Luis M Linde: Reflections on the road and challenges ahead - regulatory
changes affecting banking activity
Closing address by Mr Luis M Linde, Governor of the Bank of Spain, at the IX IESE (Instituto
de Estudios Superiores de la Empresa/Business School of the University of Navarra)
Banking Sector Meeting "Banks - beyond the crisis", Madrid, 12 December 2013.
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Firstly, let me thank Professor Juan José Toribio, the president of the Centro Internacional de
Finanzas, for inviting me to participate in this IESE Banking Sector Meeting. And allow me to
congratulate the IESE on this ninth edition of a forum that has become a classic and has
consistently been of the greatest interest and highest calibre.
I am not going to address certain matters that are very important and topical, such as the
signs of recovery in the Spanish economy, the initial steps of the launch of the Single
Supervisory Mechanism, or the asset quality review or stress tests for those banks that are to
be supervised by the Single Mechanism. I would hardly have anything novel to say there.
Rather, I wish to review some aspects of the regulatory changes which, once the crisis has
been overcome, are going to significantly affect banking activity.
Three matters concern us: the elements of the new Basel III capital accord that have not yet
been fully finalised; the Financial Stability Board's work on the regulatory framework for the
treatment of systemically important institutions; and the new powers of the Banco de España
under the draft bill on the supervision of credit institutions, which will foreseeably be
approved in the first quarter of next year.
I shall begin with Basel III.
The new capital accord improves the comparability and, thereby, the credibility of capital
ratios. Basel III increases capital requirements with better-quality instruments, and it seeks
consistency and a uniform application across banks and countries. It also adds two new
prudential tools: one in the area of liquidity, and the other in that of leverage.
First, the inclusion of the leverage ratio, the relationship between Tier 1 capital and
exposure both on and off the balance sheet, i.e. the total banking book, without taking into
account risk weights. Calculations are made at the consolidated level and, in principle, the
level is set at a minimum of 3%. It is scheduled to come into force in 2018, although an
earlier date will probably be set for the required disclosure of this figure.
This new tool has been designed as a straightforward measure that complements and acts
as a floor to the minimum risk-based capital ratio. It aims to provide additional protection
against what is known as "model risk", i.e. underestimating the regulatory capital needed
further to a calculation using the sophisticated models allowed by Basel II and III.
On the more technical side, there appears to be agreement on the definition and calculation
of the ratio, the treatment of derivatives and repos, and operations with CCPs. But doubts
remain over its final calibration and how it affects certain business models, specifically those
most centred on retail activity.
The Banco de España has supported the setting of this leverage ratio in Pillar 1 on the
understanding that it can be a good prudential tool, once correctly calibrated. In this respect,
the monitoring period prior to its entry into force will provide information and experience.
Although European regulations envisage that countries may apply this ratio as they deem fit
until its harmonisation in 2018, it is not the intention of the Banco de España, in principle, to
bring forward its application.
As regards liquidity, Basel III has added new regulatory requirements: a short-term liquidity
coverage ratio (LCR), and a long-term requirement, the net stable funding ratio (NSFR).
The short-term liquidity coverage ratio is designed so that banks may have an asset buffer
with which to meet their maximum foreseeable liquidity or funding needs over a period of at
least 30 days. As what is involved is a safety margin, this ratio might at times of stress be
below 100% of such maximum foreseeable needs, which is the level demanded once the
requirements come fully into force. However, if a bank's liquidity-generating capacity stands
at below 100% of the maximum foreseeable needs, it will be obliged to inform the supervisor,
with which it will have to agree a plan to regain the 100% level.
The initial design of this ratio is very demanding and, perhaps, not very realistic. The year
2015 was too early a date for its full implementation, and the definition of "high-quality liquid
assets" or the assumptions of liquidity needs were overly rigorous. Hence, in January 2012,
the Basel Committee of Central Bank Governors and Heads of Supervision revised the
accord to widen the base of assets considered highly liquid and to soften the implementation
timetable. This regulation is also practically finalised, at least in the Basel Committee, as an
agreement on its design and calibration has already been reached.
The short-term ratio will not come into force immediately. It will be phased in from 2015 -
when a level of 60% will be demanded - to 2019, when it will reach 100%. Nonetheless, this
timetable may be speeded up at the discretion of the different national authorities.
The Banco de España has backed the setting of the short-term liquidity ratio, and the
amendments to it, which have softened the original framework proposed. Nor does it intend
to accelerate the implementation timetable, although we believe that banks should strive to
meet it as soon as possible. As regards reporting and transparency obligations, we consider
they should be obligatory for internationally active banks, but that they could be simplified for
others.
Basel III also envisages the implementation of a long-term liquidity ratio so that banks
maintain stable funding profiles, tailored to their assets and activities. In that way, banks'
dependence on short-term funding markets is structurally reduced, since that proved to be a
very disruptive weakness in the 2008 financial crisis.
The design of this ratio is at a relatively early stage, as the preliminary proposal published in
2010 is being revised. It is expected that, early next year, a consultative document will be
available, and that the regulations will have been finalised before 2015, with this entailing a
simplification of the original rule. Further, it will be necessary to agree on certain aspects of
relevance for Spanish banks, such as, in relation to liquidity requirements, the treatment of
high-quality mortgages or matters pertaining to asset encumbrance. This ratio is expected to
come into force in 2018, although in the case of the EU, the Commission will have to submit
a legislative proposal before 2016.
I shall now move on to certain elements relating to the review of capital requirements. This
is part of a broader project: to attempt to ensure that the benefits of risk-adjusted regulations,
such as Basel III, are not achieved at the cost of introducing
excessively complex
regulations which, in addition to other problems, yield results that cannot be compared from
one bank to another.
The Banco de España is in favour of simplifying the current regulations, striking a balance
between simplicity, comparability and risk-sensitivity. In this respect, it views favourably the
transparency exercise conducted by the Basel Committee on the comparability of asset risk
weights.
The results of this exercise allow an argument to be made for the need to lessen the
differences between requirements obtained by applying the standard method and those
calculated using internal models, so that the credibility of the solvency ratios should not be
compromised. However, we believe they should not go so far as to abandon the use of
internal models; rather, standardised models, based on parameters determined by the
supervisors, should be used as a reference for internal models.
I should also like to mention here the review of the with the
treatment of the trading book,
aim of reducing regulatory capital differences between this book and the banking book, thus
avoiding regulatory arbitrage.
At the Banco de España we broadly concur with these lines of work. However, concerning
the review of sovereign risk and in order to avoid undesirable effects and consequences for
financial stability, we believe a wholesale approach should be taken, not one that is
independent or isolated in respect of each working group.
As to the review of the current framework for the treatment of securitisations, I should like
to underscore the importance of the calibration of capital requirements associated with
securitisations not being excessively conservative, and that the reopening of these markets
should not be hampered in an unwarranted fashion.
I would like to end my comments on the work of the Basel Committee by touching briefly on
another regulatory matter currently under review, the treatment of large exposures.
This falls within the field of prudential measures additional to the solvency ratio, which aim to
ensure the survival of banks in extreme situations. The review focuses on the treatment of
exposures to third parties, since that of intra-group exposures has been postponed for the
time being. The general principle is that exposures to all counterparties should be subject to
limits based on the capital of the bank.
That limit has been set generally at 25% of tier 1 capital, although for certain exposures,
such as those between systemic banks, it is stricter. Notably, provision is made for the
possibility, after an observation period, of limiting exposures to central counterparties
(CCPs), although this matter is open and first requires an assessment of the effects of other
rules governing relationships between banks and CCPs.
Let me now say a few words on some of the main regulatory projects on which the Financial
Stability Board (FSB) is currently working, particularly that to promote a new regulatory
framework for the treatment of systemically important institutions, i.e. those whose
complexity, size and interconnectedness are such that their failure could cause serious
problems to the global financial system.
This new framework rests on four pillars: additional loss absorbency, effective resolution
mechanisms, increased supervisory intensity and more resilient financial market
infrastructure.
Unquestionable progress has been made in implementing this framework. In particular, the
G-20 has approved, as a new international standard, the so-called Key Attributes of
Effective Resolution Regimes for Financial Institutions, which have to be complied with
in each jurisdiction.
In Spain, Law 9/2012 adopts and applies many of the principles set forth in the "Key
Attributes". Meanwhile, the European Union expects to adopt the Bank Recovery and
Resolution Directive by the end of the year, which will be an important step forward in fully
implementing the "Key Attributes" in all Member States.
On this last point, as you know Ecofin is currently discussing the Single Resolution
Mechanism and the Resolution Fund. It seems that agreements, or draft agreements, are
being reached and that progress is being made in the area of resolution, such as the
determination of the competent authority. Also, in the more difficult and complicated issue of
financing, headway is being made on the characteristics of the proposed Single Resolution
Fund. Negotiations are following their course and an extraordinary Ecofin meeting is
scheduled for next week to address these matters.
Let me now look at the new powers assigned to the Banco de España in the draft bill on
credit institution supervision and solvency to be debated shortly.
Obviously all the functions and powers conferred on the Banco de España, which I will
describe shortly, will have to be interpreted and implemented taking into account the powers
of the European Central Bank in the framework of the implementation of the Single
Supervisory Mechanism.
From the formal standpoint, the draft bill will consolidate in a kind of "Bank Code" all the
regulatory provisions on the creation, activity and control of credit institutions, thus putting an
end to the dispersion of legislation which has characterised the credit sector for various
decades.
Furthermore, the aforementioned consolidation aims to write into Spanish law the changes
introduced in June 2013 by the so-called CRD-IV package, i.e. the Directive and the
Regulation which incorporate the Basel III Accord into European legislation. As you know,
that transposition has been partly handled by the promulgation of Royal Decree-Law
14/2013, which includes those matters considered essential for incorporation before
1 January 2014.
Under the draft bill, and without prejudice to the framework resulting from the entry into force
of the Single Supervisory Mechanism, the Banco de España will retain its current power to
authorise the exercise of banking activities. Moreover, it will receive additional powers, such
as that to revoke banking licences.
Regarding the regime governing the purchase of qualifying holdings in credit institutions, the
Banco de España will continue to be the authority responsible for assessing the proposals of
potential purchasers, although now there are plans to give it powers of supervisory
intervention, senior officer replacement, suspension of voting rights or, in extreme situations,
licence revocation.
As bank supervisor, the Banco de España will continue overseeing compliance with
organisational and disciplinary regulations. To this end, the draft bill maintains its existing
inspection and verification powers, although with some changes, such as that requiring the
Banco de España to carry out yearly stress tests on supervised institutions to evaluate their
solvency.
Additionally, in the context of the Banco de España's prudential supervisory tasks, the draft
bill equips it with certain tools envisaged in EU legislation, including the so-called Pillar 2
measures such as additional own funds requirements, limitations on dividend distribution,
restriction of certain activities and limitation of variable compensation.
The Banco de España will also be empowered to set the "additional capital margins"
envisaged in the draft bill.
The Banco de España will continue drawing up supervisory guidelines. As a new
development, it is envisaged that, if institutions' conduct does not comply with the guidelines,
they will, if required by the supervisor, have to explain the reasons for such non-compliance.
In the area of sanctions, the Banco de España retains its current powers, independently from
the powers which may at any time be exercised by the European Central Bank within the
framework of the Single Supervisory Mechanism. Against this background, significant
changes were made which generally strengthen the regime currently in force.
Finally, the draft bill endows the Banco de España with supervisory, inspection and
sanctioning powers in respect of compliance with obligations to offset, notify and reduce risks
associated with the use of OTC derivatives.
To conclude: 2014 will, as we all know, be an extremely intense year as far as international
financial regulation and supervision are concerned. There will be no lack of work. My best
wishes to all of you and good luck.
Thank you.