Luis M Linde: Key issues on today's banking industry
Closing speech by Mr Luis M Linde, Governor of the Bank of Spain, at the 6th Santander
International Banking Conference, Madrid, 5 November 2013.
* * *
I would like first to give my thanks to Banco de Santander for inviting me to take part in this
final session of your 6th International Banking Conference, an excellent opportunity to review
and assess key issues on today's banking industry, which has to face, in the next few years,
important regulatory and operational changes.
I will comment on several elements of the new Basel III capital framework that remain
contentious or are still open to discussion. Among those, the leverage ratio, the liquidity ratio
and the very important issue of consistency in implementation. Then, I will move on to the
Financial Stability Board's work on resolution strategies and, finally, I will comment on the
European Union Bank Recovery and Resolution Directive (BRRD), and one of the most
important elements it contains, the bail-in tool.
First, the leverage ratio, the ratio between Tier 1 capital and total balance-sheet and
offbalance-sheet exposures not deducted from the calculation of Tier 1. This ratio is set, in
principle, at a minimum of 3%. Its entry into force as an obligatory Pillar 1 ratio is foreseen to
be in 2018.
This new tool has been designed as a simple, transparent measure, not linked to risk,
complementing and acting as a floor with respect to the risk-based minimum capital ratio. It
seeks to reduce excess leverage in the banking system, and to afford an additional measure
of protection against the so-called "model risk", i.e. against the risks associated with the use
of sophisticated models allowed under Basel III.
There are still doubts about this ratio as a Pillar 1 measure. I understand that the doubts do
not concern the concept, but, rather, its final calibration and how it will impact on specific
business models, in particular, those most focused on retail activity.
Moreover, it is not fully clear whether the best option will be a single percentage for all banks,
irrespective of their size or business model; or whether it would be better to opt for different
percentages, depending on the type of business or activity of the bank; or to establish a
range within which the supervisor would have discretion to decide which figure applies best
to specific institutions.
We believe that this new ratio can be a good prudential tool, once it is correctly calibrated.
European regulations envisage that countries may apply the leverage ratio as they consider
best until its harmonization in 2018, but the Banco de España does not consider necessary
to bring forward its entry into force.
With regard to liquidity regulation, Basel III has included, for the first time, a short-term
liquidity ratio (LCR) which seeks to ensure that banks have a buffer of high-liquidity assets
equal to 100% of foreseeable liquidity requirements for, at least, 30 days.
The initial design of this ratio was too demanding and, perhaps, not realistic. 2015 for full
implementation was clearly too early a date. Another controversial element was the definition
of the "high-quality liquid assets" to be included in the numerator. However, after the review
agreed by the Basel Committee in January, the ratio definition should be now fairly stable.
It should be noted that, rather than a minimum ratio that has to be met at each point in time,
such as the capital or the leverage ratios, what is involved with this new liquidity ratio is the
setting up of "liquidity buffers" that can be used in times of need. Hence, although the
minimum level is set at 100%, a bank could maintain a lower level at stressed times, but
should inform the supervisor, in order to agree on a plan to restore the required minimum
level.
As in the case of the leverage ratio, the short-term liquidity ratio does not come into force
immediately. We are now - the present year and next - in an observation period that needs
to be used for its fine tuning. At the end of this period, the ratio will be phased in from
2015 - when it will be required at the 60% level - to 2018, when it will fully apply. However,
this timetable may be accelerated at national discretion.
In this regard, Banco de España does not consider necessary to accelerate the
implementation timetable, although we believe that banks should make reasonable efforts to
comply with the liquidity ratio as soon as possible.
To sum up: We support banking prudential regulations incorporating liquidity ratios such as
those proposed. We are aware that this will entail a major effort for banks, mainly because it
demands changes in their management of this risk. Spanish banks must be active in
improving balance sheet structures.
I would like to conclude my comments on Basel III by referring to the importance of ensuring
that it is implemented in a consistent way across institutions and across countries.
This objective is framed in a project undertaken by the Basel Committee to ensure that the
benefits of having risk-sensitive regulation, like Basel III, are not achieved at the cost of an
extremely complex legislation which, apart from other problems, brings about results that
are not comparable across banks.
The Banco de España agrees with this initiative. We are in favor of simplifying current
regulations, seeking an appropriate balance - indeed, always a difficult balance - between
simplicity, comparability and risk sensitivity.
So, we view very positively the transparency exercise carried out by the Basel Committee,
with the publication of the results of the comparative analysis of banks' calculations of risk
weighted assets, both in the banking and in the trading book.
These exercises have identified significant differences which would not cause concern if they
were due to real factors, meaning different type of business or risk profiles. There would be a
cause for concern if the conclusion of such work still undergoing, together with other
initiatives taken by the European Banking Authority, showed that those differences were
largely due to differences in the application of the internal models approved by supervisors.
In this vein, I think that the Single Supervisory Mechanism, once fully operational, will bring a
higher degree of harmonization across the euro zone.
The results of this exercise demand for the Basel Committee taking measures to reduce
those differences, so that the credibility of the solvency ratios is not called into question.
However, these measures should not go to such an extreme as to abandon the use of
internal methods for calculating capital requirements: these models have been useful for
improving banks' internal management of risk. We think that the solution may lie along the
line of using as a reference for the internal models more standardized models, based on
parameters determined by supervisors.
Let me now move on to the debate on Resolution of financial institutions. I will first refer
to the Financial Stability Board's work, dealing with resolution strategies and loss absorbing
capacity.
The FSB has developed a framework to address the "too-big-to-fail" (TBTF) problem
associated with "global systemically important financial institutions" (G-SIFIs). As we
know, this framework is based on four pillars: an enhanced supervisory intensity; the
requirement of a higher loss absorption capacity; the existence of effective resolution
regimes; and an improved resilience of market infrastructures.
Substantial progress has been made in implementing this framework. In particular, the so
called "Key Attributes of Effective Resolution Regimes for Financial Institutions" have
been endorsed by the G-20 as a new international standard.
Substantive reform has been implemented or is going to be implemented soon in the main
jurisdictions in which G-SIFIs operate. In Spain, Law 9/2012 adopts and implements many of
the principles set forth in the "Key Attributes". In the European Union, the Bank Recovery and
Resolution Directive is expected to be adopted later this year. It will be an important step
towards full implementation of the "Key Attributes" in all EU Member countries.
The two main new elements of this new framework are, first, planning for orderly resolution;
and, second, the scope of the resolution tool known as "bail-in", which is linked to the
existence of an adequate level of loss absorbing capacity in each G-SIFI.
Work on resolution planning is currently under way within Crisis Management Groups
(CMGs), now set up for all the G-SIBs. There has been considerable progress in developing
resolution strategies and identifying conditions relating to the firms' legal, operational and
financial structures and their impact on resolvability.
I would now like to comment on the resolution strategies being developed for global banking
groups. These strategies are broadly based on two approaches:
•
The one called "single point of entry resolution" (SPE groups), in which resolution
powers are applied at the top of the group by a single resolution authority;
•
And the one called "multiple point of entry resolution" (MPE groups), where
resolution tools are applied to different parts of the group by two or more resolution
authorities acting in a coordinated way.
Of course, the choice of the strategy needs to take into account the structure and business
model of each banking group.
A "Single Point" strategy may be better suited to a firm that operates in a highly integrated
manner (through, for example, centralised liquidity, trading, hedging and risk management).
On the other hand, an "Multiple Point" strategy may be suitable for financial groups with a
decentralised structure and greater financial, legal and operational separation along national
or regional lines, with sub-groups of properly capitalised, self-funded subsidiaries, which
have enough managerial resources as stand-alone businesses.
The feasibility and credibility of the "Multiple Point" strategy will mostly rely on two main
issues:
• First, an effective cross-border coordination based on the cooperation agreements,
the resolution plans and with the involvement of the resolution authorities of the
main jurisdictions in which the groups operate.
•
Second, a balanced loss absorbing capacity allocation across the group, according
to local business risk profile in each jurisdiction.
Both elements will mitigate the risk of financial fragmentation due to non-coordinated
measures taken by the different authorities, namely, "ring fencing" initiatives.
Spanish G-SIBs fully comply with the pre-conditions to be considered "Multiple Point"
groups: they are organised through local retail banking subsidiaries; critical economic
functions, e.g. payment systems, are organized at the local level; subsidiaries are
selfsufficient in capital and funding; and they rely on separate firms detached from the bank for
operational support, for instance, on information systems.
So, although there are still many issues to be clarified, we think that the most realistic
resolution approach for the Spanish international banking groups is the "Multiple Point"
strategy, provided that, in the event of resolution, their organisational and financial structures
are suitable for healthy parts to be sold or maintained as a surviving group, split from their
distressed sister companies, using other resolution tools such as asset transfers or bridge
banks.
Now, I will go to the second main element of the new framework, the bail-in instrument.
Next year, most of the FSB work on resolution will focus on preparing proposals on the
adequacy of G-SIFI loss absorbing capacity in resolution, namely, what we call "gone
concern loss absorbing capacity" or GLAC. This concept is similar to the Minimum
Requirement of Eligible Liabilities (MREL) set up in the EU Bank Recovery and Resolution
Directive.
This G-SIFIs loss absorbing capacity is a complex matter, involving the need to clarify or
determine a long list of questions, for instance: its characteristics, minimum amount,
intragroup distribution and triggers for it, enforceability of bail-in; regulatory limits on loss
absorbing holdings, and disclosure.
Let me underline that a shared view on the characteristics and levels of this "loss absorbing
capacity" is critical for a "level playing field" among G-SIFIs. Also, we must avoid any
approach that might be considered as an additional layer of differentiated capital
requirements, a sort of differentiated "Tier 3" requirement.
As I mentioned before, determination of the appropriate levels of GLAC must be dependent
on the complexities and risk of the activities developed by each institution. The approach
currently being worked out in the European Bank Recovery and Resolution Directive, in
terms of both identifying characteristics and specific levels or of "eligible liabilities" is, in our
opinion, a correct approach to the problem.
Now, my last point, the discussion in Europe regarding the European Union bank recovery
and resolution directive and the entry into force of the bail-in arrangements included in that
directive.
Although still under discussion, the Bank Recovery and Resolution Directive bail-in is to be
introduced in a sequenced way. Bail-in of regulatory capital instruments will be applicable
from the moment the Directive is transposed, while bail-in of senior creditors can be
postponed to 2018, depending on each Member State.
Since we are also moving forward in setting-up a Single Resolution Mechanism [SRM] for the
17 Member States that share the Euro, an agreement has to be reached on the moment in
which bail-in of senior creditors becomes applicable, as rules have to be the same to all
Euro-members.
In this regard, it is important to note that, while sharing the main objective of bail-in, many of
the Eurosystem Central Banks, including Banco de España, have shown concerns on the
early application of bail-in tools for senior creditors, due to its potential destabilizing effects.
We would advice against too short a sequencing.
I will finish my address of today saying that my guess for 2014 related to banking regulation
and supervision, is that it is going to be a "fully loaded" year for the industry, and for national
authorities and supervisors.
I wish all of you good luck and good courage, and for all our visitors, a happy stay in Madrid.
Thank you for your attention.