We find ourselves in post-crisis is one where there are multiple reform proposals on the table: Basel III, CRD, MiFID, etc. 

In AFME report, we identify capital requirements; corporate governance; supervision; and dealing with failure as the key elements of mitigating systemic risk, which is essential for the protection and recovery of the wider economies that the financial system supports. Banks have a vital role to play in restoring economic growth and they must be able to provide the essential services that their customers require. The challenge is to provide them in a way that does not introduce excessive risk.

While AFME members support the regulators’ aim of building a more robust financial system, the degree to which some of the specific measures proposed in the wake of the crisis will affect banks’ ability to deploy their capital effectively is still to be established, as indeed is their precise impact on the reduction of risk. The industry supports the introduction of proportionate capital reforms, and welcomes the authorities’ recognition that banks’ ability to finance their customers must not be constrained, so the announcement of implementation phases for Basel 3 is welcome.

It is important that policymakers and regulators acknowledge that large parts of the financial system, including many large, complex, well-run multinational institutions, functioned well during the crisis while some smaller, less complex institutions failed. Proposed reforms that would limit banks by size, scale or function would do nothing to reduce systemic risk. At a practical level, it is also hard to envisage how the latter idea could be implemented on anything other than a global basis without creating competitive distortions between countries and unworkable structures within international firms.

AFME believes that, with a proportionate capital framework in place, financial stability can best be secured through a combination of a change in the regulatory approach, improvements in the way firms operate and the establishment of a pre-agreed process for dealing with failing banks. At the heart of the regulatory approach is what we refer to as “enhanced supervision”. This is a combination of macro- and micro-prudential regulation, built on regulators’ understanding and assessment of each individual firm, rather than a “one size fits all” approach, but taking into account also the analysis of factors influencing the wider economy. To some extent this would represent the formalisation of good supervisory practices that have evolved over time and it reflects what is known as Pillar 2 – in its broadest sense – under the Basel 2 framework. 

In the past, the Boards of some banks showed a lack of commitment to the important responsibility of setting risk tolerance or appetites and establishing that their institutions were performing to those requirements satisfactorily. Our view is that the responsibility for managing risk within financial institutions must rest unequivocally on the institutions’ own Boards. We do not propose a single governance model that would be appropriate for all firms. As with supervision, there is no “one size fits all” approach, and each Board must determine the appropriate governance measures for a firm after considering its business model and legal and geographical structure.

Even with enhanced supervision and new corporate governance practices in place, firms will fail and they must be allowed to do so. What must not happen again is the requirement for taxpayers to support the system when they do. To manage failing firms in a way that doesn’t impact on the wider financial system, two concepts worth considering are bail-in and contingent capital as part of resolution mechanisms.

What we can take from all of these points is that if systemic risk is addressed through enhanced supervision and better corporate governance, and with an effective resolution regime in place, it should be possible to have proportionate capital requirements with no need for any firm to be subjected to capital surcharges – which could well run the risk of providing, as Shakespeare wrote, “smooth comforts false”. The three-pronged approach I have outlined here, – sitting alongside the measures already under way in prudential regulation – to create a robust framework overall, will help to ensure a more sustainable and flexible financial system for the future. One that will never again need to be rescued by taxpayers. I think that that is a goal that all of us involved in these challenging issues would support.

As an organisation that brings together all the major pan-European banks, AFME focuses on a wide range of wholesale markets, business and prudential issues and – on behalf of our members – we are committed to making constructive contributions to policy development and providing thought leadership.

Full speech