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1. P a g e | 1Basel iii Compliance ProfessionalsAssociation
(BiiiCPA)1200G Street NW Suite800Washington, DC 20005-6705USA
Tel:202-449-9750Web: www.basel-iii-association.comDear
Member,Todaywewill start from someamazingBaselIII jobs.Amazing: The
average salaryand the demand for Basel III skillsin IT
jobsadvertised acrossthe UKThefirst tablebelow looksat the demand
for Basel III skillsin IT jobsadvertisedacrossthe UK.Includedisa
guide tothe averagesalariesoffered in IT jobsthat havecited Basel
III over the 3 monthsto 6 March2013witha comparison tothesameperiod
in the previous2years.Thesecond tableis for comparison and provides
aggregatesfor all of theQualityAssurance &
Compliancecategory.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
2. P a g e | 2Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
3. P a g e | 3Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
4. P a g e | 4Source:IT JobsWatch, that providesa
uniqueperspectiveon todaysinformation technologyjob market
(noaffiliation).Tolearnmore:http:/ / www.itjobswatch.co.uk/ jobs/
uk/ basel%20iii.doBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
5. P a g e | 5Where to next?Prioritiesand themes for the
BaselCommitteeKeynote addressbyMr StefanIngves,Governorof the
SverigesRiksbank and Chairman of theBaselCommitteeon Banking
Supervision totheThird BCBS-FSI High-LevelMeetingforCentral and
Eastern Europe on StrengtheningFinancial SectorSupervisionand
Current RegulatoryPrioritiesGood morning. It is my great pleasure
tobe withyou again today.I wouldlike tobegin by extendingmy
appreciationto the FinancialStabilityInstituteand the Banking
Supervisorsfrom Central and EasternEurope for their effortsin
bringing ustogether again for another of theseHigh-Level
Meetings.Last year, I waspleasedtohavebeen ableto be a part of what
wasa veryinterestingand enjoyable meetingin Warsawhosted by our
Polishcolleagues.I hopewecan replicate thesuccessof that event this
year here in Basel.I wouldlike totake theopportunity todayto
reflect a littleon what theBasel Committeehasbeen doing sincewelast
met.Then I will outlineworkcurrentlyin train aswell asour longer
termstrategic priorities.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
6. P a g e | 6TheCommitteemeetsin thisbuildingtomorrow,and
continuestohaveavery full agenda.Indeed, the key messageI would
like toleaveyou withisthat our work,although changingin nature,
showsnosigns of easingoff.What have we done?Before I
discusswhatsleft to do, let me recap what hasbeendone overthepast
year.Thekey initiativescompleted by theCommitteein thepast year
include:reachingagreement on a package of revisionsto finalise
Basel IIIsLiquidityCoverageRatio(LCR); revisingthe Core
Principlesfor EffectiveBanking Supervision;developing a policy
framework for dealingwith domestic systemicallyimportant
banks;establishingdisclosure requirementsfor the new Basel III
definition ofcapital;andupdatingthe supervisoryguidancefor
assessingthe effectivenessof abanksinternal audit function.In
addition, theCommitteeestablisheda sound
operatingframeworkwithinwhich toassessitsmembersimplementationof
Basel III.As a result, the Committeeproduced:tworegular semiannual
reports on Basel III implementationin allmember countries(along
withtwospecial reportstothe G20onimplementation);Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
7. P a g e | 7assessmentsof Basel III implementationin
theEuropean Union, Japanandthe United States;anda report analysing
the variabilityof risk-weightedasset calculationsformarket riskin
individual banks.Further down the agenda, my colleaguesfrom the
Basel CommitteeSecretariat will provide additional insightson our
implementationwork.I wouldlike tomakethepoint now,however,that
theseeffortsarecriticaltodeliveringonthe benefitsthat Basel III
offers.Ruleswrittenhave noeffect if not implemented:wecannot fail
on thisfront, and I will saymore about our effortsshortly.What are
wedoing?There is still a great deal of workbeingdone tofinishthe
Basel IIIframework.Thecapital standardsare now largely settled,
withtheexception of sometechnicalworkon issueslike
exposurestocentral counterparties(CCPs).As I notedearlier, the LCR
has alsobeen finalised albeit again withsome final technical
details to be resolved.But there are other parts of the
Baselframeworkwhichweare currentlyworkingtofleshout and make
operational.Majorprojectscurrentlyunder wayinclude:finalisingthe
specificationof the leverageratio, and
associateddisclosurerequirements;reviewingthe Net StableFunding
Ratio(NSFR), which addressesthelonger-termstructureofbank debt
andcomplementstheshort-termfocusof the LCR;Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
8. P a g e | 8completingthe review of the trading book capital
requirements.This entails an evaluation of the design of the market
risk regulatoryregimeaswellasweaknessesinriskmeasurement under
theframeworksinternalmodels-basedand standardized
approaches;enhancingthetreatment of securitisationstomake capital
requirementsmore prudent and risk-sensitive.We are
alsoreviewingways to reducemechanistic relianceon externalcredit
ratingsand toreduce current cliff effects in capital
requirements;strengtheningstandardsto limit excessiveand opaque
risk-takingthrough over-the-counter(OTC) derivativesand
toreducesystemic riskposed by OTC
derivativestransactions,marketsand practices.Work on
marginingrequirements, counterpartycredit risk and capital
forbanksexposuresto central counterpartiesare examplesof our
effortsrelatedtoderivatives;andrevising the supervisory framework
for large exposures to complementthe Committees risk-based capital
standard and to help improve banksmeasurement and control of
largeexposures.All of theseprojectsarenecessarytoensurethat
theregulatoryframeworkadequatelyfactorsin thelessonsfrom
thefinancial crisis.Thechallenge,almost fiveyears on from the
height of the crisis, is toensure that webringclosure
totheseprojectsand that theyare in placebeforethenext stage of
thefinancial cycle begins.Underpinningthe Committeespolicy
initiativesis an extensiveframeworkfor the collection and
analysisof data tohelp usassessthequantitativeimpact of a
particular policy.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
9. P a g e | 9Quantitative impact studies (QIS) have become a
central element of theCommittees work, and we have a full slate of
QIS exercises planned forthisyear.Alongside thesemiannual Basel III
monitoring reports, almost all of thepolicy initiativesI have just
mentionedhave one or more data collectionsor impact
studiesplanned.While thiscan be a burden for banksand
supervisors,thishopefullymakes for well informedpolicymaking sois
well worth theeffort.In additiontoall of thepolicyand
analyticalwork,theCommitteeintendsto:continueto monitor
memberscommitmentstothe timelyimplementationof
agreedreforms.Todate, this hasfocused on capital, but will be
expandedover thenextyear to encapsulate localimplementationof the
LCR, aswell astheframeworksfor global and
domesticsystemicallyimportant banks(G-SIBs andD-SIBs),
sincethesecome intoeffect over thenext coupleofyears;undertake a
full set of implementationassessmentsfor 2013. We willconduct
reviewsof Singapore, Switzerland, China,Australia, Brazil
andCanada.Follow-upreviewsof the European Union and the
UnitedStatesare alsoplannedonce their Basel III regulationsare
finalised;andpublisha report on the initial, detailed review of
risk-weightedassetcalculationsfor thebankingbook; wehope topublish
thefull resultsbythesummer.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
10. P a g e | 10Together withthe recentlypublished resultson
thetrading book, thisanalysisidentifiesthe specific driversthat
lead to variationsin riskweightsfor similar
exposures.TheCommitteesnext step will thenbe toconsider
policyresponsestoreduceany unwarrantedvariabilityand
tothereforeimprovethecomparability of banksratios.Atheme I will be
returning to isthe importanceof this implementationmonitoring
workfor the Committee.While it is a relatively new component of the
Committees mandate, itshould not be seen as an adjunct to the
Committees standard-settingrole.Rather, it is absolutelycritical
tosuccessfullydeliveringdesiredpolicyoutcomes.Where to next?As you
can see,theCommitteeis engagedin a varietyof
projectsthatrequireustocombinethe effortsand input of regulatorsand
supervisorsacrossa largenumber of countries.This is a
challengingtask.An even greater challenge, however, is
prioritisingamong competingprojectsto achieveour most
pressingobjectives.TheCommitteesresponsetothe financial
crisishasbeen strong, butthereis still much to accomplish.Sowehave
recentlyspent some time identifying our key strategicpriorities, to
make sure wehave a good meansof deciding what wereallymust do.Basel
iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
11. P a g e | 11Asyou may have seen, thesepriorities
wereendorsedby the Group ofGovernorsand Headsof Supervision (GHOS)
at the same time theyendorsedand announced the revisionstothe
LCR.TheCommitteesprimary focusin the short and medium term
iscompleting and embeddingthefull suiteof responsesto
issuesthatemerged from the financial crisis.With that in mind,
foremost considerationwill be given to five
priorityareas:1.completingthecrisis-initiatedreformsof thepolicy
framework;2.monitoringand reinforcingtheimplementationof
Baselregulatorystandards;3.assessingthe impact of, and industry
responseto, implementationoftheregulatory reforms;4.examiningthe
comparabilityof model-based internal risk weightingsand
consideringtheappropriatebalancebetweenthe simplicity,comparability
and risksensitivityof theregulatory framework;and5.enhancingthe
effectivenessof both micro- and
macroprudentialsupervision.Completion of the crisis-initiated
reformsof the policyframeworkAs I have alreadyhighlighted, the
policyreformsinitiatedin response tothefinancial crisis are not yet
complete.While thebasic frameworksfor risk-based capital and, more
recently,liquidityarenow largely settled, manyof theother reformsI
noted earlierremain verymuch a workin progress.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
12. P a g e | 12Toensure that theweaknessesin the regulatory
frameworkbrought tolight by thefinancial crisisdonot persist for
any longer thannecessary,theCommitteeisaimingtohavemuchof this
workcompletedbytheendof 2014.This is an ambitioustarget, but
giventhe importanceof thesereforms,thereis nobasis for
unnecessarydelay.Our plan is for theleverageratiowork whichis
largely devoted to thedetailedspecificationoftheexposuremeasure(ie
thedenominator) oftheratio tobe largely completed this year, while
theNSFR, tradingbook,securitisationand largeexposurespolicy
workwill be finalizedin 2014.TheCommitteealsohas twoother major
policy initiativesthat it planstolaunchsoon.While not
obviouslythought of asimmediateand essential
responsestothefinancialcrisis,theyareneverthelessquiteimportant for
ensuring thattheoverall prudential frameworkremainsrobust,
andexistingreforms areeffective.Theseprojectsare:a review of the
standardised (credit and operational risk) approachestocapital
adequacy, whichneed tobe re-examinedin light of callsforgreater
simplicityand comparabilityin the regulatoryframeworkaswellasthe
desire toreducethe relianceon credit ratingagenciesif
possible;andan examinationof theneed for a capital framework for
interest rateriskin thebankingbook, particularlygiven
thedesiretolimit arbitrageopportunitiesbetweenthe trading and
banking books.Theselasttwoprojectsarestill at an embryonic stage,
soI cannot saytoomuch about what theymight entail at thispoint in
time, but theywill beBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
13. P a g e | 13thelast piecesin what hasessentiallybeen a
completeoverhaul of theregulatoryframework sincethe financial
crisis.Monitoring and reinforcing implementation of Basel
regulatorystandardsAs I have alreadysaid, theestablishment of the
implementationmonitoring programme hasbeen a high priorityfor the
Committee; it iscritical tothesuccessful delivery of the benefitsof
theagreedreforms.Startingfrom scratch at thebeginningof 2012,a
comprehensiveassessment framework hasbeen developed that
isgrowingin itsacceptanceand credibility, and I am pleasedtoreport
that theCommitteenowhasdedicatedcapacityin the area of
implementation work.Theimplementationframeworkis beingcontinuously
strengthenedthrough a lessonslearned process.Our goal istotakeamore
holisticviewon theimplementationprocessbyfocusing not onlyon the
existenceof a regulatory frameworkbut
alsoonitsfunctioning.Theimplementationprocessis alsoenvisagedto be
closely linked to theongoing policydevelopment process,
creatingapositivefeedback loopthat can help strengthenthe
regulatory regime.There is no doubt that this newmonitoring and
assessment initiativehasalready had a positiveimpact.Asaresult of
theregularmonitoring
ofhowcountriesaretrackingagainstagreeddeadlines,aswell asthe
forthcomingcountry assessments,member
jurisdictionsregularlyapproach the Committeeabout specificaspectsof
the Baselframework,actively seeking to ensure that their
localadoptionof theBasel rules wouldnot beinadvertentlyout of
linewith thespirit of the agreement.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
14. P a g e | 14Jurisdictionshavealsobrought
forwardthereleaseof their rulestoensurethat their
progresswascaptured in theperiodicupdatesthat
theCommitteehasprovided to the G20 and made
public.Theself-assessment responsesundertakenfortheassessment
processarealsobenefitingthe implementationprocess.In addition,
theassessmentsof driversthat lead tovariationof bankingand
tradingbook risk-weightedassetsare continuing and areto likelylead
to both more consistent implementationof existingrules, and
thedevelopment of policy optionstoaddressidentified areasof
weakness.Thepriorityfor theCommitteenow is tobuild on
theseachievementsinmonitoring regulatory compliancewithBasel
standardsand tocontinuetoenhancetherigour ofall
aspectsoftheimplementationmonitoring andassessment process.There
isa very full agenda planned for 2013 and beyond which will
deliverquite a number of new monitoring requirements(such
asrulesrelating toliquidity, the leverage ratio and G-SIBs), as
well as country and thematicassessment reports.It is a credit
tomember jurisdictions,and evidenceof their commitmenttothe
process,that this workcan be undertaken:first, it requires
thewillingnessof each member tobe subject to review by their
peers,andthen a continuingstrong commitment, includingsubstantial
resourcingof expert staff, from all involved.Nevertheless, the
effort will be well worthit if weachieveour objectiveofconsistent
implementation of the Baselstandards.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
15. P a g e | 15Assessing the impact of, and industry
responseto, theimplementation of the regulatory reformsThemajor
reformsthat have been developed by theCommittee, coupledwith
thosebeingintroduced at thedomestic level,
aredesignedtofundamentallyreshapebanking.Thereforms are
intendedtogenerate amore resilient financial system, inwhichhigher
levelsof capital and liquidityare held, and in whichrisk
isappropriatelymanaged and priced.This will obviouslyhave
consequencesfor the costsof
financialintermediation,althoughstudiesundertakensuggest
thatthiscost isbothrelativelysmall,
andconsiderablyoutweighedbythebenefitsof increasedfinancial
stability.Nevertheless, thisis not a caseof set and
forget.TheCommitteeismindful of two potential consequencesfrom
theprogrammeof reforms.While a degreeof deleveragingand
increasedrisk premia areintendedconsequencesof thereforms, there is
alwaysa danger that someunintended consequencesmay
arise.TheCommitteeneedsto continueto undertakemonitoring
exercisestoensure that it respondswhen truly unintended
consequencesmaterialise;weunderstand fullythat, if left unattended,
theywill serve to underminesupport for thereform agenda.However, we
also need to avoid using thisasan excuseto delay necessaryreforms;
to the extent there are unintended consequences, we need to
seehowthey can be addressed without losingthe reform benefits.Basel
iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
16. P a g e | 16A second potential consequence relatesto the
incentives that may arise asthe banking sector adaptsto the reforms
by moving into those businesseswhererisk-adjusted(regulatory)
returnsare greatest.This reshapingof banking (either withinbank
balance sheetsor outsidetheregulated bankingsystem) needstobe
monitoredon an ongoingbasisfor the Committeeto maintain a robust
regulatory framework inlight of the evolving nature of thebanking
industry.That doesnot mean that theregulatoryframework shouldbe in
aconstantstateofflux,
asthereareconsiderablebenefitsforfinancialfirmsbeingable toplan in
a stableenvironment.But, equally, wecannot have a regulatoryregime
that is set in stone, andcompletelyunresponsivetochangesin the
environment that it is taskedwith regulating.Creating greater
simplicity and comparability in the
regulatoryframeworkAvigorouspublic debate hasdeveloped
recentlyastowhether the Baselregulatoryframework strikes an
appropriate balanceamong
differentdesirablecharacteristics:simplicity, comparability and
risksensitivity.Thepolicydevelopment processmusttaketheseandseveral
other oftencompeting factorsintoaccount, and findingthe right
balance ofteninvolvesa difficult set of trade-offs.Nevertheless, it
is important to keep thisissueunder review,and
sotheCommitteeestablished a high-leveltask force last year with a
view tolookingat thisconcern from a broader,strategic
perspective.The Committee has already had some discussions on the
task forcesfindings, and will have more in the coming months
(including at ourmeetingthat beginstomorrow).Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
17. P a g e | 17The way forward will also be guided by the
findings of the reviewsof riskweighted assetsthat I mentioned
earlier, since at the heart of that work isa concern about
comparability.It is too earlytosayhow wewill take
thisworkforward.Someissues,such asthosein relation tomarket risk
modelling, can betaken up via our existingtrading book
review.Others might require tweaksto the framework,or
supervisoryguidance,whichcan be implemented in the near term.And
othersmight necessitatea deeper, longer-term review before
wecandecideon anysolution.We will publish a discussion paper in
thecoming monthsthat dealswithdiscussessome of the complex
trade-offsthat need tobe made.But one point I wouldstressis that
whateverwedecideupon, it will bedesignedtostrengthenthecurrent
framework,andthereisnothingthat isbeingproposedthat
shouldgivereasontoholdoffontheimplementationof Basel III and other
recently agreedreforms.Enhancing the effectivenessof both micro-
andmacroprudential supervisionNot surprisingly, the
Committeesagendain thepast few years hasbeendominated by
policymaking.In 2012,implementationalsocame to thefore.Butit
isperhapsstatingtheobviousthateffectivesupervisionisthekeytoensuring
that regulation, once implemented, continuestowork asintended.Basel
iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
18. P a g e | 18Onlyif supervisorsaregiventhetoolstheyneedtoact
can theyeffectivelyperform their role.As the policy reform agenda
movestowardscompletion, and thenewrules are rolledout bynational
regulators, the Committee willincreasinglyturn itsattention
toenhancingsupervisorypractices.Enhancing microprudential
supervisionTheCommitteehasa great deal of guidanceon
supervisorymattersalready on issue.However,much of this
wasdeveloped beforethe financial crisisand willbenefit from
beingupdated to reflect lessonslearnedin recent years.Given the
general applicability of much of this material,
thebenefitsofthisworkwill alsoextend well beyond Basel
Committeemembercountries.As withall multi-year projects,thiswill
require prioritisation.Near-term attention is likely tobe given
tooperational risks (internalcontrolsand informationtechnology),
governance, supervisorycolleges,stresstestingand dealingwithweak
banks.Enhancing the practical implementation of
macroprudentialsupervisionThesystemically important bank SIB
regimeswill continueto be apriorityareafor theCommittee over
thecoming years.Although the regimesfor global SIBsand domestic
SIBs have now beenpublished, both will require a certain amount of
ongoing maintenanceandmonitoring.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
19. P a g e | 19Furthermore,asnotedin theG-SIB
standard,themethodology, includingthe indicator-basedmeasurement
approach itselfand the cutoff /threshold scores,will be subjectto
periodic review and refinement everythreeyears.Beyond this work,the
Committee will now turn itsattentionto thepractical
implementationof toolsand techniquesto deal with systemicrisks.This
will includetwocomplementaryareasof
work:RegulatoryconsequencesofSIB classification:BeingaSIB
meansmorethan just higher capital.In light of the riskstheyimposeon
thefinancial system, SIBs must beheldtoa higher standard
withrespect tosupervisoryexpectationsfor riskmanagement
functions,data aggregation capabilities,risk governanceand internal
controls, all of whichare topics that
featureprominentlyintheCommitteeswork plan.In addition, given
theprinciples-basednature of the D-SIB framework,the Committeewill
monitor emergingpracticeasbanking
supervisorsmovetowardsimplementationsoastofacilitatecross-bordercooperationandmutual
understanding.Use of microprudential toolsfor macroprudential
purposes:TheCommitteewilloverseepreparationsforthecountercyclical
buffer,aswellasexchangeinformation on thewiderrangeof
microprudential toolsthathavebeen usedfor macroprudential
purposes(eg sectoral adjustmentstorisk
weights,stresstestingrequirements, loan-to-valuelimitsor
varyingmargin requirements).Concluding remarksSincethe financial
crisis, theBasel Committeehasaccomplished a greatdeal.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
20. P a g e | 20But westill have work to dotocompletethe
overhaul of the regulatoryframeworkand fullyfactor in all of
thelessonslearned.We alsoneed toseewhetherwehavethebalanceright
whenit comestosimplicityand risk sensitivity.That work
isgoingtokeepthe Committeebusyfor at leastthe next twoyears.But
that is far from the end of it, because, asI have noted a number
oftimestoday, our policyworkwill not generate itsfull benefitsif
notimplemented in a full, timely and consistent manner.Soour
implementationmonitoring workis equallyimportant.And theneven
whenthenew standardsare implemented, wewill
needeffectivesupervisorsto ensure that theyare adheredto.This is an
area wheretheCommitteehasthepotential todomuch
more,particularlyonce thepolicy pipelinebeginsto slow.In other
words,theBasel Committeewill continue toprovideyou withmuch totalk
about at this meetingand thosein the future!Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
21. P a g e | 21Financial Stability Board reportstoG20 on
progressof financialregulatory reformsTheChairman of the Financial
StabilityBoard (FSB) reported to the G20FinanceMinistersand Central
Bank Governorson progressin thefinancial regulatoryreform
programme.In connection withthis, the FSBis publishing:a letter
bythe FSB Chair tothe G20, sent ahead of theirmeeting, reporting on
the good progressbeingmade in financialreforms, includingin
thefollowingpriorityareas:ocreatingcontinuouscore marketsby
completingOTC derivativesand
relatedreforms;ostrengtheningtheoversight and regulation of
shadowbanking;obuildingresilient financial institutions;andoending
toobig tofail.TheletteralsosummarisestheFSBsrecent workand
planstomonitortheimplementationof reforms.An assessment of the
effect of the G20 financial reform programme ontheavailability of
long-term finance.This assessment hasbeen contributed by the
FSBaspart of abroaderdiagnosticreport
preparedbyinternationalorganisationstoassessfactorsaffectinglong-term
financing.TheFSB assessment concludesthat, while there may be
short-termadjustment effects, the most important contribution of
thefinancialreform programme tolong-term investment financeis to
rebuildconfidenceand resiliencein theglobal financial system.Basel
iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
22. P a g e | 22a joint update by the International Accounting
Standards Board (IASB)and the Financial Accounting StandardsBoard
on the statusand timelineof their remainingprojectson
convergingtheir standards.At todaysmeetingtheG20
FinanceMinistersand Central BankGovernorsreaffirmed their
commitment tothe full, timely and consistentimplementationof
internationallyagreed financial sector reforms,andlookedforwardto a
comprehensive report on progressin implementingall reformsat the St
Petersburg G20Summit in September.G20Ministersand
Governorsalsowelcomedthe establishment of theFSBin January asa
legal entitywithgreater financial autonomy and
enhancedcapacitytocoordinatethedevelopment and implementationof
financialregulatorypolicies,while maintainingstronglinkswith
theBank forInternational Settlements.Progressof Financial
Regulatory ReformsFinancial market conditionshave improved over
recent months.Nonetheless, medium-term downsiderisksremain, given
weak growthprospectsand high levelsof public and private sector
debt in manyeconomies.Therecent improvement in financial market
conditionsowesmuch tocentral bank actions, in particular, the
accommodativemonetarypolicyaimed at stimulatingthe economic
recovery.As a consequence, market participantsappetitefor risk
hasincreased,but this hasnot yet translatedintoa robust recovery in
real investment.Thebeginningof thereturn of risk
appetitetofinancial markets whileintendedand welcome raisesanumber
of issues.First, market participantsand authoritiesneed to be on
guard againstmispricing of risk and valuationsof assets.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
23. P a g e | 23Second, the importanceof timelycompletion of
the reformstoover-the-counter(OTC) derivativesmarketsand theshadow
bankingsystem hasincreased.Third, historicallylowinterest
ratesinmanycountriesposechallengesforinstitutional
investorswithlong-datedliabilitiesand may
leavemarketparticipantsmore vulnerable tounanticipatedmovementsin
the yieldcurve.Financial institutionsand supervisorsshould
continuetoassesstheresilienceofthefinancialsystem throughregular
stresstesting, notablyofcredit and interestrate risk, and
completetheprocessof balance-sheetrepair.1.Reportssubmitted for
thismeetinga.Regulatory factors affecting the availability of
long-termfinanceAs part of the diagnosticworkyou requestedof the
internationalorganisations,the FSBhasprepared an assessment of the
effect of theG20financial reform programme on the availability of
long-terminvestment finance.ThereformsincludeBaselIII, OTC
derivativesmarket reforms, andchangesaffectingtheregulatory and
accountingframework forinstitutional investors.Thegeneral
conclusion is that, while there may be some short-termadjustment
effects, the most important contribution of thefinancialreform
programme tolong-term investment financeis to rebuildconfidenceand
resiliencein theglobal financial system.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
24. P a g e | 24As a result, thesereforms should
substantiallyenhancethefinancialsystems capacityto
intermediateinvestment flowsthrough the cycle atall investment
horizons.Hence, the G20 regulatoryreforms are
unambiguouslysupportive oflong-term investment and economic
growth.Thesubmissionsof FSB members found littleevidencethat
theregulatoryreformshavehad a notableimpact on long-term
financingtothispoint.This is not surprisinggiven the fact that the
reform processisstill at anearlystage.Several featuresof
thereformsaredesignedto avoid major unintendedconsequences:thelong
phase-in period for reforms;the ongoingimplementationmonitoring;
and, in certain cases,the flexibilityto adjustrules during the
observation period.Thefinancial reform programme is not specificto
theregulation oflong-term finance.Nevertheless, the reforms will
change the incentives of some financialinstitutions and the costs
of certain transactions, which may affect thecomposition of
long-term finance.In particular, institutional and other
long-horizoninvestorsare expectedtoassume a greater rolein funding
long-term assetsand more of thisinvestment may be intermediatedvia
capital marketsrather than thebankingsystem.There arethree areasfor
specific follow-upby the FSB.First, there should be ongoing
monitoring to identify any regulatoryfactors that may
disproportionately affect the provision of long-termfinancesothat
theycan be addressed.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
25. P a g e | 25Second, the FSBcould workwith
otherstoexaminewhetherregulatoryfactorsmayconstraintheability
ofnon-bankstoexpandtheirprovisionoflong-term finance.Third, the FSB
can contributeto thework of other internationalorganisationstohelp
promote the development of longer-term domesticsavingsand
thecapacityof domesticfinancial systemstointermediatethem,
particularlyin emergingmarket and developing economies(EMDEs).b.
Update on accounting convergenceTheChairsof the
InternationalAccounting Standards Board and
theUSFinancialAccounting StandardsBoard havewrittenyou on their
work onconvergenceof accountingstandards.ThetwoBoardsexpect tomake
progresson the twokey outstandingissuesof impairment of
loans,wheretheyexpect to completetheirdeliberationsin 2013, and
insurancecontracts, whereboth Boards will beholdingpublic
consultationsthis year.Of thesetwooutstandingissues,the need for
convergence on a newforward-lookingexpectedlossapproach to
provisioningis of mostimmediateconcern for end-usersand from a
financial stabilityperspective.We note withconcern thedelaysin
convergencetodate.We thereforerecommendthat theG20asktheIASB and
FASB topreparebyend-2013a roadmapfor converging to a common
approach forimpairment and for achievingthe G20objectiveof a
singleset of highqualityaccountingstandards.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
26. P a g e | 262. Priorities and work plansa. Creating
continuousmarketsTheFSB remainsfullycommittedtotherapid
completionof the G20sagreedreformsto OTC derivativesmarkets.As you
are aware, thesecomplex reformsaretakingsomewhat longerthan
originallyplanned.TheFSB will submit for your April meetingits
latestprogressreport onimplementation, includinga
comprehensivestock-takeof reformsasofend-2012,estimatesof theextent
towhichtransactionsarebeingcentrallyclearedand reportedto trade
repositories, and an overview of theremainingissuestobe resolved.It
is important that all
jurisdictionspromptlycompletethenecessarychangestolegislativeand
regulatoryframeworksto put thesereformsintopractice.Tomaintain
momentum, I have asked FSBmember jurisdictionstoconfirm
beforetheSeptember Summit that the legislationand regulationfor
reportingto traderepositoriesare in place,and
alsothestepstheyaretakingtocompletetheimplementationof other OTC
derivativesreforms.Ministersmay wishtotake a particular interest in
progressin theirjurisdictionsto ensure timely compliance
withtheseimportant reforms.TheFSB haspreviouslyidentified
regulatoryuncertaintyasthemostsignificant impediment tofull and
timelyimplementationof the OTCderivativesreforms.Toreducethis
uncertainty, regulatorsareworkingtogether toidentifyand
addressconflicts,duplication and gapsin thecross-borderapplication
of rules.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
27. P a g e | 27Theywill provideanupdateinApril ontheir
progressand next steps,anda report totheSummit on how theidentified
cross-border issueshavebeen resolved.Internationalpoliciesin
remainingimportant areaswill
alsobepublishedbytheSummit.Theseincludecapital requirementsfor
exposurestocentralcounterparties, marginingstandardsfor
non-centrallyclearedtransactionsand guidance on resolutionof
central counterparties.Standard settersareundertakingan assessment
of the incentivestocentrallyclear transactionsthat
thesestandardscreateand will adjustthem asnecessarytoensure a
robust system.TheFSB will alsoreport at the Summit the findingsof a
newmacroeconomicimpact assessment of theOTC
derivativesregulatoryreforms.Standard settersarealsodeveloping
international guidanceon authoritiesaccesstotraderepositorydata,
includingin suchawaythat it can beaggregatedacrosstrade
repositories.This guidance, whichwill be issuedfor
consultationshortly and finalisedbytheSummit, will be important for
ensuring that authoritiescan useinformation from
traderepositoriesin their oversight of OTC derivativesmarketsand
assessment of systemic
risk.MinistersandGovernorswillwishtoensurethereiseffectivecross-borderaccessto
thisinformation, whichisvital tothemonitoringof emergingfinancial
vulnerabilities.The global Legal Entity Identifier (LEI) system
will enhance the usabilityof the data; the Regulatory Oversight
Committee as the governance bodyof the global LEI system
wasestablishedin January 2013.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
28. P a g e | 28EstablishingtheGlobalLEI Foundationisthekeynext
steptolaunchthesystem in March2013.TheFSB continuestooffer strong
support to theLEI initiativeand theFSB Secretariat will serve asROC
LEI Secretariat for theinitial period.b. Strengthening the
oversight and regulation of shadowbankingAs you will recall, theFSB
deliveredtoyou lastNovember an initial set
ofrecommendationstostrengthenthe oversight and regulationof
shadowbanking.We have receiveduseful feedback through a public
consultationon theinitial recommendations.TheFSB isrefiningthe
recommendationsrelatingto securities lendingand repos, and
thoserelatingto the policymeasuresfor shadowbankingentitiesother
than money market funds.The recommendations will address bank-like
risks to financial stabilityemerging from outside the regular
banking system while not inhibitingsustainablenon-bank
financingmodelsthat do not posesuch risks.Theapproach is designed
tobe proportionateto financial stabilityrisksbyfocusing on
thoseactivitiesthat are material to the system, using
asastartingpoint thosethat werea sourceof systemic risk duringthe
crisis.We will deliver certain recommendationsto the St Petersburg
Summit.Thesemeasuresshould be viewed asthe start of a broader
processsincetheyaddressthespecific risksthat aroseduring thecrisis
and weallrecognisethe ability of the shadow bankingsector
toinnovate.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
29. P a g e | 29c. Building resilient financial institutionsIn
January, agreement wasreachedbytheGroupofGovernorsandHeadsof
Supervision on theLiquidityCoverage Ratio(LCR) to beapplied
tobanks.Theagreement expandsthe rangeof high-qualityliquid
assetsthat canbeincluded in theLCR and
incorporatesevidence-basedassumptionsabout liquidityoutflowsin
timesof stress.TheLCR will be introducedin 2015asplanned, withthe
minimumrequirementsbeginningat 60% and reaching100%by
2019toallowtheglobal banking system sufficient time
toadjust.d.Ending too-big-to-failProgressisbeing madeby the IAIS in
developingand testing amethodologyfor identificationof global
systemically important insurers(G-SIIs), and in developing
appropriatepolicy measures.This work should becompleted in the
second quarter of 2013.An identificationmethodology for non-bank
G-SIFIs will be issuedforconsultationin the secondhalf of
2013.Although implementationof theG-SIFI frameworkhasmuch farther
togo, wewill deliver an assessment totheSt. Petersburg Summit of
theprogressmade in developing crediblepoliciesfor ending
too-big-to-fail(TBTF).3. Implementation of reformsBasel
IIIConsistent implementationof Basel III is fundamental to
strengtheningtheresilienceof theglobal banking system,
maintainingmarketBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
30. P a g e | 30confidencein theregulatory reformsand
providinga level playing fieldfor
internationallyactivebanks.The27member jurisdictionsof the Basel
Committeeon BankingSupervision(BCBS) continuetomake
progresstowardimplementation;11had issued final regulationsby12
February 2013and theremaining 16jurisdictionshave tableddraft
regulations.TheEuropeanUnion andtheUnitedStatespublisheddraft
regulationsin2012and intend tofinalisethem over thecourse of
2013.TheFSB and BCBSwill prepare a full update on countriesadoption
ofBasel III in domesticregulationfor your April
meeting.Thecountriesthat havemissedtheJanuary 2013start date are
workingtofinalisetheir regulationsand are expected to meet
the2019timelineforfull implementation.Several more memberswill
undergoa consistencyassessment of theirfinal regulationsby theBCBS
in 2013.By end-2013,all jurisdictionsthat are the home
regulatortoglobalsystemicallyimportant banks(G-SIBs) will have been
subject to anassessment of their Basel III implementation.Other
jurisdictionswill be subject to regulatory
consistencyassessmentsshortlythereafter.TheBCBS hasconcluded an
initial examination of the internationalconsistencyin the
application of theBasel III risk weightingschemefortradingbook
assets.Asimilar review is underwayregarding the banking book.Basel
iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
31. P a g e | 31Theanalysisforbankstradingbooksindicatesthat
supervisorydecisionsandvariationsin banksmodels contributetothe
substantial differencesinbankscalculationsof market
risk.(Theaveragerisk weightingof tradingassetsfor most banksin
thestudyvaried between15% and 45%.)Thestudyalsoshowsthat
bankspublic disclosuresare insufficient forunderstandinghow much of
thesevariationsin banksreportedriskweightingsof assetsare
owingtodifferinglevelsof actual risk versusthatowingtoother
factors.This situation is unacceptable, and the
studyhighlightsthreepolicyoptionswhichare beingaddressed in the
BaselCommitteesongoingwork:(i)Improving bankspublic disclosures,
buildingon therecommendationsof theEnhanced
DisclosureTaskForce;(ii) Narrowingdown modellingchoicesfor
banks;and(iii) Further harmonisingsupervisorypracticesover approval
of models.Resolution regimes and G-SIFI resolution plansAn
effectiveand credibleresolution regime for SIFIs is a
criticalcomponent of the policy framework for ending TBTF.Full
implementationof theFSBKeyAttributesof
EffectiveResolutionRegimeswill provideauthoritieswiththepowersand
toolsnecessaryforthispurpose.We will shortlyconcludethefirst peer
review of FSB membersimplementationof theKeyAttributes.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
32. P a g e | 32Theworkunder thereview confirmsthat reformsare
underwayin manyjurisdictionsto align national statutoryregimes
withthe FSB KeyAttributes, but that significant work remains.We are
developingan assessment methodology to assist countrieswiththeir
implementation, and toprovidea basisfor future peer reviewsandIM F
and World Bank assessments.Themethodology will be testedin pilot
assessmentsbythe IMF andWorld Bank later thisyear and publishedin
the second half of 2013.TheFSB and itsmemberswill alsothis year
addressthe specific aspectsof resolutionof insurersand financial
market infrastructuresand theprotectionof client assetsin
resolution.By June 2013, resolution strategiesand plansshould be in
placefor allG-SIFIs designated in November 2011.Toassist this
processthe FSB haspubliclyconsulted on specific aspectsof recovery
and resolutionplanningand isnow finalisingitsguidance.Progressin
ending TBTF is contingent on the feasibilityand credibilityof
putting theseresolutionplansintooperation.We will launchin
thesecond half of 2013a first round of assessmentsunder the G-SIFI
ResolvabilityAssessment Processtoevaluatetheprogressmade.Reducing
the reliance on Credit Rating Agency (CRA) ratingsTheFSB
hasrecentlylaunched a thematic peer review to assistitsmembersto
fulfil their commitmentsunder the roadmap forimplementingthe
FSBprinciplesfor reducingreliance on CRA ratings.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
33. P a g e | 33This will includea stock-take of
referencestoCRA ratingsin nationalauthoritieslawsand regulationsand
of actionsbeing taken toremove orreplace
thesereferences.Thefindingswill feed intotheprogressreport on CRAs
for theSummit,while thepeer review will be completed by
early2014.Monitoring the impact of reformson EMDEsTheFSB will
organisea workshopfor EMDEs in the first half of
2013tosharelessonsand experienceson implementingagreed financial
reformsand on undertakingex anteassessmentsof their impact.FSB
members withsignificant experiencein undertakingsuchassessmentswill
be asked topresent their methodologies.TheFSB will report the
findingsof theworkshopand other relevantmonitoring processesat
theSt. Petersburg Summit.4. FSB resources, capacity and
governanceFinally, I am pleasedto report that theFSB hasnow been
establishedwith a legal personality.Alongside this,a
rollingfive-year agreement under which theBISwillhost and
provideresourcesfor theFSB hasbeen activated, and aninstitutional
mechanism for theFSBsfinancial and
resourcegovernanceestablished.TheFSB hasalsoadoptedProcedural
Guidelinesfor itsoperational andadministrativeactivitiesand
practices.Theseareimportant stepstowardsimplementationof the
G20recommendationsat Cannesand Los Cabostoplace theFSB on
anenduringorganisational footing, withstrengthenedgovernance,
greaterBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
34. P a g e | 34autonomy in resource use and enhanced
capacitytocoordinatethedevelopment and implementation of financial
regulatorypolicies,whilemaintainingstrong linkswiththe BIS.TheFSB
will next elect new chairs for three of its Standing
Committeesandbegin a review of the composition of their
memberships.FollowingtheSt. PetersburgSummit, the FSB will set in
train areview of the structure of itsrepresentation,
whichweenvisage tobecompleted under theAustralianPresidencyof the
G20.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
35. P a g e | 35Dodd-Frank Act StressTest2013TheDodd-Frank Act
requires allfinancial companiesthat havemore than $10 billionin
totalconsolidatedassetsand areregulated by a Federal
financialregulatoryagencytoconductcapital stresstestsat
leastannually.TheFederalReservefinalizedthoserequirementsforBHCswithbetween$10
billion and $50 billion in assetsand state member banks and
savingsand loan holding companies with over $10 billion in assets
on October9, 2012.TheFederal Reserve expectslarge, complex bank
holding companies(BHCs) to hold sufficient capital tocontinue
lendingto support realeconomicactivity, evenunder adverseeconomic
conditions.Stress testing is one tool that helps bank supervisors
measure whether aBHC has enough capital to support its operations
throughout periods ofstress.TheFederal Reserve
previouslyhighlightedthe useof stresstestsasameansof
assessingcapital sufficiencyunder stressduring the
2009SupervisoryCapitalAssessment Program (SCAP) and the 2011and
2012Comprehensive CapitalAnalysis and Review (CCAR) exercises.In
the wakeof thefinancial crisis,theCongressenacted theDodd
-FrankWall Street Reform and Consumer ProtectionAct
(Dodd-FrankAct), which requires the Federal Reserve to conduct an
annual stresstestof largeBHCs and all nonbank financial companies
designatedby theFinancial Stability Oversight Council (FSOC) for
Federal ReserveBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
36. P a g e | 36supervision to evaluate whetherthey have
sufficient capital toabsorblossesresultingfrom adverseeconomic
conditions.TheDodd-Frank Act alsorequiresBHCs and other financial
companiessupervised by the Federal Reserve to conduct their own
stresstests.TheFederal Reserve adopted
rulesimplementingtheserequirementsinOctober 2012.Under the
rules,18BHCs arepart of theDodd-FrankAct supervisorystressteststhis
year (DFAST 2013).This report describesthe hypothetical,
severelyadversescenario designedbythe Federal Reserve;providesan
overview of the analytical frameworkand methodsusedtogeneratethe
projectionsof revenues,expenses,losses,
andtheresultingpost-stresscapitalratiosforeachofthe18BHCs;and
disclosesthe resultsof the2013Dodd-Frank Act
supervisorystresstest.TheFederalReservebelievesthat disclosure
ofstresstestresultsprovidesvaluableinformationtomarket
participantsand the public, enhancestransparency, and promotes
market discipline.Theprojectionsprovide a uniqueperspectiveon the
robustnessof thecapital positionsof these firms
becausetheyincorporatedetailedinformation about therisk
characteristicsand businessactivitiesof eachBHC and because theyare
estimatedusinga consistent approachacrossall the BHCs,
providingcomparable resultsacrossfirms.TheFederal Reserve
alsobelievesthat providinginformation about
themethodologyusedtoproducethe resultswill offer useful context
tointerpret thoseresults.Theprojectionswerecalculatedusing input
data provided bythe 18BHCsand a set of modelsdeveloped or
selectedby theFederal Reserve,based on a hypothetical,
severelyadverse macroeconomic and financialBasel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
37. P a g e | 37market scenario developed by the Federal
Reserve.Theseverelyadversescenario featuresa deep recessionin
theUnitedStates,Europe, and Japan, significant declinesin asset
pricesandincreasesinriskpremia,
andamarkedeconomicslowdownindevelopingAsia.TheFederal Reserve
alsoapplied a separate global market shock to
sixBHCswithlargetrading, privateequity,
andcounterpartyexposuresfromderivativesand
financingtransactions.Themodels project revenues,
expenses,losses,and the resultingpost-stresscapital ratios for each
BHC over a nine-quarter planninghorizon extendingthrough the end of
2014.TheFederal Reserves projectionsshould not be
interpretedasexpectedor likelyoutcomesfor thesefirms, but rather
aspossibleresultsunderhypothetical,
severelyadverseconditions.Theseprojectionsincorporatea number of
conservative modelingassumptions, but donot make explicit
behavioral assumptionsabout thepossibleactionsof a BHCs
creditorsand counterpartiesin the scenario,except through the
severelyadversescenarios characterizationsoffinancial asset
pricesand economic activity.Tomake theprojectionsof
post-stresscapital ratiosmore comparableacrossBHCs,
theprojectionsreflect assumptionsabout
capitaldistributionsprescribedin the Dodd-Frank Act stresstest
rule.Over thenine-quarter planninghorizon, each BHC
maintainsitscommon stock dividend paymentsat thesame level asthe
previousyear,but repurchasesand issuanceof common stock is assumed
tobe zeroexcept for common stock issuanceassociatedwith expensed
employeecompensation.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
38. P a g e | 38Theresultsof theseprojectionssuggest that, in
the aggregate, the 18BHCswouldexperiencesubstantial lossesunder the
severelyadversescenario.Over thenine quartersof theplanninghorizon,
lossesat the 18 BHCsunder the severely
adversescenarioareprojectedtobe $462billion,
includinglossesacrossloanportfolios,losseson securitiesheld
intheBHCsinvestment portfolios, tradingand counterpartycredit
lossesfrom the global market shock, and other losses.Projected net
revenuebeforeprovisionsfor loanand leaselosses(pre-provision net
revenue, or PPNR) at the 18BHCsover the ninequartersof
theplanninghorizon under theseverelyadverse scenariois$268billion,
whichisnet of
lossesrelatedtooperational-riskeventsandmortgagerepurchases,aswellasexpensesrelatedtodispositionofownedreal
estateof $101billion.Taken together, thehigh projected lossesand
lowprojectedPPNR at the18BHCs resultsin projectednet income
beforetaxesof -$194billion.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
39. P a g e | 39Thesenet incomeprojectionsresult in substantial
projected declinesinregulatorycapital ratios for nearlyall of the
BHCsunder theseverelyadversescenario.As illustrated in figure 1,the
aggregate tier 1common ratiowouldfallfromanactual11.1percent in
thethirdquarterof2012toapost-stresslevelBasel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
40. P a g e | 40of 7.7 percent in thefourth quarter of 2014,
includingassumed capitalactionsfor the18 BHCs.TheDodd-Frank Act
requires the Federal Reserve to conduct an
annualsupervisorystresstest of BHCs with$50billion or more in
totalconsolidatedassetsand nonbank financial companiesdesignatedby
theFSOC for Federal Reserve supervision(collectively,
coveredcompanies).TheDodd-Frank Act
alsorequirescoveredcompaniestoconduct
theirownstresstests(company-run stresstests) semiannually.Together,
the Dodd-FrankAct supervisory stresstestsand thecompany-run
stresstestsare intended to provide BHC management andboardsof
directors, the public, and
supervisorswithforward-lookinginformation tohelp identify
downsiderisksand the potential effect ofadverseconditionson capital
adequacyof these largebankingorganizations.TheFederal Reserve
adopted rulesimplementingthese requirementsinOctober 2012.Under the
implementationphase-in provisionsof the Federal ReservesDodd-Frank
stresstest rules,only the 18BHCs that previouslyparticipated in the
SCAP are required to conduct company-run stresstestsduring the
current stresstest cycle that began in October 2012.Similarly, the
Federal Reserve hasconducted supervisorystresstestsononlythese18
BHCsfor DFAST 2013.Both setsof stresstestsare alsointegrated
intothe Federal Reservesassessment of capital adequacy under
CCAR.Important differencesbetweenthe Dodd-Frank Act
supervisorystresstestsand the CCAR post-stresscapital analysisare
outlinedin box 1.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
41. P a g e | 41Toprovide context totheFederal
ReservesDodd-Frank Act supervisorystresstest
results,thefollowingsectionscontain an overview of
theFederalReserves Dodd-FrankAct stresstest rules,focusing on
theprocessfor the supervisorystresstestsand the
requirementsforcompany-run stresstestsfor covered
companies.Supervisory StressTestsUndertheDodd-Frank Act stresstest
rules, theFederalReserveconductsannual
supervisorystressteststoevaluatewhethera
coveredcompanyhasthecapital, on a total consolidatedbasis,
necessaryto absorblossesandcontinueitsoperations bymaintainingready
accessto funding, meetingitsobligationsto creditorsand other
counterparties, and continuing toserveasa credit intermediaryunder
adverseeconomicand financialconditions.As part of this
supervisorystresstest for each covered company, theFederal Reserve
projectsrevenue, expenses,losses,and resultingpost-stresscapital
levels, regulatorycapital ratios, and the tier 1commonratio under
three scenarios (baseline, adverse, and severelyadverse),usingdata
asof September 30.TheFederal Reserve generallyusesa common set of
scenariosfor allcoveredcompaniesin the supervisory
stresstest.However,the Federal Reserve may use additional
scenariosorcomponentsof scenarios for all or a subset of the
covered companiestocapture salient sourcesof risk, and
thesescenariosmay usedata fromdatesother than theend of thethird
quarter.In DFAST 2013, large, complex BHCswithsignificant
tradingactivitiesare subjecttoa global market shock that
reflectsgeneral market stressandheightened uncertainty, which
affectstradingpositionsand elevatescounterpartycredit risk.Basel
iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
42. P a g e | 42TheDodd-FrankAct codified theFederal
Reservespracticeof disclosinga summary of theresultsof
itssupervisory stresstest.In this paper, theFederal Reserve is
disclosingthe resultsof the 2013Dodd-FrankAct
supervisorystresstestsconducted under theseverelyadversescenario,
includingfirm-specificresultsbasedon theprojectionsmadeby the
Federal Reserve of each BHCsrevenues, expenses,
losses,andpost-stresscapital ratiosover the planning horizon.Box 1.
Dodd-Frank Act Supervisory StressTests andthe CCAR
Post-StressCapital AnalysisWhile closelyrelated, there are some
important differencesbetweentheDodd-FrankAct
supervisorystresstestsandtheCCAR
post-stresscapitalanalysis.Theprojectionsof pre-tax net income from
the Dodd-Frank Actsupervisorystresstestsaredirect inputstothe CCAR
post-stresscapitalanalysis.Theprimary differencebetweenthe
Dodd-FrankAct supervisorystresstestsand the CCAR post-stresscapital
analysisis thecapital actionassumptionsthat arecombined with
theseprojectionsto estimatepost-stresscapital levelsand
ratios.Capital ActionAssumptionsfor theDodd-Frank Act Supervisory
StressTestsToproject post-stresscapital ratiosfor theDodd-FrankAct
supervisorystresstests, the Federal Reserve usesa standardizedset
of capital actionassumptionsthat are specified in the Dodd-FrankAct
stresstest rules.Common stock dividend paymentsare assumed to
continueat the samelevel asthe previousyear.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
43. P a g e | 43Scheduled dividend, interest, or principal
payments on any other capitalinstrument eligible for inclusion in
the numerator of a regulatory capitalratio are assumed to be
paid.Theassumptionsare that repurchasesof common stock are
zero.Thecapital action assumptionsdonot include issuanceof new
commonstock, preferred stock, or other instrument that wouldbe
includedinregulatory capital, except for common stock
issuanceassociatedwithexpensed employee compensation.Capital
ActionsforCCARIn contrast, for theCCAR post-stresscapitalanalysis,
theFederalReserveusesBHCsplanned capital actions,and
assesseswhethera BHC wouldbe capableof meeting
supervisoryexpectationsfor minimum capitalratios even if stressful
conditionsemergedand theBHC did not reduceplannedcapital
distributions.As a result, post-stress capital ratios projected for
the Dodd-Frank Actsupervisory stress tests should be expected to
differ significantly fromthosefor the CCAR post-stresscapital
analysis.For example, if a BHC includesa dividendcut in itsplanned
capitalactions,itspost-stresscapital ratiosprojected for the CCAR
capitalanalysiscould be higher than thoseprojected for the
Dodd-FrankActsupervisorystresstests.Conversely, if a BHC
includessignificant dividend increases,repurchases, or other
actionsthat depletecapital in
itsplannedcapitalactions,thepost-stresscapital ratiosfor the CCAR
could be lower.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
44. P a g e | 44Company-Run StressTestsAs required by the
Dodd-Frank Act, the Federal Reserves stresstest rulesrequire
covered companies to conduct two company-run stress tests
eachyear.In conducting theannual test, a coveredcompany usesdata
asofSeptember 30 and reportsitsstresstest resultsto theFederal
Reserve byJanuary 5.In addition, a covered company must conduct a
midcycle test andreport the resultsto the Federal Reserveby
July5.TheDodd-Frank Act stresstest rulesalign the timingof
annualcompany-run stresstestswiththe annual
supervisorystresstestsofcoveredcompanies.In
theirannualstresstests,coveredcompaniessubject totheDodd-FrankAct
stresstest rulesmust usethe scenariosprovidedby the
FederalReserve.Each year, theFederal Reserve will provide at least
three scenariosbaseline, adverse, and severelyadversethat are
identical tothescenariostheFederal Reserve usesin theannual
supervisorystresstestsof covered companiesBy providinga common set
of scenariosto allfirms, the resultsof company-run and supervisory
stresstestsfor all 18BHCswill be based on comparable underlying
assumptions.Tofurther enhancecomparability, the supervisory
stresstestsandcompany-run stresstestsconducted under the Dodd-Frank
stresstestrules usethe same set of capital action
assumptions.According to these assumptions,over
thenine-quarterplanninghorizon, each BHC maintainsitscommon stock
dividend paymentsatthesamelevel asthe previousyear;
scheduleddividend, interestorprincipal paymentson any other capital
instrument eligiblefor inclusionin theBasel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
45. P a g e | 45numeratorof a regulatory capital ratioare
assumed tobepaid; butrepurchasesof suchcapital
instrumentsandissuanceof stock is assumedtobe zero.Finally, each
covered company must publicly disclose a summary of theresults of
its company-run stress test under the severely adverse
scenarioprovided by the Federal Reserve.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
46. P a g e | 46Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
47. P a g e | 47Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
48. P a g e | 48Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
49. P a g e | 49Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
50. P a g e | 50Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
51. P a g e | 51Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
52. P a g e | 52Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
53. P a g e | 53Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
54. P a g e | 54Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
55. P a g e | 55Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
56. P a g e | 56Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
57. P a g e | 57Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
58. P a g e | 58GovernorDaniel K. TarulloAt the Cornell
International Law JournalSymposium: The ChangingPoliticsof
CentralBanks, New York, New YorkInternational Cooperation in
FinancialRegulationNext month marks the fifth anniversary of
thefailure of Bear Stearns--inretrospect, thebeginningof themost
acutephaseof thefinancialcrisis.Thecross-borderdimensionsof the
crisisitselfand theglobaleffectsof the GreatRecessionthat
followedprovokeda major efforttostrengtheninternational
cooperationin financial regulation.While a good deal hasalready
beenaccomplished, thiseveningI will suggest the next stepsthat
wouldbe mostuseful inadvancingglobal financial stability.Of course,
the fashioning of an international agenda requires a
clearunderstanding of the overall regulatory aims of participating
nationalauthorities.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
59. P a g e | 59Here is whereinternational regulatory
cooperation linkstothesubject ofthisconference--if not quite
thechangingpoliticsof central banks, thenatleasttheir
changingpolicy goalsin thewakeof thefinancial
crisis.Almostbydefinition, systemic crisesreveal failures
acrossthefinancial system,from breakdownsin risk management at many
financial firms toseriousdeficienciesingovernment regulationof
financialinstitutionsandmarkets.While the recent
crisiswasnoexception, it haspresented
particularchallengestothepolicyfoundationsofcentralbanks,especiallythoseliketheFederal
Reservethat carry out regulatory
mandatesalongsidetheirmonetarypolicy missions.SoI begin withsome
remarkson thenature of thosechallenges,beforeturningtoa
discussionof how changesin approach should informinternational
cooperationin financial regulation.Central Banks and the Financial
CrisisIn surveying the failings of financial authorities, both here
and abroad,onecan certainlyidentify some specific characteristicsof
pre-crisisregulation that look todayto have been
significantlymisguided, ratherthan the advancestheywereformerly
thought tobe.So, for example, regulatorsbecame prone to placetoo
much confidencein thecapacityof firms to measure and managetheir
risks.Indeed, thedecadeorsoprior tothecrisishad seen
anaccelerationof theshift from a dominantlyregulatory approach
toachievingprudential aims--onethat restson activitiesand
affiliationrestrictions,and otherreasonablytransparent
rules--towardgreater emphasison a supervisoryapproach,
whichrelieson a more opaque, firm-specific processofwatchingover
banks ownrisk-management and compliancesystems.Yet thebreadth and
depth of the financial breakdownsuggest that it hasmuch deeper
roots.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
60. P a g e | 60In many respects,this crisiswasthe
culminationof fundamental shiftsinboth theorganization and
regulation of financial marketsthat began inthe1970s.TheNew Deal
reforms of financial regulation, themselvesspawnedby asystemic
crisis, had separated commercial banking from investmentbanking,
cured theproblem of commercial bank runsby providingfederal deposit
insurance,and brought transparencyand investorprotectionsto
tradingand other capital marketsactivities.This regulatory approach
fostered a commercial banking system thatwas,for thebetter part of
40years, quitestableand reasonablyprofitable,though not
particularlyinnovativein meetingtheneedsofdepositorsand
borrowers.In the1970s, however, turbulent
macroeconomicdevelopmentscombinedwith technological and
businessinnovationsto produceanincreasinglytight squeezeon
thetraditional commercial bankingbusinessmodel.Thesqueezecamefrom
boththeliabilitysideof banks balancesheets,intheform of more
attractivesavingsvehiclessuchasmoneymarketfunds,and from the asset
side, with thegrowthof public capital marketsand international
competition.Thelargecommercial banking industrythat saw both its
fundingand itscustomer basesunder attack sought removal or
relaxation of theregulationsthat confinedbank
activities,affiliations, and geographicreach.While supervisors
differed with banks on some importantparticulars, they were
sympathetic to this industry request, in partbecause of the
potential threat to the viability of the traditionalcommercial
bankingsystem.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
61. P a g e | 61Theperiod of relativelegal and industry
stabilitythat had followedtheNew Deal thusgavewayin the 1970stoa
nearly 30-year period duringwhichmanyprevailingrestrictionson
bankswererelaxed.Agood number wereloosenedthrough
administrativeaction bythebankingagencies,but important statutory
measuresheaded in the samedirection.This legislativetrend
culminated in the Gramm-Leach-BlileyAct of1999, which consolidated
and extended the administrativechangesthathad allowedmore
extensiveaffiliationsof commercial bankswithinvestment banks,
broker-dealers,private equity firms, and other
financialentities.But in sweepingawaytheremnantsof one key element
of theNew Dealregulatorysystem, neither Gramm-Leach-Bliley nor
financial regulatorssubstituted new regulatory mechanismstomatch
the wholesalechangesin thestructure of thefinancial
servicesindustry and thedramaticgrowthof novel financial
instruments.In fact, I wouldgeneralize this last observation
tosaythat theneed toaddressthe consequencesof
theprogressiveintegrationof traditionallending,
tradingactivities,and capital marketslies at theheart of
threepost-crisischallengesto thepolicy foundationsof the Federal
Reserveand, to a greater or lesser degree, manyother central
banks.Microprudential RegulationThefirst challengeposed by the
crisiswasto traditional, microprudentialregulation, whichfocuseson
the safetyand soundnessof eachprudentiallyregulated firm.Not all
central bankshave microprudential regulatory authority, ofcourse,
and--asin theUnited States--thosethat dosometimesshare itwith other
agencies.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
62. P a g e | 62But the shortcomingsof pre-crisisregulatory
regimeshavebeen ofconcern toall central banks.Most notably, capital
requirementsfor bankingorganizations,particularlythe largeonesthat
might be regarded astoo-big-to-fail,simplywerenot strong
enough.Risk-weightsweretoolowfor certain traded assetsthat had
proliferatedascredit and capital marketsintegratedmore
thoroughly.In some cases,thearbitrageopportunitiespresented by
existingcapitalrequirementswerean incentivefor securitizationand
other capitalmarketsactivities.Theexposurescreated by
off-balance-sheetactivitiessuch asstructuredinvestment vehicles
(SIVs) werebadly underweighted.Minimum capitalratioswerenot high
enoughand, in meetingeven
thoseinadequaterequirements,firmswereallowedtocount liabilitiesthat
didnot reallyprovidetheabilityto absorb lossesand still maintain
the firmsasviable, functioningintermediaries.There hasalreadybeen a
substantial responsetothis challenge.With the support of the
Federal Reserve and other U.S. bank regulators,theBasel Committeeon
Banking Supervisionhasstrengthenedcapitalrequirementsby
raisingrisk-weightingsfor traded assetsand improvedthequalityof
loss-absorbingcapital through a new minimum
commonequityratio.Thecommittee alsohascreated a capital
conservation buffer andintroduced an international
leverageratio.TheseBasel2.5and Basel III reforms either havebeen,
or soon will be,implementedintheUnitedStatesandmostother
countriesthat arehometointernationallyactivebankingfirms.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
63. P a g e | 63Also, theBasel Committeehasjust
recentlyadoptedthe LiquidityCoverageRatio(LCR), a first step in
addressingliquidityproblems.In theUnited States, some important
additional stepshavebeen taken.Beginningat thepeak of the crisis,
theFederal Reserve hasconductedstresstestsof
largebankingorganizations, making capital requirementsmore
forward-lookingby estimatingthe effect of an
adverseeconomicscenario on firm capital levelsin a manner
lessdependent on firmsinternalrisk-measurement infrastructure.And
the provision of theDodd-FrankAct popularly knownasthe
CollinsAmendment ensuresthat banking organizationscannot
usemodels-basedapproachesto reducetheir minimum capital
belowgenerallyapplicable, more standardized risk-based
ratios.Macroprudential RegulationAsecond challengefor central
banksis that the crisisrevealed the needfor a much more activeset
of macroprudential monitoring and regulatorypolicies--that is, a
reorientationtowardsafeguarding financial stabilitythrough
thecontainment of systemic risk.Thefailure to attendto, or even
recognize, financial stabilityriskswasperhapsthemost glaring public
sector deficiencyin the pre-crisisperiod.This wasa fault by
nomeanslimitedto central banks.On the contrary, systemic risk had
alsocome toseem more theoreticalthan real to manyacademicsand
financial market participants.Even most of thoseinsideand
outsidetheofficial sector whoargued forstronger capital or other
prudential standardsdid not appreciatethedegreetowhichthesecondary
mortgage market had turned intoa houseof cards.Still, regardlessof
formal mandates, central banks arebetter positionedthan most other
government agenciestoseeand evaluatetheemergenceBasel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
64. P a g e | 64of asset bubbles,excessiveleverage,and other
signsof potential systemicvulnerability.In some respectsthis second
challengeisan extension of the first, sincethesafetyand soundnessof
largeinstitutionsmust take account of therelativecorrelationof
their asset
holdings,interconnectedness,commonliquidityconstraints,and other
characteristicsof largebankingorganizationsasa group.Similarly,
systemic risks and too-big-to-fail problems can increaseiflarge,
highly leveragedfirms may operateoutsidethe perimeter
ofstatutorymicroprudential oversight,
aswasthecasepriorto2008withthelarge, free-standinginvestment
banksin theUnited States.And market disciplinewill be
badlycompromised if financial marketparticipantsbelievethat an
insolvent counterparty cannot beresolved inan orderly fashionand
thusis likely toreceivegovernment assistanceunder stress.Here
again, domestic and international efforts have already
producedsignificant reform programs, though implementation of some
of theseprogramsislessadvanced than Basel2.5and Basel
III.Domestically, theFederal Reserves annual
stresstestsexaminetheeffectsof unexpectedmacroeconomicshockson
asset classesheldwithinall major regulated firms.TheDodd-Frank Act
gave theFinancial StabilityOversight Council(FSOC) authority
tobring systemically important firms that are notalready bank
holding companieswithintheperimeter of Federal Reserveregulation
and supervision.TheFSOC is activelyconsideringseveral firms for
possibledesignation.Finally, theDodd-Frank Act gavethe Federal
Deposit InsuranceCorporation orderlyliquidationauthority for
systemicallyimportantBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
65. P a g e | 65financial firms, therebycreatingan
alternativeto the Hobsonschoiceofbailout or bankruptcythat
authoritiesfaced in 2008.Internationally, the Basel
Committeehasagreed toa regimeof capitalsurchargesfor
largebanksbasedon their systemic importance.There is alsoan
initiativeto parallel U.S. effortsto
identifynon-banksystemicallyimportant firms.TheBasel Committee and
the Financial Stability Board
havedevelopedinternationalprinciplesforresolutionauthority,
thoughmost oftherestoftheworldis behind the UnitedStatesin
actuallyimplementingthoseprinciples.But meetingthemacroprudential
challengewillrequire measuresbeyonda more comprehensive, cross-firm
approach tomicroprudentialregulation.Much academicand policy work
of thepast several yearshasrevived andelaborated
thepreviouslysomewhat heterodox view that
financialinstabilityisendogenousto the financial system, or at
least thekind offinancial system wenowhave.Consider,for example,how
the intertwiningof traditional lendingandcapital marketsgaverise to
what hasbecome knownasthe shadowbankingsystem.Shadowbanking,
whichrefers tocredit intermediation partly or whollyoutsidethe
limitsof thetraditional banking system, involvesnot
onlysizeablecommercial and investment banks, but many firms of
varyingsizesacrossa rangeof markets.While some of themore
notoriouspre-crisiscomponentsof theshadowbankingsystem are
probablygone forever, current examplesincludemoneymarket funds,
thetripartyrepomarket, and securities lending.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
66. P a g e | 66From the perspectiveof financial stability,
theparts of theshadowbankingsystem ofmostconcernarethosethat
createassetsthought tobesafe,short-term, and liquid--ineffect, cash
equivalents.For a varietyof reasons, demand for such
assetshasgrownsteadily inrecent years,andisnot
likelytoreversedirectionintheforeseeablefuture.Yet theseare the
assetswhosefunding is most likelytorun in
periodsofstress,asinvestorsrealize that their resemblancetocash or
insureddepositsin normal timeshasdisappearedin thefaceof
uncertaintyabouttheir underlying value.And, as was graphically
illustrated during the crisis, the resulting forcedsales of
assetswhose valuesare already under pressure can accelerate
anadversefeedback loop, in whichall firmswithsimilar
assetssuffermark-to-market losses,which, in turn, can lead tomore
fire sales.Thiskindof contagionlayat theheart
ofthefinancialstressesof2007and2008.As alreadynoted,
pre-crisisshortcomingsat the intersection ofmicroprudential
andmacroprudential regulationhavemotivatedavarietyof reforms, many
explicitlydirected at the problem of
too-big-to-failinstitutions.While some of thesereforms remain
unfinished, and some additionalmeasuresareneeded, therehasbeen
considerableprogress.Unfortunately, thesame cannot be saidwith
respect to shadowbankingand, more generally,
thevulnerabilitiesassociatedwithwholesaleshort-term
funding.Thesevulnerabilitiesinvolveboth large,
prudentiallyregulatedinstitutions,and thustoo-big-to-fail concerns,
and thebroader financialsystem.Basel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
67. P a g e | 67Except for the liquidityrequirementsagreedtoin
theBasel Committee,however, theliabilitysideof the balancesheetsof
financial firmshasbarelybeen addressedin the reform agenda.Yet here
is wherethesystemic problemsof interconnectednessandcontagion are
most apparent.And, asevidencedby the funding stressesexperiencedby
a number ofEuropean banksprior tothe stabilizingmeasurestaken by
the EuropeanCentral Bank, theseproblemsare still verymuch
withus.Within theUnited States, reform effortsare underwayin some
discrete,but important, areas.Theprovisionsof Dodd-Frank
requiringmore central clearingofderivativesand minimum marginsfor
thosethat remain uncleared aredesignedtoprovidemore systemic
stability.As to shadowbanking itself, theFSOC recentlyproposed
optionstoaddressthestructural vulnerabilitiesin moneymarket mutual
funds,withan eye towardrecommendingactionby the Securitiesand
ExchangeCommission.And the Federal Reserve hasbegun usingits
supervisoryauthoritytopressfor a reductionin intradaycredit risk in
thetripartyrepomarket.But thesemeasuresare incomplete, and donot
extend to all forms ofshort-term funding that can poserun risks, a
universe that is likely toexpand asprudential constraintsbegin
toapplytolargeexistingshadowbankingchannels.Monetary PolicyWhile
the first twopolicy challengesare shared among
regulatoryandfinancial agencies, the third liessolely withcentral
banks.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
68. P a g e | 68In the wakeof thecrisis,weneed to consider
carefullytheview thatcentral banksshould assessthe effect of
monetary policy on financialstability and, in someinstances, adjust
their policy decisionsto takeaccount of theseeffects.The dramatic
rise in housing prices, and the associated high amounts ofleverage
taken on by both households and investors, occurred during
anextendedperiod of lowinflation.Somehave suggested that, by not
raisingratesbecauseinflationremainedsubdued, monetary policy in
theUnitedStatesand elsewheremay have contributed to themagnitudeof
thehousing bubble.Whatever the meritsof that much-contestedpoint,
it seemswisetoaddressthisissueaswefacewhat could well be another
extended periodof low inflationand lowinterestrates.It is important
tonote that incorporatingfinancial
stabilityconsiderationsintomonetarypolicydecisionsneednot
implythecreation of an additionalmandate for monetary
policy.Thepotentiallyhugeeffect on price stability and employment
associatedwith boutsof seriousfinancial
instabilitygivesamplejustification.Here I want tomention some
commentsby my colleagueJeremy Stein acoupleof weeksago.After
reviewingthe traditional argumentsagainst usingmonetary policyin
responsetofinancial stabilityconcernsand relying instead
onsupervisorypolicies,Governor Stein offeredseveral reasonsfor
keepingamore open mind on thesubject.First, regulation hasitsown
limits,not theleast of which is theopportunityfor
arbitrageoutsidethe regulated sector.Second, whateveritsbluntness,
monetary policy hasthe advantageofbeingable to"get in all the
cracks" of thefinancial system, an attributeBasel iii
ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
69. P a g e | 69that is especiallyuseful if
imbalancesarebuildingacrossthefinancialsectorand not just in a
particular area.Finally, by alteringthe composition of
itsbalancesheet, central banksmayhaveasecond policyinstrument
inadditiontochangingthetargetedinterest rate.So, for example, it
ispossiblethat a central bank might under someconditionswant tousea
combination of thetwoinstrumentstorespondtoconcurrent concernsabout
macroeconomicsluggishnessandexcessivematuritytransformation by
loweringthe target (short-term) interest rateand
simultaneouslyflatteningthe yield curve through
swappingshorterduration assetsfor longer-term ones.Tobe clear, I
donot think that weareat present confronted with asituationthat
wouldwarrant thesekindsof monetarypolicy action.But for that very
reason, it seemsthat now is a good timetodiscusstheseissuesmore
actively, sothat if and whenwedo
facefinancialstabilityconcernsassociatedwith asset bubblesbackedby
excessiveleverage, wewill havea well-consideredview of
therolemonetarypolicymight playinmitigatingthoseconcerns.Advancing
the International Reform AgendaLet me turn nowtothewayin whichour
shiftsinpolicy approachshouldinform theagenda for international
cooperation in financial regulation.For
obviousreasons,themonetarypolicy issuesarenot
directlyrelatedtothisagenda, though our understandingof these
issuesmay profit fromdiscussionswithour central bank colleaguesfrom
around the world.It is equallyobviousthat the other twosetsof
policy changesare quitecloselyrelated to theinternational
agenda.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
70. P a g e | 70Morethan in most other areas,thefinancial
sphere suffers from a basiclack of congruencebetweenthe authorityto
regulateand theobject ofregulation.Thuswehave a
significantlyinternationalizedfinancial system, in whichshocksare
quickly transmittedacrossborders, but a nationally-basedstructure
of regulation.Withincountries, responsibilitiesmay be
dividedbetweenprudentialregulatorsand market regulators,among
regulatorswith similarmandates,or both.Central
banksmayhaveexclusiveprudential authority, shareit
withotheragencies,or have none at all.International
arrangementsboth reflect, and try tocompensatefor, thiswebof
divided and overlapping domesticauthority.Thusthere are sectoral
standardssetters like theBaselCommittee, theInternational
Organizationof SecuritiesCommissions(IOSCO), and
theInternationalAssociation of InsuranceSupervisors(IAIS) on
theonehand, but alsobroader groupingssuch asthe Group of Twenty,
theFinancial Stability Board (FSB), and theInternational
MonetaryFund ontheother.In addition, under theumbrella of the
international home of centralbankers,the Bank for International
Settlements,numerousothercommitteesworkacrossfieldsalsocoveredbyoneormoreofthegroupsIhavejustmentioned.There
are some obvious weaknesses with such an assortment ofinternational
arrangements, notably the difficulty of
coordinatinginitiativeswheremore than one group is workingon an
issue.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
71. P a g e | 71This kind of coordination challengecan be
further complicatedby theparticipationin international
discussionsof variousnational officialswithout domesticauthority in
a particular area.The sheer proliferation of international
arrangements, each with its ownstaff, has at times also led to a
proliferation of studies and initiatives thatbecome burdensome to
the national regulators and supervisors who havebeen overtaxed at
home since the onset of the crisisand ensuing domesticreform
efforts.Yet thereare alsosome strengthsderived from
thecrowdedinternationalfieldof organizationsand
committees.Onesuchvirtue is that issuesnot fallingsquarely within
theremit of aparticular kind of standardssetter can nonethelessbe
dealt withinternationally.This, in fact, hasbeen
theexperiencewiththe ongoing internationaleffort to agree on
minimum margin requirementsfor derivativesthat arenot
centrallycleared.Another is that different
perspectivesarefrequentlybrought tobear on asingleset of
problems.At some point, it likelywill be beneficial to rationalize
somewhat theoverlapping, sometimescompetingeffortsof
thesevariousinternationalarrangements.For thenear tomedium term,
though, it is important to havesomeprinciplesfor decidingupon the
international agenda that should governtheeffortsof these
arrangementsasa whole.First, initiativesshould be
prioritized.Onepoint of emphasisshould be completing, and
ensuringimplementationof, the internationallyagreed-upon framework
forBasel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
72. P a g e | 72containingthetoo-big-to-fail
risksassociatedwithsystemicallyimportantfirms.Another shouldbe
distillingthevariousideasrelatingtoshort-termfundingvulnerabilitiesintoa
few that have promiseasdiscrete, relativelynear-term initiatives,
whilecontinuingstudyof other, morecomprehensivemeasures.Asecond,
relatedprincipleis that initiativesshould be focused
andmanageable,reflectingnot onlythe limitedcapacityof
participatingnational authorities, but alsothe desirabilityof
reachingat least atemporaryequilibrium at whichfirms can get on
withthebusinessofplanningtheir strategiesin a clearerregulatory
environment, andregulatorscan begin to take stockof the
cumulativeeffectsandeffectivenessof thechangesthat have
takenplacein that environment.Athird
principleisthat,inmostinstancesat least,
internationaleffortstodevelop new regulatorymechanismsor
approachesshould build onexperiencederived from national practicein
one or more jurisdictions.Thechallengesencountered during the
initial effort to devise an LCR intheBasel Committee, withlittleor
noprecedent of national quantitativeliquidityrequirementsfrom
whichto learn, should counselcaution intryingtoconstruct new
regulatorymechanismsfrom scratchat theinternational level.There
will doubtlessbe exceptionstothisgeneral principle, such aswherethe
transnational arbitrageincentivesof a regulatory measure
aresostrong asto make national effortsdifficult toinitiateand
sustainwithout substantial lossof financial activitytoother
countries.And, in theimmediateaftermath of thecrisis, there
wasaneedtoharnessthebroad-based demandsfor reform and move
forwardon some priorityreforms without benefit of learningfrom
national initiatives.Basel iii ComplianceProfessionalsAssociation
(BiiiCPA)www.basel-iii-association.com
73. P a g e | 73On the other hand, there may alsobe areaswhere,
notwithstandingtheimportanceof a particularregulatoryobjectivefor
international financialstability, it may be preferable to maintain
a varietyof approachestoachievingthat objective.Bearing in mind
both these principles and the key areas for policychange at central
banks and other financial regulators, let me nowsuggest some
specific subjectsfor near-term emphasis.As to the frameworkfor
systemically important financial institutions(SIFIs), I wouldurge
that twoongoing initiativesbe completedover thenext year and
twoideasthat have been in the discussionstagebedeveloped
intoconcrete proposals.First, the proposal for a capital surcharge
for systemically importantbankingorganizationsis nearing
completion.TheBasel Committeecontinuestorefinethemethodology tobe
used inidentifying the firmsand
calibratingthesurchargeamount--perhapsabyproduct of the fact that
this methodology had tobe developedin theBasel Committeewithout
benefit of prior precedent.But I have confidencethat thisworkwill
be successfullycompleted.Thesecond ongoinginitiative--workon
designatingnon-bankSIFIs--hastodatebeen pursued mostlyin theIAIS
and thushasconcentrated on insurancecompanies.It is important to
take the time to evaluate carefully the actual systemicrisk
associ