Opening speech

Opening speech by Mr Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank, at the 18th International Conference of Banking Supervisors, Tianjin, China, 24 September 2014.

Introduction

Good morning and welcome to the 18th International Conference of Banking Supervisors (ICBS). I'd like to thank our hosts, the China Banking Regulatory Commission (CBRC), and in particular Chairman Shang and his staff for hosting this year's ICBS. Hosting a conference such as this, with more than 100 supervisory authorities from around the world, is a significant undertaking. On behalf of everyone here today, I express our deepest appreciation for all the hard work that has gone into organising the ICBS in Tianjin, and congratulate you on doing such an outstanding job.

China joined the Basel Committee in March 2009 - in the midst of what turned out to be a prolonged, far-reaching and complex financial crisis. Since then, the CBRC and the People's Bank of China have become active members of the Basel Committee and have made valuable contributions during an extremely busy and critical period. When I think about what the Committee has achieved since the financial crisis, I don't think it would have been possible without the support of the Chinese authorities and the other members that joined the Committee in 2009. The new members have brought an important new dimension to the Committee table - drawing, of course, on their own experience and perspective as emerging economies.

If the Basel Committee is to achieve its core mission of strengthening regulatory standards and supervisory practices around the globe, then we must make sure that our reach is broad and our work is carried out in an inclusive manner. In this regard, I am pleased to announce that representatives from Chile, Malaysia and the United Arab Emirates have been invited to join the Basel Committee and attended their first meeting earlier this week. This is one of many steps that the Committee has taken in recent years to enlarge its geographical outreach and enhance its position as a global standard setter.

The Basel Committee was founded almost 40 years ago to foster cooperation and coordination between central banks and, in doing so, to strengthen the regulation and supervision of international banks. The principles of cooperation and information-sharing remain as strong and important today as they did when the Committee was founded. No matter what the regulatory framework or how consistent the implementation - there is no escaping the need for cross-border coordination and cooperation. Indeed, it is a fundamental element of effective international banking supervision. The Committee's response to the crisis is a successful illustration of this. While many of us were managing national responses to the crisis, the Committee came together to develop and implement a revised international regulatory and supervisory framework. This framework - Basel III - strengthens prudential and supervisory safeguards and, more importantly, helps underpin the economic recovery. The Basel III package of reforms remains the centrepiece of the G20's regulatory response to the crisis. This is a reflection of the cooperative and collegiate spirit of the international supervisory community.

The Committee is now close to finalising the Basel III package of reforms. At its meeting this week, the Committee agreed final modifications to the net stable funding ratio (NSFR), which will be published in the coming weeks. The NSFR complements the liquidity coverage ratio (LCR) and ensures that a bank maintains a stable funding profile in relation to the composition of its assets and off-balance sheet activities. After many decades of trying, we now have a global liquidity standard.

It is now more than seven years since the start of the financial crisis. The biennial ICBS provides an opportunity for us, as an international community, to reflect on the effectiveness of the international standards, to discuss emerging issues, and to explore the challenges ahead.

This ICBS focuses on both the post-Basel III reform agenda and the role of the financial system in promoting economic growth. However, finalising the Basel III framework does not mean that our policy work is done. We need to look closely at the regulatory framework, remind ourselves of the reasons why we put these measures in place, and ask whether they are delivering the right outcomes.

The reliability and comparability of risk-based capital ratios

And that leads me to one of the important post-Basel III reform issues: the reliability and comparability of risk-based capital ratios. Consistency in the implementation of risk-based capital standards is a vital element in strengthening public confidence in regulatory capital ratios and promoting an international level playing field. The Committee is therefore assessing bank capital ratios with a view to ensuring that they appropriately reflect the risks that banks face.

Our assessments thus far have found significant variation in banks' risk-weighted assets that are not explained by underlying differences in the riskiness of banks' portfolios. Excessive variation in risk-weighted assets undermines confidence in the risk-based capital framework as a measure of bank safety. The Committee is well aware of these concerns, and we are taking steps to reduce the variation arising from differences in how banks measure risk. At the same time, we know that variation in risk-weighted assets can arise from differences in the rules and implementation standards set by national regulators, and so we are also focusing on these areas..

The steps the Committee has taken, and plans to take, to address excessive variation in risk-weighted assets include:

  • the introduction of capital floors and benchmarks, and greater restrictions on the scope of banks' internal risk estimates. In this regard, there is recognition that not all risk parameters are suitable for modelling;
  • providing clarity on aspects of the Basel framework that are ambiguous, and reducing areas for national discretion;
  • strengthening the disclosure requirements relating to risk-weighted assets by amending Pillar 3 of the Basel framework; and
  • ensuring consistent implementation of Committee standards and monitoring outcomes of risk-weighted asset variability.

Rather than go into the details of these measures, which I have spoken about previously, let me instead use this opportunity to talk more generally about the outcomes we are trying to achieve. We sometimes have a tendency to get bogged down in the policy details, and it is easy to lose sight of the overall objective. At the end of the day, the outcomes we are aiming for are:

  • a regulatory framework that promotes effective supervision;
  • consistent global implementation;
  • effective bank risk measurement and management; and, ultimately,
  • a strong, stable and efficient banking system.

Too often, we have not given enough attention to whether the regulatory standards can be implemented consistently, or whether the standards serve to promote, or if they might potentially hinder, the task of day-to-day supervision.

Improving the measurement and management of risk is, of course, a primary objective of bank managers and supervisors, and it is a critical factor for financial system stability. The Basel Committee spends a lot of time trying to ensure that banks' capital and liquidity buffers are strong enough to keep the system safe and sound. But a buffer can only be as reliable as the underlying risk measurement and management.

No matter what we do as regulators and supervisors, it is ultimately bank managers that determine whether a bank will be successful. It is important to recognise the primacy of bank management - that is a fact that should also bear on the design of the regulatory and supervisory framework itself.

With this in mind, how should the regulatory framework be designed in order to promote the outcomes we want to achieve? This brings me back to the issue of variability in risk-weighted assets.

So, what should be done about it? Just as the unwarranted variation in risk-weighted assets arises due to a variety of factors, there are a multitude of measures that the Committee is considering to address the issue. But at the heart of the issue is a debate about the basic design of the regulatory framework itself.

On one side of the debate is the view that the current regulatory framework, with its reliance on internal models, should be highly risk-sensitive and therefore most likely to promote better risk measurement and management in the longer term. The underlying principle is that improvements in risk management are best achieved by promoting regulatory approaches that are aligned with internal bank risk management practices. However, those who support this view still recognise that changes need to be made. There need to be more restrictions on modelling assumptions and techniques, and an acceptance that not all risks can be modelled. Moreover, safeguards can be put in place, such as capital floors and the leverage ratio, to serve as a backstop to the risk-based regime. In summary, one side of the debate believes that the outcomes we want to achieve are best promoted by maintaining internal risk models, though in in a more limited way with floors and other safeguards.

On the other side of the debate, there is evidence that in some cases internal models have been used to minimise risk-weighted assets - and, therefore, regulatory capital - rather than to promote improvements in risk measurement and management. Those who hold this view argue that the complexity and opacity of internal modelling approaches have hindered rather than helped supervision. Moreover, they assert that the outcomes we want to achieve (including better risk management) can be promoted by significantly simplifying the regulatory framework. It is important to note that, even under this approach, there is a role in the regulatory framework for the internal models of large internationally active banks. For example, such banks could still be required to meet rigorous risk measurement and management standards but, instead of rewarding them with a lower capital requirement, a higher capital requirement would apply where banks fail to meet supervisory expectations for risk measurement and management.

I have laid out two quite different views of how the regulatory framework should be designed to best achieve our desired outcomes. The one dangles a carrot to induce better risk measurement and management at banks and relies on internal models to determine regulatory capital requirements. The other relies on supervisory-determined models for setting minimum capital requirements, but threatens a stick to penalise those banks that do not meet required risk management standards.

The questions I have posed, but which I do not intend to answer are:

  • which regulatory framework is most likely to promote effective supervision, consistent implementation and effective risk measurement and management? and
  • which approach is likely to find the right balance between simplicity, comparability and risk sensitivity?

The simpler we make the framework, the less risk-sensitive it becomes. Conversely, the more risk-sensitive the framework is, the more complex implementation and supervision become. There are no easy answers, but the need to balance these items is becoming ingrained in the mindset of those responsible for policy development and implementation.

The Committee is undertaking a long-term strategic review of the capital framework to determine whether there are areas where we could reduce the level of complexity or where comparability could be improved to better meet the Committee's objectives. We are also looking at whether the use of banks' own risk models to calculate regulatory capital is helping or hindering the Committee's pursuit of those goals.

Concluding remarks

To conclude, I would like to come back to my starting point - that is, the importance of communication and cooperation amongst supervisors. The foundations of global banking are much stronger when we share information and act together in implementing sound prudential standards. Cooperation and coordination enhance trust between authorities and improve our effectiveness. Yet, as with any relationship, trust can take a long time to develop, but can be destroyed quickly. The ICBS offers us all an opportunity to further build that trust. For any financial system to function well, its players need to have confidence in each other - banks, regulatory authorities and market participants alike. Market participants need to be able to compare reported regulatory ratios, and comparability needs to be supported by consistent implementation and a comprehensive disclosure framework. And there needs to be confidence that the rules work: that riskier banks hold more capital and that the rules are consistently applied.

At the same time, we must continue to monitor implementation of the Basel reforms. The Basel Committee has already started to assess the consistency of domestic implementation of Basel III capital requirements and will soon be broadening its review to include the LCR, systemically important bank frameworks and the leverage ratio. Consistent implementation will help improve comparability, and reassure market participants that they can accurately assess bank risk.

As our work is ongoing, it would be wholly misleading to say that we are done. A supervisor's job is never done. We believe that we are on the right path to a more resilient financial system but we must remain vigilant in the face of changing banking activities and markets, and we must also learn the lessons from implementation. The Committee is exercising this vigilance through its impact monitoring, by assessing the consistency of implementation, by refining selected elements of the framework, and also by thinking more broadly about the regulatory framework while staying alert to new threats to financial stability.

I hope that the discussions today and tomorrow are productive ones and that you find them valuable in steering your own work. I also look forward to hearing your views on the issues on the Committee's agenda and wish you an enjoyable and rewarding two days in Tianjin.