Financial stability is a global public good. The cross-border spillovers of financial distress can result in under-investment in financial stability by individual jurisdictions and regions... distress in one jurisdiction or region can easily spill over to other parts of the globe.
Good afternoon and thank you for inviting me to take part in this public hearing on the EU banking reform package.
I will be focusing my remarks today on the implementation of the
outstanding Basel III reforms. I will first offer some reflections in my
capacity as Chair of the Basel Committee and then offer some specific
comments on the state-of-play in Europe in my capacity as Governor of
the Bank of Spain.
By way of a brief overview, the Basel Committee is the primary global
standard setter for the prudential regulation of banks and provides a
forum for cooperation on banking supervisory matters. Its mandate is to
strengthen the regulation, supervision and practices of banks worldwide
with the purpose of enhancing global financial stability. In pursuing
its work, the Committee is anchored by rigorous empirical analysis,
including a comprehensive evaluation work programme. Such an approach
helps ensure that the Committee's approach is grounded as far as
possible by impartial evidence.
Financial stability is a global public good. The cross-border
spillovers of financial distress can result in under-investment in
financial stability by individual jurisdictions and regions.
Given the global nature of the financial system, distress in one
jurisdiction or region can easily spill over to other parts of the
globe. We have seen numerous examples of such cross-border spillovers in
previous financial crises. An open global financial system therefore
requires a set of global minimum and consistent prudential standards. In
our interconnected world, a failure to achieve this could result in
regulatory fragmentation, regulatory arbitrage, an uneven playing field
for internationally active banks, and increased risks to global
Since its inception in 1974, Basel Committee members have
demonstrated their strong commitment to cooperating on global financial
stability issues, including by means of developing a global regulatory
framework for internationally active banks. The latest version of this
framework, known as Basel III, seeks to address the shortcomings in the
banking system that were exposed by the Great Financial Crisis (GFC).
The Basel III framework was finalised in 2017 and was endorsed by the
Starting with my perspective as Chair of the Committee, I would like to make three broad points.
First, I think it is helpful to recall the rationale of these reforms
and why they remain as important today as they were when they were
finalised in 2017.
While much has changed since 2017, the Covid-19 pandemic and other
structural trends have only further underlined the importance of a
resilient banking system. The Basel III reforms have played a central
role in ensuring the banking system has remained operationally and
financially resilient during the pandemic.
Unlike the experience of the GFC, banks have been able to continue
supporting the real economy. Bank customers, whether they be depositors,
borrowers or users of other banking services, have benefitted greatly
from the resilience of the banking system and will continue to do so. We
should also recognise that public support measures have largely
buttressed banks from losses to date. We should therefore not become
complacent about the need to implement the outstanding Basel III
While the initial set of Basel III reforms fixed a number of fault
lines in the pre-GFC regulatory framework, the way in which banks
calculated risk-weighted assets (RWA) – the denominator of banks'
risk-weighted capital ratios – remained largely unchanged. Yet the GFC
painfully demonstrated the excessive degree of variability in banks'
modelled capital requirement. For example, when banks were asked to
model their credit risk capital requirements for the same hypothetical
portfolio, the reported capital ratios varied by as much as 400 basis
Similarly worrying levels of variability could also be seen in other
modelled risk categories, including market and counterparty credit risk.
And the GFC highlighted shortcomings with the operational risk
framework, where banks' modelled capital requirements were
insufficiently robust to cover losses stemming from misconduct and
inadequate systems and controls.
This excessive degree of RWA variability threatened the credibility
of banks' reported capital ratios. At the peak of the GFC, investors
lost faith in banks' published ratios and placed more weight on other
indicators of bank solvency.
The outstanding Basel III reforms seek to help restore credibility in the calculation of banks' RWA in four ways:
- First, they will enhance the robustness and risk sensitivity of the
standardised approaches for credit risk, market risk and operational
risk, which will facilitate the comparability of banks' capital ratios.
- Second, they will constrain the use of internally modelled
approaches by ensuring that modelled parameters are subject to greater
safeguards and that advanced modelling approaches are not used for
portfolios with limited historical data.
- Third, the Basel III reforms will introduce a robust risk-sensitive
output floor. The output floor provides a risk-based backstop that
limits the extent to which banks can lower their capital requirements
relative to the standardised approaches. This helps to maintain a level
playing field between banks using internal models and those on the
standardised approaches. It also supports the credibility and
comparability of banks' risk-weighted calculations thanks to the
accompanying public disclosure requirements, as banks will be required
to publish their total RWA that constitute the denominator of their
risk-weighted capital requirements, including with the output floor
- And fourth, the reforms will complement the risk-weighted framework
with a finalised leverage ratio. The leverage ratio provides a
safeguard against unsustainable levels of leverage and mitigates gaming
and model risk across both internal models and standardised risk
The gravity of the regulatory fault lines that Basel III seeks to
address remains as important today as it was pre-pandemic. For example, a
recent report by the European Banking Authority on banks' modelled
capital requirements points to a "significant" level of capital
dispersion "that needs to be monitored". So it is critical that all Basel Committee jurisdictions implement the Basel III reforms in a full and consistent manner.
The second point I would like to address is the assertion that the
Basel III reforms have not been adequately designed to reflect
jurisdiction- or region-specific characteristics, and that their
implementation will impede economic growth and banks' ability to tackle
structural trends and challenges, such as the digitalisation of finance
or climate-related financial risks. Such statements do not accurately
reflect the rigorous process that the Committee followed, and do not
serve the interests of a sustainable and inclusive economic recovery....
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