Nout Wellink: Working on the future of the financial sector
Speech by Mr Nout Wellink, President of the Netherlands Bank and Chairman of the Basel
Committee on Banking Supervision, at the Dutch Embassy, London, 19 February 2010.
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I will first briefly share with you my view of the recent developments in the financial sector
and on the crisis. Second, I will discuss what the future role of supervision will be in order to
minimize future crises. I will speak about some of the initiatives of the Basel Committee, and
why these alone will not be enough. And finally, I will speak about the role of the financial
sector itself.
Let me first of all start by saying that although the financial sector has been hit severely, and
probably none of us has ever experienced something like this before, it is not a unique
situation from a historical perspective. In The Netherlands and the United Kingdom there
have been a significant number of large financial and economic crises throughout history.
One famous example of this is the Dutch tulip mania in the early 17th century, when the
prices of tulips fell dramatically after an excessive speculative bubble period. Or, the collapse
of Overend & Gurney bank in 1866 London, which triggered a series of bankruptcies of
several smaller, but otherwise solvent British banks. We struggled, but came out stronger
after each.
Just as what must have been said after each of those events, let me assure you that this
crisis will also not be the last. All of our measures and good intentions aside, we are of
course always perfectly prepared for the most recent crisis. The next crisis is a different
story. What we can do is learn from each crisis and try to prevent and mitigate a similar
crisis, and to do our best to diminish the likelihood and impact of any future crisis.
Our recent crisis is, in my opinion, the result of many problems. Let me mention some. One
is undoubtedly the search for yield that has often led to excessive risk taking. Or the
compensation schemes and bonuses in the financial sector that by leading to a strong public
outcry, have laid the foundations for a lack of trust in the financial sector.
Supervision and the regulatory system must take responsibility for the crisis too. Despite the
continuous improvement of regulatory practices throughout the years, certain risks were built
up due to regulatory arbitrage opportunities.
But this crisis also showed a fundamental lack of transparency. Customers (private and
institutional alike) did not know anymore just what exactly they were buying; supervisors
found it increasingly difficult to assess which risks financial institutions where subject to, and
institutions had more difficulty with valuing their products. Transparency was gone, which not
only contributed to the lack of trust between financial institutions, but also between client and
institution.
You will therefore understand that we, as supervisors, had to act quickly and act decisively.
As chairman of the Basel Committee, let me mention some of the measures that the
committee proposes. And I would also like to use this opportunity to convince you that these
measures are really necessary. Despite being a significant improvement over the previous
accord, Basel II has shown to still contain some significant weaknesses and shortcomings.
Of many of these we were aware, but we were not able to adequately address them.
However, now, under the pressure from the crisis, many of these issues are open for debate
again.
Let me talk about some of these measures in more detail. First, we are going to improve the
level and quality of capital. We have seen during the crisis that the current levels are not
adequate and that in the end it is only the capital of the highest quality that counts in adverse
conditions. An extension of this measure is that we will make capital requirements less
cyclical, by means of additional capital buffers that are built up during economic upswings.
This might imply that less profit can be used to pay out dividends or bonuses, as it is instead
used for increasing the firm's capital buffers. Second, we want to make sure that we really
cover all risks and allocate adequate capital to each. A key aspect of this is to prevent
regulatory arbitrage opportunities, particularly with securitizations and between banking
activities and trading activities. Third, we will work on an international accord on liquidity
buffers and supervision, instead of the current fragmented, national rules.
Furthermore, the Basel Committee proposes to supplement these risk-based measures with
a non risk-based measure that acts as a backstop in order to prevent an excessive build-up
of leverage during favourable economic periods. The design of the leverage ratio as a
simple, transparent, and supplementary measure of capital that is based on gross
exposures, will therefore serve as a safeguard against attempts to game the risk-based
requirements and address model risk and measurement error. By the end of 2010 we hope
to have fully calibrated these measures such that they can be phased in as economic
conditions improve, with the aim of implementing them by end-2012.
I would like to stress that these measures are really necessary. Not only to prevent further
harm, but also to restore trust in the financial sector. Trust is an extremely important aspect
of any services sector, and the financial sector is a services sector pur sang. If a feeling of
uneasiness remains among clients and investors, or financial institutions cannot trust each
other as they should, then financial (and consequently economic) development grinds to a
halt. So restoring trust in the financial sector is an absolute priority and we have to go great
lengths to achieve this.
At the same time it seems as if the sense of urgency for change among bankers and
politicians has somewhat diminished lately, now that we see the first signs of recovery.
Opposition against the proposals from the Basel Committee is growing, through lobbies from
the financial sector. For this reason, we, as supervisors, have to do our utmost best to uphold
these proposals, because otherwise countries may be forced to implement measures on their
own. The result of this will be a distortion of the international level playing field, which in the
end will not benefit the financial sector.
It is for this reason that we will organise a comprehensive quantitative impact study in the
first half of this year. With this impact study we can see what the impact of all individual
proposals will be, as well as the aggregate impact of all proposed measures combined, so
that we can implement measures with care, in a responsible and well-considered manner.
And all of these measures will be considered in the light of the economic recovery, making
sure that they will not harm the recovery process. I am aware of the current debates about
reducing the size of the sector, adding taxes, cutting bonuses, and the like. It is true that
there are indeed excesses which are not acceptable anymore, and these have to be dealt
with. At the same time, we should refrain from overreacting and take care to not implement
measures which we have not fully thought through.
Beside all these new regulatory measures we have realised that there is also an urgent need
for closer international supervisory cooperation. The rapid development in cross border
banking has shown us supervisors that our current organisational structure is no longer
adequate and limits our ability to rapidly respond to developing situations. A shift towards a
more unified regulatory framework has therefore slowly been set into motion, for instance in
Europe with the new structures for CEBS or CEIOPS, or through the intensified use of
supervisory colleges. Crucial, though, in this process, is full and mutual openness and
willingness to share information.
But there are limits to what supervision can do. We cannot supervise everything, even if we
want to. Do we have to double our number of supervisors, or triple them? Will that be
enough? And we have to realise that more supervision and rules also creates a moral hazard
problem, because we take away the incentive for institutions and clients to take their own
responsibility and use common sense when engaging in financial products. A good example
of this is the deposit guarantee scheme. If one would keep on increasing the guarantee level,
clients eventually become less alert and institutions might lower liquidity buffers. Both
dangerous developments.
It is therefore that I would like to stress today the fact that market participants have to
recognize their own responsibilities too, and act more according to them. This applies to
institutional managers, traders, fund managers, accountants, and even customers. More than
ever before should all market participants consider the consequences of their actions and
continuously ask oneself questions about everything one does. In answering such questions
I think that a prudent attitude must be taken and greater awareness of one's social
responsibility, and ask one every time whether the right thing has been done and whether the
actions are not harmful to vulnerable parties.
I think that an important step in the awareness of one's own responsibility is aiming for
greater openness. Transparency is really something that should be improved. Because only
when customers really understand financial products; or when the public understands
compensation decisions, or bank managers and supervisors really know which risks an
institution is subject to, will trust in the sector be restored. In the end, we may not forget that
the financial sector is above all a services sector and this requires a great deal of
responsibility and care from the side of all. I would therefore very much invite you to help in
bringing greater openness and social responsibility to the financial sector.
I hope that I have been able to convince you that there is truly a need for change in the
financial sector. Not only in terms of regulatory practices but also in terms of attitude and
culture. I therefore welcome every initiative from the sector in order to achieve this and I look
very much forward to a fruitful debate.