening the stability of the system as a whole it would seem appropriate to look to use
a macroprudential tool to reduce that risk.
Adjustments we have made already
The Bank has already made several changes to the regulatory framework that can be thought of as dynamic
adjustments.
Two such changes have been made to the leverage ratio requirement.
In response to a recommendation by the FPC, central bank reserves have been removed from the
calculation of the denominator of the leverage ratio since summer 2016.22 This change was intended to
ensure the leverage ratio did not impede the transmission of monetary policy. But to offset the removal of
central bank reserves and ensure the amount of capital banks need to meet the leverage ratio requirement
did not decrease, the requirement was also raised from 3% to 3.25%.
A second change was designed to deal with window dressing behaviour that we had started to observe.
From 2016 banks have been required to report and disclose the denominator of the leverage ratio based on
23,24
assets averaged over the quarter. Previously it was based on assets observed on the last day of the
quarter. But this led to banks seeking to shrink their balance sheets at quarter-ends in an attempt to
22
Prudential Regulation Authority Statement on the leverage ratio,
https://www.bankofengland.co.uk/-/media/boe/files/prudentialregulation/publication/pra-statement-on-the-leverage-ratio-august2016.pdf?la=en&hash=F50C86C8AAA788EBFAC159F009BBED7D2FE07B83, August 2016.
23
Prudential Regulation Authority Policy Statement 27/15,
https://www.bankofengland.co.uk/-/media/boe/files/prudentialregulation/policy-statement/2015/ps2715.
24
Banks in scope of the UK leverage ratio framework are required to disclosure a leverage ratio each quarter. A bank's leverage
ratio
denominator should be based on its daily on-balance sheet exposures averaged over the quarter and its monthly (on the last day of the
month) off-balance sheet exposures averaged over the quarter.
increase the leverage ratios they disclosed. This led in turn to volatility in some financial markets at these
times (Chart 6). Volatility at quarter-ends appears to have abated since this change.
The Bank announced last year it will also make an adjustment to its approach to setting Pillar 2A add-ons to
banks' capital requirements
in order to ensure the regulatory framework is proportionate to all lenders,
thereby supporting effective competition, whilst not compromising on safety and soundness.25
The adjustment allows supervisors to reduce Pillar 2A add-ons for banks which use the Standardised
Approach for credit risk to reflect how risk weights under this approach tend to be higher than the risk
weights determined using internal models at other banks for some types of assets. This is particularly the
case for UK mortgages (Chart 7).
Another part of the regulatory framework to which we have made adjustments is the Senior Managers and
Certification Regime.
We recognised following the implementation of the regime in 2016 that not all individuals that should be were
in scope of the regime. In particular, the regime did not include a specific senior management function or
responsibility related to areas such as operational continuity and operational resilience, including resilience
the Bank's growing emphasis on these areas, as
to cyber risk. This omission was inconsistent with
highlighted earlier.
In response a new function - the Chief Operations function - has been added to the regime to ensure there
is clear and appropriate accountability for operational continuity and resilience.26
Identifying dynamic adjustments
We are doing two things to enable us to identify aspects of regulation that might need adjustment.

Horizon scanning
One of these is that we are collecting evidence of the effects of regulations on and new risks faced by
individual banks by pooling intelligence gathered in different parts of the Bank as part of a horizon scanning
27
process.
25
Prudential Regulation Authority Policy Statement 22/17,
https://www.bankofengland.co.uk/-/media/boe/files/prudentialregulation/policy-statement/2017/ps2217.pdf?la=en&hash=38A16F0135791C4803EC1948DBF86CFB8330DBCB.
26
Prudential Regulation Authority Policy Statement 12/17,
https://www.bankofengland.co.uk/prudentialregulation/publication/2016/strengthening-accountability-in-banking-and-insurance-amendments-and-optimisations.
27
See 'Looking both ways', a speech by Sam Woods, 10 July 2017,
https://www.bankofengland.co.uk/speech/2017/looking-both-ways.
The process draws on supervisory and market intelligence, macroeconomic analysis, and thematic analysis
of trends in key financial markets.
With the information collected through this process we can then reflect on whether any developments
warrant dynamic adjustments to be made to microprudential regulations.While horizon scanning helps us
make decisions about dynamic adjustments, as well as supporting a
supervisory oversight of banks' behaviour, it does not absolve banks from their responsibilities
well-informed
to identify key risks as part of their own risk management, hold financial resources to mitigate those risks, or
deal with the PRA in an open and cooperative way.
 Evaluation work
The other way we are gathering evidence on the effects, including unintended consequences, regulations
are having is running evaluation exercises.
This is something that is happening internationally. A framework for post-implementation evaluations was
developed by the Financial Stability Board in 201728 and is now being applied to several of the post-crisis
reforms.29 The Basel Committee has started a programme of evaluating the reforms to banking regulation.30
The Bank is playing an active part in these exercises.
An evaluation is a rigorous assessment of the effects a regulation is having on the financial system and wider
economy. An evaluation should consider whether a regulation is achieving its aims and whether it is having
any unintended effects.
To do a proper evaluation a policy needs to be in force so one can observe the policy's effects. As the
post-crisis reforms are still being implemented, evaluation is going to be a multi-year project.
One evaluation that is underway already relates to the G20's reforms to
over-the-counter (OTC) derivatives
markets. This is examining whether or not the post-crisis reforms are supporting incentives to clear OTC
derivatives via a central counterparty, a G20 aim. For instance, it is considering whether the leverage ratio
requirement on banks is weakening incentives to provide clearing services.
Bank staff have researched the effect the leverage ratio is having on client clearing (Acosta-Smith, Ferrara,
Rodriguez-Tous (2018)). The results suggest that the leverage ratio may be deterring banks that are most
affected by this regulation from clearing OTC derivatives trades on behalf of clients. Box 1 discusses this
28
http://www.fsb.org/wp-content/uploads/P030717-4.pdf.
29
See the letter from the Financial Stability Board chair to G20 Finance Ministers and Central Bank Governors, 18 March 2018,
http://www.fsb.org/wp-content/uploads/P180318.pdf.
30
by Stefan Ingves, 'Basel III: Are we done now?',
See a speech https://www.bis.org/speeches/sp180129.pdf.
work in more detail and sets out some thoughts on how one might approach the financial stability case of
making an adjustment in this area, in line with the principles I outlined earlier.
This evaluation exercise highlights that interactions between different types of policy are likely to be a fertile
area for research going forward.
Summary
The finalisation of Basel III late last year represented a final step towards completing the reforms to banking
regulation that followed the crisis.
I hope I have been able to convey today the reasons for those reforms and the financial stability benefits
both here in the UK and internationally.
The focus of regulators has now shifted towards completing the implementation of the post-crisis reforms,
but also towards monitoring for any unintended effects the reforms are having, as well as being alert to new
risks that emerge.
We will consider making adjustments to regulations in response to unintended consequences and new risks
to ensure that the resilience we injected into the banking system post-crisis stands the test of time.
by Giuseppe di Lampedusa, "if we want
Or put in the words of t