11 February 2013

Bundesbank/Dombret: Regulatory agenda of the international financial system - A coherent strategy

Dombret said that the close linkages in the financial system made it necessary to take account of existing connections and cross-linkages in regulation too. Otherwise, there is a risk of individual regulatory measures working in opposite directions or even cancelling each other out.

Consistent implementation taking centre stage

Although we still have a fair stretch of road ahead of us, the focus is rapidly moving away from the development of regulatory measures towards implementing them. In the future, monitoring their implementation will undoubtedly be shifting more and more to centre stage.

The reason for this is that, if the regulatory measures agreed at international level are to have their intended effect, it will be absolutely crucial for them to be implemented consistently in the individual countries as well. That also includes adhering, as far as possible, to the timelines agreed for their implementation so that competitive distortions are avoided as far as possible. To prevent the emergence of a regulatory gap, the regulations should be applied not only in the G20 countries but also, preferably, in all countries with developed financial systems.

Regulators and supervisors are aware of the importance of consistent national implementation. For that reason, we have significantly expanded our work in monitoring national implementation over the past few years. Thus, the self-commitment of the FSB members to lead by example in the implementation of international standards is subject to a regular review with publication of the results. In addition, for three years now, a system of peer reviews has been in place among FSB members to investigate the relationship between promise and performance or, in other words, how far the internationally agreed standards and principles have been implemented nationally. In cooperation with international standard-setting bodies, in October 2011 the FSB presented a coordinated framework for monitoring and reporting on the implementation of the agreed reforms. In this connection, greater attention is being paid to areas such as the Basel framework and measures relating to SIFIs, but also including the shadow banking system. In-depth monitoring and regular publication in the form of progress reports to the G20 are also helping to keep up the pressure for implementation.

In order to prevent regulatory arbitrage between sectors and countries, we have to fix our sights even more firmly on the systemic aspects of regulation. The key requirement for doing this is to assess the overall effects of the regulatory measures and to analyse any potential interactions between them.

Impact studies play a major part in gauging the macro-economic effects of new proposed regulation. I therefore expressly welcome the fact that all the Basel reforms – including the new Basel III liquidity standards – are being accompanied by studies that assess both their short and long-term effects on banks and the real economy.

Repeated fears have been voiced from within the financial industry that the stricter Basel III regulations combined with the more far-reaching requirements for SIFIs will have the effect of restricting the credit supply. The Basel Committee has looked into this question and come to the conclusion that the drawbacks are outweighed by the advantages, namely the gain in stability and the reduced likelihood of future crises. A moderate increase in the cost of lending and minor losses in growth will thus not put at risk the supply of credit to the economy.

Pressing ahead with work on the various elements of the reform agenda in parallel harbours the risk that individual measures might conflict with each other. In our closely interlinked financial system, focusing on sector-specific measures can easily lead to unintended interactions occurring or even conflicting incentives being set. Such a lack of consistency might lessen the desired effects of the new regulations or even negate them entirely.

One possible instance of unwanted interactions is the combined effect of European banking regulation and the EU solvency regime for insurers. This is because banking regulation aims to place bank funding on a stable, that is a long-term basis, while, under certain conditions, the solvency regime gives preference to bank bonds with short maturities. Capital requirements increase relatively sharply given longer duration of the bank debt securities held by insurance companies – at least when the standard formula is used. The outcome might be that insurers change their asset allocation to the detriment of bank debt securities. As insurers are among the most important investors in bank bonds, this could ultimately lead to an increase in banks’ funding costs.

Within a single sector, too, different regulations can set conflicting incentives. One example of this might be the interplay between the EU crisis management directive and the scheduled liquidity ratio requirements. This is because the draft proposals of the directive provide for short-term liabilities being excluded from bail-in, thus setting incentive for short-term funding. This is diametrically opposed to the aim of regulating liquidity, which is to safeguard the maintenance of liquid funds even under unfavourable circumstances and for longer periods of time.

Of course, a final judgement on the effects of each of the regulatory initiatives can only be made when their precise details are known and as soon as robust empirical evidence is available.

In the end, for the regulatory reforms to have their desired effect, it will be absolutely crucial that we identify any potential interactions of this kind and, as far as possible, avoid them. This is quite clearly anything but an easy task. It means weighing up the aims and effects of various measures. It could also mean that measures which have already been adopted have to be amended or revised while they are in the process of being implemented or soon after. The latest example of this is the revision of the liquidity standard by the Basel Committee. Having said that, however, it should be clear to both the general public and those affected by regulation that this is not a case of watering down measures once they have been adopted. Rather, it is matter of taking due account of systemic aspects of regulation so as to avoid possible unwanted consequences.

Full speech

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