28 March 2014

Bundesbank/Dombret: Regulatory reform - unresolved issues and the need for international cooperation

Regulatory reform has to continue, argued Andreas Dombret, highlighting outstanding issues such as "too-big-to-fail" banks, shadow banking, OTC derivatives and accounting standards. He stressed the need for international cooperation.

"Too-big-to-fail"

There is one thing we have to do to resolve the too-big-to-fail problem: we have to restore the fundamental principles of a market economy, most importantly the principle of liability. To restore it, banks must be able to fail without dragging the entire financial system down with them. What we need are effective resolution mechanisms for banks.

Putting practicable resolution procedures in place is a difficult endeavour, especially in the international context. A well-coordinated approach between authorities is needed. The purpose is to maintain systemically important activities while resolution procedures are applied. Coordination and advanced planning of resolution measures enable authorities to consider financial stability from an international point of view, not merely from a national perspective. To this end, a new international standard on the recovery and resolution of systemically important institutions has been developed by the Financial Stability Board.

At the European level, a central pillar of the envisaged banking union is the Single Resolution Mechanism. This instrument will allow authorities to restructure or resolve banks without putting taxpayers' money at stake.

Shadow banking

Shadow banks create bank-like risk without being subject to bank regulation. Their activities are not evil per se, but the ensuing systemic risk needs to be contained. All activities must be made transparent, in particular vis-à-vis supervisory authorities, and they need to be adequately regulated. In that regard, I welcome the global regulatory initiative on shadow banking - again under the leadership of the Financial Stability Board. Here too, international cooperation is essential for establishing effective regulation. It is to be welcomed that the G20 have placed the shadow banking system high up on their agenda.

OTC derivatives and CCPs

Trading in derivatives certainly has the potential to cause massive losses, to disrupt markets and to threaten financial stability. But it is not just during trading that financial stability can be put at risk; it can also be jeopardised at the back office level when transactions are cleared and settled.  The G20's decision to require OTC derivatives to be cleared centrally was an important cornerstone in regulating OTC derivatives markets.

However, CCPs themselves are becoming more systemically important. This harbours potential side effects which need to be monitored. Furthermore, effective recovery and resolution regimes need to be in place for CCPs. The regulation of OTC derivatives markets should be the same across all jurisdictions - in spirit, in wording, and in terms of its outcome.

Some progress has been made over the past year towards resolving these cross-border issues but some are yet unresolved and urgently need to be addressed. Recent regulatory initiatives in the US worry me. They seem to contradict the need for international cooperation. A "Balkanisation" of the regulatory space represents a genuine risk, and any regulatory decision should be taken with that consideration in mind - in Europe as well as in the United States. And this not only applies to regulation itself but also to the foundation on which it rests. Regulating and supervising financial institutions requires information. And to satisfy the need for international cooperation, this information has to be internationally comparable. Unfortunately, this is not always the case.

Full speech

© Deutsche Bundesbank