nout wellink : fundamentally strengthening the regulatory framework for banks remarks by mr nout wellink, president of the netherlands bank and chairman of the basel committee on banking supervision, at the korea - fsb financial reform conference : an emerging market perspective, seoul, 3 september 2010. * i. * * introduction and background let me start by thanking our korean hosts and the financial stability board for organising this conference. the timing could not have been better as the basel committee has entered the final phase of completing its reform programme. it is especially fitting that this meeting is hosted by the republic of korea, given the importance and continuing growth of the south korean economy, its membership on the basel committee, and of course its key role as current chair of the g20. as you know, the basel committee ’ s reform programme will be presented to the g20 leaders for their endorsement when they meet here in november. a number of commentators have questioned whether the basel committee ’ s reforms of global banking standards are really necessary for countries that neither “ caused ” the crisis nor were directly affected by it. however, i should point out that all were affected indirectly through the global economic downturn. this includes emerging market economies. to me, at least, it is clear that we all have a lot to learn from both the recent and past financial crises. history has shown that crises have emanated from all regions of the world and have a range of causes. none of us knows what will be the source of the next crisis. what we do know, however, is that in a dynamic, ever changing global economy, there will be future crises and that it will be hard to predict them in advance. moreover, as banks are at the centre of the credit intermediation process, it comes as no surprise that the deepest and most prolonged downturns occur when the banking sector ceases to perform its central role in the economy. we therefore must increase the resilience of the banking system to financial and economic shocks, in particular through higher capital and liquidity buffers, but also through a more resilient infrastructure. we also must change incentives in areas such as governance practices, compensation and the moral hazard associated with too - big - to - fail institutions. this is the best form of preparation and will contribute to increasing our long term growth and welfare. the reforms of the basel committee are intended to address these identified shortcomings by promoting a more resilient banking sector that can support more sustainable growth

history has demonstrated – critical element to the regulatory capital framework is a backstop to the risk - based capital requirement. i am talking, of course, about the newly introduced leverage ratio. in the lead up to the last crisis, banks managed to comply with the risk - based regime : they reported brilliant tier 1 risk - based ratios, while building up massive levels of on - and offbalance - sheet leverage. in good times, the market did not seem to care about this, but when the crisis hit, market participants required banks to meet basic measures of leverage. the subsequent process of deleveraging resulted in a downward spiral between the financial sector and real economy. to contain these cycles of boom and bust leverage and the gaming of the risk - based regime, the basel committee ’ s governing body agreed recently on the design of the leverage ratio and an indicative calibration of 3 %. it is important to understand that the new leverage ratio not only includes on - balance sheet positions but also off - balance sheet items and derivatives, like credit derivatives. for global banks with significant capital market activities, this 3 % calibration is likely to be more conservative than the traditional measures of leverage that have been in place in some countries. the proposed minimum of 3 % will serve as the basis for testing during a parallel run period that will begin in january 2013 with full disclosure starting january 2015. the reason for the parallel run period is not to prolong the implementation. rather, we want to make sure that the risk - based requirement and the leverage ratio floor interact in a manner that makes sense. and this can only be done when observed over different points of the economic cycle, taking into consideration the impact on different types of business models. buffers the next essential element of the new regulatory capital framework is the build up of buffers in good times that can be drawn down in periods of stress. to achieve this, the committee has proposed a capital conservation buffer. during the crisis, some banks that were under stress – in an attempt to signal their financial strength – continued to pay out dividends instead of retaining their profits, which would have replenished their capital. this behaviour was partly driven by a collective action problem : a reduction in dividends, it was feared, would be viewed as a sign of financial weakness. as a bank ’ s capital levels move closer to minimum requirements, the conservation buffer would impose a constraint on a bank ’ s discretionary distributions. these include dividend payments, share buy