Andreas Dombret: Prospects for, and obstacles to, greater
proportionality in regulation - a supervisor's perspective
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank,
at the second Regional Banking Conference of the State of Hesse, Brussels, 21 February 2018.
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1. Introduction
Ladies and gentlemen
I would like to start by thanking you very much for the warm welcome and for inviting me to this
event.
When I was asked to speak to you here today about the prospects for, and obstacles to, greater
proportionality in banking regulation, I jumped at the opportunity - and I did so because this is a
topic that is especially close to my heart.
Let's take a look back: when the debate first started in 2016, I sought to have the Bundesbank
review whether smaller credit institutions were unduly burdened by regulation. And once we were
able to show clear signs of this, I decided that the Bundesbank should be quick to turn the debate
towards potential solutions.
This is all the more important to us because we regard diversity as a key attribute, not only in
nature and our society but also in our economy and the banking sector. After all, diversity is
crucial to economic development, too - it means increased competition for the best approaches,
more choice in decision-making, and greater innovation.
Today, I have been presented with the task of talking about regulatory proportionality from a
supervisor's perspective. As you have already heard what the credit institutions have to say, I
need only give a rough overview of the reasons for greater proportionality and the burdens
weighing on smaller institutions. Instead, I will focus on the prospects for, and obstacles to,
greater proportionality, before wrapping things up by outlining what greater proportionality in the
EU might look like.
2. Why do we need greater proportionality?
The arguments in favour of greater proportionality are myriad - you have doubtless spoken about
many of the reasons for it at this conference already. And, as far as banking supervisors are
concerned, too, there are strong arguments as to why greater regulatory proportionality is
needed.
Now that the financial crisis is over, we have stricter rules and a common European approach to
supervision in the form of Basel III and the banking union. These rules are mainly geared towards
large banks with international ties, which is not exactly surprising considering these banks were
the ones at the epicentre of the crisis.
In Europe, however, the international standards since Basel I have been applied to all banks. In
this sense, we have a single rulebook for the EU that is designed to guarantee a level playing
field. That's one side - the bright side - of the coin. On the flip side - the tarnished side, so to
speak - this unity has come at much too a high cost to smaller and medium-sized institutions
ever since Basel II.
The Basel III reforms have made it even harder for these banks, as the rules are getting more
and more complicated and explicit, and the list just keeps getting longer. This is increasing the
compliance workload - that is, the effort associated with meeting the requirements as well as
demonstrating that they have been met. In fact, these rules are well suited to the lion's share of
increasingly complicated banking business - but the reality is that not all banks and savings
banks have as complex a set-up as is assumed under the new framework.
After almost a decade of regulatory reform, the international community of banking supervisors
has been asking itself a number of questions for some time now. In which areas are reforms
counterproductive? Where are they disproportionate? To come to the point straight away, we can
only answer these questions if we start by looking at the excessive strain placed on smaller and
less complex institutions.
3. Opportunities and obstacles: reduce operational burden, retain minimum capital and
liquidity requirements
What, then, do the burdens faced by smaller and medium-sized institutions look like? There is
one point I would like to make quite clear. The problem is not so much capital or liquidity
requirements but rather the high operational burden as a result of implementing these regulations
and complying with them. This burden is considerable for all institutions, regardless of their size.
However, small institutions, owing to their smaller staff sizes, are far less able to spread the
costs of compliance across their employees and have to either hire additional staff or enlist
external help. This tends to lead to proportionally higher burdens.
The diagnosis is therefore clear: small and medium-sized institutions are, to a certain extent,
groaning under the weight of increasingly complex regulation, which often goes above and
beyond the level of complexity seen in their business models. But what is the right course of
action? Before we administer any form of medication, I would like to outline three principles that
need to govern treatment.
First, financial stability must remain our primary concern. In concrete terms, this means that
institutions that are systemically important or pursue a risky business model cannot expect
any easing of requirements.
Second, the concept of the rule of law means, in short, that all relief measures must
conform to the principle of equal treatment.
Third, treatment is likely to be most effective where discomfort is greatest - in other words, it
should target the day-to-day burden for institutions with low-risk business models. Any
easing of solvency or liquidity rules is out of the question.
Allow me to expand on the last point: virtually all smaller institutions already meet capital and
liquidity requirements. Recently, when finalising Basel III, we saw to it that smaller institutions, in
particular, would not be unduly burdened. While globally systemically important institutions are
now subject to slightly stricter requirements commensurate with risk, small and medium-sized
banks have scarcely been affected - in fact, requirements have been eased for many small
German institutions.
To put it in no uncertain terms, sufficient capitalisation and liquidity is the most important line of
defence for banking supervision and financial stability. With that in mind, there can be no leeway
as far as this is concerned.
4. Greater proportionality in the EU
Within the framework of the principles I just mentioned, new treatments are providing
considerable scope for banking regulation that is more proportionate for, and thus more
reconcilable with, smaller and less complex institutions.
In the EU, work on this was kicked off in 2016 with an initiative launched by the finance ministers
of the United Kingdom and Germany. As this topic has also kept us at the Bundesbank very
busy, we had our say a short time later by presenting initial concrete proposals for increasing
proportionality in Europe. We have been working on improving and fine-tuning our proposals ever
since.
As part of its general overhaul of EU banking regulation, the European Commission put forward
proposals for strengthening the principle of proportionality. The European Parliament then
produced a draft report, on which it was possible to submit comments until recently. While
completing the report is not the final step, it's nevertheless an important step for the legislative
process. At this point, I would like to say a special word of thanks to rapporteur Peter Simon for
his excellent work. The proposals for eased requirements in the areas of disclosure and
reporting are highly extensive and, to my mind, a very welcome development. Furthermore, we
consider it a good thing that the thresholds are to be raised for trading book institutions. It is
much to my regret, however, that a general approach - such as the small banking box - was
rejected. I'll come back to this shortly.
Without wishing to anticipate the final result of the legislative process, I would like to paint a
picture of how we, as German banking supervisors, need to tackle the issue of proportionality in
the EU. With that in mind, let's turn our attention to three key questions: who, how, and what?
Let's begin with "who", as in who should be subject to eased requirements. As I have already
mentioned, we are focusing on small institutions. In other words, the target group comprises
institutions with a manageable level of total assets. The problem is that the definition of
"manageable" varies from country to country in the EU. In order to account for this heterogeneity,
we will probably set an absolute threshold value for total assets combined with a relative
threshold value that takes national GDP into account.
This quantitative threshold value will be accompanied by additional criteria in order to prevent
institutions with riskier business models from benefiting from simplified rules. Thus, banks to
which reduced requirements apply are not permitted to use internal models; they ought to have a
small trading book and carry out derivatives transactions to a limited extent only; and they may
not participate to any meaningful extent on the capital market or in cross-border activities. But as
experience has taught us that it is all but impossible to draw up an exhaustive list of criteria
covering all eventualities, the final decision must rest with the supervisors. And, of course, banks
should ultimately also have the opportunity to reject their classification as such an institution.
Now let's turn to "how". There are basically two potential ways of improving proportionality here.
First, we could take a small-scale approach and introduce simplifications and exceptions for
individual rules. Second, we could create a whole new framework that is specifically tailored to
small banks and low-risk institutions. The second solution would be further-reaching and
clearercut. But at present, the majorities in Europe appear to favour the small-scale solution.
And then we still have to consider "what". It is important the emphasis lies on reducing the
administrative workload and minimising the red tape. The measures we are currently reviewing
include exceptions to disclosure requirements, reductions in the granularity of reporting
requirements and a simplified form of the net stable funding ratio (NSFR).
In deciding which areas could potentially be simplified, we must weigh up the benefits of
regulation - that is to say, the preservation of financial stability - against the costs generated for
the private sector. Essentially, all regulations that are non-essential to effective supervision are
up for discussion.
Conversely, that also means that many rules are not up for debate, however. As I have already
mentioned, no concessions can be made, in particular, when it comes to the risk-weighted
capital ratio, the leverage ratio or the short-term liquidity coverage ratio.
One other aspect, I believe, is particularly crucial. The business models of small banks are
neither generally simple nor automatically low-risk - and that is especially true when seen in their
entirety. A supervisory system that works according to the principle of proportionality therefore
needs to be simple but also robust. Financial stability must not be jeopardised under any
circumstances.
5. Finalised Basel III standard must be implemented proportionately
For the same reason - that is, to strengthen financial stability - it is very important that we
implement the recently finalised Basel III package fully in the EU. After all, that's no less than we
expect of the US and the other member countries of the Basel Committee.
But as I see it, full implementation of the Basel III rules doesn't mean that all banks need to be
affected by these highly complex rules to the same extent. To recap, the Basel standards are
primarily aimed at internationally active banks.
In this regard, member countries of the Basel Committee are free to apply other rules to smaller
banks that are only active in their own home markets and do not pose a threat to international
financial stability. And this is the framework we should largely use when revising the EU rules.
For instance, when it comes to a review of the trading book, we at the Bundesbank are in favour
of retaining the simple, standardised approaches that are currently in place for small institutions
with small trading books. Although the new, complex standardised approach is all well and good
for institutions that engage in substantial trading activity, I don't think they are suited to locally
based savings banks or people's banks.
We also support the idea put forward by the European Commission and the European
Parliament of excluding development banks from the scope of the CRD/CRR regulatory
framework. Given, above all, the particularities of the business models of German development
banks and their public mandate, I fail to see why these institutions should be subject to complex
international regulation. In this respect, we at the Bundesbank strongly support the concept of a
criteria-based exemption rule for development banks. We are also calling for institutions with total
assets in excess of €30 billion to be covered by an exemption. In doing so, we are going beyond
the European Commission's draft proposal. The report published by the European Parliament,
too, follows a similar train of thought under certain conditions - which means that it's now up to
the German negotiators in Brussels to set the right course.
So what I am saying is that when implementing the Basel III reforms in the EU, the rules must be
applied in full to internationally active banks. But when it comes to smaller banks that are not
internationally active, first, we should focus specifically on reducing the operational burden by
scaling back or removing inappropriately complex rules. And second, we need to check whether
it would be possible to exempt entire groups of institutions such as development banks from the
European regulation.
6. Conclusion
Ladies and gentlemen, the euro area is experiencing impressive economic growth again for the
first time in a decade. A differentiated banking system is a key pillar of the economy - and I am
convinced that this diversity makes our economy more dynamic and more resilient.
And we must be careful not to burden this differentiated banking system unnecessarily through
regulation. For us, as supervisors and regulators, this means addressing parts of the banking
regulation that have become overly complex.
We should not place any disproportionate obstacles in the way of small institutions and savings
banks. It is now up to the European Parliament, the EU Council of Ministers and the European
Commission to pave the way for substantial improvements.
Together with my banking supervision colleagues at the Bundesbank, I will continue to strive for
greater proportionality in banking supervision. The current developments in Brussels give us
reason to be optimistic.