Andreas Dombret: Regulatory agenda of the international financial
system - a coherent strategy
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at the Bankenkonferenz 2013, Austrian Working Group on Banking and
Finance, Vienna, 11 February 2013.
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1. Welcome
Professor Lucius
Ladies and gentlemen
First of all, thank you very much for inviting me to speak to you today at the opening of the
banking conference.
Even though today's discussion is focused on the banking sector, please allow me to take an
overarching perspective in my speech by looking at the financial sector as a whole. This is
because the close linkages in the financial system - both within sectors and across sectors
and countries - make it necessary to take account of existing connections and
cross-linkages in regulation, too. Otherwise, there is a risk of individual regulatory measures
working in opposite directions or even cancelling each other out. Instead of a coherent
strategy, we would then have a patchwork carpet.
2. The regulatory agenda for the international financial system
At their summit in Washington D.C., the Heads of State or of Government of the G20 opted
for an all-embracing approach. They decided to subject all systemically important financial
institutions, financial markets and financial instruments to appropriate regulation and
monitoring. After all, the financial crisis had exposed shortcomings in the financial system as
a whole as well as in its regulation. The aim of the regulatory agenda is therefore to eliminate
these shortcomings and to make the financial system as a whole more resilient.
The plan of action adopted in Washington marks the hour that the regulatory agenda saw the
light of day, so to speak. At the following G20 summits, this agenda was successively refined
and worked through stage by stage. In this context, the international Financial Stability Board
(FSB) plays a key coordinating role. This is because the regulatory agenda consists of
several components on which the relevant standard-setting bodies and international
committees are working in parallel. The reforms that are being tackled range from
strengthening financial supervision through improved transparency regulations to measures
designed to correct the false incentives stemming from systems of remuneration.
Coordinating all these strands of work is the task of the FSB, which is also responsible for
regular reporting to the G20.
The large number of work strands and regulatory provisions might create the impression that
the sometimes exaggerated faith in the market prior to the crisis is now being replaced by
excessive faith in government. Let me make it clear: what matters for us is not the sheer
number of regulations but their quality.
After all, the purpose of regulations is to create a consistent and reliable regulatory
framework that sets the right incentive for market players to behave in a risk-conscious
manner. The regulatory reforms initiated by the G20 are therefore also aimed at reasserting
market economy principles - such as the unity of liability and control in particular. Ultimately,
functioning financial markets are indispensable for our general economic wellbeing, since
they ensure the efficient allocation of risks and capital.
3. Cross-linkages and connections
The close interlinkages within the international financial system mean that sector-specific
regulations can also impact on other sectors and market players. The individual elements of
the regulatory agenda therefore not only have to build up stage by stage, one on top of the
other; they also have to be interlocked.
For example, close links exist between the banking and insurance sectors, not least because
insurers invest in bank bonds on a significant scale. Regulation of one sector therefore
always has implications for the other. For that reason, any interactions between the solvency
regime for insurers and bank regulation have to be borne in mind if we are pursuing a
coherent regulatory agenda.
The regulatory framework for systemically important financial institutions, known as SIFIs,
provides us with an example of the cross-sector applicability of regulatory provisions. This
framework was developed under the aegis of the FSB and was adopted by the G20 in
November 2011. Its objective is to contain the systemic risks emanating from SIFIs. To this
end, the framework rests on two pillars: the first of these comprises better loss-absorbing
capacity in comparison with other institutions. This is achieved by capital surcharges going
beyond Basel III set according to the systemic importance of the given institution. The
second pillar consists of mechanisms allowing the restructuring and resolution of SIFIs
without plunging the financial markets into turbulence. The example of the recently
nationalised SNS Reaal in the Netherlands shows the importance of putting in place
regulations in this sector.
The SIFI framework was initially applied to globally systemically important banks. In a second
stage, it was extended to banks which are systemically important at the domestic level.
Finally, intensive work is being performed at present on transferring it to insurers and
financial market infrastructures which are systemically important globally. In terms of its
application, the framework is thus not restricted to a specific sector. Furthermore, it can be
applied to banks which are systemically important internationally as well to banks that are not
systemically important at the global level but at the domestic level. This means that the SIFI
framework takes account not only of interlinkages across sectors but also of the close
connection between national and supranational levels.
In designing the new Basel framework, Basel III, the close interlinkages in the financial
system - between sectors as well as between jurisdictions - have to be taken into account in
order to prevent regulatory arbitrage. This is because the new capital and liquidity standards
for banks will not only lead to an increase in the quality and quantity of capital and an
improvement in liquidity. At the same time, these more stringent regulations will potentially
set incentives to shift transactions and thus circumvent the stricter banking regulation. I am
thinking in this context not only of shifts into less strictly regulated jurisdictions but also, in
particular, of transactions being shifted towards less strictly regulated players of the shadow
banking system.
These examples also show clearly that we have already passed a number of important
milestones in financial market regulation, but are still a long way from our destination.
Progress in work on the various elements of the reform agenda is at different stages. Some
reforms have already taken the form of planned legislation or have already entered into
force; others will follow this year. Even so, we still have a lot to do.
Besides solving the "too big to fail" problem, developing comprehensive recommendations on
the regulation of the shadow banking system is among the upcoming major projects this
year. Here, I expect the publication of our final report in September. The future viability of the
business models of a number of banks will also be subjected to scrutiny - not least against
the backdrop of the ongoing discussion about the introduction of a model involving a
separation of commercial and investment banking, or the Volcker Rule.
And then we also still have a lot of work to do on the regulation of OTC derivatives trading.
The G20's original time schedule for implementing the recommendations on the reform of the
OTC derivatives markets by the end of last year failed to be met. It is therefore all the more
important not to ease off at this point but to press on resolutely with its implementation.
Delays in the timetable cannot always be avoided. But they should not lead to the envisaged
reforms being watered down. Otherwise, we would be jeopardising our goal of making the
financial system as a whole more resilient to crises.
4. Consistent implementation taking centre stage
Although we still have a fair stretch of road ahead of us, the focus is rapidly moving away
from the development of regulatory measures towards implementing them. In the future,
monitoring their implementation will undoubtedly be shifting more and more to centre stage.
The reason for this is that, if the regulatory measures agreed at international level are to
have their intended effect, it will be absolutely crucial for them to be implemented
consistently in the individual countries as well. That also includes adhering, as far as
possible, to the timelines agreed for their implementation so that competitive distortions are
avoided as far as possible. To prevent the emergence of a regulatory gap, the regulations
should be applied not only in the G20 countries but also, preferably, in all countries with
developed financial systems.
Regulators and supervisors are aware of the importance of consistent national
implementation. For that reason, we have significantly expanded our work in monitoring
national implementation over the past few years. Thus, the self-commitment of the FSB
members to lead by example in the implementation of international standards is subject to a
regular review with publication of the results. In addition, for three years now, a system of
peer reviews has been in place among FSB members to investigate the relationship between
promise and performance or, in other words, how far the internationally agreed standards
and principles have been implemented nationally. In cooperation with international
standard-setting bodies, in October 2011 the FSB presented a coordinated framework for
monitoring and reporting on the implementation of the agreed reforms. In this connection,
greater attention is being paid to areas such as the Basel framework and measures relating
to SIFIs, but also including the shadow banking system. In-depth monitoring and regular
publication in the form of progress reports to the G20 are also helping to keep up the
pressure for implementation.
In order to prevent regulatory arbitrage between sectors and countries, we have to fix our
sights even more firmly on the systemic aspects of regulation. The key requirement for doing
this is to assess the overall effects of the regulatory measures and to analyse any potential
interactions between them.
Impact studies play a major part in gauging the macroeconomic effects of new proposed
regulation. I therefore expressly welcome the fact that all the Basel reforms - including the
new Basel III liquidity standards - are being accompanied by studies that assess both their
short and long-term effects on banks and the real economy.
Repeated fears have been voiced from within the financial industry that the stricter Basel III
regulations combined with the more far-reaching requirements for SIFIs will have the effect of
restricting the credit supply. The Basel Committee has looked into this question and come to
the conclusion that the drawbacks are outweighed by the advantages, namely the gain in
stability and the reduced likelihood of future crises. A moderate increase in the cost of
lending and minor losses in growth will thus not put at risk the supply of credit to the
economy.
Pressing ahead with work on the various elements of the reform agenda in parallel harbours
the risk that individual measures might conflict with each other. In our closely interlinked
financial system, focusing on sector-specific measures can easily lead to unintended
interactions occurring or even conflicting incentives being set. Such a lack of consistency
might lessen the desired effects of the new regulations or even negate them entirely.
One possible instance of unwanted interactions is the combined effect of European banking
regulation and the EU solvency regime for insurers. This is because banking regulation aims
to place bank funding on a stable, that is a long-term basis, while, under certain conditions,
the solvency regime gives preference to bank bonds with short maturities. Capital
requirements increase relatively sharply given longer duration of the bank debt securities
held by insurance companies - at least when the standard formula is used. The outcome
might be that insurers change their asset allocation to the detriment of bank debt securities.
As insurers are among the most important investors in bank bonds, this could ultimately lead
to an increase in banks' funding costs.
Within a single sector, too, different regulations can set conflicting incentives. One example
of this might be the interplay between the EU crisis management directive and the scheduled
liquidity ratio requirements. This is because the draft proposals of the directive provide for
short-term liabilities being excluded from bail-in, thus setting incentive for short-term funding.
This is diametrically opposed to the aim of regulating liquidity, which is to safeguard the
maintenance of liquid funds even under unfavourable circumstances and for longer periods
of time.
Of course, a final judgement on the effects of each of the regulatory initiatives can only be
made when their precise details are known and as soon as robust empirical evidence is
available.
In the end, for the regulatory reforms to have their desired effect, it will be absolutely crucial
that we identify any potential interactions of this kind and, as far as possible, avoid them.
This is quite clearly anything but an easy task. It means weighing up the aims and effects of
various measures. It could also mean that measures which have already been adopted have
to be amended or revised while they are in the process of being implemented or soon after.
The latest example of this is the revision of the liquidity standard by the Basel Committee.
Having said that, however, it should be clear to both the general public and those affected by
regulation that this is not a case of watering down measures once they have been adopted.
Rather, it is matter of taking due account of systemic aspects of regulation so as to avoid
possible unwanted consequences.
5. Conclusion
Ladies and gentlemen
The international regulatory agenda is not a patchwork. Rather, it represents an
all-embracing approach covering a wide range of issues from institutions to financial markets
to individual instruments. This coherent strategy consists of several interlocking structural
elements, the overall impact and potential interactions of which have to be carefully
analysed. For it is only with an internally consistent regulatory agenda that we can make the
international financial system more stable and more resilient to crises.
In order to achieve this goal, the international agreements now finally also have to be
consistently transposed into national regulations and laws. Even if slight delays to the original
timetables cannot always be avoided, there should be no doubt about the determination of all
the G20 countries, including the EU, to continue fulfilling their commitment to implement the
reforms.
Thank you for your attention. I look forward to the ensuing discussion.