Finalising Basel III

Introductory remarks by William Coen, Secretary General of the Basel Committee, at the meeting with the European Parliament's Committee on Economic and Monetary Affairs (ECON Committee), Brussels, Wednesday 12 October 2016.

Mr Chair,

Honourable Members of the Committee,

Mesdames et Messieurs les Députés du Parlement européen,

Ladies and gentlemen,

It is a great pleasure to address you today on the work of the Basel Committee on Banking Supervision, in my capacity as Secretary General of that body.

My remarks will focus on three issues. I will start by providing some background information about the Basel Committee and the way in which it operates. Second, I will outline the key elements of the Basel Committee's reforms following the global financial crisis. I will then say a few words about the Committee's outstanding post-crisis reforms.

The Basel Committee on Banking Supervision

Let me start by providing an overview of the Basel Committee on Banking Supervision.

The Basel Committee is the primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervision. Our mandate is to strengthen the regulation, supervision and practices of banks worldwide, with the purpose of enhancing global financial stability. Indeed, global common minimum standards allow for an international level playing field and support globally integrated capital markets.

The Basel Committee reports to the Group of Central Bank Governors and Heads of Supervision. The Committee seeks its governing body's endorsement for major decisions and its work programme. The Committee is global in nature, covering 30 jurisdictions and comprising 53 members and observers. It includes all of the G20 members and provides regular updates on its work to G20 Leaders. About a third of the Committee's members are from the European Union, including the European Central Bank and the Single Supervisory Mechanism. The European Commission and the European Banking Authority are also active participants in the work of the Committee.

The Basel Committee does not possess any formal supranational authority. As a result, its decisions do not have legal force and it has no enforcement authority. It relies on its members' commitments to implement agreed standards. These members are directly accountable to their national legislature. The manner in which the agreed standards are applied is at the discretion of members. Some have chosen to apply the rules to just the largest, internationally-active banks in their countries. This includes the United States and Japan, for example. Others, like the European Union, have elected to apply the rules to all banks.

In developing global standards and principles, the Basel Committee is guided by three tenets:

  • a firm commitment to its mandate, which is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability. A banking system that is resilient will be able to support the real economy and contribute positively to growth over the medium to long term;

  • an extensive consultation process with a wide range of stakeholders, including academics, analysts, central banks and supervisory authorities, industry participants, the public sector and the general public; and

  • a comprehensive and rigorous assessment of the impact of the Committee's policy reforms, on both the banking system and the wider macroeconomy, the output of which is reflected in the design, calibration and transitional arrangements of the Committee's policy measures.

The Basel Committee's response to the global financial crisis

Let me move on to discuss the work of the Basel Committee since the financial crisis.

The global financial crisis highlighted a number of weaknesses in the financial system and the global regulatory framework, including:

  • too much leverage, with insufficient high-quality capital funding banks' assets;

  • excessive credit growth, fuelled in part by weak underwriting standards and an underpricing of credit and liquidity risk;

  • a high degree of systemic risk, interconnectedness among financial institutions and common exposures to similar shocks;

  • inadequate capital buffers for banks to mitigate the inherent procyclicality of financial markets and to maintain lending to the real economy in times of stress; and

  • insufficient liquidity buffers and excessive exposure to liquidity risk, both direct and indirect (eg through the shadow banking system).

These fault lines amplified the depth and severity of the global financial crisis. At the peak of the crisis, the market lost confidence in the reported solvency and liquidity positions of many banks.

The weaknesses in the banking sector were transmitted to the rest of the financial system and the real economy, resulting in substantial costs. Nine years after the start of the crisis, the global economy is still recovering from its effects. These costs include much higher public debt, increased unemployment and substantial output losses. The cumulative loss of output since the crisis is of the order of 25% of one year's world gross domestic product. Nominal growth is running at half of its pre-crisis rate.

In response to the crisis, the Basel Committee introduced a comprehensive and wide-ranging strengthening of global bank standards, most notably through the Basel III framework. This framework has two complementary objectives: (i) ensuring minimum standards of resilience so that financial firms are less likely to fail, and (ii) reducing the impact on the financial system and the economy in case they do.

The Committee's post-crisis reforms set significantly higher requirements for loss absorption and place greater emphasis on higher-quality capital, while better capturing the full scope of risks that banks face. Key new aspects of the framework include:

  • a leverage ratio requirement;

  • capital buffers to mitigate various sources of systemic risk; and

  • a set of standards limiting excessive liquidity and maturity transformation.

In addition to strengthening the regulatory framework, the Committee has introduced a range of measures to align incentives and strengthen banks' governance arrangements. It has continued to improve the effectiveness of supervision. To promote full, timely and consistent implementation of its post-crisis reforms, in 2011 the Committee put in place a rigorous framework to monitor and review its members' implementation of the Basel regulatory framework.

The Basel Committee's outstanding post-crisis reforms

So, what remains of the regulatory reform agenda? While the Committee's reforms have tackled some of the major weaknesses of the pre-crisis regulatory framework, the framework remains centred on risk-weighted capital requirements. The Committee's own review of this framework, supplemented by a wide range of empirical evidence, suggests that more can be done toward achieving a better balance between risk sensitivity, simplicity and comparability. In particular:

  • some parts of the regulatory framework are unduly complex, challenging the ability of banks' boards and supervisors to adequately oversee the way in which banks manage their risks;

  • a number of studies have found material variation in the risk-weighted assets calculated by banks, which has eroded faith in the comparability, if not the accuracy, of banks' capital ratios; and

  • the blanket use of a single metric - in this case, the risk-weighted capital framework - does not allow for a sufficiently robust regulatory framework.

As a result, the Committee's outstanding post-crisis reforms can be grouped into three broad categories:

  • First, the Committee is working on enhancing the risk sensitivity and robustness of standardised approaches, which facilitate the comparability of banks' capital ratios.

  • Second, the Committee is considering additional constraints to the role of internally modelled approaches in the capital framework, particularly in areas for which the use of models may not be suitable for calculating regulatory capital.

  • Third, the Committee is finalising the design and calibration of the leverage ratio and a potential capital floor based on standardised approaches. These measures would complement the risk-weighted capital framework and help ensure that the regulatory framework is more robust to arbitrage and erosion over time.

We are well on track to finalise these reforms by the end of the year, and this will represent an important step. Regulatory reform has been ongoing since the start of the global financial crisis in 2007. Banks, investors and other stakeholders need clarity and certainty when it comes to the global standards for bank regulatory capital. We have consulted on various proposals to modify the global framework and have conducted an extensive quantitative impact study to assess the impact of the proposed revisions.  Our careful review of comments on our proposals and our analysis of the results from our impact assessment allow us to proceed in a measured and deliberate way so that the minimum requirements agreed by the Committee can help ensure more resilient banks and banking systems.

Thank you very much for your attention. I would be very pleased to answer any questions from members of the Committee.