François Villeroy de Galhau: Basel III - an assessment, an outlook
Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at AGEFI's financial
regulation meetings, Paris, 6 December 2016.
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Accompanying slides.
Our meeting tonight could not be more timely: we are now in a pivotal period for the Basel III
reforms, eight days after the meeting of the Basel Committee in Chile, one month before the
decisive meeting of the GHOS (Group of Governors and Heads of Supervision). We started to
write this new page of banking regulation very soon after the financial crisis. Eight years have
passed since the Lehman crisis. It is high time to put an end to this regulatory chapter, to focus
on implementation and supervision, and to give stability and predictability to the financial industry
and thereby to the economy. But before laying out the prospects for the coming weeks - which is
what you probably expect from me tonight - it is necessary to take stock of the measures of the
Basel III package that have already been adopted: the results are considerable, and positive.
1 Basel III reforms were absolutely essential after the crisis
No one, I hope, can seriously dispute - even among the banking industry, including on the other
side of the Atlantic - that after the financial crisis it was necessary to significantly strengthen
regulation to reduce risks. The financial crisis has had heavy economic and fiscal costs, as well
as social costs through the drama of unemployment. Its political consequences for our
democracies are still visible today. We must all wish and act for a better prevention of future
risks: it is a collective imperative. Remarkable achievements have been carried out since 2009
under the impetus of the G20 and the Financial Stability Board. Basel III is a very comprehensive
reform that has significantly strengthened the prudential system for banks and financial stability
[slide 2]. Beyond the very last measures of the Basel III package still under discussion, great
progress has already been made:
First, by raising capital requirements, Basel III has made the financial system much stronger
than before the crisis. Banks now have more capital and of higher quality. [slide 3] To take
the example of France, major banking groups more than doubled their core tier 1 capital
between 2008 and 2015, from a total of EUR 132 billion to EUR 275 billion. The improvement
in solvency was mainly achieved through the increase in capital, rather than through the
reduction in average weighted assets - i.e. financing to the economy.
Also, Basel III broadened banking regulation beyond the solvency ratios to take into account
the diversity of risks to which banks are exposed. A leverage ratio - relative to the
unweighted balance sheet total - was introduced. Two new liquidity ratios also complement
the regulatory framework: the LCR (Liquidity Coverage Ratio) covers short-term liquidity, the
NSFR (Net Stable Funding Ratio) controls the refinancing structure. French banks have
already adjusted [slide 4]: they have almost doubled their liquidity reserves since 2011 and
now largely meet the LCR requirement, which will only be fully binding in 2018.
Lastly, Basel III makes it possible to respond more effectively to financial stability issues by
providing dedicated tools, such as countercyclical capital buffers, or for systemically
important banks. In 2013, France set up the Haut Conseil de stabilité financière (HCSF -
High Council for Financial Stability), which is qualified to take macroprudential measures; the
HCSF has its European equivalent with the ESRB (European Systemic Risk Board). And the
new European Single Resolution Mechanism (SRM) is now fully in force.
A question is nevertheless often raised: what is the economic impact of these new rules? Are
they likely to overly constrain the financing of the economy and hence to weigh on growth? I
believe it would be desirable that, over time, we set up instruments for conducting an ex post
assessment of these economic effects: the Financial Stability Board is working on this issue, on
the basis of a plurality of methods and including the benefits derived from a lower probability of
crises occurring. We discussed this at our meeting in London on 17 November. However, today
no one can seriously claim that the supply of credit in France or in Europe is constrained by
prudential ratios. There has been no rise in the cost of credit, quite the contrary, and growth of
credit to the economy is particularly robust in France, at + 4.6% for loans to businesses and +
4.1% for households in October 2016 [slide 5]. The Eurosystem's accommodative monetary
policy has certainly contributed to this by fostering excess liquidity for European banks. For the
future, however, the question may arise. We must absolutely avoid this pitfall in the finalisation
phase of the Basel III reforms.
2 As the final pieces of the Basel III framework are put in place, we must keep in mind the
need to safeguard financial security and the ability of Europe's banks to finance the real
economy
Basel III is nearing completion. The last remaining work areas chiefly concern the measurement
of risk on bank balance sheets. Beyond the technical questions raised, two key challenges have
to be met.
First comes the question of how internal models fit into the prudential risk assessment
framework. On this issue, we should not aim at the wrong target. It is certainly important to limit
the variability of results between banks and across countries, but only if this variability is
unjustified. Several papers have stressed the differences between European and US banks. In
particular, the latter have on average higher risk-weighted assets (RWAs) as a percentage of
total unweighted assets - what we call density. Yet we must steer clear of drawing simplistic
conclusions [slide 6]. The variations observed between Europe and the United States are not due
to the sole use of internal models rather than the standardised approach. We also have to
consider the very different nature of bank balance sheets in the two zones, notably owing to more
widespread use of securitisation - of real estate loans especially - and market financing in the
US, not to mention differences in accounting rules. Naturally, we must reinforce confidence in
internal models by supervising them closely - a task long performed by the Autorité de contrôle
prudentiel et de résolution (ACPR) and more recently taken on as well by the Single Supervisory
Mechanism in Frankfurt - but this need not be at the cost of full-blown standardisation. Risk
sensitivity must be maintained because it represents a huge step forward with Basel III, ensuring
that requirements are proportionate to risk taking. You can see [slide 6-3] that the correlation
between RWAs and the cost of risk is high in Europe as well, confirming that different risk
profiles are largely responsible for the difference in RWAs between geographical zones. In other
words, the task at hand is to finalise Basel III, not to build a new Basel IV, a notion that has been
widely decried in some quarters.
The second challenge involves the impact of the new prudential rules and, ultimately, their
effectiveness in achieving the stated goals. Systematically strengthening capital is no longer the
aim, since the requisite adjustments in this area have, as I said, mostly been carried out. A
further across-the-board increase is unwarranted from a financial stability perspective and might
interfere with orderly financing of the economy, especially in Europe, where bank intermediation
plays such a crucial role in the economy. Admittedly, capital requirements could go up at some
banks as a result of adjustments to the parameters of their internal models, when justified. We
must also bear in mind that some measures aimed at bolstering the prudential framework were
adopted recently and have yet to be implemented - I am thinking particularly of the fundamental
review of the trading book, that is, of the treatment of market risk.
G20 leaders have repeatedly underlined the general objective of refining the Basel III framework
"without further significantly increasing overall capital requirements". They reaffirmed this stance
in Shanghai in February, in Washington in April, and again in Hangzhou in September. The Basel
Committee must, of course, comply with the mandate entrusted to it.
The initial proposals published by the Basel Committee in the first half of 2016 fell short in terms
of meeting these two challenges, as I underlined at that time. Their impact was excessive and
they raised technical issues on several fronts. But considerable progress has been made, both
since the summer and at the Santiago meeting. To achieve this took unwavering determination
on the part of the French negotiating team, a strong cohesion within the euro area, particularly
between France and Germany, and substantial expert work by ACPR and Banque de France
staff, to whom I extend my congratulations.
We have not yet reached an agreement. But the possible outlines of the final Basel III reform are
becoming clearer. Among other things, they include:
Risk sensitivity is to be maintained, with certain portfolios remaining eligible for internal
models. Additionally, a number of excessive technical parameters were removed at the last
Basel Committee meeting, both for credit risk and operational risk.
Guaranteed loans will be considered equivalent to mortgage loans. This is a major advance
for French banks and should lower the requirements on these portfolios. This will reinforce,
not threaten, real estate lending in France.
Even so, we are not yet at the end of the process:
Numerous details still have to be clarified, and appropriate treatment of specialised financing
(for equipment and large-scale projects) needs to be secured for the long term.
The debate is still lively over the principle and calibration of an output floor - i.e. the potential
introduction of a capital floor for internal models, calculated as a percentage of the
standardised approach.
The Banque de France and the ACPR will remain vigilant until the work with our European
partners is completed. And should an agreement be reached, its future transposition in Europe
would obviously be dependent on compliance by other major geographical zones, including the
United States and its incoming administration.
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I would like to end by sharing my belief with you. Provided that it is balanced, a final agreement on
Basel III is in everyone's interest. Banks, first of all, need to see an end to the regulatory
uncertainty that is weighing on their strategy and depressing their market valuations. Companies
and households will also benefit by being able to count on stable financing. And it is in the interest
of France and Europe to maintain shared rules at a global level that will help to ensure an orderly
international financial system and fair treatment of all participants. While it is still too early to say
with certainty, for some important points still remain outstanding, I am nevertheless more
confident that we will be able to reach this decisive agreement by the beginning of next year.
Thank you for your attention.