Andreas Dombret: Basel III - goal within sight
Opening speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at the Bundesbank symposium on "Banking supervision in dialogue", Frankfurt am
Main, 15 March 2017.
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1. Introduction
Ladies and gentlemen
I would like to warmly welcome you to this year's Bundesbank symposium. I am delighted that
this year, too, so many of you have decided to join us at Kap Europa, where our event is once
again fully subscribed.
Precisely one week ago a sensational news story was making the rounds. No, the Basel
Committee didn't complete the Basel III reform package just in time for our symposium. The
influence of this symposium doesn't stretch quite that far, unfortunately ...
I am taking about the sensational discovery in Egypt, where archaeologists discovered a statue
of Ramses II weighing seven tonnes and towering nine metres high.
So why on earth am I telling you this? What does Ramses II have to do with Basel III? After all,
my speech is supposed to be about the Basel III reform. Allow me, if you will, to keep you in
suspense a little longer and reveal the answer to this question at the end of my speech.
2. Are we there yet? The current status of negotiations
Ladies and gentlemen, we are very close to concluding the Basel reforms. And the closer we get
to the end, the more we turn our attention to what these reforms will mean. Many institutions are
worried, not least in Germany. What will the overall package look like in the end? Will the new
standards be too strict? And how can the new requirements be fulfilled?
These are all questions that are being asked, and rightly so. After all, banks and savings banks
have seen extensive reforms since the financial crisis, and they are afraid that the reforms will go
even further and might be too much for them to cope with. This is why the reform is also often
referred to as "Basel IV" ...
But how justified are these fears? This is what I want to talk about today. Let's start off by looking
at the facts. What is the status of the negotiations and what can we expect?
First of all, let's just remember that a large part of Basel III has already been fully agreed on and
implemented. That said, the final parts are still missing. This concerns, in particular, the new
rules on calculating risk-weighted assets, and this is what the ongoing negotiations are about.
The Chairman of the Basel Committee, Governor Stefan Ingves, will give you a first-hand
account of this following my speech - and I would like to express my thanks to him for this
already.
We have made real progress in Basel since the end of last year. We have been able to reach a
consensus in nearly all of the open points while also taking into account important concerns
raised by Germany.
Take, for example, real estate loans - an important business area for banks, not only in
Germany. Here, German negotiators were able to secure an agreement that regional differences
will be better taken into account. After all, while more lenient standards are used in most other
countries, the valuation of real estate collateral in Germany is particularly conservative. We were
always of the view that these different methods should not be treated equally in the Basel
standards. Anything else would distort global competition and punish those institutions that
assess the risks of real estate financing with particular care.
Another example are the internal models for estimating credit risk. The Bundesbank has always
objected to a too severe limitation of these models. This is because the use of models is always
more risk-sensitive than the standardised approach to calculating equity capital. Here, too, we
were able to drive a balanced compromise. The same applies to the measurement of operational
risk and the details regarding the upper borrowing limit.
When it comes to finalising Basel III, I feel it is particularly important that - for all the constraints
placed on internal models - we continue to keep an eye on risk sensitivity. Because both
extremes - a risk-insensitive approach to capital backing on the one hand, and the unfettered
use of internal models to measure risk on the other - have undesirable side-effects.
Ladies and gentlemen, we have every right to be quite satisfied on the whole with the current
status of negotiations. But I will make no secret of the fact that a number of items are still
unresolved. One of these is the proposal to introduce a new output floor, as it is known, for
riskweighted assets. This output floor would need to be applied by institutions which use internal
models - that is, mainly the large institutions.
I'm giving nothing away when I say that Germany's supervisors have taken a critical view of this
proposal. This output floor is designed to help curb excessive variability in the calculation of
riskweighted assets. But it needs to be calibrated carefully, because setting too high a hurdle quite
simply creates the wrong incentives. After all, there are good reasons why model calculations
are designed such that higher risks require more capital, and lower risks less. If this
straightforward principle were undermined by an excessively high output floor, it would be to the
detriment of risk sensitivity. This would give institutions less of an incentive to run their
businesses in a risk-oriented manner. Incidentally, fewer than 50 banks use internal models in
Germany - out of just under 1,900 institutions overall under our supervision. This means that the
number of institutions affected by an output floor is relatively small, particularly important though
those institutions undoubtedly are.
What is more, a robust line of defence is already in place today, in the shape of the leverage
ratio, which sets additional minimum capital requirements to prevent internal models from being
abused by those looking to understate the capital they need to set aside. This leverage ratio
offers sound protection, and it improves on the current provisions under the European regulatory
regime.
We will therefore stick to our position in negotiations that any output floor should not be too high.
There is no need for that - and it would even be damaging. To put it in no uncertain terms: an
excessively high output floor is out of the question as long as we're involved.
Ladies and gentlemen, as you can see, negotiations are on the right path, by and large. So what
happens next?
There is a general consensus on the Basel Committee that we shall continue to work towards
creating the clarity and certainty that market participants need to plan for the future. And do so as
quickly as we can. I do not intend to commit to a time schedule today, not least because the
United States, a major negotiating partner, is recalibrating its position. But as far as the
Bundesbank is concerned, we will stay at the negotiating table and are always ready to stake out
common ground. We naturally need to take into account the differences between the European
and US banking systems and the fact that the new rules will need to be palatable to all the
negotiating partners. These are, after all, global minimum standards we are talking about - no
more and no less.
The pace of negotiations isn't decisive, either. It's the outcome that counts. And I believe we will
have achieved a good outcome if it reduces excessive variability in the calculation of
riskweighted assets without relinquishing the principle of risk sensitivity.
3. Don't overstate the case: effects on German institutions are limited
But success is also about the ability of banks and savings banks to absorb the impact of the
reform and pass into a new world of regulation. I've now reached the section of my speech
where even the biggest regulatory gripers will probably prick up their ears ...
Our internal impact studies show quite clearly that the future requirements from Basel are
manageable for German institutions as long as we conclude the reform in its intended shape.
Speaking from a German perspective, I consider it a successful outcome that a set of rules
which has to take into account the idiosyncrasies of 28 countries and communities achieves
such a high degree of regional balance.
What will the impact on German banks and savings banks look like, exactly? To provide a reliable
answer to that question we have taken the Basel Committee's latest figures and added a number
of calculations of our own. Our scenarios thus reflect the current status of negotiations.
On balance, we do not see any material increase in risk-weighted assets, and thus in capital
requirements, for the bulk of participating institutions. What this means specifically for many
banks in Germany is minimal increases of less than 5% on average. We even find instances
where capital requirements decline. Fears of a strong upturn in capital requirements across the
entire German financial system are unfounded, in my eyes - quite the opposite, in fact. So the
sense of panic observed in some quarters is no longer warranted. Let's not beat around the bush
here: it's time critics came down from their barricades over Basel III and started to look ahead.
There is, however, one thing which I do not wish to play down: the need for action is, of course,
different for each institution. Certain institutions will almost certainly be affected by the Basel
proposals. Those institutions affected the most could very well be confronted with higher capital
requirements, in a few exceptional cases by more than 20%. Above all, this is due to the
proposed output floor. This output floor will be binding for the majority of the large German banks,
although to very differing extents. However, this also means that particularly the savings banks
and cooperative banks, which primarily use the standardised approach, will barely be affected
and will even benefit from Basel III to a certain extent.
For those institutions that are the most heavily affected, fulfilling the Basel III requirements will
undoubtedly present a challenge that should not be underestimated. Yet for them as well - and
let's remember there is just a relatively small number of such institutions - I consider the
consequences of the reforms to be acceptable. Past experience teaches us that preliminary
calculations tend to overestimate rather than underestimate the actual requirements. This is due,
among other things, to the fact that we look at bank balance sheets as at a specific reporting
date and do not take the banks' reactions, such as restructuring operations on the asset side,
into account. However, this is where I do see considerable leeway for a number of institutions.
The equity ratio of German banks and savings banks has risen by more than half a percentage
point to currently 16.2% since September last year, which was due primarily to the reduction in
risk-weighted assets.
Furthermore, the new rules will not come into play overnight. It is planned that all institutions shall
be given longer implementation deadlines to give them enough preparation time for the transition.
This will extend the period in which institutions can, for example, retain profits in order to
strengthen their capital base. It may also make it easier to raise fresh capital if a favourable
market environment can be expected. Not least, the transitional periods also provide institutions
with sufficient time to thoroughly check their business models. As the German representative in
the Basel Committee, I will do everything I can to ensure that the transitional arrangements are
adequate.
While some institutions will have their work cut out for them, the majority of German credit
institutions will barely need to take any action. This applies, in particular, to small and
mediumsized institutions. As I mentioned earlier, some of you in this room can probably even expect to
see lower capital requirements in future. With a bit of luck, we will be able to create the first Basel
III fan base here tonight.
4. Don't lose sight of the objective: Basel III in context
With this in mind, I would now like to steer your attention away from the immediate towards the
longer-term implications of the Basel III reforms. After all, this set of rules has the demanding
task of laying down global standards for the banking system - possibly for many years to come.
You will, of course, experience this first hand in a variety of different ways. Credit institutions will,
after all, either be subject to additional strain or may even see some relief. And that is not an
undesirable side-effect of the reform, but its main achievement. The idea behind the Basel
reforms is ultimately to create incentives to encourage responsible bank governance. And the
best way to do this is by means of risk weighting. These incentives do, of course, work in both
directions: they make certain activities more expensive and make others more attractive. On the
whole, I am convinced that all banks will benefit in future from a fairer distribution of the capital
requirements within the banking sector.
Furthermore, the successful implementation of the reform package can help to further calm the
markets. It will certainly pay off; last year we did, after all, see growing fears that European banks
were undercapitalised, which meant that their risk premiums continued to climb.
Ladies and gentlemen, Basel III is not designed to make life difficult for you and your institutions.
On the contrary: in the long term, I am convinced that that the entire banking sector will benefit
from better rules.
That is why the current debate about deregulation in the United States gives me cause for
concern. If the Americans do not implement the Basel III framework, we Europeans will certainly
not introduce the new rules unilaterally - and the whole world will suffer the consequences. We
learned this lesson from Basel II. Of course, I understand that the many regulatory changes over
the last few years involve a great deal of effort and that smaller institutions, in particular, are
finding them cumbersome. And I am firmly convinced that the Basel III rules do not need to be
applied wholesale to small, regional banks.
That's why I am pleased to see that the debate about greater proportionality in banking regulation
is gaining momentum in Europe. We should therefore take an unbiased look at whether the
Basel III framework really should apply in full to all banks and savings banks in Germany, or
whether a less strict approach, in the form of exemptions for smaller institutions, would make
sense. By this, I mainly mean exemptions relating to operational requirements. Exemptions from
capital and liquidity requirements, on the other hand, cannot and must not be made, in the future
as in the past.
But that's the subject of a different debate. And that debate must not be used as a pretext to do
away with Basel III. Because today's financial system is not constrained by borders, we need
strict global regulatory and supervisory standards. They are crucial to ensuring global financial
stability. We should bear in mind the lessons we learned from the crisis in this regard.
5. Conclusion
Ladies and gentlemen, in conclusion, allow me to revisit three points and draw a few parallels
with the story of our ancient Pharaoh.
First - and this is perhaps the most important message of my speech today - if in the coming
days we can reach a compromise in Basel that sufficiently addresses Germany's concerns, then
German institutions will be able to deal with the implications. I mentioned earlier that we do not
want to substantially increase capital requirements in Germany. On average, we are talking
about small increases of under 5% in Germany. And from Germany's perspective, we are
advocating for things to stay that way. For the small number of banks for which we have
calculated increases of more than 20%, in some cases, the transitional arrangements will
provide enough time to respond to the new requirements.
Second, the statue of Ramses is not only a work of art; it is also testament to the highest quality
of craftsmanship, which is one major reason it has survived for three thousand years.
Figuratively speaking, this is how we, too, must approach the Basel reform package. It's not just
about developing uniform, consistent rules - risk sensitivity is another of our guiding principles.
During the negotiations, we will therefore call for higher risk to go hand in hand with higher capital
requirements.
Third, like the unearthing of the Ramses statue, the completion of the Basel reform package will
take place in several stages. Some of these are very delicate and thus require a concerted effort
from all those involved. Acceptable compromises must be made on all sides. While the final part
of the Ramses statue is being carefully excavated with a crane over the next few days, we
should now focus all our efforts on bringing Basel III to a successful conclusion. Although we are
not under time pressure here, we are all aware of the importance of global standards and will
benefit from reaching an agreement. Both supervisors and institutions need clearly defined
regulation. But it goes without saying that we cannot and will not come to an agreement at any
price - any compromise we make must be one we can live with.
I was - and still am - confident that we can reach a successful outcome in Basel and secure a
well-rounded package of reforms that can then be used to achieve the desired effect in the
banking sector. Because it is in nobody's interest for archaeologists to be unearthing unused
parts of the Basel III framework three thousand years from now.
Thank you very much.