François Villeroy de Galhau: Are the regulations implemented to
guarantee financial stability compatible with the required
acceleration in euro area growth?
Speech by Mr François Villeroy de Galhau, Governor of the Bank of France, at the Académie des
sciences morales et politiques (Academy of Moral and Political Sciences), Paris, 6 November
2017.
* * *
I would like to thank Anne-Sophie Cavallo, Marine Dujardin, Pierlauro Lopez, Elise Peron,
Guillaume Richet-Bourbousse, Bérengère Rudelle, Valerio Scalone and Oana Toader for their
help in preparing this speech.
Dear Chairman,
Dear Permanent Secretary,
Dear Academicians,
Ladies and gentlemen,
It is an honour for me to speak before you this afternoon and I wish to warmly thank your
Chairman Michel Pébereau for his kind invitation. We also have with us at this illustrious
gathering some of my most renowned predecessors: Jacques de Larosière and Jean-Claude
Trichet. I am very pleased that the topic you have chosen for this year is that of reforms. This
term is often given too little prominence in France, between our supposed taste for revolutions
and our actual conservatism. We have to turn to Alexis de Tocqueville in order to attempt to bring
back the patience of enduring effort to our history: "[The French Revolution] took the world by
surprise; yet it was the mere natural result of very long labours, the sudden and violent
1
termination of a task which had successively engaged ten generations of men". The example of
our neighbours, from Germany to Spain, is today nevertheless illuminating in this respect:
reforms work in Europe. They are the way, the only way, to make compatible our European
social model, which is legitimate, and economic growth, which is essential in order to reduce
unemployment and to finance our future.
Today, I will focus my talk on other no less important reforms, implemented in a particularly
disrupted context: the financial regulations introduced in the wake of the 2007-2009 crisis. Is
there any need to recall the disastrous consequences that this crisis inflicted on the real
economy, the social dramas, and the democratic fragmentation with the rise of populism?
Financial stability is therefore a common good that needs to be guaranteed. It is one of the three
core tasks of the Banque de France, alongside monetary strategy and services to the economy.
We have been striving to achieve it in the international bodies that coordinated the financial
reforms after the crisis. The urgency of the situation required rapid and effective action, and as
early as April 2009, the G20 launched a global concerted action plan. This afternoon, I would like
to start by explaining the ambivalent relationship between finance and growth, and the attendant
need for financial regulation. Then, I will discuss at greater length what has been done, with an
initial assessment of our achievements. Lastly, I will consider our challenges for the future.
I. The ambivalent relationship between finance and growth.
I would like to say right away that finance is a remarkable instrument for economic progress,
decisive in the birth of European and then global capitalism since the 16th century. In order to
support trade initially, then investment, and innovation today, - as well as growth -, it is naturally
vital to create the right conditions for financing the economy and for sound financial institutions.
Many academic studies confirm that finance makes a positive contribution to economic
growth because it reduces transaction and information costs and leads to a better allocation of
capital. It is estimated for example that between 1960 and 1995, some developing countries
would have accelerated real per capita GDP growth by an additional 0.4 to 1 percentage point per
3
year if their financial systems had been more developed. Some authors even go as far as
positing that it would be preferable to let market forces prevail without worrying about the
emergence of bubbles or financial imbalances which would be absorbed by themselves. This
would mean that financial crises would just be the price to pay in the short term for stronger
medium to long-term growth. The conclusions of these studies are nevertheless evidently too
radical: they place finance at the helm of the economy rather than an instrument at its service, an
instrument used to achieve a goal, that of the work and progress of mankind.
Indeed, as with all human endeavours, finance is not immune to certain excesses, or to
4
certain limits. Some studies have highlighted the inherent instability of the financial system.
The existence of excessive risk-taking - the economists Guttentag and Herring use the concept
5
of "disaster myopia" - or the possibility of bank runs are among the examples of market failures
or negative externalities, which justify public intervention and financial regulation. Similarly, some
indicators, which are initially signs of economic development, may in extreme cases reflect the
over-exuberance of the financial system, which may hamper growth. For instance, it is
commonly acknowledged that when volumes of debt as share of GDP are too high, this has a
6
negative impact on growth in the long term. Beyond public debt - discussed in a report by your
Chairman in 2005, and alas still topical - private debt in France now stands at 130% in France,
7
compared with 122% in the euro area and 150% in the United States. Regulation can and must
play a protective role, by setting certain limits ex post and by shoring up resilience to destabilising
impacts ex ante. A 21st century Rabelais would say that finance without conscience is but the
ruin of the soul. I will return to individual conscience in my conclusion. But undoubtedly, finance
without rules could be the ruin of the economy.
To be sure, financial regulation is necessary particularly because financial crises often have
considerable economic and social costs, with serious and lasting repercussions. A study by
8
Laeven and Valencia in 2013, which considers 147 banking crises between 1970 and 2011,
estimates the median output loss between the peak of activity before the crisis and the three
years after at around 23% of GDP, and the median increase in public debt over the same period
at 12% of GDP, while total government bailout spending amounts to almost 7 percentage points
of GDP. Moreover, beyond the immediate effects, financial crises reduce the economy's
longterm potential: companies cut back on their R&D, capital and infrastructure investment, which
results in a decline in productivity and a slowdown in technological progress.
The 2007-2009 crisis is unfortunately an illustration of this; it was the worst crisis since that of
the 1930s. The financial imbalances generated by the bursting of the subprime bubble in the
United States spread rapidly to the global economy. The crisis affected both the level and trend of
GDP, leading to a permanent loss in wealth. Cumulative GDP losses compared to the pre-crisis
9
trend are estimated at a quarter of global GDP. In a number of countries, in particular in
southern Europe, GDP has still not returned to its pre-crisis level.
II. The new regulations have increased the solidity of the financial sector, without
weighing to any notable extent on economic growth
The exorbitant costs of the 2007-2009 crisis highlighted the urgent need to reinforce financial
stability, and the response was unequivocal. In 2009, at their meetings in London and then
Pittsburgh, the G20 leaders rose to the challenge of their historical mission, setting an ambitious
agenda for global cooperation. The opening words of the communiqué from the London summit
still merit repeating today: "A global crisis requires a global solution [...]. We believe that the only
sure foundation for sustainable globalisation and rising prosperity for all is an open world
economy based on market principles, effective regulation and strong global institutions. We have
today therefore pledged to do whatever is necessary to: restore confidence, growth and jobs;
repair the financial system to restore lending; strengthen financial regulation to rebuild trust."
This unprecedented regulatory effort concerned all financial system participants. Four main
objectives were set: (i) to make financial institutions more "resilient", that is increase their
soundness and their ability to withstand crises; (ii) to put an end to the problem of "too-big-to-fail"
institutions - which benefited from an implicit guarantee that they would be bailed out by the
government; (iii) to make over-the-counter derivatives markets more secure, notably through
central clearing; and (iv) to transform unregulated market activities - shadow banking - into a
sound form of market financing. At the global level, responsibility for the operational
implementation of these objectives was entrusted to the Financial Stability Board, and to the
Basel Committee on which both the Banque de France and ACPR are active.
Since 2010, significant, albeit uneven, progress has been made on all four G20 objectives. I shall
focus here on the first of these: financial institutions are now more resilient. The Basel III
Accords, adopted in 2010, have increased both the quantity and quality of banking sector
own
funds; in addition, they ensure better account is now taken of the diverse risks to which banks
are exposed, thanks to the introduction of a leverage ratio - measured as a share of total
unweighted assets - and two new liquidity ratios for bank cash levels. Requirements have also
been increased in the insurance sector, with the entry into force of the new Solvency II
regulatory framework in Europe at the start of 2016. At the end of 2016, French insurance firms
subject to Solvency II had a solvency capital ratio of 222%, well in excess of the required 100%.
These various tools, known as microprudential as they are intended to reduce the individual risks
incurred by financial institutions, have been supplemented with a set of
socalled macroprudential tools, designed to improve the stability of the financial system as a
whole. In France, the development of macroprudential policy led to the creation, under the 2013
Banking Law, of the High Council for Financial stability (HCSF), chaired by the Minister for
Finance, and on which the Banque de France plays an active role. This High Council meets once
a quarter with a total of eight members, three of whom are independent economists. It identifies
any risks of potential financial "bubbles", and has the power, where necessary, to implement a
series of macroprudential measures, including a countercyclical capital buffer - currently set at
0% - or tighter lending standards.
Ten years after the start of the crisis, eight years after London and Pittsburgh, it's time now to
stand back and take stock. Our achievement today is that the objective has largely been
10
met. The first assessments show that these reforms have had a significantly positive
impact on the soundness of banks, both in terms of their ability to withstand liquidity shocks
and their solvency, with the core capital ratio (Common Equity Tier 1 or CET1) of the main banks
operating at international level rising by 5 percentage points since 2011, from 7.4% at end-2011
11
to 12.3% at end-2016. As for the four largest French banks, their own funds have more than
doubled since the crisis: in 2008 they amounted to EUR 132 billion; in 2016 that figure reached
EUR 296 billion. Put another way, the majority of French banks have increased their capital levels
by more in the past eight years than in the previous century.
This increase in financial institution resilience has not been achieved at the expense of
economic activity. This brings me to the crux of the question put to me by your Academy today.
First, the objective of the regulators was clearly to limit the potential adverse effects of their
reforms on the real economy, and to ensure that financial activities support growth and economic
12
development. In 2010, before the roll-out of Basel III, major work was carried out to measure
the impact of these reforms. The Basel Committee's Macroeconomic Assessment Group
concluded, from a broad range of estimates, that for every 1 percentage point rise in the target
capital ratio, the cost of credit would increase by an average of around 0.15 percentage point. Yet
in practice, this credit tightening never materialised. The favourable effects of the fall in interest
rates under the accommodative monetary policy stance have far outweighed any negative
consequences of stricter regulatory requirements. Today in Europe, as in France, the flow of
bank lending to businesses and households remains robust. Indeed, the strength in private
sector lending is even the focus of particular vigilance in France and on the part of the HCSF. In
September 2017, growth in bank lending to households and businesses reached 5.7% and 5.4%
respectively in France, twice the rates observed in the euro area as a whole. Since the start of
2010, the cumulative growth in both forms of lending (29%) is almost twice that of nominal GDP.
No one can seriously argue that the financial reforms have, up to now, restricted the credit
supply, and hence growth, in France. At the same time, it should be stressed that the French
banking system - one of the most resilient in Europe and the world - has fulfilled its role in
financing the economy. Beyond the French banking sector, the Financial Stability Board has also
noted an improvement in the resilience of all financial institutions at global level, with no decline in
13
the provision of financing to the real economy.
I'd just like to say a few words on what seems to me to be a false debate. Although the recovery
has indeed been slower in Europe than in other geographical regions, this cannot be attributed to
overregulation. The scale of the euro area's difficulties can in part be explained by the fall-out
from the debt crisis which has affected its members since the start of the 2010s. In addition,
certain more specifically European or French problems, such as the slowdown in productivity or
the lack of sufficient structural reforms, are also limiting the acceleration in growth. Lastly, for the
time being at least, the regulations have, on the whole, been applied at least to the same extent in
the United States as in Europe.
III. Five challenges for a balanced regulatory framework
That said, I will be careful not to be utopian about these new regulations. We are still faced
with five challenges and if I may, I would like to consider each of them in turn.
1) The first challenge is to complete the rules for banks' minimum capital requirements by
The majority of the work - let's say 80% - has already been
finalising the Basel III reform.
done: its main aspects were approved in 2010-2011 and are now widely implemented. However,
discussions remain ongoing on the question of risk weighting in bank balance sheets. The goal is
to limit any unjustified variability in the weighting between banks or countries. However, this must
not result in a standardisation, as the variability of results is also a reflection of different risk
profiles. The risk sensitivity allowed for in banks' internal models represents a huge step forward,
as it ensures that requirements are proportionate to risk-taking. Naturally, we must reinforce
confidence in internal models by supervising them closely, as the ACPR has long done and as
the Single Supervisory Mechanism in Frankfurt does today. But the task at hand is to finalise
Basel III, not to build a new Basel IV based mainly on the standard approach that by definition
would not take account of differences between countries and banks.
It is in the strategic interests of France, which has always promoted international rules, to
conclude a final agreement on Basel III. We have made significant progress, particularly during
the latest Basel Committee meeting last month on 4 and 5 October, but we are not there yet,
even though I hope that an agreement will be reached as quickly as possible. If we are to reach
an agreement, two conditions must be met. First, the agreement must be fair - it must be
applied by all jurisdictions, in all its components, including by the Americans in the measurement
of market risks, i.e. the "fundamental review of the trading book" (FRTB). Second, the agreement
must be reasonable, in terms of the increased capital requirements that will apply to French and
European banks - including through the introduction of the so-called "output floor" on capital
requirements for banks that use internal models. On the one hand, these capital requirements
would have to be met over time through "normal" allocations of profits to reserves, without any
bank having to resort to a dedicated capital increase. On the other hand, these new rules must
be fully compatible with the smooth financing of the French and European economy and sound
credit growth. In particular, our mortgage lending model, based on guaranteed loans, and our
financing of SMEs cannot be called into question. In my view, these are the principles that will
determine whether any future agreement can be accepted.
2) The second challenge is to finalise measures that target non-banks. First, progress must
continue on the "resolution" of central counterparties - their treatment in the event of difficulties -,
as they have become systemically more important with compulsory centralised clearing for
derivative instruments. Above all, we must ensure a balance between financing channels. All
discussions on the shadow banking system must continue in order to take account of the risks
that may have moved into this sector as a result of the ramping up of requirements in the
regulated sector, and for banks and insurers in particular. It has been estimated that the
14
segments that may pose financial stability risks represented a total of USD 34 trillion. The
priority has now shifted from the solvency of banks, which has improved substantially, to the
liquidity of the shadow banking sector, particularly funds and asset management companies that
are exposed to the risks of sudden panic-driven runs. Lastly, progress is required on FinTechs
and above all on the major digital platforms and businesses, which, if they carry out financial
activities, will have to comply with similar regulations sooner or later.
3) The third challenge is evaluation. Evaluation is essential to the credibility of the financial
reforms that have been adopted worldwide, and to this end, the G20 adopted a
postimplementation evaluation framework this summer. This framework should allow us to determine
whether the reforms have actually achieved their desired results, without any unexpected,
adverse effects, and to make adjustments if this is not the case. Two initial evaluations are
already underway: the first deals with the effectiveness of reforms that encourage the use of
central clearing while the second assesses the impact of G20 reforms on access to financing,
which will begin by looking at infrastructure financing before focusing on credit to small and
medium-sized enterprises (SMEs). The first evaluation reports are expected to be made public
by the end of 2018.
4) The fourth challenge, in order to consolidate the progress we have made, is to
ensure that
the new regulatory framework is implemented consistently across the board while
In The Country Doctor, Balzac wrote "...in all things
remaining vigilant to avoid backtracking.
human, is not constancy the highest expression of strength?", rightly reserving this virtue for the
great men of his day. Now, as you know, the new US government has raised the possibility of
15
reviewing their national banking regulations. Certain national adjustments could be considered
appropriate and justified, as is the case, for example, for regulations that concern entities whose
operations are only local in scale, or regulations that are purely American in scope such as the
Volcker rule on proprietary trading portfolios. But the same cannot be said for abandoning the
minimum requirements agreed internationally that apply to entities operating on a global scale,
like the FRTB that I mentioned previously. Unilateral deregulation would be nothing less than a
lose-lose scenario with serious consequences for the stability of the global financial system - we
would be paving the way for the next financial crisis - as well as the competitive landscape for
US and European banks. International cooperation on financial reforms is a common good that
has been extremely precious during these past eight years and is crucial to our future.
5) The fifth challenge is to complete the European framework and ensure greater
Since 2014, the euro area has
consistency between regulation, supervision and resolution.
taken decisive steps with its Banking Union, which now ensures the uniform supervision of the
banks of 19 countries. But in order to complete it, further progress is needed on three levels.
First, with regard to concrete mechanisms, the second pillar of the Banking Union, which deals
with "resolution" in the event of difficulty, must be finalised and simplified. Second, laws and
requirements, which all too often accumulate diverse additional regulations and amendments,
should be coordinated in a consistent manner. Moreover, cross-border banking mergers in
Europe are still too difficult. Lastly, as regards the interaction between institutions, we should
develop a better interaction between the various European authorities, and even envisage, going
forward, a single authority that would strive to enhance the soundness of the European banking
sector. And in addition to the regulatory aspect, we must endeavour to implement what I call the
Financing Union for Investment and Innovation. The goal is to better channel the euro area
savings surplus of EUR 350 billion to the areas where investment is needed, and encourage the
pooling of private risks, particularly through the development of corporate equity.
I would like to conclude by mentioning a sixth and final challenge: the inherent of any
limitations
regulation, no matter how worthy it may be. First, financial stability is not simply a question of
regulation; it rests on a trifecta of regulation, microprudential supervision and macroprudential
policies, and relies on each of these components in equal measure. What's more, and above all,
there must be complementarity between collective rules and individual behaviour - ethics. Prior
to 2007, self-regulation was the norm, especially in Anglo-Saxon countries, placing excessive
trust in codes of conduct and business ethics. Today, let's make sure we don't tip the scales too
much in the other direction. The Académie des sciences morales et politiques is here to remind
us that rules will never be a substitute for individual conscience. This also applies to the financial
sector. Thank you for your attention.
1
Alexis de Tocqueville, The Old Regime and the Revolution, Book I, Chapter V.
2
Robert King and Ross Levine (1993), "Finance and Growth: Schumpeter Might be Right", Quarterly Journal of
Economics, August, 153 (3), pp. 717-738. Ross Levine (1997), "Financial Development and Economic Growth:
Views and Agenda", Journal of Economic Literature, June, 35, pp. 688-726. Thorsten Beck (2014), "Finance,
growth and Stability", Journal of Financial Stability, 10 pp.1-6. Thorsten Beck, Tao Chen, Chen Lin and Frank M.
Song (2016), "Financial innovation: the Bright and the Dark Sides", Journal of Banking and Finance, 72, pp. 28-
51.
3
See, notably, Ross Levine, Norman Loayza, Thorsten Beck, "Financial intermediation and growth: Causality and
cause", Journal of Monetary Economics, Volume 46, Issue 1, August 2000, pp. 31-77 and Thorsten Beck, Ross
Levine, Norman Loayza, Finance and the sources of growth, Journal of Financial Economics, Volume 58, Issues
1-2, 2000, Pages 261-300.
4
Carmen Reinhart and Kenneth S. Rogoff, "The aftermath of financial crises", American Economic Review 99,
No. 2, 2009, pp. 466-472. Moritz Schularick and Alan M. Taylor (2012), "Credit Booms Gone Bust: Monetary
Policy, Leverage Cycles and Financial Crises, 1870-2008", American Economic Review, 102 (2): pp. 1029-
1061. Thomas Philippon and Ariell Reshef (2013), "An International Look at Growth of Modern Finance", Journal
of economic perspectives, 27, pp. 73-96. Stephen Cecchetti and Enisse Kharroubi (2015), "Why does financial
sector growth crowd out real economic growth", BIS working papers, 490.
5
Jack Guttentag and Richard Herring, "Disaster myopia in international banking", Essays in International
Finance, No. 164, 1986.
6
See notably Jean-Louis Arcand, Enrico Berkes and Ugo Panizza, "Too Much Finance?", Journal of Economic
Growth 20, 2015, p. 105-148.
7
Private non-financial sector debt as share of GDP, Q1 2017. Sources: Eurostat data, Federal Reserve, Banque
de France calculations.
8
Luc Laeven and Fabian Valencia, "Systemic banking crises database", IMF Economic Review, Vol.61, No. 2,
2013, cited by Taryk Bennani, Laurent Clerc, Virginie Coudert, Marine Dujardin and Julien Idier, "Politique
macroprudentielle, prévenir le risque systémique et assurer la stabilité financière", Pearson, 2017, p.118.
9
See IMF World Economic Outlook, April 2015 and see Patrice Ollivaud and David Turner, "The effect of the global
financial crisis on OECD potential output", OECD, Working Papers, No. 1166, 2014.
10
See in particular "The impact of financial reforms", Banque de France Financial Stability Review No. 21, April
2017.
11
Basel Committee, Basel III Monitoring Report, September 2017.
12
See reports by the Basel Committee's Macroeconomic Assessment Group (MAG) and Long term Economic
Impact Group (LEI).
13
Financial Stability Board, Implementation and Effects of the G20 Financial Regulatory Reforms, August 2016,
2nd Annual Report.
14
Financial Stability Board, Global Shadow Banking Monitoring Report 2016, May 2017.
15
See US Department of the Treasury, "A Financial System That Creates Economic Opportunities", June 2017.