28 May 2013

Bundesbank/Dombret: Boring banking?

Dombret said that in his view banking had become more challenging since the outbreak of the crisis. "Making banking boring does not necessarily mean making finance boring. Only think of the shadow banking issue…"

I was asked to speak about simplicity and complexity. I want to start with the latter. I am deeply concerned about complexity. Where does the real risk of complexity lie? With respect to regulation and the change of the landscape it is not so much a single measure or a single initiative that creates complexity. It is more the interplay of different approaches.

One important strand of regulation is concerned with liquidity. Regulation sets new requirement in order to protect the banking system against a shortage of liquid assets. At the same time, a financial transaction tax is envisaged that might have drastic effects on the liquidity on some important markets. How do these measures interplay? What will the outcome be? To my mind, this is a truly complex question.

Now let me turn to simplicity. I very much like simplicity. But it is important to remember another basic principle: It is unfair to treat different things equally.

So, there is always a trade-off between appropriateness and simplicity. And now, taking a very bold leap from football back to banking regulation: It is appropriate to demand more capital for holding high-risk assets than for holding nearly risk-free assets. In addition, an apparently simple leverage ratio could serve as a valuable backstop and act as a safeguard, in particular, against model errors and miscalibration of risk weights. I fully agree with the leverage ratio’s overall intention to deliver transparent and credible ratio, complementing the risk-based capital requirements – how simple it really is still has to be seen, especially in the light of different national accounting standards.

Nevertheless, the core message of Basel III itself is quite simple. It is all about:

•    more capital,
•    better-quality capital,
•    and introducing a global liquidity standard.

All in all, it is about tightening the micro-prudential dimension of regulation, which forms a first line of defence against systemic risk.

The new macro-prudential dimension of regulation serves as the second line of defence. There are three pressing issues on the reform agenda:

The first problem concerns systemically important financial institutions, SIFIs for short. To realign risks and return, the reform agenda is putting much effort in resolving the “too-big-to-fail” problem. Capital surcharges for SIFIs will be applied to help achieve this goal.

In addition, a proposal for a framework for the recovery and resolution of credit institutions and investment firms has been adopted; this is even more essential, as only a system that allows an orderly restructuring of SIFIs will impose the necessary market discipline on them. Thus, the second pressing issue which needs to be solved is the concern with shadow banking and its lack of transparency. Here, the adoption of the EU regulation on the OTC derivatives market represents a significant step towards greater stability and transparency in an important segment of shadow banking.

Obviously, there is a risk that stricter banking regulation will set incentives to move business to less regulated parts of the financial system, thus causing regulatory arbitrage.

The third pressing issue is the inherent bias of the financial system towards pro-cyclicality. In the next stage, macro-prudential policymakers will have to learn how to handle the new instruments and will need to define strategies which include intermediate objectives.

Full speech

© Deutsche Bundesbank