03 October 2014

Bank for International Settlements - Andreas Dombret: The quest for stability - regulating and supervising banks

Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, at the Handelshochschule Leipzig, Leipzig, 2 October 2014.'It isn't a question of whether but of how to regulate.'

First of all, let me tell you a short story I heard the other day. A young banker decided to get his first tailor-made suit. As he tried it on, he reached down to put his hands in the pockets but, to his surprise, found none. He mentioned this to the tailor, who asked him, "You're a banker, right?". The young man answered, "Yes, I am.", to which the tailor replied, "Well, whoever heard of a banker putting his hand in his own pocket?".

It is certainly true that the reputation of bankers has suffered during the crisis. But still, banks and savings institutions play a vital role in any modern economy and, indeed, in our everyday lives. We simply could not manage without them. Entrepreneurs, bankers and individuals alike: we all benefit from a stable banking and financial system. Financial stability is therefore a public good, not just nationally but on a global scale, too. At the same time, banking can sometimes be associated with external effects. It doesn't just affect banks and their business associates; it also has an impact on third parties with no stake in the game. And during the financial crisis, those third parties were the taxpayers.

Regulators and supervisors can rectify a market failure of this kind, and it is in the public interest for them to do just that. It isn't a question of whether but of how to regulate.

I believe that regulation must be coherent on at least three levels.

First, regulation has to be coherent across borders and regions. We have a global financial system, and it therefore requires global regulation. Where regulation varies from country to country, there is a danger of regulatory arbitrage - of banks moving their business to countries with the lightest-touch regulation. The problem with this behaviour is that the risks stemming from these transactions could potentially affect the entire financial system. This is why the G20 have made the issue of financial market regulation a priority. In cooperation with the Financial Stability Board and the Basel Committee on Banking Supervision, they are working to develop a coherent regulatory framework at the global level. Even so, I'm concerned to see that some countries outside Europe are adopting their own regulatory initiatives which breach the principle of cross-border coherence. I believe that the danger of banking regulation one day returning to the principle of "every man for himself" needs to be taken seriously.

Yet regulation not only needs to be coherent across borders and regions but also across different sectors. Here, too, the central issue is the danger of regulatory arbitrage. One current example is the growth of the shadow banking industry, where financial enterprises conduct business which creates bank-like risks but is either regulated insufficiently or not at all. In many cases, these risks are not even recorded. Yet the shadow banking industry may become a source of systemic risk. We therefore need to expand the regulatory framework in this area to ensure that it is coherent.

Third, it goes without saying that the content of regulation also needs to be coherent. The capital rules are a case in point. Unlike for all other forms of credit, banks do not have to hold capital against government bonds in line with the risks that they carry, and this inconsistency has dangerous side-effects. Since the euro-area sovereign debt crisis - if not before - it has become clear that government bonds are anything but risk-free. In this area too, we should work to restore the coherence of regulation in the medium term.

More in full article on Bank for International Settlements's website

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