28 January 2013

Bundesbank/Dombret: Credible threat

In an interview, Dombret said that policy-makers needed to issue a 'credible threat' to banks, to the effect that they would be restructured or resolved in the event of insolvency. "It must also be possible for systemically important banks to exit the market", he said.

What reform steps are still needed?

Many! The shadow banking system needs to be better monitored and regulated. A package of measures on this topic is to be presented in September. And the regulation of cross-border trading in over-the-counter derivatives needs to be vigorously pursued. The original timetable for this was postponed at the end of 2012. And a compelling solution finally needs to be found for the “too big to fail” issue with regard to large systemically important banks. At the moment, it is the state – and ultimately the taxpayer – that has to bail out banks that get into financial difficulties, and that is not acceptable.

In Europe there is now a draft of a Recovery and Resolution Directive. Do you consider that practicable, or will governments always be susceptible to blackmail?

Policy-makers need to issue a credible threat to banks to the effect that they will be restructured or resolved in the event of insolvency. It must also be possible for systemically important banks to exit the market. The current debate on this topic is heading in the right direction. Banks must draw up recovery plans, and supervisors must be endowed with extensive powers of intervention. Then, if push comes to shove, we would be able to force banks to offload individual business fields. In this way it would be possible to contain an emerging crisis and prevent a spill-over into the entire financial system.

In order to ringfence particularly risky operations, one could introduce the segregation of banking functions, as the Liikanen Commission recommended. Would that be a good idea?

In general, I am convinced that the stability of the financial system is not jeopardised by the fact that an institution conducts both traditional banking business and investment banking. We have seen from the financial crisis that the banks that got into difficulty were not traditional universal banks, but specialised institutions. The stability of the banking system was put at risk because the banks were extremely closely interlinked through the money and derivatives markets.

Nevertheless, I would not rule out a segregation of functions – as recommended in the Liikanen Report – in future, not least because ringfencing would not mean abandoning our tried and tested universal banking model altogether. But a convincing regulatory justification would then have to be given for the intervention in the structure of our financial system that this would entail. Besides, I consider it more important to establish a credible resolution mechanism for insolvent financial institutions in order to solve the “too big to fail” problem.

But the banks themselves are supplying the arguments for stricter segregation, as the manipulation of the Libor reference rate has demonstrated. Do supervisory authorities intend to at least get tough here?

The central banks want to draw up proposals for reforms by March of this year. But it is and always will be primarily the duty of the private sector to design reference rates in such a way that they are meaningful and not susceptible to manipulation.

Libor is growing less meaningful in any case because fewer and fewer banks want to participate in the survey.

I am indeed concerned about the banks’ withdrawal, as the meaningfulness of the benchmark will suffer as a result. Yet I would not like to see enforced participation – the main priority must be for banks in the private sector to be responsible for themselves.

Wouldn’t it be better to choose a reference rate that is based on transactions that have actually been concluded – as is the case with the swap or repo rate, say – instead of on a survey?

As a matter of fact, discussions are already underway regarding alternative reference rates – based, for instance, on transactions or collateralised operations. It won’t be possible to find a replacement for Libor or Euribor overnight, however, although there could be other points of reference in future. I would welcome that.

Full interview

© Deutsche Bundesbank