samchain/econo-pairs-v1 huggingface dataset:
David Rule: Regulatory reform, its possible market consequences and the case of securities financing Speech by Mr David Rule, Executive Director for Prudential Policy of the Bank of England, at the Federal Reserve Bank of Chicago Annual International Banking Conference, Chicago, 6 November 2014. *  *  *  The financial crisis revealed fundamental weaknesses in pre-crisis bank regulation. The regulatory response internationally has been broad and deep. Whereas before the crisis, regulators struggled to keep up with financial markets innovation, since the crisis banks have struggled to keep up with regulatory innovation. That may continue for another year or so as reforms are finalised and implemented. But the broad shape of the new bank regulatory regime is now clear. And, as regulators, we should prepare for a period in which market innovation is likely to increase again – both the good kind that improves services for customers and the more ambiguous kind in which firms adjust their activities in response to regulatory constraints. We need to follow these adjustments closely in order to understand the overall effect of regulatory change on banks and financial stability, and to identify, and where appropriate address, any unintended consequences. I would like to use this time to explore some of the possible effects, and focus on securities financing transactions as one area where tougher regulation is both needed but might have wider consequences.

In principle, banks should allocate capital to individual business units based on the marginal capital requirements of those activities to the bank as a whole – so if a bank overall is constrained by risk-weighted capital requirements, it will allocate capital based on risk-weighted assets even to business units for which the leverage ratio or stress test is binding on an individual basis. But as banks move closer to the critical point at which the leverage ratio rather than the risk-weighted ratio becomes binding – an average risk weight of 35% based on a Tier 1 leverage ratio requirement of 3% and risk-weighted requirements and buffers of 8.5%3 – they will need to be increasingly mindful of both constraints. The banking system will be substantially better capitalised in future than it was pre-crisis. But regulators will need to follow closely how banks are adapting to tougher bank capital standards and identify any adverse unintended consequences. Those might take the form, for example, of loopholes that provide an opportunity for regulatory arbitrage, an unexpectedly significant impact on financial markets or a conflict with other regulatory priorities, such as shifting derivatives markets towards central clearing. Where appropriate, we will need a snagging process to review and adjust through the international regulatory bodies. Securities financing transactions One example of a market where tougher regulation was both needed but might have wider consequences is securities financing.
1  But it has not always been the case that we do not talk much about money itself. There have been times, times when the machinery of money itself has failed or when it has changed, that there has been debate, often long and bitter, about what money is and how it should work. th  The creation of the Bank of England itself, which caused much controversy, in the late 17 century, can be seen as ingenious marriage between the King’s fiscal needs and the economy’s need for a larger and a state authorised money supply using the new technology of ‘notes’ or claims drawn on banks. 2  The same period also saw a protracted debate about the debased state of the English coinage and how to fix the value of money, a debate involving John Locke among others and leading to a painful set of statutory and technological reforms carried out by Isaac Newton no less. The development of modern economies has been punctuated by debates about the nature and technology of money. 1  Milton Friedman made use of Mill’s characterisation of money as a machine when describing ‘what monetary policy can do’ in his seminal address to the American Economic Association in 1967. 2 In 17th century England, goldsmiths would take custody of their customers’ gold and issue a paper note in receipt.

There is now an increased demand for highly-skilled knowledge workers that are able to meet the changing requirements of an increasingly globalised and borderless workplace. More interconnected businesses within national economies and across the globe have also increased expectations for employees to be highly versatile and able to adapt to the fast changing conditions. Talent mobility has therefore increased substantially not only across geographical boundaries, but also across sectors, as the demand for talent in financial services by the energy, telecommunications, software and  BIS central bankers’ speeches  1  consultancy sectors are likely to increase over time. Organisations including financial institutions therefore need to give greater attention to these shifts and develop clear strategies to narrow the skills gap, in particular to address growing shortages in the mid to senior level talent groups. The recent regulatory reform in the financial sector and the onset of new standards and requirements under both Basel II and Basel III, the emergence of new risk disciplines and the fundamental changes in financial reporting standards, also require financial professionals to be equipped with new knowledge and skills. Similarly, talent shortages continue to be acute in high-growth areas such as wealth management, Islamic finance, and investment advisory services.
Combined with higher interest rates, this may reduce profitability in the commercial property market, increasing banks’ losses. Losses on loans to the property industry accounted for a large share of banks’ loan losses during the banking crisis. Outlook for the banking industry Banks in Norway have experienced extremely favourable developments over the past few years: strong lending growth, minimal loan losses, high returns in securities markets and firm cost control. Despite lower interest margins, banks’ net interest income in NOK is rising as a result of strong lending growth. Measured in relation to total assets, however, net interest income is  6  BIS Review 100/2007  falling. In recent years, this has been offset by a reduction in costs. Today’s high debt growth is not sustainable over time, and it is unlikely that the pressure on interest margins will abate. Given these developments, banks must reduce costs or increase income from other sources if they are to maintain their current profitability. To illustrate the effect of lower lending growth on banks’ income, we have carried out a simple calculation where the interest margin is held constant. If lending growth among banks had only been 3 per cent in 2006, banks’ net interest income and pre-tax results would both have been approximately 6 per cent lower this year. The composition of banks’ income has been fairly stable in the past ten years, even though net interest income has become less important since 2002.

One reason for these developments is that net price gains on securities have increased in this period. Bearing in mind that this was a favourable period for securities markets, it will be difficult to maintain the income share from price gains in periods of more normal returns in securities markets. With a slower rise in house and commercial property prices and lower lending growth, combined with a normalisation of loan losses, banks may find it more difficult to maintain the high level of profitability that we have witnessed in recent years. The new capital adequacy rules have had a strong impact on Norwegian banks and will continue to do so in the years ahead. How banks choose to utilise capital freed up as a result of the reduced minimum capital requirements, may have an impact on both competition and structure in the Norwegian banking sector. Freed-up capital may be used to finance lending growth, acquire other institutions or pay back capital to shareholders and other stakeholders. On average, Norwegian banks’ capital adequacy is solid. However, the substantial reduction in minimum capital requirements, even though there are transitional arrangements, also entails some risk that banks will reduce their capital to such an extent that the buffer needed to meet unforeseen events may become smaller than advisable. Banks’ profitability may also depend on the duration and severity of liquidity problems in international financial markets. Although Norwegian banks are probably somewhat less exposed than banks in many other countries, the impact may nonetheless be felt.
But we are united in our commitment to our dual mandate and in our belief that Fed independence is essential to the public interest, because it allows us to make tough decisions insulated from short-term political pressures. At FOMC meetings, each Committee member presents a current outlook for his or her region and the nation. For these assessments, we consult our researchers and add critical information that we learn from listening to our boards of directors, regional advisory councils and community leaders, such as you and others I’ll meet on this visit. This trip includes a meeting with the Long Island Housing Partnership – and a visit to some distressed neighborhoods, a tour of the D’Addario string factory and lunch with its workers; and concludes with a tour and meeting at the Brookhaven National Laboratory. BIS central bankers’ speeches  1  At the New York Fed, we continually track conditions in our District, and we have created a number of tools for that purpose. For example, my staff produces monthly indexes of economic activity for New York City, the entire state of New York, and New Jersey. These indexes are essentially measures of local output – similar to gross domestic product, or GDP, at the national level. These measures provide a more complete gauge of activity than the employment report, which is another important metric at the state level.

Sunil Mendis: Financial system stability and Basel II - the way forward Inaugural address by the Chief Guest Mr Sunil Mendis, Governor of the Central Bank of Sri Lanka, at the 17th Anniversary Convention of the Association of Professional Bankers, Colombo, Sri Lanka, 28 August 2005. *  *  *  Ladies and Gentlemen It is an honour for me to be invited to give the keynote address at this forum of eminent bankers in Sri Lanka and distinguished persons from the international banking arena. I am happy to see our friends from the Reserve Bank of India and from the Basel Committee who will no doubt make this convention very lively for discussion on a subject which concerns us all. As Central Bankers we have a common interest in ensuring financial stability which impacts upon the macroeconomic performance. Further, as monetary policy transmission takes place through the financial institutions for the achievement of its target of economic and price stability, the Central Bank has the responsibility for ensuring that the financial system as a whole is sound. It should be strong enough to withstand internal and external shocks. We must ensure that our payments and settlements system is protected from the risk of failure at any cost since it is the conduit through which our economic business and commercial activity is facilitated.
Basel II represents a significant step towards achieving a more risk-sensitive supervisory approach. It will enhance banks’ safety and soundness, thereby strengthening the stability of the financial system as a whole and ensuring that it can better serve as a source for credit and growth for the economy. I believe that the framework should be adopted as soon as possible, according to the proposed implementation date, to realise the benefits of a stronger and more stable financial system in a global competitive world. I like to think of the new capital framework as an opportunity. An opportunity to ensure that regulation and supervision takes a forward-looking approach to capital and risk management, that it remains up-to-date with sound practices in the industry and that our supervisory framework motivates sound capitalisation, responsible risk-taking, transparency and prudent behaviour. It also represents an unparalleled opportunity for banks to improve their capital strategies and risk management systems. And finally, it provides supervisors with an opportunity to improve their dialogue with the industry and to enhance co-operation among banking supervisors across jurisdictions. This last point is crucial to achieving effective and consistent implementation and it is an area in which I strongly believe that the European Union is in a unique position to lead the way. As I will comment  BIS Review 3/2005  1  later, I believe that the EU can make faster and more tangible progress in this area than is currently possible on a wider international basis.

It will help to avoid redundant and unco-ordinated approval and validation work, thereby reducing the implementation burden on banks, and conserving supervisory resources. In this regard, the Committee’s Accord Implementation Group continues to encourage practical work among supervisors on applying Basel II effectively and efficiently to internationally active banking organisations. The AIG is currently working with supervisors of different areas of the world to conduct a number of “real case” studies to gain better insight into the practicalities of co-operation between home and host supervisors. In this context, if you will permit me, I would like to speak from my perspective as a European banking supervisor, and pick up on the statement I made at the beginning of my intervention. As I said, I believe that Europe is in a unique position to lead the way in the cross-border implementation of the  BIS Review 3/2005  3  new framework and to make faster and more tangible progress than is currently possible on a wider international basis. I think we need to seize this opportunity with both hands, because it will not just benefit us in the EU, contributing to the fulfilment of the Lisbon objectives, but, I believe, will also have a positive impact beyond our borders. We have two major advantages in this respect. Firstly, the division of supervisory responsibilities between our countries is embedded in our common single market legislation in the banking field, founded on harmonisation and mutual recognition.
The measure of inflation expectations that appears to have the strongest link to actual wage increases is firms’ inflation expectations one year ahead from the National Institute of Economic Research’s business tendency survey.7 According to this measure, inflation expectations have followed actual inflation fairly well. In other words, the agents have not been “tricked”, but have realised that inflation can deviate from the target in the short run. If wage increases are based on this measure, then in other words real wages have not been too high and unemployment has thus not been “unnecessarily high”. Before I move on to the next type of criticism, I would like to emphasise that what I have said here should not be interpreted to mean that I wish to make light of inflation undershooting the target. The Riksbank should of course do its best to attain the inflation target and I can assure you that we do. However, it is not an easy task, and I believe that many people understand this. Proposal for higher inflation target and target for employment Another type of criticism is aimed at the target formulated for monetary policy. It comes in slightly different forms, but a common theme is that the inflation target should be raised, and that it should be combined with an explicit target for employment or unemployment.

Monetary policy only affects employment indirectly in the long run When setting a policy target, it is important that whoever is to meet the target can do so on a lasting basis. A natural target for a central bank is to keep inflation at a particular level over time. The central bank’s ability to govern inflation ultimately depends, somewhat simplified, on its ability to affect the amount of money in the economy. It cannot steer inflation with a high amount of precision, but still well enough to ensure that it is on average close to the target over time.10 But when it comes to targets for employment, monetary policy does not have the same power. The best way for monetary policy to promote a good long-run development of employment is to “keep the house in order”. By this I mean keeping inflation low and stable – supplying a nominal anchor – and in addition holding the economy in balance by dampening fluctuations in economic activity. This creates a good macroeconomic environment where companies dare to invest and hire. The possibility of monetary policy to influence the long-run employment rate, the equilibrium level, is thus in all essentials indirect. Employment target not meaningful and potentially counter-productive The long-run employment rate is essentially determined by factors beyond the control of monetary policy, such as demography and, above all, the functioning of the labour market.
Rising prices All in all, inflation has largely developed in line with the forecast in the February Monetary Policy Report. The consumer price index, CPI, increased by 3.4 per cent in March. This is an inflation rate well in excess of the target of 2 per cent. A large part of the upturn in the CPI – close to one percentage point – is linked to an increase in mortgage interest expenditure for home-owners and thus to the interest rate increases made by the Riksbank over the past two years. However, the upturn is also due to the rapidly rising commodity prices in the world market. This became clear in autumn 2007 in particular. CPI inflation then rose by just over 1.5 percentage points in just a few months. The primary reason was higher commodity prices. When such rapid price impulses from abroad have an effect on inflation, monetary policy is unable to counteract them immediately. Moreover, it may be very difficult, if at all possible, to predict this type of fluctuation. This is why one cannot expect to avoid effects on inflation like those we have seen recently. A balancing act Now, as I have said, both we and other central banks have to manage the balancing act I described. The Riksbank’s statutory target is price stability, and we must conduct monetary policy so that inflation attains the target of 2 per cent within a couple of years.

Also on the 18th, one of the firms that had been working with Long-Term to raise new capital asked the Long-Term Capital partners if the firm could share the information it had with us. The partners at Long-Term Capital responded that they would prefer to present the information themselves and called me to arrange such a presentation. After conferring with Chairman Greenspan and Secretary Rubin, we agreed that a visit to Long-Term Capital’s offices was needed. A team from the New York Fed, led by Peter Fisher, the head of our Markets Group, and joined by Treasury Assistant Secretary Gary Gensler, met with the Long-Term Capital partners at their offices on Sunday, September 20. During this meeting, we learned the broad outlines of Long-Term Capital’s major positions in credit and equity markets, the difficulties they were having in trying to reduce these positions in thin market conditions, their deteriorating funding positions and an estimate of their largest counterparty exposures. The team also came to understand the impact which Long-Term Capital’s positions were already having on markets around the world and that the size of these positions was much greater than market participants imagined. BIS Review 78/1998  -3-  The New York Fed’s Judgements Mr. Chairman, I would like now to turn to my second point, and focus explicitly on the question of our judgment that the abrupt and disorderly close-out of Long-Term Capital’s positions would pose unacceptable risks to the American economy.
This makes sense, as ON RRP is a good substitute for tri-party repo with private counterparties, and therefore this facility forms a fairly firm floor on overnight repo rates for lenders that have access to the facility.40 As I’ll show in a moment, volumes declined in the private repo market, as is typical on quarter-ends. Evidence to date on other “lenses” Turning to the second lens I noted earlier, we have achieved excellent control while avoiding any unintended change in the structure of the financial system. Figure 11 shows RRP take-up over time, grouped by counterparty type. Take-up, both in aggregate and at the counterpartytype level, has been stable since liftoff. Among the money funds shown in this figure, government-only funds make up more of the demand on typical days, with funds that can invest in a broader universe of money market instruments, called prime funds, accounting for the balance. This has also been stable since liftoff.41 Indeed, more recently, usage has come down as unsecured and secured rates have firmed some. Even with zero usage, the ON RRP facility  BIS central bankers’ speeches  7  could still be effective in underpinning the level for money market rates by supporting lenders’ bargaining power. In addition, as shown in Figure 12, lending volumes in secured and unsecured money markets have been stable, suggesting that the Federal Reserve’s facilities have not displaced activity in the private sector.42 Figure 13 shows activity in unsecured markets by select lender types.

Likewise, the preparations and hard work that we undertake today to prepare for Basel II will, at the same time, strengthen the financial and supervisory infrastructures in our countries more generally, even before we implement Basel II. These preparations are important in helping to ensure the effectiveness of our supervisory systems, to enhance the transparency of our markets, and to develop the sense of a risk management culture in the industry. Together, they will contribute to the promise of greater financial stability in our markets. That is surely a goal worthy of the preparations we will demand of our banks, of our markets, and of our own agencies. We must recognise that, just as banking is becoming an increasingly complex business, the job of bank supervisors will only become more challenging in the coming years. To promote sound banking and risk management practices on a national, regional, or global level, we will need to work together and cooperate even more in the future. Your participation in this conference speaks to your interest in finding ways to deepen our cooperation as we move into this next journey for supervisors. “El trabajo compartido es mas llevadero,” as we say in Spanish: “Many hands make light work” - and, looking around this hall, you will see many hands ready to cooperate. And so, in closing, I encourage you to make the most of this unique opportunity to build contacts and working relationships and to share views on how we can work together toward greater financial stability in the future.