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Over the next few years the international regulatory authorities will move towards completing the programme of reforming the global financial system. Domestically, that will mean implementing those reforms, as discussed in the Record of the Financial Policy Committee’s latest meeting published this morning.
To make banks more resilient to stress – the essential steps are, of course, new regulatory requirements for capital and liquidity. Second, to ensure that banks and other financial firms can fail in an orderly way without taxpayer solvency support – that’s the resolution agenda. Third, to simplify the network of counterparty-credit exposures amongst banks and others that arises from derivatives transactions – central counterparties (CCPs). Fourth, to ensure that those CCPs are not themselves Too Important To Fail – resolution again, plus rules to allocate losses amongst bank clearing members and others so that a distressed CCP can recover without going into resolution. Fifth, to ensure that the reregulation of banks does not simply cause the systemic risks associated with excess leverage and liquidity mismatches to be reinvented outside banks – the shadow banking reforms. And sixth, to make securitisation safer and more efficient – a complicated raft of reforms, including overdue steps to remove mechanistic reliance on Credit Rating Agency ratings.
Cumulatively, those reforms will change the face of global finance – for the better. But no doubt there will also be effects that have not been anticipated, resulting in a need for running repairs. The work to produce the reforms has also revealed conceptual gaps and flaws in the inherited regulatory framework that will, sooner or later, need to be addressed.
Mr Tucker said: “Over past decades, banking, and banking supervision, somehow got detached from the most essential truth: that banks can fail. Thus, we have banks using brands that do not represent any legal entity, as if banks were simply trying to sell something, not running a business in borrowing and lending. We have an international regime that encourages but does not require adequate loss-absorbency in each and every entity within a banking group. We have had a regime that is focused on the capital needed in a going concern, but not on the organisational and capital structures that would help the authorities to contain disorder in the face of chronic distress. All those issues are now, I believe, in the open. There is a clear way forward on resolution. But there will have to be some consequential recasting of the international regulatory regime.”
Of course, none of the reforms will be foolproof. Mistakes will be made; mistakes there cannot be seen. In future, it has to be possible to make running repairs to the regime where faultlines are exposed.
Stress-testing – not only of banks but of CCPs and, in time, of other intermediaries – can help to expose those faultlines. It can help to calibrate macro- and micro-prudential policy. And a good stress-testing regime will make it easier to explain and defend the standard of resilience that the Bank requires. And for that, the Bank can be held to account.