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I would like to applaud the scientific committee, as the agenda for the next two days covers a range of very interesting and highly topical financial stability issues. These include the macroeconomic impact of post-crisis reforms, the use and governance of macroprudential policy, the interactions between monetary policy and financial stability, and the implications of climate-related risks.
Many of these topics relate to the so-called "regulatory cycle". In my remarks today, I will refer repeatedly to this cycle. What is it? The regulatory cycle is somewhat akin to, but distinct from, the better known business and financial cycles. It operates as follows:
The first phase is about regulatory design. It is typically set in motion by a financial crisis, when there is a strong impetus, both domestically and globally, to address areas of regulatory and supervisory deficiency. This impetus helps authorities to develop and agree reforms that strengthen the resilience of financial markets and institutions. As the scars and costs of the crisis are clearly evident, vested interests are weak.
The second phase is about implementation. Full, timely and consistent implementation of the reforms is necessary to ensure that societies can reap the financial stability benefits. But implementation may be put on hold while international standards are being adapted to national realities. The longer the delays, the more time vested interests have to recover.
The third phase is about assessment. Once the reforms are finalised and start to be implemented, accountability calls for a thorough evaluation of their impact. It is crucial to review how far the reforms have achieved their objectives and mitigated the risks in question. These evaluations also allow policymakers to assess the broader impact of reforms and the extent to which there may be unintended consequences.
We are currently in this third phase, in which memories of the crisis gradually fade. It is characterised by a weakening in the will to persevere with the ambition and implementation of the reforms. Vested interests gain momentum, promoting the fallacy that "this time is different", and that delaying, diluting or rolling back post-crisis reforms is the convenient path to promote jobs and growth.
The third phase is key, as it will shape the financial regulatory framework and its effectiveness in mitigating the impact of future crises. How the post-crisis reforms are assessed will determine whether any potential adjustments are likely to accommodate private vested interests - thereby undermining financial stability - or whether any adjustments are truly evidence-based and thus serve the public good.
In my remarks today I will focus on the link between research and the various phases of the regulatory cycle.
First, I will discuss the post-crisis reforms and how academic research helped to shape them. In this part, I will start by reviewing the post-crisis regulatory framework, essentially reviewing the design phase of the regulatory cycle. I will then turn to the ongoing second phase of implementing the reforms. And since we are in Europe, I will zoom in on challenges that the region faces in agreeing and implementing a common set of prudential policies.
Second, I will ask how academic research can contribute to our understanding of financial stability. With many of the key regulatory reforms already implemented, research can provide an objective view of their effects, thus contributing to the evaluation phase of the regulatory cycle. Furthermore, academic analysis can identify and assess financial vulnerabilities of both a structural and cyclical nature. Such work will help policymakers in their efforts to build a more robust financial system.
The regulatory framework that has emerged following the crisis is one with multiple metrics. Compared with the pre-crisis framework, which relied only on the risk-weighted capital ratio, the revised international regulatory framework now features a leverage ratio, large exposure limits, liquidity standards, macroprudential instruments, such as the countercyclical capital buffer, and higher loss-absorbing requirements for systemically important banks.
The shift to multiple metrics in Basel III, and greater reliance on stress testing on the part of national authorities, reflect the importance of using a range of complementary and mutually reinforcing regulatory standards together with supervisory judgment. By definition, tail risks are hard to measure. Relying on a single regulatory standard to maintain financial stability is therefore likely to be insufficient. An approach based on multiple metrics is more resistant to arbitrage and erosion over time, as each metric offsets the shortcomings and adverse incentives of the others. And their disclosure enhances market discipline by providing market participants with more information about a bank's risk profile.
As we approach the peak of the implementation phase and move to the evaluation phase, there is an increased risk of complacency and backsliding on enacting the globally agreed standards. For example, the Basel Committee's periodic assessments of the adoption of the Basel III reforms show growing evidence of delayed or inconsistent implementation. There is always merit in undertaking detailed evaluations and considering whether changes are warranted based upon strong empirical evidence. However, changes based solely on the lobbying of vested interests will weaken financial stability. While the process of reaching international agreement was critical, putting the rules in place is now the crucial next step. Failure will undermine the progress made so far to enhance global financial stability.
Research that serves policy well is challenging to design and execute. So, while applauding your efforts, I also want to stress that financial stability-related research follows a cycle of its own. Economic crises foster new efforts. Then the "good times" blunt the edge of academic and policy interest, opening the door to the build-up of imbalances, sowing the seeds for the next crisis. But, this time, I hope that it will indeed be different!