Andreas Dombret: On the road to greater regulatory
proportionality?
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank,
at the strategy conference of the Rhineland Savings Banks and Giro Association, Bonn, 29
August 2017.
* * *
1. Introduction
Ladies and gentlemen
Some of you may perhaps recall that I have been a guest at the Rhineland Savings Banks and
Giro Association's strategy conference once before - two years ago, to be precise. On that
particular occasion, I shared my views on a variety of topics including the precarious situation in
Greece and the slump in China's equity market. Fast forward to the present day, and there are
other, not entirely new challenges we are looking at: digitalisation, regulatory matters, interest
rate levels.
We are here today to discuss strategies which you can use to counter the current challenges. I
would like to make a practical contribution to today's proceedings by talking about the challenge
of regulation. My speech here will focus particularly on small banks and savings banks with a
regional footprint and show how the regulatory landscape might evolve for them.
2. Regulation - a challenge
Let me begin by asking you this: what do you, personally, associate with regulation and
supervision? I trust you will all now be thinking of your competent analysts at the Bundesbank.
But for many of you, I would imagine, your thoughts will also be turning to paperwork, constraints,
costs. And let me tell you: you wouldn't be wrong. Regulation and supervision are indeed a
challenge - they do create constraints, they do run up costs.
Yet it is no less true that regulation is necessary, and it is useful. The paperwork, the constraints,
the costs - there are good reasons for all these things.
After all, the services provided by banks and savings banks are crucial for a stable economic
cycle, for growth and prosperity. Banks and savings banks fund investments, they manage
savings and deliver important services, such as processing payments.
But taking risks is also part of the banking business. And when you take risks, there's a chance
you might fail. But when a financial institution fails, the implications are far-reaching - and I don't
just mean for the institution itself, but also for its investors, for the real economy, and for us all.
The financial crisis, which marks its tenth anniversary over the next few weeks, taught us that the
failure of a single institution is enough to trigger a chain reaction throughout the entire sector.
Smart regulation ensures that banks and savings banks can still go about their business, but that
they are appropriately protected against the biggest risks. It shields the economy, consumers
and the financial system itself against turbulence. The reason we can't give financial institutions
full rein is because of the important part they play in the economic cycle.
That's a point that often goes unnoticed in the debate surrounding regulation. Please don't get me
wrong: regulation and supervision are not sacrosanct; criticism is certainly not out of bounds. In
the days when I myself was being supervised, I voiced criticism when I felt it was right to do so.
But criticism, whatever form it may take, needs to be constructive and honest and it shouldn't be
unduly sweeping. Regrettably, that cannot be said of all the utterances in the public debate on
this topic.
3. Regulatory proportionality is lacking
Regulation and supervision are crucial, and it's right that they should be something of a burden.
But it is also clear that needlessly heavy demands should be avoided. Regulation needs to cost
as much as necessary but also as little as possible.
And I fear this is a mark we've been falling short of in some respects lately. Because regulation
has grown ever more complex over time. The years since the onset of the financial crisis, in
particular, have seen the Basel Committee adopt wide-reaching global reforms. The idea behind
these initiatives was to learn the right lessons from the financial crisis and to be better equipped
going forward to fend off disruptions of that magnitude. The increased complexity of regulations,
then, is merely a reflection of the mounting complexity of global banking business. So you could
say it is warranted - and the sector's global players are mostly certainly in a position to get to
grips with the new rules.
But in actual fact, the bulk of these complex rules, especially in Europe, apply not only to major
multinational institutions but to every single bank and savings bank as well. And that's quite a
problem. Because when small and medium-sized institutions comply with the rules, they do not
benefit from the same economies of scale which their larger rivals can harness. For one thing,
small institutions face much heavier costs, relatively speaking, when they invest in IT
infrastructure or hire an additional employee for their Compliance department. That's a downside
they can only partly offset by cooperating with other institutions from their network. As such, the
single rule book runs counter to the idea of a level playing field and creates problematic
incentives in terms of uniformity and size in the banking sector.
Regulation today already takes account of proportionality to a degree. Tiered standards exist in
areas such as reporting, where large institutions are required to meet more frequent and
comprehensive reporting standards, and supervisors largely exercise proportionality when
applying the minimum requirements for risk management. Proportionality is also embedded, in
principle, in the EBA guidelines on the supervisory review and evaluation process. But in practice
I repeatedly encounter situations where the existing gradations are inadequate in my eyes. The
proportionality principle is nothing new, then, but it still has not been anchored deeply enough.
4. The road to greater proportionality: a chronology
That's why we took action and explored ways in which the principle of proportionality could be
embedded more deeply within the regulatory and supervisory frameworks. Let me start by
running you briefly though the events of the past one-and-a-half years.
German Finance Minister Wolfgang Schäuble and his then UK counterpart George Osborne
moved the ongoing debate forward substantially in April last year by noting, in a joint paper, the
increasing complexity of banking regulation and pointing to the excessive burden on small
institutions running straightforward business models. It is a topic we at the Bundesbank also feel
very strongly about. Hence my decision to go public with the first set of specific proposals a little
while later.
That November then saw the European Commission likewise table its proposals for
strengthening proportionality as part of the general overhaul of EU banking regulation, which is
still an ongoing process. These proposals would make major changes to the small print, and I
am certain that we will be able to roll out a number of meaningful initial improvements.
That said, the proposals don't go far enough - which is why we thought ahead. The
establishment of a German Specialist Working Group was followed by the drafting of a
Bundesbank paper setting out concrete measures as well as several consultations with the
German central associations. The outcome of this process is a German "non-paper" - that is, a
discussion paper - which the Federal Ministry of Finance put before the competent expert group
of the European Commission in June this year.
5. Which way?
When working out this common German proposal, there were essentially two paths we could
take to move towards greater proportionality. Should we look into specific adjustments, or should
we go straight into creating a separate regulatory framework for small institutions?
The first path has a clear practical advantage: it would be quick and relatively simple to
implement, especially since European legislation on banking regulation is currently being revised
anyway. It does have its disadvantages, however: realistically speaking, smaller institutions will
not gain any substantial relief from their burdens on account of a few specific improvements to
regulation. There is also the risk of ending up with a patchwork of exceptions that are difficult to
interpret.
The second path would be more radical. The creation of a separate regulatory framework for
small institutions - also known as the "small banking box" - would mean more fundamental relief
for these institutions. A clear and consistent definition would also prevent any difficulties in
interpretation. Though the implementation and maintenance of this would be somewhat more
complicated, in future the regulations for small and large banks would be developed in parallel
and in alignment with each other. Depending on how the threshold values for the small banking
box are set, there is also the risk of cliff effects.
We have carefully weighed up these and many other arguments in the Specialist Working Group
on Proportionality. The group's purpose was to facilitate the exchange of views between
politicians, supervisors and the banking industry. The Federal Ministry of Finance, BaFin, the
Bundesbank and the five central associations of the German banking industry were all
represented in this group.
These members agreed that it would be expedient to bolster proportionality in regulation. The aim
of the working group was therefore to work out specific proposals on how to alleviate the burden
of regulation on small institutions with simple business models. And it delivered on that aim: the
non-paper that I mentioned earlier, which was written with the group's help, is now in Brussels,
where it is being used as the basis for further discussion at the European level.
5.1 The question of "Who?": a three-tier approach
So what does the German proposal look like? First, let me address the "Who?", namely who are
the relief measures intended for. The proposal takes a three-tier approach in this regard.
At the very top are the systemically important and potentially systemically risky institutions - the
smallest group in terms of numbers but extremely important in terms of risk. Because of this, it is
also the most intensely regulated. Generally speaking, this group includes institutions with total
assets of over €20 billion. Nothing will change for these institutions: all of the Basel III
requirements will still apply, as will the additional capital buffer, the total loss absorbing capacity,
and so on.
A second group would include institutions which are not large and systemically important, but
which are also not small and low-risk, which is why it is not possible to make any extensive
simplifications for them. Nonetheless, the proposal does include for this middle group some
targeted relief measures which could be achieved by making specific amendments to the current
regulations.
Finally, the third group is made up of small and non-complex institutions - the banks that are
most affected by the fixed costs of regulation without their systemic importance being considered
individually. This group - the largest in numerical terms - is to have its cost burden alleviated
radically by means of a separate regulation: the small banking box.
The burning question now, of course, is which institutions belong in which group - and
particularly, which banks could be included in the small banking box. I will say right off that I am
not able to conclusively answer this important question today. These classifications have to be
balanced carefully, and we will do this as part of European-level discussions.
I would, however, like to give you an initial idea of how this classification might look. By talking of
small institutions, this suggests that a qualification criterion for the small banking box would be
relatively modest total assets. For example, in Germany, a total assets threshold value of €3
billion could put more than 80% of institutions into this category.
What constitutes large and small in other member states is completely different, however. To
account for this heterogeneity, absolute size would have to be supplemented with relative size.
This could be the ratio of the bank's total assets to its home country's economic power or the
size of the domestic banking sector, though in this case, too, size isn't everything. I've already
said that not only do institutions in the small banking box have to be relatively small, they also
must not be too complex. This is why we need additional criteria.
First, only institutions that we believe would be subject to insolvency proceedings in the
event of resolution may be part of the box.
Second, candidates for the small banking box must not engage in any notable capital market
or cross-border business.
Third, they should have, at most, a small trading book and a small derivatives book.
Fourth, instead of internal models, they may only use the standardised approach.
This list of requirements prevents institutions with riskier business models from being part of the
simplified regime.
Experience has taught us, however, that there will almost never be a perfect list of criteria that
covers every eventuality. This is why the final decision should always rest with the supervisors.
Should they have serious misgivings, they can opt not to subject an institution to the simplified
rules. They can also take into account the systemic risks arising from the connectedness of
several small institutions - that is to say, small banks which are "too many to fail".
Incidentally, this possibility to choose should not be a one-way street. I believe that institutions
that would be considered eligible for the small banking box should also nevertheless be given the
option of being supervised pursuant to the more complex rules.
But coming back to the figures: if we were just to apply a threshold value of €3 billion, around
1,300 banks and savings banks in Germany could fall under the simplified rules, or just over 80%
of all institutions, as mentioned earlier. This would be equivalent to 14% of the German banking
sector's total assets. Of course, this is just an initial calculation and it doesn't include the
additional criteria I listed.
If you look at the banks and savings banks in North Rhine-Westphalia alone, the picture is largely
the same: here, too, around 80% of the institutions could come under the simplified rules. This
would be equivalent to 24% of total assets in this state.
Some of you will no doubt be wondering what happens when institutions are close to the
threshold value. This is a good question, because alone around 50 German savings banks have
total assets between €2.5 and 3.5 billion, some of which are in the Rhineland - perhaps some of
you even run one of these institutions.
The question of potential cliff effects always comes up when quantitative thresholds are set.
Nonetheless, we regulators cannot do without thresholds. I believe two things are important to
prevent institutions from moving in and out of categories or, worse still, basing their business
strategy on attempts to stay within a certain threshold. First, quantitative thresholds must be
flanked by qualitative criteria and supervisors must also take decisions on a case-by-case basis.
In other words, just because a bank's total assets fall below a specified threshold, that is
nowhere near enough for it to be included in the small banking box. Second, we are discussing
introducing transitional arrangements to help make it easier to switch between regimes -
something that we want to be an option.
Ladies and gentlemen, a sensible and workable definition of institutions whose burden could be
relieved is perfectly feasible. And while it may appear that way at first glance, creating the small
banking box does not necessarily require a whole new set of rules. All that is needed is a short
section in the CRR dedicated to the issue.
5.2 The question of "what?": reducing the paperwork
That leaves the second key question: what exactly might the box look like? Let us start at the
heart of the problem, namely, the paperwork which the complex requirements create in various
areas.
Some of these requirements could be completely eliminated for institutions in the small banking
box. I could, for instance, imagine largely exempting small banks from disclosure requirements
and abolishing remuneration rules for them. In addition, they could be absolved from recovery
and resolution planning.
Full exemption from other requirements would be a step too far. But that should not prevent us
from trying to make things easier for small banks. For example, reporting could be reduced to a
core reporting process - a standardised reporting approach, if you like. A simplified form of the
net stable funding ratio (NSFR ) is also up for debate.
When designing the small banking box we must weigh up the benefits for supervisors, ie
ensuring financial stability, against the burden it creates for banks. As a rule of thumb, we can
say that any rules that are dispensable for effective supervision are up for negotiation.
6. Limits of the small banking box
Conversely, however, that also means that a lot of rules are not up for debate. And that brings
me to the limits of the small banking box. I will not beat about the bush: there can be no
concessions in terms of risk-based capital ratios, the leverage ratio or the short-term liquidity
ratio. And the list goes on. Small banks' business models are neither per se simple nor
automatically low-risk - and that is particularly true when looking at them as a whole. The new
regime must therefore be simple yet robust. Whatever happens, financial stability must be
guaranteed.
And, of course, we also want to avoid unintended consequences. Simplifications in one area
must not create additional work in another area. That also means that a sensible division of
labour and cooperation within banking associations should not be made needlessly complicated.
However, I am not overly concerned about this issue either. As I said earlier, the principle of
proportionality is not new and is already well-established in our risk-oriented supervisory practice.
So far, the banking associations have managed well in organisational terms. And I would like to
remind you that the very purpose of our joint proposal is to avoid unnecessarily high amounts of
paperwork.
7. What happens next?
The objective of reducing the regulatory burden for small and medium-sized institutions is
attracting more and more supporters. Speaking in Jackson Hole at the weekend, Chair of the
United States Federal Reserve Janet Yellen spoke in favour of reducing the burden on smaller
1
institutions.
Achieving this goal will be no stroll in the park, however. In drawing up a concept for the small
banking box, we have taken the first important steps. The aim now is to gain a European majority
for our idea.
For a reminder of how difficult that could be, we have to bear in mind just how different European
countries and their banking sectors are. A lot of our European neighbours have only a relatively
small number of banks, virtually all of them medium-sized to large. Others have a lot of small
banks, but have experienced serious problems with them in the recent past. And in some other
countries, the banking system is currently undergoing a far-reaching transformation process,
which means that the structure of the banking system will experience sweeping change.
The question we encounter is always the same: why should we agree to a small banking box?
That is the situation within Europe, and that is where we must provide information, explain the
situation and convince people.
For that to succeed, we must present a united German front. If we in Germany do not manage to
all stand behind the small banking box concept, we will have a hard job convincing other
European countries.
Ladies and gentlemen, the motto of your strategy conference today and tomorrow roughly
translates as "Building a successful future. Together". Let us make that the motto for the small
banking box project.
Thank you for your attention.
1
Janet Yellen, "Financial Stability a Decade after the Onset of the Crisis", 25 August 2017,
www.federalreserve.gov/newsevents/speech/yellen20170825a.htm