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right ready I'm your Kevin this evening my name is childhood have all the matters is that our speaker this evening is stephanie tanner's governor of the swedish central bank the Riggs Bank and also the chairman of the Basel Committee and he is going to be talking it on Banking Supervision and he's going to be talking about making the financial system safer and more stable and nobody did in this whole world is more qualified to speak to this subject understand he first came to a real prominence or this I came to Maryland when he handled and resolved the Scandinavian banking crisis particularly in Sweden in 91 92 look that lady moaned the IMF where he was involved in dealing with financial crises in 97 98 following which he then came back with a governor of the Swedish Riksbank where he is just started was reappointed for a second term I calculate years ago and he is now a chairman at the Basel Committee on Banking Supervision being that for several years which is in charge of trying to set up the international regulatory system so that we don't have as many crises we've had in the last few years so we're very privileged to have someone as extraordinarily well qualified to talk on this subject is Stefan so there with you thank you thank you for that can someone help I'm sorry I forgot sorry machine maybe no I'm increasingly forgetful after Stefan is fatally there will be a brief response by John Daniel Senta and the systemic percenter has been organizing here this evening and so we have to thank them and the British taxpayer for doing this exercise and an excellent use of tax monies on Tuesday so sniffing sorry to lose taken towards come on a little bit longer no problem no problem and thank you so much for giving me the opportunity to to be here and I have dealt with systemic risk for many years in many parts and corners of the world so it's it's an honor to be talking about these things in a place which actually is called a systemic risk center hopefully though that you never have to do I hope that you never have to deal with the stuff that I've had to deal with over the years but and I'm gonna talk about why hopefully we can we can come up with a more stable financial system going going forward and I'm doing that from a Basel Committee perspective and the Basel Committee is doing an awful lot of technical work within the within the field of bank supervision rules and regulations a lot of it is actually quite quite technical I don't have enough time tonight to go through all the technical details so I'm not going to deal with the plumbing but you can ask me questions when I'm through with this on whatever you you're like also outside what what I happen to talk to you about here and I'll do my best despite the multitude of plumbing aspects that go with all of this that I can show you a kind of broad pictures I'm gonna paint with a very broad brush and I hope that I can convey to you the key bits and pieces of all of this stuff that the Basel Committee is working on presently and stuff that the Basel Committee hasn't been working on on in the in the in in the in the past so what I'm going to talk about is why Basel three why is it that we have made it to Roman Roman three and what's the content of this thing that we call Basel three in terms of putting rules and regulations in place determining what banks are allowed or not allowed to do I'm going to go through some of the key accomplishments some of the things that we have done so far and I'm also going to comment on the remaining remaining work and when it comes to remaining work I do think that this is a type of work that basically never never ends this is like a muddy river that flows and flows and it's winding any changes over time and that's also because banks and Bank banking sectors change over time and our understanding of what's a good way of regulating banks and what what is not such a good way of regulating banks also changes changes over there over over time now this time around the starting point is the financial crisis the one that that we ended up with after there what nowadays what we call the Great Moderation and this is just one way of describing this here in the terms of c.d.s premier for a five-year u.s. senior unsecured debt for a number of very large and internationally active active banks you can show this in many different shapes and format at the national level you can you can come up with stories that are not that they similar in many different different ways from many different parts parts of the world but basically the only thing I want to show her is that the whole thing ended up in a huge mess back in 2008 2009 10 and a little bit less than that a few years a few years later and I think that it's important here that we remind ourselves of the background what you see up in the in the left hand left hand corner and in the beginning of 2007 because then cdspring a very very close to zero so if you take that as a signal almost no one expected actually these things to go wrong the way they are the way they went wrong now given that this happened a lot of things went wrong and then of course when that happens to people sort of feel that wow this was bad now what do we do so that it doesn't happen and doesn't happen again and that's the perspective I'm using what I'm talking to you tonight going through some of the things that the Basel Committee has been doing or or is doing presently now a financial crisis they are costly you can describe this in many many different different ways you can you can measure the cost of a financial crisis as well in many different ways and we can argue about how to how to measure this so this is just only illustrative but one way of looking at this is to say that if you end up with a serious financial crisis in one form or the other it tends to show up in the form of a permanent loss to the GDP and it seems to be very hard to to sort of claw that back in in the form of higher growth in the in the future you can get back to the old growth rate but but as you can see here if you look at the difference between the yellow graph and the red graph and the blue one for that matter it's very very hard to do them do this in such a way that you can claw back the loss of output when you end up with these issues here you can see two Kings one in in the early 90s and I ended up being the director-general of the bank support Authority so it was part of my job to sort out that domestic mess and then you see another one in oh seven oh eight oh nine this time around it wasn't a problem for us domestically because our banks and our domestic economy was okay but the Iceland went bust the Baltic countries ran into deep deep economic difficulties and a whole bunch of other countries are still struggling trying to get out of them out of that day out of that mess I'm not gonna talk about it at all tonight but presently given that our housing market is booming I hope that I never have to deal with a third yeah third King and when it comes to this this this graph you can find similar graphs for quite a substantial number of countries so there's nothing that original about this particular graph there are similar ones that you can you can find from many many different parts of the world and that's why we want to avoid particularly a systemic financial crisis as much as we possibly can now then that brings me then to to to Basel vows of Basel 3 and what people have been thinking about and what to come up with in order to avoid this happening happening again and let me try to convey to you the first first part of this which is really dealing with more and better quality capital as a first step to rebuild constantly confidence if you look at the graph here and the bars if you look at this part called Basel basel 2 you can basically focus just on the 2% which is a core equity tier 1 and in basel two banks were allowed to operate with with all the way down to 2% core equity tier 1 and then two percent additional Tier one and then four percent what is called tier two given that tier two has to be a multiple of Tier one I concluded already in the 90s when I was dealing with our banks that when you run into trouble tier two is basically useless and that big that is because when there is a lot of uncertainty there out there it's all about equity and that comes back in one form or the other now also keep in mind if you look at the two percent here on the basel ii on the left-hand side then here i'm talking about risk weighted assets and that's important in this in this context because risk weighted assets means that that they are always lower than total assets given that you also take the risk weights into account and that means that if you were to express the two percent in leverage terms leverage the leverage ratio will be even lower than than two percent and that means that in this environment it was possible to run a bank with very very little equity compared to the overall size of the balance sheet of the bank now then back in two thousand and eight nine and ten when these these issues were discussed in the Basel Committee it was made it was very very clear earlier on that that banks needed better quality capital and then the name of the game sins has been to figure out how to how to do that and a substantial part and the first part of and the first part of I thought I had turned it off second tribe my apologies so the first part of it was to deal with capital increasing capital in one in one form one form or the other and and that that is also what happened and there was a a strong focus on core equity here what is called core equity tier 1 which is basically equity and then the minimum requirement was set to four and a half percent and in Tom on top of that there was in there was a there is a capital conservation buffer of two and a half percent that takes you to seven and then in addition to that when it comes to what is called globally systemically important financial institutions there is an additional capital charge on them there's about twenty nine thirty of them of an additional two and a half and that takes you to nine and a half and then to the extent that credit is increasing above trend there is you know there's also a possibility to add a bit more using what is called the counter cyclical capital buffer and this takes you all the way up to up to a twelve twelve percent and then there are tiny parts of additional tier 1 and tier two so you can see here that the capital structure is actually quite different compared to what we what we started what we started out with when you look at look at Basel Basel 2 now so that's that's that's where we are and then in addition to this these this these are the minimum requirements but then a number of countries have actually chosen to to go a bit higher than higher than this and and/or are already at this level or above when it comes to Swedish banks for example we have a requirement of 12% excluding the counter-cyclical capital capital buffer and Switzerland and a few others have used similar approaches so that's that's where that's where we are now in addition to this already back in 2010 there was a discussion about the whole system of risk weights and to what extent there would be a need for a backstop in in addition to to do this and that's the leverage ratio so back in 2010 there was an agreement that we would work on a leverage ratio with him on a leverage ratio which back then was kind of argued back back and forth at around three percent and what has happened since is that earlier this year the Basel Committee agreed on the first international globally agreed definition of a laboratory show ever and it took took a bit of work to get to that point and the issue was how to define total assets and how to deal with off-balance sheet items now we are presently we will presently get back to how to calibrate the leverage ratio and I think that that will happen around let's say 2016 2020 or 17 something something something like that and as you may be aware in some countries take the US for example when it comes through their largest banks I think they have decided on a leverage ratio between 5 to 5 T in the range of 5 to 6 6% so I'd say that generally speaking since 2010 the views on the level of the leverage ratio have changed in the sense that the numbers seem to be going up where we eventually and are passive I don't know because this is an negotiation and a discussion that we have to go through over there over the coming over the coming years now in addition to this together with the Financial Stability Board there's an other conversation going on for large internationally active banks called G Lac G Lac stands for gone concerned loss-absorbing capacity that's basically saying that once the authorities have decided that this particular institution I'm talking about a large one a globally active Bank is gone then you need additional loss-absorbing capacity on the liability so it's something that you can turn into equity so that you can wind down the institution in an orderly way over let's say a year or something something like that this is a conversation that is going on presently where it will take us I don't I don't I don't know it will take probably a year more than that to come up with a G lakh definition another way of looking at G lakh is to say that if you if you talk about this in the European context this is really about turning a Bailey noble debt into a globally accepted concept and then when you turn talk about bailing double debt then that of course raises the issue how much how much of it should you have and what kind of ordering do you use when you burn through the different different buffers here and how Tech's our technique how technically do you go about doing and doing all of it or all of this geolock is essentially or will essentially be designed in such a way that you can wind down a very large Bank over time in an orderly way so that ideally governments end up don't end up owning owning the banks this can be done technically in many different ways one one way of doing it would be to to to count G lakh in terms of risk weighted assets another way of doing it would be to do it in terms of leverage ratio exposures and another way of doing it in in turn would be to do it with some measure of liabilities an easy way of thinking about G lakh is to say that it's kind of a type of tier 2 capital if you go back to bars barson - and that means that if g lock is added then you add something more to correct with it tier 1 and that should essentially hopefully over time make the whole system system safer now in addition in addition to this but the Basel Committee has also set quantitative requirements on liquidity and are two parts they're two parts to that the first one is this thing called the liquidity coverage ratio and the liquidity coverage ratio is a if you set the detail Society is a very very simple measure it it basically says you should have enough money to last you for 30 days that's the that's the core of the liquidity coverage ratio and to come up with that kind of a ratio you need to define high quality liquid assets and that's quite complex because people have different views on what a high-quality liquid asset is and it also differs in different parts of the world and then you have to make certain assumptions about the net cash flow you have during 30 days and then basically you said you basically this measure says that you should have enough cash on hand to last you for 30 days and then you can say 1 30 days that's not very much but if you in hind with hindsight if you look at what happened to some of the banks that went under they had much less copper and much less liquid assets then than that what is remarkable and and professor good heart he knows all about this because he he has written a thick book on the history of the Basel Committee that it took 40 years for the Basel Committee to discuss liquidity back and forth and for some periods the whole issue of liquidity was more or less buried until we got to a point where we actually ended up with the liquidity coverage coverage ratio now in addition to that presently we are working on what is called net stable funding ratio which is dealing with
ong-term funding of banks and it's basically saying that you should use your available state stable funding what you have on the liability side in such a way that that you have more available available stable funding than what you have required stable funding requires stable funding here's what you have on the on the on the assets side and just to give you an example suppose for the sake of the argument that you have a lot of mortgages on your balance sheet then it wouldn't be so good to defund those mortgage mortgages in the overnight market so you would need their more long-term available available stable funding for for that another way of thinking about the net stable funding ratio is to say that it's a kind of a way that duration measure were required the the available stable funding should have a duration which is longer than the required stable funding that that you that you need we're presently discussing how to do this how to put this together and if everything runs on track yes I hope it will we hope to have finished the nsfr discussions within the committee in the course of the fall and that means that the nsfr should be done sometime towards the end of them towards the end of the year now let me illustrate to you a little bit what how you what these measures are all about and how you can define a bank or a banking sector in terms of the measures that I have just talked about and I just use I use the Swedish banking sector as as an example but you can actually do this for any country so there are three additional measures in addition to the capital measure and this is what it this is what it looks like you have the core equity tier one requirement in my my case in happens to be 12% you have the liquidity coverage ratio which has to be a hundred percent and you have the net stable funding ratio we has to be a hundred percent or more and you have the leverage ratio which hasn't been decided yet in terms of the level so here is just three percent for illustrative purposes so basically if you are a bank in the future the name of the game is not to be inside the box that's a bad thing and then bad things are supposed to happen to you it's not harder than that now and let's take a look at Swedish banks where they were and I'm talking about the the the four major major banks in our system they're really large ones this is where there were in the first quarter of 2011 as you can see the LCR is below a hundred percent the nsfr is way below a hundred percent core equity tier one is around 12 that's fine and the leverage ratio is let's say around four percent so that's that's where they that's where there were now let's go to the fourth quarter a 2013 this is what the picture looks like then the banks have increased their LC or substantially the leverage ratio is unchanged basically and core equity tier 1 is way above 12 percent and the NSF are still doesn't look very good now what has happened here how come core equity tier 1 went up when leverage stayed the same well that's because the risk weights went down and I'll get back to I'll get back to that in a in a in a few minutes also when you look at the liquidity coverage ratio for our banks most of that is actually euros and dollars because there is an excess supply of liquid assets in euros and dollars but if you were to look at the liquidity coverage ratio defined in Swedish kronor it is way below a hundred percent and on the on our side on the central bank side we have said that that's not acceptable and we have suggested to our supervisors we don't have supervision that it should be as a minimum at least 60% so this is what it looks like and this is this is how you can define banking systems in any country in the future in terms of these measures that they are used by the by the Basel Committee so this is kind of the the a summary measure of defining what describing what banks look like so so much about the technical aspects of this let me describe now a few other things that we have been up to lately and the first this has to do with strengthen supervisory frameworks there's this document called the basel core principles of supervision and there are about 10 15 years old they were revised in 2012 in in order to incorporate lessons from the crisis and they highlighted the need for greater supervisory intensity and the importance of taking pre-emptive actions to address the systemic risk now pre-emptive action is easy to say but very hard to do because that's the Supervisory version of taking away the punchbowl before the party gets going and that upsets the banks and many others as well but that is what you need to do in order to make these systems work in addition to this we have also published a number of papers on data aggregation principles and this is it sounds highly technical it's quite important because if you have a large Bank which is globally active eventually if things turn sour you need to understand what positions you have and then you need to understand what what assets and liability you have when you aggregate all of them so that you can fully understand what's going on and we have written and published on supervisory colleges because the more cross-border banking you have the more supervisor ecologist you end up with and then more complex they tend to get which is really any few in London because you have so many bankster and in some instances you are the home supervisor is in London and in a large number of other instances London happens to be host to many many banks and this creates actually quite complex structures when it comes to doing and doing with dealing with this the perennial issue dealing with weak banks how do you how do you wind them up or how do we define assets liabilities how do you deal with all those or all those issues and this is basically also equivalent to what is called the asset quality review that's going on in Europe presently we have written on sound capital planning looking looking for forward-looking capital planning in such a way that you don't wake up one morning and find yourself all of a sudden we were not enough capital and on the issue of external and internal audits audits of banks so this looks it looks good but there are many many more things that need to be done because the Boston three package and related reforms address the short comment shirt comings but there we need to do more as I said we have to finalize the net stable funding ratio we're also presently working on revisions to the securitization frame securitizations framework this has been a long-standing issue we have published many papers on this and there's been many many comments from from from banks and others on how to how to do this as you are aware securitization wasn't all that successful always during the financial crisis they produce the larger problems in different parts of the world well on the other hand there are certain types of securitizations that weren't that dangerous after all I mentioned the G lack already gone concerned loss absorbing capital so here we have more to do but in addition to do in addition to this we have found and this has been extensively discussed in the past few years that regulation only if it is consistently implemented so it's not enough to have all this stuff on the books and it's not enough to agree in Basel what to do and what not to do but not really to deliver in terms of your I the in terms of actually also producing a change on the ground and here we have found unacceptably large variations in the calculation of the risk weighted assets and this holds bought both across a global sample when when you look at many banks in different parts of the world but it also holds as well when it comes to at the national level and what this really means is that you can have two banks holding roughly the same type of portfolio and if they use very different methods for calculating the risk weights you can still end up with the different capital capital requirements and let me let me just show to you one very simple example and this is probably over Evan this is just illustrative so it's an oversimplification but it's just to drive drive home the point suppose for the sake of the argument that we have two banks a and B and and they have roughly they hold roughly the same portfolio but Bank a has very low risk weights and Bank B has high risk weights now in the bank a case given that the risk weights are low the capital requirement ends up being 7% and in the case of high risk weights then you end up being below 4% so in that sense this really matters when it comes to particularly the minimum reserve requirement and here lack of comparability undermines basically the credibility of the capital ratios and you know also actually hampers recovery in the banking sector if you have if you have problems in the banking sector because what happens if you can't really understand what's going on and how to compare different banks then the whole banking sector actually up under a cloud and when that happens if you cannot understand whether bank is you cannot understand the difference between different banks because you don't understand how the risk weights are calculated and you don't understand how the risk weights are reported then people tend to be suspicious and that produces all sorts of difficulties for for the banking sector as a whole and here actually I think it's fair to say that that the risk weight system has lost credibility in the past few years and that we need to make quite an effort to correct this because if that does not happen then we will slowly drift into other other ways of determining how much capital banks are supposed to hold so so much about risk weights which is a key issue but also as I started out saying earlier implementation in in addition to that is it is key what is absolutely remarkable when it comes to implementation is that this is very new on the side of the Basel Committee to actually go to countries and check to what extent they implement or not it used to be in the old days that it was considered to be too intrusive to go and check whether they actually did what they promised in Barcelona they would do so this has only been going on for a couple of years how to look at look at this and it's dealing with the consistency of national regulations and the delivery of comparable outcomes particularly when it comes to when it comes to risk weights so far we have almost 100% concentrated on on capital and the capital requirements and that bit that is because we have been negotiating the DLC or and the nsfr and we will later settle on the level of the lever equation so then what we have done is that we have put together a system called a regulatory compliance assessment program which is an is that essentially means that we put together teams of experts that go to countries and they take a look we have completed seven of these assessments so far and by the way they are publicly available if you want to if you want to read these things we have done Japan Singapore Switzerland China Brazil Austria Australia and Canada and if you look at the changes that were made as part of the assessment process over 200 changes and amendments have been made when some of these countries were not quite in compliance with this document that is called the rules text that defines what Basel 3 actually at the technical level looks looks like presently we are working on the EU the US Mexico and and Hong Kong and we hope to publish the US and the EU assessments in the course of the in the course of the fall before the end of 2015 will do another for India South Africa Russia and Saudi Arabia and by the end of 2016 we will be through the whole the whole lot and but then I'm only talking about the Basel Committee member countries and jurisdictions the IMF first I think it's a hundred and eighty five member countries or something like that so there are very very large parts of the world there are not really included in this in this at all so it will it will take forever if we want to do the assessments in the whole world and by then we're probably in two thousand four or five or six so so this will this will go this will just go on and on and on and on in addition to this because I also alluded to the work in Basel similar to a muddy river that's that flows slowly once in a while we need to assess the capital framework and it's effectiveness against the objectives that we have set for ourselves and that is we want these systems to be simple transparent risk sensitive and comparable now if that is really the case time will time will tell and that means that once in a while we need to take care take stock of the whole thing and ask ourselves did we end up where we wanted to end up and this is a kind of a long-term project that we should do periodically and this holds particularly when implementation matures and when banks and markets also evolve because when you do these things when you negotiate these things at the global level there is no way exempted or knowing whether these things will work the way they were they were intended or not so in that sense there is a perennial need to discuss these things and make a few adjustments here and there so and then let me conclude Besant tree has targeted the key weaknesses that were identified by the crisis some of these weaknesses had actually been around for a long time so you can you can also go back in time and find them before the crisis that we went through a few years ago first one the most important one probably is dealing with the quality and the level of capital the second one is dealing with unstable funding profiles the LCR and the NSF our third one is dealing with weaknesses in risk management and supervision how you actually go about doing these things third issue is to look into to what extent all of this is consistently implemented all over there all over the world now what we need to do in addition to finalize the job is to finalize the outstanding regulate regulatory reform that I talked about we need to continue the implementation and the monitoring of all of this and it's important that we do this in a transparent way so that all of this is publicly available so that those who who are interested in this type of work and look at what comes out of it and we need to seriously address the problem of unwarranted risk weighted assets variability because if you can choose if there's a perception out there that you can choose the risk weighs on your own in a way that is most favorable to yourself as a bank then we do have a problem and we need to discuss and we will discuss probably for many years to come how to deal with that issue so that we regain credibility to the rwa system let me also finally finish with with there a general reflection of Maher and saying that I've talked about various constraints that are imposed on the banks when they run their banking business what that really means when you talk about this in terms of capital and the other constraints is that there basically is a kind of a trade-off between these constraints the lower the capital requirement the higher the likelihood that you add more and more constraints on what banks are allowed or not allowed to do the higher the capital requirements the low then the more liberal you can be when it comes to what banks are allowed or not allowed to do but how to find a reasonable trade-off that's not that's not so easy and that's really for the future since when it comes to the LC or the nsfr and the leverage ratio they haven't really been finished yet in the sense that all the banks all over the world have to comply with them because there is also an element the gradualism to all of this when the banks have to adjust to this until let's say 2018 2019 2020 I actually carry with me a PowerPoint slide with all the different implementation day because I can't remember them myself because there are so many of them but I'm not gonna show that one to you thank you right John Danielson will now give a short response Stefan has one of the most important and difficult jobs in the world how can we deploy the financial system and simultaneously allow the final financier in a room to participate in economic growth now this balance between safety and risk
taking has always been and will always be a key challenge to regulators and invariably no matter what they do they will be criticised now I can hardly think of a better pedigree for the job Thunder of Stefan he had the oldest central bank in the world one that easily predates this start that down the road by a good half a century the Riggs Bank has an impressive record in monetary policy and did set the gold standard for its crisis response in the early 1990s Stefan their fur hats an institution with an institutional memory and reputation for successfully handling the two main tasks of central bank's monetary policy and financial stability now this this dual experience is needed because the Basel Committee faces difficult challenges when it when designing the post crisis a regulatory system the banking system in its country is unique it reflects the country's economic and political history and we can see this by looking at the frequency of crisis across developing countries on average developed countries suffer a banking crisis every 40 years and Sweden is average in this regard some countries are much more crisis prone the United Kingdom and United States suffer a crisis every 15 years or so now this means that banking regulations need to be tailored to the unique national characteristics of its country however the reason for the work of the bathroom committee is that banking is international so that we also need the international regulations and to avoid the regulatory arbitrage the regulations need to be uniform now this creates one of the dilemmas that is so common in the world of regulation and is one of the key reasons why the job of the bathroom committee is so difficult now historically the committee has had considerable success a key motivation for passing one was the heterogeneity in capital regulation in the early 1980s when Japanese banks are lost lower capital than banks elsewhere and therefore could use more leverage to expand and it seemed at the time they were taken over the world not surprisingly their Western rivals got upset and were lobbying to reduce their capital levels to those of Japan Vasil one was successful in halting this erosion of capital standards worldwide the question is will Basel 3 be seen as similarly successful in meeting stated objectives now it is a significant improvement over his predecessor and to me the biggest improvement is an emphasis on core equity and the introduction of the joint leverage ratios now we still of course have disagreements ask to the levels of capital but they reflect the different strengths of the banking system in the various countries and the willingness to consider taxpayers money as yet another form of bank capital the introduction of the liquidity requirement Stephan mentioned is welcome but I sometimes wonder if it wouldn't have been better to learn back to the lessons of pass and sue capital and minimize the scope for manipulation I do worry when regulations give birth to a new financial practices as we are now see is so extensively in the liquidity space after all it was capital structure optimization and hybrid instruments that undermined the bottom two ratios now in some places parcel 3 is a step backwards us and how market risk is calculated our research artists system in risk center suggests that under the current proposed whose market risk will be measured more inaccurately than in parcel two and what also given banks more go for the manipulation of the measurements now furthermore the growth in complexity in is a worry the number of pages in Basel 1 was about 30 and bathroom 3 about 350 and I read them all at the time depending on how one counts Basel 3 exceeds 5 exceeds 500,000 pages so number of different working documents are one sort of has to keep track of and I think very few people will end up reading the whole thing and on current trend bar so four would be at least few thousands if not more now when this gets translated international rule books this number multiplies rapidly now trying to specify regulations and risk taking in such menu detail might just end up creating a large number of loopholes I would not be surprised if bankers just read Basel 3 as a manual for taking risk now there is a concern echoed by an LSE professor in 1945 Friedrich Hayek who wrote a seminal piece called the use of knowledge in society about why central planning of economies does not work his point at the time was that it is impossible to aggregate local economic knowledge so that a handful of central planners could efficiently organize the economy a corollary to Hayek's point is that the regulators cannot sensibly aggregate all the local risk taking into a set of simple metrics be the value at risk or risk weighted assets it isn't risk I think where the committee faces a thorny logical problem if you want regulations to be risk sensitive it is illogical for banks to reach different conclusions on the risk of the same portfolio a point Stefan just mentioned a few minutes ago it is therefore important that risk be harmonized across banks and the committee has on other forms publicly expressed concerns about exactly this the problem is that the harmonization of risk forecast methods is strongly throw cyclical increasing the frequency and severity of banking ultimately the problem with risk-based regulation is that risk cannot be accurately measured any firm-wide risk number such as value at risk resembles nothing more than a random number more worryingly the risk that is mastered it tends to be negatively correlated with the actual underlying non-measurable risk therefore by regulating with risk measures we create procyclical t now this is a point well made by the former head of the be is Andrew Crockett who said the received wisdom is that risk increases in recessions and Falls and booms and contrast it may be more helpful to think of risk as increasing during our swings as financial imbalances build up and materializing in recessions now my last concern today is about the lack of transparency in the regulatory process we do not really know who sits at the table and it seems to be little or no involvement with anybody outside of the regulatory banking complex while banking regulated by banking regulations affect every part of society society seems to be given little room to influence the process decided in smoke-filled rooms and parcel however it is easy to criticize the Bussard process needs to reconcile very different views and try to create harmonious regulations for very different banking systems the overall thrust of the process is very positive and while there are many areas that could be done better the opposite is true and the direction is correct the job of the Basel Committee is important it is the only game in town and given all the constraints we will never get anyways what we economists would call optimal regulation business I want to thank Stephane for joining us here tonight if you if you keep I mean the holy show procyclical it is kind of a it's a perennial issue that has been with us for a long long long long time and and it's it's hard to it's hard to deal with one way of dealing with it is to make sure that banks are more capital than they had in the past because then at least in the downturn you you can you can manage the downturn more and more easily compared to if there is not not enough not enough capital on the whole issue of risk weights the issues what to what to do and and one can one can do that in many many different different ways one way of dealing with it would be to put in constraints on the type of models banks are allowed to use another way of doing it would would be to put in floors so that so that you can't go below X but it's too early to tell which way which way we will go when it comes to transparency we're working on that and transparency has increased an increase in my view substantially over time and and when it comes to these documents that we produce and we produce hundreds and hundreds of pages we can argue whether that's a good thing or not a good thing but the vast majority of those documents are actually publicly available at one one stage or or another there are not always the clearest of documents that you can find but sometimes you have to be a very bit vague to get to a compromise thank you very much now we can turn to questions and while you're all thinking of questions so I got one in a sense I'm semi dying was which is that the the criticism the different banks assess our waz separately in different ways is absolutely just but an awful lot of the criticism of our or risk-weighting is that they are sort of fixed independent of context and that they were certainly initially fixed with a certain political content i know particularly the zero-risk waiting for all osed government debt in a world in which certain events of recent years makes that seem to be a bit odd and the relatively ever example of the risk-weighting of mortgage debt as compared to other lending to the private sector there's much more to a rather arbitrary political choice than there any scientific measurement of what the effective risks the banks historically have been so the time is not just the banks creat risk weights differently it's that the in the initial sort of choice of what the risk weights are and their constancy over time irrespective of what's going on strikes observers as rather odd the one this is one what it took to get to a negotiated solution on how to do this and and that means that they're always elements of let me call it national interest in one form or or the other and that that produces some oddities so to speak from time to time and it's one one issue is the whole issue of sovereigns which is being discussed today and and and a new probably will take take many years for the committee to to look into that look into that issue again so you have a point in the sense that this is not this is not a 100 percent pure actuarial approach to risk there are other elements to it as well but that one if that's basically what it takes to get to a global agreement questions prohibitive that might come Thank You governor when you've complete the huge task of reregulate in the banking system don't you think that you will shift risky behavior from the banking system elsewhere into the financial system what the governor hit the Bank of England here is called shadow banking and do you think that's a good thing or a bad thing and who will go about regulating that shadow banking system when you finished regulating the banks thank you you know you know it all depends because if you tighten the rules on the bank's side then some of the business is likely to move elsewhere but the key to it then is to make sure that it doesn't sort of come back to the banks through the backdoor in one way or the other and from the Basel committees perspective the way we have dealt with the whole concept or ratio of shadow banking is to make sure that if banks lend to shadow banks if I express it that way and the capital requirements have to be high enough so that you don't end up in a situation which has happened many many times in the past that you think that the whole thing is outside the banking sector but when things go wrong then all of a sudden everything kind of feeds back into the banking sector in one form or the other but this doesn't really mean that the way there may well be financial sector activities that produce good value for society and despite the fact that they are not on the books of the banks hello I have a question about cocoa bonds and as you may know one way for banks to manage the cost of increased capital ratios is to issue subordinated debt such as contingent convertible contingent capital bonds these innovative new products allow banks to issue debt in a way that can manage their capital ratios can you tell us a bit about there the Basel committees discussions about how cocoa bonds could be included as part of the capital ratio levels how they came about this including Coco's as part of capital I mean the the bank usually talked about it that while Coco's you are supposed to use on top of the capital that you have you use cocoa station to make sure that you never have to deal with the supervisors because if you do cocoa there's a completely a private sector undertaking then you can put your own capital ratio on whatever level you'd like and if you put it high enough then it ensures that you never have to deal with the supervisors or at least it takes much much longer than otherwise and so there are kind of Coco's and Coco's when it comes to how to how to do this do this but this is my view when it comes to how you deal with Coco's on top of this and this is where it gets actually of course quite complicated and once we get into the whole issue of gee lack and that's a few years down the road that's Bailey noble debt in one in one way or the other and we'll see how to how to do this and essentially what the whole issue is all about is how to structure the liability side of a of a bank in a way that that makes make sense but I do think though what is very very important here is to stick to the whole concept concept concept of core equity tier 1 and Coco's are not core equity tier 1 like this wondering if I get back to your comment about cotija one equity from that what do you think about the EU Commission's decision to water down CID 4 and allow more things to count of equity I'm thinking of hybrid capital and what do you think about the issues surrounding double counting well we'll see as I said there will published the EU bottle 3 assessment in the course of in the course of the fall so I wouldn't really want to a point on that now once the assessment is done it will just in front Thank You you mentioned making sure that risks from the shadow banking sector don't flow back into the banking sector are you trying to do that also through the net stable funding ratio no not really the NSF Indiana Safari just as I said trying to to put a requirement that you have to have a portfolio which is more match than some of these portfolios used to they used to be in the used to be in the in in the past since the Basel three framework is essentially about risk management and making sure that we don't get the frequency in the depth of crisis we have do you mind talking for a minute about the experience in Sweden post crisis where you have been in you know various debates with the government etc about whether or not there are issues in the Swedish domestic context etc so basically much of that discussion has been over and above the Basel three framework where the Swedish banks on apart from one parameter are reasonably compliant so can you use that as an example to illustrate the limits of what Basel 3 can achieve when the challenges that supervises regulators in central bankers face over and above that well that brings in that brings us into maybe a kind of a different lecture because that's dealing with this all but now with modern words concept of macro Prudential supervision and who's supposed to say no and for what reason and do you say no early enough in order to ensure that the system stays safe and safe and stable but then we're getting into a whole bunch of issues that go way beyond Basel 3 the only thing that kind of touches on or on the issue that you're raising here is the counter-cyclical capital buffer and the counter-cyclical capital buffer is a nice tool in the sense that it increases the capital that the banks need to hold but you cannot really or the things now let me put it this way the counter-cyclical capital buffer doesn't really work if you want to use it for example in order to to avoid households borrowing too much when they when they do mortgages and that's because the counter-cyclical capital buffer will only produce an increase in the mortgage rate of let's say 20 25 basis points so if households are borrowing too much you need to go beyond actually what is say in in Basel 3 to get a handle on that on the subject of capital requirements could you speak a little bit about the capital requirement ratio itself the idea behind bringing down to hammer in in terms of higher capital requirements would be to to rate to have that buffer but banks could al
o just decrease loans and could you could you speak to the to that fact especially in the context right now of Europe where the the issue is really that there's a decrease in lending could you speak to the issue of where these are these high capital requirement ratios might hinder that or if there is any type of of you know sort of what do you call that sort of a trade off ok this issue the issue arising is really how to get from A to B in an orderly way and what happens in the economy and in there in in the meantime and in order to deal with that issue there already one when when Basel three was was first announced back in 2010 we talked about very long adjustment period so we're talking about 1819 and and that means that banks have had ample of time to adjust to the new to the new capital ratios but in addition to that if you have a problem with with capital in the banks well then first best is to recapitalize the banks regardless of Basel 3 thank you I've got three quick questions the first one is as you stated in the in your presentation that the implementation implementation part was a major issue under governance part what has been the progress on your on your observation about the real implement because in the crisis and the software labor it was the governance and the and the band and they and that caused the whole whole issue what has been the progress on that at number one number two one of the criticism that Basel 3 has come is that I mean each country are not on the same economic framework there are many countries which need their priorities and growth employment and there when you are tying up a lot of capital in the in the in terms of the Taiwan capital and in the total capital and the liquidity maintenance then it is really good keeping a pressure and the growth um it is not it is not supporting that yeah that's it yeah yeah well when it comes to implementation as I try to to show to you there is an implementation process going on and it's a transparent process and and it's easier today than in the past to keep track of what countries are actually doing or well not not doing when it comes to governance then that's more dealing with what's in the boss of core principles for supervision and how you how you run run run banks that's not so much leading with the technicalities of Basel Boston 3 and then on the third issue of capital this is a perennial discussion about the short run versus the long run and if you look at the numbers if you look at the capital numbers that we ended up with if I put it that way as during Basel too if you take a longer time perspective and if I express it in terms of the leverage ratio the leverage of Bank say before shortly before things started falling started falling apart it was very very low in a historic perspective because if you have a leverage ratio of let's say 1% there is not much capital in those banks so there was a need actually to increase confidence in capital in the banks in one one way or the other but when you do that nothing in life is for free so you always have this trade-off between the short-run and and and the long-run I thought that was a really interesting talk but there are two issues that others have raised that I would be very much welcome hearing your take on the first is it is my and many other people's experience particularly in ecology that more complicated things are more fragile and that essentially is the main theme of Andy Hall Danes dog in the frisbee and I wonder what you think of that and secondly if I could put on top of it I don't know whether you have read the essay that Benjamin Friedman wrote a couple of years ago in which he made an attempt to assess the growth of as it were rent taking within the system he tried to make an estimate of the total cost of running the American banking system as a ratio to all profit earned in America and showed that from 30 years ago to 15 years ago it doubled and then it was in the way to doubling again before it fell apart and he basically said what we want is a fundamental reappraisal of how we allocate capital efficiently in a free market which doesn't have a lot of relevance to much of these fancy instruments I hope you don't think that's a silly question oh then not at all not at all or maybe very deep questions and it's complicated more fragile well banks do complicated things banking is much much more complicated today than it was in the past and what we try to do is to come up with a kind of a compromise in the sense that we say okay we have the system with respects many parts of that system are quite complicated particularly when you get into future for futures forwards options on balance sheet off balance sheets derivatives in different shapes and shape shapes and form but in order to ensure that to buy a bit of insurance if I express it that way then we are working as I explained towards a system where also there will be a leverage ratio and a leverage ratio that acts as a backstop and just for the sake of the argument let's assume that we get the risk weights totally wrong the new steel would have a leverage ratio which makes it impossible to expand the balance sheet of a bank in in indefinitely indefinitely now the counter-argument to using a leverage ratio is to say well since the leverage ratio doesn't distinguish between different types of risks then then then you can you can sort of maximize the size of your balance sheet by by just running in one direction and ending up holding only one let's say for the sake of the argument one type of asset so both both ways of doing each have their pros and cons and what we try to do is to find a reasonable balance between between the two the other question when it comes to rent seeking in the banking sector and if there are other ways of finding a model of channeling savings to investments in society because that's ultimately ultimately what that is all about well that's way above the level of the Basel Committee since we deal with the plumbing in the present state of the world all right I'm going to take three more questions one two and then three that and that's going to be you mentioned G Lac and how it might take a year or more to kind of get a global agreement on it Mark Carney's been quite specific that he wants an agreement by the Brisbane g20 meeting I think that's October November so is he gonna sort of have to fly out there empty-handed and tell the leaders he doesn't have anything no no no we're talking I think about one on that one on the same thing because it's one thing to come to an agreement it's a different thing to do all the technical work so that you actually can implement implement something I mean similarly when we work with in the Basel Committee we can come to an agreement in broad terms on something but then it takes a while to actually write up unfortunately nowadays those 500 pages called the rules text so as always when you do these things a lot of it the devil is the devil is in the detail and you have particularly when you talk about gee lack for example then actually the issue is how to define the pecking order and when things go badly and that will require a bit of technical work actually to do to do that but first there there is a need for a global agreement at the political level and if once that's there then then the technicians can can can deal with the technical aspects of it so that you can produce something which is technically full has Basel three led to an increase in the risk weightings on SME lending and related to that has does basel three lead to a reduction in SME lending all other things being equal this juncture because then you would have to look at what happens in the individual in individual countries SME lending seems to be a perennial issue have been dealing with this as long as i have been dealing with the banking sector either at the global level or domestically in my own or in my own country the whole issue of risk weights is on the table and we will probably we will have to discuss that for many years because what i have talked about here when it comes to Basel three is really levels of capital how you define the different buffers how these different measures that I've talked about relate to each other and how you put the system together and that's fairly independent on let's say risk weights to particularly SM yes Emmys that's a different type of issue yes hello John I'll go from you're a week governor I just wanted to follow up on a part of Professor good hearts question regarding with risk rating of sovereign bonds I was struck by a comment in your response that the committee's approach is not 100 percent act oriole so it's not a hundred percent scientific so I guess that leads to the question as as what you see the committee's principal political obstacles both had a sovereign and supra sovereign level to implementing bank risk weightings towards government bonds that are scientifically optimal well in the real world there are many countries and many different views and then you discuss and you discuss for years and years as I mentioned when I talk about the LCR it took 40 years of conversations before we actually ended up with an LCR so there is no such thing as absolute purity when it comes to doing these things because there are different interests as always when you talk about things at the global global level and then you have to do do your best to get to get to a they negotiated agreement because to have that kind of an agreement is probably better for the world compared to having nothing at all there may be no such thing as absolute purity but you came very close to absolute transparency so and you've gone on answering questions for a very long time and I'm brilliantly same so may we thank Stephane again for an excellent evening thank you you
