24 February 2015

BIS: Financial reform and the role of regulators

Speech by Jaime Caruana, General Manager of the BIS, at the Global Association of Risk Professionals' (GARP) 16th Annual Risk Management Convention. He focuses on the question: What is the role of regulators? 

Before trying to answer question: “What is the role of regulators?”, Mr. Caruana makes two preliminary points:

• “We need to recognise increasing complexity and to adopt a wide perspective in managing risks. We have learned that the economy is growing more complex, more global, and that the interconnections within the financial sector and with the real economy are increasing in ways that are difficult to fully appreciate. We have also learned that risk management itself has a tendency to encourage procyclicality, especially by assessing risks as minimal precisely when they were at their greatest. Moreover, each institution has tended to assess risks without taking into account its own contribution to systemic risks. This narrow view needs to be widened."


• “We need to take on board the evolving nature of markets and risks. Financial intermediation and markets evolve, risks evolve and regulators must adapt as well. The need to adopt a wider perspective, a systemic perspective, and to understand this evolving nature of risk are among the major challenges for regulators and financial institutions alike."

"The financial system has become more complex, more globalised and more intertwined with the real economy, and risks and leverage continue to mutate. To try to capture this complexity and the evolving and elusive nature of risks, we - both officials and private risk managers - need to be humble and recognise that there are limitations to our knowledge and models, no matter how sophisticated they are.

As in any complex system, the behaviour of the whole financial system is dependent not only on the parts but also on the linkages. Dynamics can easily become non-linear - small causes can produce large effects. Of course, it is still very important to improve risk management systems, but even with state-of-the-art systems, some risks cannot be fully captured and internalised. Setting initial conditions right, being prepared ex ante - meaning robust buffers in terms of capital, liquidity and risk assessment - is more important than trying to manage stress dynamics.

Creating the right risk culture, appropriate governance and risk management systems requires a wide perspective, understanding our limitations and the need to operate with sufficient room for manoeuvre to be able to tackle a broad range of scenarios.

From the regulatory perspective: more than designing new rules, completing the agenda, ensuring consistent implementation and monitoring results will take up most of the resources. Hopefully, changing times can be adapted to - at least for a while - through a more proactive supervision, leaving space for the industry to incorporate not only the rules but also the spirit of the reforms."

Full speech

© BIS - Bank for International Settlements