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Basel 3 May 2013

Basel 3 May 2013



Basel iii Compliance Professionals Association (BiiiCPA) ...

Basel iii Compliance Professionals Association (BiiiCPA)

The Basel iii Compliance Professionals Association (BiiiCPA) is the largest association of Basel iii Professionals in the world. It is a business unit of the Basel ii Compliance Professionals Association (BCPA), which is also the largest association of Basel ii Professionals in the world.

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    Basel 3 May 2013 Basel 3 May 2013 Document Transcript

    • P a g e | 1Basel iii Compliance ProfessionalsAssociation (BiiiCPA)1200G Street NW Suite800Washington, DC 20005-6705USA Tel:202-449-9750Web: www.basel-iii-association.comDear Member,I had a difficult timein thepast to explainliquidityrisk management and ratios.Now I know what todo. Problem solved!I will use a pollution-mitigatingtechnology, likescrubbersto explain liquidityrisk.Mr. JeremyC Stein, Memberof the Board of Governorsof the Federal Reserve System explainedhow:―Supposewehave a powerplant that producesenergyand, asa byproduct, somepollution.Supposefurther that regulatorswant toreducethepollutionand have twotoolsat their disposal:Theycan mandatethe useof a pollution-mitigatingtechnology, like scrubbers, or theycanlevyatax ontheamount of pollution generatedby theplant.In an ideal world, regulation wouldaccomplishtwoobjectives.First, it wouldlead toan optimal level of mitigation– that is, it wouldinducethe plant toinstall scrubbers up tothe point wherethecostof anBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 2additional scrubber isequal to themarginal socialbenefit, in termsofreducedpollution.And, second, it wouldalsopromote conservation:Giventhat thescrubbersdon‘t get rid of pollutionentirely, onealsowantstoreduceoverall energyconsumption bymaking it more expensive.Asimplecaseis onein whichthe costsof installingscrubbers,aswell asthesocial benefits of reducedpollution, are knownin advanceby theregulator and themanager of the powerplant.In this case, the regulatorcan figure out what theright number ofscrubbersis and require that theplant install thesescrubbers.Themandate can thereforepreciselytarget the optimal amount ofmitigation per unit of energy produced.And, to the extent that the scrubbers are costly, the mandate will alsoleadto higher energy prices, which will encourage some conservation, thoughperhapsnot the sociallyoptimal level.This latter effect isthe implicit tax aspect of themandate.Amore complicatedcaseis when the regulator doesnot know ahead oftimewhat the costsof building and installingscrubberswill be.Here, mandatingtheuse of a fixednumber of scrubbers ispotentiallyproblematic:If the scrubbersturn out tobe very expensive, the regulation will end upbeingmore aggressivethansociallydesirable,leadingto overinvestmentin scrubbersand largecost increasesfor consumers;however, if thescrubbersturn out tobe cheaper than expected, theregulation will havebeen too soft.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 3In otherwords, whenthecostofthemitigationtechnologyissignificantlyuncertain, a regulatory approachthat fixesthequantityof mitigationisequivalent toone wherethe implicit tax rate bouncesaround a lot.Bycontrast, aregulatoryapproachthat fixesthepriceof pollutioninsteadof the quantity– say, by imposing a predeterminedproportional tax ratedirectlyon the amount of pollution emittedby the plant – is moreforgivingin the faceof this kind of uncertainty.This approach leaves the scrubber-installation decision to the manager ofthe plant, who can figure out what the scrubbers cost before deciding howtoproceed.For example, if thescrubbers turn out to be unexpectedlyexpensive, theplant manager can install fewer of them.This flexibilitytranslatesintolessvariabilityin theeffectiveregulatoryburden and hence lessvariabilityin the price of energy toconsumers.Scrubbers and high-quality liquid assetsWhat doesall thisimplyfor the designof the LCR?Let‘s workthrough theanalogyin detail.Theanalog to the powerplant‘senergyoutput is thegrossamount ofliquidityservicescreatedby a bank – via its deposits,thecredit linesitprovidesto itscustomers, the prime brokerage servicesit offers,and soforth.Theanalog to themitigationtechnology– the scrubbers– is the stock ofHQLA that the bank holds.And the analogto pollution is thenet liquidityriskassociated withthedifferencebetweenthesetwoquantities, somethingakin to the LCRshortfall.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 4That is,whenthebank offersalot of liquidityondemandtoitscustomersbut fails tohold an adequatebuffer of HQLA, this is whenit imposesspillover costson the rest of thefinancial system.In the caseof thepowerplant, I argued that a regulation that callsfor afixed quantityof mitigation– that is, for a fixednumber of scrubbers– ismore attractivewhenthere is littleuncertainty about thecost of thesescrubbers.‖Thank you Jeremy!I have justopenedmy master plan. I have to learn more about scrubbers.I now see other similaritiesbetweentheBISand scrubbers. Onlynow Ican understand theshapeof the BISbuilding!I think I have just found another regulatoryarbitrageopportunity. Arealnational discretion, justified.Scrubbersarecapableof reduction efficienciesin the rangeof 50% to98%. Why should theLiquidityCoverage Ratiobe 100%?Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 5ALCR from 50% to98% (meaning50,001%) is good enough!Thecalculationsin Basel and scrubbersare alsoalmost the same!Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 6Liquidity regulation and central bankingSpeechby Mr Jeremy C Stein, Member of the Boardof Governorsof theFederal Reserve System, at the―Finding theright balance‖ 2013Credit MarketsSymposium, sponsored bythe Federal ReserveBankof Richmond, Charlotte, North CarolinaI‘d like to talk todayabout one important element of the internationalregulatoryreform agenda– namely, liquidityregulation.Liquidityregulation is a relativelynew, post-crisisaddition tothefinancial stabilitytoolkit.Key elementsincludethe LiquidityCoverage Ratio (LCR), whichwasrecentlyfinalizedbythe Basel Committeeon Banking Supervision, andthe Net StableFundingRatio, whichis still a workin progress.In what follows, I will focuson the LCR.Thestated goal of the LCR is straightforward,even if some aspectsof itsdesignare lessso.In the wordsof theBasel Committee, ―Theobjectiveof theLCR is topromotetheshort-term resilienceof the liquidityrisk profile of banks.It doesthis by ensuringthat bankshavean adequatestock ofunencumberedhigh-qualityliquid assets(HQLA) that can be convertedeasilyandimmediatelyin privatemarketsintocashtomeettheir liquidityneedsfor a 30 calendar day liquiditystressscenario.‖In other words,each bank isrequired to model its total outflowsover 30days in a liquiditystressevent and then tohold HQLA sufficient toaccommodatethoseoutflows.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 7This requirement isimplemented witha ratiotest, wheremodeledoutflowsgo in thedenominator and thestock of HQLA goesin thenumerator;whentheratio equalsor exceeds100percent, therequirementis satisfied.TheBasel Committeeissued the first versionof the LCR in December2010.In January of thisyear, thecommitteeissueda revisedfinal version of theLCR, followingan endorsement byitsgoverningbody, theGroup ofGovernorsand Headsof Supervision (GHOS).Therevision expandsthe rangeof assetsthat can count asHQLA andalsoadjustssome of the assumptionsthat govern the modeling of netoutflowsin a stressscenario.In addition, thecommitteeagreed in January toa gradual phase-in of theLCR, sothat it only becomesfullyeffectiveon an international basisinJanuary 2019.On thedomesticfront, theFederal Reserve expectsthat theU.S. bankingagencieswill issuea proposal later this year toimplement theLCR forlargeU.S.bankingfirms.While thisprogressiswelcome, a number of questionsremain.First, towhat extent should accesstoliquidityfrom a central bank beallowedto count towardsatisfying theLCR?In January, the GHOS noted that theinteraction betweentheLCR andtheprovision of central bank facilitiesiscriticallyimportant.And the group instructedthe Basel Committeeto continueworkingonthisissuein 2013.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 8Second, what stepsshould be taken to enhancethe usability of the LCRbuffer – that is, toencouragebanksto actuallydraw down their HQLAbuffers,asopposed tofire-sellingother lessliquid assets?TheGHOShasalsomade clearitsview that, during periodsof stress,itwouldbe appropriatefor banksto usetheir HQLA, therebyfallingbelowtheminimum.However,creatinga regimein whichbanks voluntarilychooseto dosoisnot an easytask.Anumberofobservershaveexpressedtheconcernthat if abank isheldtoan LCR standard of 100percent in normal times,it may be reluctant toallowitsratioto drop below 100percent whenfacing largeoutflows, evenif regulatorswereto permit this temporarydeviation, for fear that adeclinein the ratiocould be interpretedasa sign of weakness.My aim hereistosketchaframeworkforthinkingabout theseandrelatedissues.Among them, theinterplay betweentheLCR and central bank liquidityprovisionisperhapsthemostfundamentalandanatural startingpoint fordiscussion.Bywayofmotivation, notethat beforethefinancialcrisis, wehadahighlydeveloped regime of capital regulationfor banks– albeit onethat looksinadequatein retrospect – but wedid not have formal regulatorystandardsfor their liquidity.Theintroduction of liquidityregulation after the crisiscan be thought ofasreflectinga desire to reducedependenceon the central bank asalender of last resort(LOLR), based on thelessonslearnedover thepreviousseveral years.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 9However,to the extent that some role for the LOLR still remains,onenow facesthe questionof how it should coexistwith a regime of liquidityregulation.Toaddressthis question, it is useful to take a step back and ask anotherone:What underlying market failure is liquidityregulation intendedtoaddress, and whycan‘t this market failurebe handledentirelyby anLOLR?I will turn to this questionfirst.Next, I will considerdifferent mechanismsthat could potentiallyachievethegoalsof liquidityregulation, and how thesemechanismsrelate tovariousfeaturesof theLCR.In sodoing, I hope toillustratewhy, even though liquidityregulation is aclosecousin of capital regulation, it neverthelesspresentsa number ofnovel challengesfor policymakers and why, asa result, weare going tohaveto be opentolearningand adaptingaswego.The case for liquidity regulationOneof theprimary economic functionsof banksand other financialintermediaries,suchasbroker-dealers,is to provide liquidity– that is,cashon demand – in variousforms totheir customers.Someof thisliquidityprovisionhappenson the liability sideof thebalancesheet, withbank demand depositsbeinga leadingexample.But, importantly, banks alsoprovide liquidityvia committed linesofcredit.Indeed, it isprobablynot acoincidencethatthesetwoproducts– demanddepositsand credit lines– are offered under the roof of the sameBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 10institution;theunderlying commonalityis that both require an abilitytoaccommodateunpredictablerequestsfor cash on short notice.Anumber of other financial intermediaryservices,such asprimebrokerage, alsoembodya significant element of liquidityprovision.Without question, theseliquidity-provisionservicesare sociallyvaluable.On the liabilityside, demand depositsand other short-term bankliabilitiesaresafe,easy-to-valueclaimsthat arewellsuitedfor transactionpurposesand hencecreatea flowof money-like benefitsfor their holders.And loancommitmentsare more efficient than an arrangement in whicheachoperatingfirm hedgesitsfutureuncertainneedsby―pre-borrowing‖andhoarding theproceedson itsown balancesheet;this latterapproachdoesa poor job of economizingon thescarce aggregate supplyof liquidassets.At thesametime, asthefinancial crisismadepainfullyclear, thebusinessof liquidityprovision inevitablyexposesfinancial intermediariestovariousforms of run risk.That is, in responsetoadverse events, their fragile funding structures,together withthe binding liquiditycommitmentstheyhavemade, canresult in rapid outflowsthat, absent central bank intervention, lead bankstofire-sellilliquid assetsor, in a more severe case,to fail altogether.And fire salesand bank failures– and theaccompanying contractionsincredit availability– can have spillover effectstoother financialinstitutionsand to the economy asa whole.Thus, while bankswill naturallyhold buffer stocksof liquid assetstohandleunanticipatedoutflows, theymay not hold enough because,although theybear all thecostsof this buffer stocking, theydonotcapture all of thesocial benefits, in termsof enhancedfinancial stabilityand lowercoststotaxpayers in the event of failure.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 11It is this externalitythat createsa role for policy.Therearetwobroadtypesof policytoolsavailabletodeal withthissortofliquidity-basedmarket failure.Thefirst isafter-the-fact intervention, either by a deposit insurerguaranteeingsome of thebank‘sliabilitiesor by a central bank actingasan LOLR.Thesecond type isliquidityregulation.As an exampleof theformer, whenthe economy isin a bad state,assumingthat aparticularbank isnot insolvent, thecentralbank canlendagainst illiquidassetsthat wouldotherwisebefire-sold,therebydampingor eliminatingthe run dynamics and helpingreducetheincidenceof bankfailure.In much of theliteratureon banking, such interventionsare seen astheprimarymethod for dealing withrun-likeliquidityproblems.Aclassicstatement of the central bank‘srole asan LOLR is WalterBagehot‘s1873book Lombard Street.Morerecently, the seminal theoretical treatment of this issueis byDouglasDiamond and Philip Dybvig, whoshowthat under certaincircumstances, the useof deposit insuranceor an LOLR can eliminaterun risk altogether, therebyincreasingsocial welfareat zero cost.Tobeclear, thisworkassumesthat thebank in questionisfundamentallysolvent, meaning that whileitsassetsmay not be liquid on short notice,thelong-run valueof these assetsisknownwithcertaintyto exceed thevalueof thebank‘sliabilities.Onewaytointerpret themessageof this research is that capitalregulation is important toensuresolvency, but oncea reliableregime ofBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 12capital regulation is in place, liquidityproblemscan bedealt withafter thefact, via somecombinationofdepositinsuranceanduseof theLOLR.It followsthat if one is goingto make an argument in favor of addingpreventativeliquidityregulationsuch asthe LCR on top of capitalregulation, a central premisemust be that the use of LOLR capacityin acrisisscenario is sociallycostly, sothat it is an explicit objectiveof policytoeconomize on itsusein such circumstances.I think this premiseis a sensibleone.Akey point in this regard – and one that hasbeen reinforcedby theexperienceof thepast several years – is that the linebetweenilliquidityand insolvencyisfar blurrier in real life than it is sometimesassumed tobein theory.Indeed, one might argue that a bank or broker dealer that experiencesaliquiditycrunch must havesomeprobability of havingsolvencyproblemsaswell;otherwise,it is hard tosee whyit could not attract short-termfundingfrom the private market.This reasoningimplies that when thecentral bank actsasan LOLR in acrisis, it necessarilytakesonsome amount of credit risk.And if it experienceslosses,theselossesultimatelyfall ontheshouldersoftaxpayers.Moreover,theuseof an LOLR to support banks whentheyget intotroublecan lead tomoral hazard problems, in thesensethat banksmaybelessprudent ex ante.If it werenot for thesecostsof usingLOLR capacity, the problem wouldbe trivial, and there wouldbenoneed for liquidityregulation:Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 13Assuming a well-functioningcapital-regulationregime, the central bankcouldalwaysavert all firesalesand bank failuresexpost, simplybyactingasan LOLR.This observation carries an immediate implication:It makes no senseto allowunpriced accessto thecentral bank‘sLOLRcapacityto count toward an LCR requirement.Again, the wholepoint of liquidityregulation must be either toconserveon theuseof the LOLR or in the limit, to addresssituationswheretheLOLR is not availableat all – as, for example, in the caseofbroker-dealersin theUnitedStates.At thesametime, it isimportant todraw adistinctionbetweenpriced andunpriced accessto the LOLR.For example, takethecaseofAustralia, whereprudent fiscal policyhasledto a relatively small stock of government debt outstandingand hencetoa potential shortageof HQLA.TheBasel Committeehasagreed totheusebyAustralia of a CommittedLiquidityFacility (CLF), wherebyanAustralianbank canpaytheReserveBank ofAustralia an upfront fee for what is effectivelya loancommitment, and this loan commitment can then be countedtowarditsHQLA.In contrast to free accesstotheLOLR, this approachisnot at oddswiththegoalsof liquidityregulationbecausetheup-front feeis effectively atax that servestodeter relianceon the LOLR – which, again, is preciselytheultimategoal.I will return tothe ideaof a CLF shortly.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 14Thedesign of regulationOnceit hasbeen decided that liquidityregulationis desirable, thenextquestion ishow best toimplement it.In this context, notethat the LCR hastwologicallydistinct aspectsasaregulatorytool:It is a mitigator, in thesense that holding liquid assetsleadstoa betteroutcome if there is a bad shock; it is alsoan implicit tax on liquidityprovision by banks, tothe extent that holdingliquidassetsiscostly.Of course,one can say somethingbroadlysimilar about capitalrequirements.But the implicit tax associated withtheLCR is subtler and lesswellunderstood, soI will go intosome detail here.An analogymay help to explain.Supposewehaveapowerplant that producesenergyand, asabyproduct,somepollution.Supposefurtherthat regulatorswant toreducethepollutionandhavetwotoolsat their disposal:Theycan mandatethe useof a pollution-mitigatingtechnology, likescrubbers,or theycan levya tax on theamount of pollution generatedbythe plant.In an ideal world, regulation wouldaccomplish twoobjectives.First, it wouldlead toan optimal level of mitigation– that is, it wouldinducethe plant toinstall scrubbers up tothe point wherethecostof anadditional scrubber isequal to themarginal socialbenefit, in termsofreducedpollution.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 15And, second, it wouldalsopromote conservation:Giventhat thescrubbersdon‘t get rid of pollutionentirely, onealsowantstoreduceoverall energyconsumption bymaking it more expensive.Asimplecaseis onein whichthe costsof installingscrubbers,aswellasthesocial benefits of reducedpollution, are knownin advanceby theregulator and themanager of the powerplant.In this case, the regulatorcan figure out what theright number ofscrubbersis and require that theplant install thesescrubbers.Themandate can thereforepreciselytarget the optimal amount ofmitigation per unit of energy produced.And, to the extent that the scrubbers are costly, the mandate will alsoleadto higher energy prices, which will encourage some conservation, thoughperhapsnot the sociallyoptimal level.This latter effect isthe implicit tax aspect of themandate.Amore complicatedcaseis when the regulator doesnot know ahead oftimewhat the costsof buildingand installingscrubberswill be.Here, mandatingtheuse of a fixednumber of scrubbers ispotentiallyproblematic:If the scrubbersturn out tobe very expensive, the regulation will end upbeingmore aggressivethansociallydesirable,leadingto overinvestmentin scrubbersand largecostincreasesfor consumers;however, if thescrubbersturn out tobe cheaper than expected, the regulationwill havebeen too soft.In otherwords, whenthecostofthemitigationtechnologyissignificantlyuncertain, a regulatory approachthat fixesthe quantityof mitigationisequivalent toone wherethe implicit tax rate bouncesaround a lot.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 16Bycontrast, aregulatoryapproachthat fixesthepriceof pollutioninsteadof the quantity– say, by imposing a predeterminedproportional tax ratedirectlyon the amount of pollution emittedby the plant – is moreforgivingin the faceof this kind of uncertainty.This approach leaves the scrubber-installation decision to the manager ofthe plant, who can figure out what the scrubbers cost before deciding howtoproceed.For example, if thescrubbers turn out to be unexpectedlyexpensive, theplant manager can install fewer of them.This flexibilitytranslatesintolessvariabilityin theeffectiveregulatoryburden and hence lessvariabilityin the price of energy toconsumers.Scrubbers and high-quality liquid assetsWhat doesall thisimplyfor the designof the LCR?Let‘s workthrough theanalogyin detail.Theanalogto the powerplant‘s energyoutput is the grossamount ofliquidityservicescreatedby a bank – via its deposits,thecredit linesitprovidesto itscustomers, the prime brokerage servicesit offers,and soforth.Theanalog to themitigationtechnology– the scrubbers– is the stock ofHQLA that the bank holds.And the analogto pollution is thenet liquidityriskassociated withthedifferencebetweenthesetwoquantities, somethingakin to the LCRshortfall.That is,whenthebank offersalot of liquidityondemand toitscustomersbut fails tohold an adequatebuffer of HQLA, this is whenit imposesspillover costson the rest of thefinancial system.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 17In the caseof thepowerplant, I argued that a regulation that callsfor afixed quantity of mitigation– that is, for a fixednumber of scrubbers– ismore attractivewhenthere is littleuncertainty about the costof thesescrubbers.In the context of the LCR, the cost of mitigation is the premium that thebank must pay – in the form of reduced interest income – for itsstock ofHQLA.And, crucially, this HQLA premium is determined in market equilibriumand dependson the total supplyof safe assetsin the system, relative tothedemand for thoseassets.On the onehand, if safeHQLA-eligibleassetsare in ample supply, thepremium is likelytobe low and stable.On the other hand, if HQLA-eligible assetsare scarce, thepremium willbeboth higher and more volatile over time.This latter situation is the one facing countrieslike Australia, where, as Inoted earlier, the stock of outstanding government securities is relativelysmall.And it explainswhy, for such countries,havinga price-basedmechanismaspart of their implementationof the LCR can be more appealingthanpure relianceon a quantitymandate.When one sets an up-front fee for a CLF, one effectively caps the implicittax associated with liquidity regulation at the level of the commitment feeand tamps down the undesirable volatility that would otherwise arise froman entirelyquantity-based regime.Moreover,it bearsreemphasizingthat havinga CLF withanup-front feeis very different from simplyallowingbankstocount central - bank -eligiblecollateral asHQLA at no charge.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 18Rather, the CLF is like the pollution tax.For every dollar of pre-CLF shortfall – that is, for every dollar of requiredliquidity that a bank can‘t obtain on the private market – the bank has topaythe commitment fee.Soeven if there isnot asmuch mitigation, thereis still an incentiveforconservation, in thesensethat banks areencouragedto dolessliquidityprovision, all elsebeing equal.This wouldnot be thecaseif the CLF wereavailableat a zeroprice.What about the situation in countrieswheresafeassetsaremoreplentiful?Theanalysis here hasa number of moving parts becausein addition totheimplementationof the LCR, substantial increasesin demand for safeassetswill arise from new margin requirementsfor both clearedandnonclearedderivatives.Nevertheless,giventhelargeandgrowingglobalsupplyofsovereigndebtsecurities,aswellasother HQLA-eligibleassets,most estimatessuggestthat the scarcityproblem should be manageable, at least for theforeseeablefuture.In particular, quantitativeimpact studiesreleasedby the BaselCommitteeestimatethat the worldwide incremental demand for HQLAcomingfrom both the implementationof the LCR and swapmarginrequirementsmight be on the order of $3 trillion.This is a largenumber, but it compareswith a global supplyofHQLA-eligibleassetsof more than $40trillion.Moreover,the eligiblecollateral for swapmargin is proposedtobebroader than theLCR‘s definition of HQLA – including, for example,certain equitiesand corporatebondswithout any cap.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 19If one focusesjust on U.S.institutions,theincremental demand numberis on the order of $1trillion, while the sum of Treasury, agency, andagencymortgage-backedsecuritiesis more than $19trillion.While this sort of analysisissuperficiallyreassuring, thefact remainsthattheHQLA premium will depend on market-equilibrium considerationsthat are hard to fullyfathom in advance, and that are likely tovary overtime.This uncertaintyneedsto beunderstood, and respected.Indeed, themarket-equilibriumaspect of theproblemrepresentsacrucialdistinctionbetweencapital regulationand liquidityregulation, and it isonereasonwhythelatter isparticularly challengingtoimplement.Although capital regulationalsoimposesa tax on banks – tothe extentthat equityisamore expensiveform of financethandebt – thistax wedgeis,toafirstapproximation, afixed constant foragivenbank, independentof the scaleof overall financial intermediation activity.If Bank Adecidestoissuemore equitysoit can expand itslendingbusiness,this need not make it more expensivefor Bank B tosatisfyitscapital requirement.In other words,thereis noscarcityproblem withrespect to bank equity –bothAand B can alwaysmake more.Bycontrast, thetotal supplyof HQLA isclosertobeingfixedat anypointin time.Policy implicationsWhat doesall of this implyfor policydesign?First, at a broadphilosophical level, the recognitionthat liquidityregulation involvesmore uncertaintyabout coststhancapital regulationsuggeststhat even apolicymaker witha very strict attitudetowardcapitalBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 20might find it sensibleto besomewhat more moderate and flexiblewithrespect toliquidity.This point is reinforced by the observationthat whenan institutionisshort of capitalandcan‘t get moreontheprivatemarket, thereisreallynobackup plan, short of resolution.By contrast, asI mentioned earlier, whenan institution isshort ofliquidity, policymakers do have a backup plan in the form of theLOLRfacility.Onedoesnot want torelytoomuch on that backup plan, but itspresenceshould neverthelessfactor intothedesign of liquidityregulation.Second, in thespirit of flexibility, while aprice-basedmechanism such astheCLF may not beimmediatelynecessaryin countriesoutsideofAustralia and a few others,it is worthkeepingan open mind about themore widespreaduse of CLF-like mechanisms.If a scarcityof HQLA-eligible assetsturnsout tobe more of a problemthan weexpect, somethingalong thoselineshasthepotential to be auseful safetyvalve, asit putsa cap on thecostof liquidityregulation.Such a safety valvewouldhave a direct economicbenefit, in thesenseofpreventingtheburdenof regulationfrom gettingundulyheavyin anyonecountry.Perhapsjust asimportant, a safetyvalvemight alsohelp to protect theintegrityof the regulation itself, by harmonizingcostsacrosscountriesandtherebyreducingthetemptationofthosemosthard-hit bytherulestotry tochip awayat them.Without suchasafetyvalve, it ispossiblethat somecountries– thosewithrelativelysmall suppliesof domestic HQLA – will find the regulationconsiderably more costlythan others.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 21If so, it wouldbenatural for them to lobbyto dilutetherules– forexample, by arguingfor an expansion in thetype of assetsthat can countasHQLA.Taken toofar, this sort of dilution wouldunderminethe efficacyof theregulation asboth amitigatorand a tax.In this scenario, holdingthe linewithwhat amountstoa proportional taxon liquidityprovision wouldbe a better outcome.Onesituation whereliquid assetscan becomeunusuallyscarceis duringa financial crisis.Consequently, evenif CLFs werenot counted towardtheLCR in normaltimes,it might be appropriatetocount them during a crisis.Indeed, while theLCR requires banks tohold sufficient liquid assetsingood timestomeet their outflowsin a givenstressscenario, it implicitlyrecognizesthat if thingsturn out even worsethanthat scenario, centralbank liquiditysupport will be needed.AllowingCLFs tocount toward theLCR in such circumstanceswouldacknowledgethe importanceof accesstothecentral bank, and thisaccesscould be priced accordingly.Finally, a price-based mechanism might alsohelp promote a willingnessof banksto draw down their supplyof HQLA in a stressscenario.As I noted at the outset, one important concern about a pure quantity-based system of regulation isthat if a bank is held toan LCR standardof100percent in normal times,it may be reluctant toallowitsratio tofallbelow 100percent whenfacinglargeoutflowsfor fear that doing somightbeseenby market participantsasa sign of weakness.By contrast, in a system withsomethinglike a CLF, a bank might innormal timesmeet 95 percent of itsrequirement by holdingBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 22private-market HQLAandtheremaining5percent withcommittedcreditlinesfrom thecentral bank, soit wouldhavean LCR of exactly100percent.Then, when hit withlargeoutflows, it could maintain its LCR at 100percent, but dosoby increasingits useof central bank credit linesto25percent and selling20 percent of itsother liquid assets.This scenariowouldbe the sort of liquid-asset drawdownthat one wouldideallylike to seein a stresssituation.Moreover, the central bank could encourage this drawdown by varyingthe pricing of its credit lines – specifically, by reducing the price of thelinesin the midst of a liquiditycrisis.Such an approach wouldamount totaxingliquidityprovision more ingood timesthan in bad, whichhasa stabilizing macroprudential effect.Thisexamplealsosuggestsadesignthat mayhaveappealinjurisdictionswherethere is a relatively abundant supplyof HQLA-eligible assets.Onecan imagine calibratingthe pricingof the CLF soasto ensure thatlinesprovidedbycentralbanksmakeuponlyaminimal fractionofbanks‘requiredHQLA in normal times– apart, perhaps,from the occasionaladjustment periodafter an individual bank is hit withan idiosyncraticliquidityshortfall.At the same time, in a stressscenario, when liquidityisscarce and there isupward pressure on the HQLA premium, the pricing of the CLF could beadjusted so as to relieve this pressure and promote usability of the HQLAbuffer.Such an approach would respect the policyobjective of reducing expectedreliance on the LOLR while at the same time allowing for a safety valve ina period of stress.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 23Thelimit caseof thisapproach is one wheretheCLF countstowardtheLCR onlyin a crisis.ConclusionBywayofconclusion, letmejustrestatethat liquidityregulationhasakeyroleto playin improving financial stability.However,weshould avoid thinkingabout it in isolation;rather, wecanbest understand it aspart of a larger toolkit that alsoincludescapitalregulation and, importantly, thecentral bank‘sLOLR function.Therefore, proper design and implementation of liquidityregulationssuch asthe LCR should takeaccount of theseinterdependencies.In particular, policymakers should aim tostrike a balancebetweenreducingrelianceontheLOLR ontheonehandandmoderatingthecostscreated by liquidityshortageson the other hand – especiallythoseshortagesthat crop up in timesof severe market strain.And, asalways, weshould bepreparedtolearnfrom experienceaswego.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 24Basel III Capital: AWell-Intended IllusionThomasM. HoenigVice Chairman, Federal Deposit InsuranceCorporationInternationalAssociation of Deposit Insurers2013Research Conference, Basel, SwitzerlandIntroductionAristotle is creditedwith being thefirst philosophertosystematicallystudylogical fallacies,whichhe definedasargumentsthat appear validbut, in fact, arenot.I call them well-intendedillusions.Onesuch illusion of precision is the Basel capital standardsin whichworldsupervisory authoritiesrely principallyon a Tier 1capital ratiotojudgethe adequacyof bank capital and balance sheet strength.For the largest of thesefirms, each dollar of risk-weighted assetsis fundedwith 12to15cents in equitycapital, projecting the illusion that thesefirmsare wellcapitalized.Thereality isthat each dollar of their total assetsis funded withfar lessequitycapital, leavingopenthematter of how wellcapitalizedtheymightbe.Here‘show theillusionis created.BaselsTier 1capital measure is a banks ratio of Tier 1capital torisk-weightedassets.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 25Each category of bank assets is weighed by the supervisory authority on acomplicated scale of probabilitiesand models that assign a relative risk oflossto each group, includingoff balancesheet items.Assetsdeemed lowrisk are reported at loweramountson thebalancesheet.Thelowertherisk,thelowertheamount reported onthebalancesheet forcapital purposesand thehigher the calculatedTier 1ratio.We know from years of experience using the Baselcapital standardsthatoncethe regulatory authorities finish their weightingscheme, bankmanagersbegin theprocessof allocatingcapital and assetstomaximizefinancial returns around these constructedweights.Theobjectiveis tomaximize a firmsreturn on equity(ROE) bymanagingthe balancesheet in such a manner that for anylevel of equity,therisk-weightedassetsare reported at levelsfar lessthan actual totalassetsunder management.Thiscreatestheillusionthatbankingorganizationshaveadequatecapitaltoabsorbunexpected losses.For thelargest global financial companies,risk-weightedassetsareapproximatelyone-half of total assets.This "leveragingup" hasserved worldeconomiespoorly.In contrast, supervisorsand financial firmscan choosetorely on thetangibleleverageratio tojudgethe overall adequacyof capital for theenterprise.This ratiocomparesequitycapital to total assets,deductinggoodwill,other intangibles,and deferred tax assetsfrom both equity and totalassets.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 26In additiontoincludingonly loss-absorbingcapital, it alsomakesnoattempt to predict or assign relativerisk weightsamong asset classes.Usingthisleverageratioasour guide, wefind for thelargest bankingorganizationsthat each dollar of assetshasonly4 to 6centsfundedwithtangibleequitycapital, a far smallerbuffer than asserted under the Baselstandards.Comparing MeasuresTable1reportstheBasel Tier 1risk-weightedcapital ratio and theleverageratiofor different classesof banking firms.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 27Column 4 showsTier 1capital ratiosrangingbetween12 and 15percentfor the largest global firms, giving theimpression that thesebanksarehighly capitalized.However,it is hard tobe certain of that by lookingat thisratiosincerisk-weightedassetsaresomuch lessthan total assets.In contrast, Column 6 showsU.S.firms averageleverageratiotobe 6percent using generallyacceptedaccountingstandards(GAAP), andColumn 8 showstheir averageratioto be3.9percent using internationalaccountingstandards(IFRS), whichplacesmore of thesefirmsderivativesonto thebalancesheet than doesGAAP.Thebottom portionof Table1showsthe degreeof leverageamongdifferent size groupsof banking firms, whichis striking aswell.TheTier 1capital measuresuggeststhat all size groupsof banks holdcomparable capital levels,while the leverageratioreports a differentoutcome.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 28For example, the leverageratiofor most bankinggroupsnot consideredsystemicallyimportant averagesnear 8 percent or higher.Under GAAP accounting standards, the difference in this ratio betweenthe largest banking organizations and the smaller firms is 175-250 basispoints.Under IFRSstandards, thedifferenceisasmuch as400-475basispoints.Thelargest firms, whichmost affect theeconomy, hold the least amountof capital in the industry.While thisshowsthem tobe more fragile, it alsoidentifies just howsignificant a competitiveadvantagethese lowercapital levelsprovidethelargestfirms.Thesecomparisonsillustratehow easily the Baselcapital standard canconfuseand misinform the public rather than meaningfullyreport abankingcompany‘srelativefinancial strength.Recent history showsalsojusthow damagingthiscan be totheindustryandtheeconomy.In 2007, for example, the10 largest and most complex U.S.bankingfirmsreported Tier 1capital ratiosthat, on average, exceeded 7 percent ofrisk-weightedassets.Regulatorsdeemed theselargest to be well capitalized.This risk-weightedcapital measure, however,mapped intoan averageleverageratioof just 2.8percent.We learned all toolatethat having lessthan 3 centsof tangiblecapital forevery dollar of assetson thebalancesheet is not enough to absorbeventhesmallest of financial losses,and certainlynot a major shock.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 29With the crisis, the illusion of adequate capital wasdiscovered, afterhavingmisled shareholders,regulators,and taxpayers.There are other, more recent, examples of how this arcane measure canbe manipulated to give the illusion of strength even when a firm incurslosses.For example, in thefourthquarter of 2012, DeutscheBank reported a lossof 2.5 billion EUR.That same quarter, its Tier 1risk-basedcapital ratioincreasedfrom 14.2percent to15.1percent due, in part, to ―model and processenhancements‖ that resultedin a declinein risk-weightedassets, whichnowamount to just16.6 percent of total assets.On Feb. 1, SNSReaal, the fourth largest Dutch bank with$5billion inassets,wasnationalized by the Dutch government.Just seven monthsearlier, on June 30, 2012,SNSreported a Tier 1risk-basedcapital ratio of 12.2 percent.However,the firm reported a Tier 1leverageratiobased uponinternational accountingstandardsof only1.47percent.This leverageratiowasmuch more indicativeof the SNS‘spoor financialposition.TheBasel III proposal belatedlyintroducestheconcept of a leverageratio but callsfor it tobe only 3 percent, an amount alreadyshown to beinsufficient toabsorb sizablefinancial lossesin a crisis.It iswrongtosuggest tothepublic that, withsolittlecapital, theselargestfirmscould survive without public support should theyencounter anysignificant economicreversals.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 30Misallocating Resourcesand CreatingAsset ImbalancesAn inherent problem with a risk-weighted capital standard is that theweights reflect past events, are static, and mostly ignore the marketscollectivedaily judgment about the relativerisk of assets.It alsointroducestheelement of political and special interestsintotheprocess, whichaffectstheassignment ofriskweightstothedifferent assetclasses.Theresult is oftentoartificiallyfavor onegroup of assetsover another,therebyredirectinginvestmentsand encouragingover-investment in thefavoredassets.Theeffect of thismanagedprocessisto increaseleverage, raisetheoverall risk profile of theseinstitutions,and increasethevulnerabilityofindividual companies, the industry, and the economy.It is no coincidence,for example, that after a Basel standard assignedonlya 7 percent risk weight ontripleA, collateralizeddebt obligationsand similar lowrisk weightson assetswithina firmstradingbook,resourcesshiftedtotheseactivities.Overtime, financial groupsdramaticallyleveragedtheseassetsontotheirbalancesheetsevenasthe risksto that asset classincreasedexponentially.Similarly, assigningzero weightstosovereign debt encouragedbankingfirmsto invest more heavily in theseassets, simultaneouslydiscountingtherealrisk theypresentedand playing animportant rolein increasingit.In placing a lowerrisk weight on select assets,lesscapital wasallocatedtofundthemandtoabsorbunexpectedlossforthesebanks,underminingtheir solvency.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 31AMore Realistic Capital Standard Is RequiredTaxpayersaretheultimatebackstoptothesafetynetandhaverealmoneyat stake.In choosingwhichcapital measure is most useful, it is fair toaskthefollowingquestions:- Doesthe BaselTier 1ratio or the tangibleleverageratiobest indicatethecapital strengthof the firm?- Whichone is most clearlyunderstood?- Whichone best enablescomparison of capital acrossinstitutions?-Whichone offersthemost confidencethat it cannot be easily gamed?Charts 1through 4compare the relationship of the tangibleleverageandBaselTier1capitalratiostovariousmarketmeasuresforthelargestfirms.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 32Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 33Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 34Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 35Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 36Thesemeasuresinclude:theprice-to-book ratio, estimated defaultfrequency, credit default swapspreads, and market value of equity.In each instance, thecorrelationof thetangibleleverageratioto thesevariablesis higher than for the risk-weightedcapital ratio.While such findingsare not conclusive, theysuggest stronglythatinvestors,whendecidingwhereto placetheir money, rely upon theinformation provided by the leverageratio.We woulddowellto do thesame.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 37Despiteall of theadvancementsmadeover theyearsin riskmeasurementandmodeling, it isimpossibleto predict thefuture or to reliablyanticipatehow and towhat degreeriskswill change.Capital standardsshould serve to cushion against theunexpected, not todivineeventualities.All of the Baselcapital accords, includingtheproposedBasel III, lookbackwardand then attempt to assign risk weightsintothe future.It doesnt work.In contrast, the tangible leverage ratio provides a simpler, more directinsight into the amount of loss-absorbing capital that is available to afirm.Aleverageratio asI‘ve definedit explicitlyexcludesintangibleitemsthatcannot absorb lossesin a crisis.Also, using IFRSaccounting rules, off-balancesheet derivativesarebrought ontothe balancesheet, providingfurtherinsight intoa firmsleverage.Thus, thetangibleleverageratiois simpler tocomputeand more easilyunderstood by bank managers,directors, and thepublic.Importantlyalso,it ismore likely tobe consistentlyenforcedby banksupervisors.Amore difficult challengemay be todetermine an appropriateminimumleverageratio.Chart 5providesa historyof bank leverageover thepast 150years for theU.S. banking system and givesinitial insight intothisquestion.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 38It showsthat the equitycapital to assetsratiofor the industryprior to thefounding of the Federal Reserve System in 1913and the Federal DepositInsuranceCorporation in 1933ranged between13 and 16 percent,regardless of bank size.Without any internationally dictated standard or any arcane weightingprocess, markets required what today seems like relatively high capitallevels.In addition, thereis an increasingbodyof research(Admati and Hellwig;Haldane;Miles,Yang, and Marcheggiano) that suggeststhat leverageratios should be much higher than theycurrentlyare and that BaselIII‘sproposed 3percent figure addslittlesecurity to thesystem.Finally, and importantly, some form of risk-weightedcapital measurecouldbe useful asabackstop, or check, against whichto judgetheadequacyof theleverageratiofor individual banks.If a bank meets the minimum leverage ratio but has concentrated assetsin areas that risk models suggest increase the overall vulnerability of thebalance sheet, the bank could be required to increase its tangible capitallevels.Such a system providesthemost comprehensivemeasure of capitaladequacyboth in a broad context of all assetsand accordingto a banksallocationof assetsalonga definedrisk profile.Tangible Leverage Ratio and the Myth of UnintendedConsequencesConcernsareoften raisedwithinthefinancialindustryandelsewherethatrequiringthelargest and most complex firms tohold higher levelsofcapital asdefined usinga tangibleleverageratiowouldhaveseriousadverseeffectson theindustry and broader economy.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 39It hasbeen suggested, for example, that requiring more capital for theselargestbankswouldraisetheir relativecost of capital and make them lesscompetitive.Similarly, there is concern that failingto assign riskweightstothedifferent categoriesof assetswouldencourage firms toallocatefundstothehighest riskassetsto achievetargeted returnstoequity.Theseissueshave been well addressed byAnat Admati and MartinHellwig in their recentlypublishedbook, The Bankers‘New Clothes.Therequired ROE and the abilityto attract capital are determinedby ahost of factorsbeyond the level of equitycapital.Theseinclude a firm‘sbusinessmodel, itsrisk-adjustedreturns, thebenefitsof servicesand investments, and theundistorted, ornon-subsidized, costsof capital.Alevel of capital that lowersrisk may very well attract investorsdrawn tothemore reliablereturns.Table1showsmany of the bankswithstrongerleverageratiosalsohavestockpricestradingat a higher premium tobook valuethan the largestfirmsthat are lesswell-capitalized.There alsois a concern that requiringa stronger, simpler leverageratiowouldcausemanagers to placemore risk on their balancesheet.While possible, the argument isunconvincing.With more capital at risk and without regulatory weightingschemesaffectingchoice, managers will allocatecapital in linewithmarket riskand returns.Furthermore,risk-weightedmeasuresandstrongbank supervisioncanbeavailableasa back-up system tomonitor such activity.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 40Moreover,given theexperienceof therecent crisisand the on-goingeffortsto manage reported risk assetsdown, no matter the risk, it ringshollowto suggest that having a higher equitybuffer for the same amountof total assetsmakesthe financial system lesssafe.In addition, there isa concern that demanding more equitycapital andreducingleverageamong thelargest firms wouldinhibit thegrowthofcredit and the economy.This statement hasan implied presumptionthat the Basel weightingschemeismore growthfriendlythan a simpler, stronger leverageratio.However,having a sufficient capital buffer allowsbanks to absorbunexpected losses.Thisservestomoderate thebusinesscycleandthedeclineinlendingthatotherwiseoccursduring contractions.If the Basel risk-weight schemesare incorrect, whichthey oftenhavebeen, this toocould inhibit loangrowth, asit encouragesinvestmentsinother more favorably, but incorrectly, weightedassets.Basel systematically encouragesinvestmentsin sectorspre-assignedlowerweights-- for example, mortgages, sovereign debt, and derivatives-- and discouragesloanstoassetsassignedhigher weights-- commercialand industrial loans.We may have inadvertently created a system that discourages the veryloan growth we seek, and instead turned our financial system into onethat rewardsitselfmore than it supportseconomicactivity.If risk weightscould be assigned that anticipateand calibraterisks withperfect foresight, adjusted on a daily basis,then perhapsrisk-weightedcapital standardswouldbe the preferred method for determininghow todeploycapital.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 41However,they cannot.Tobelieve theycan isa fallacythat putsthe entire economic system atrisk.Changing the DebateThetangibleleverageratiois a superior alternativeto risk-weightingschemesthat haveproven tobean illusionof precisionand insufficient indefiningadequatecapital.Theeffect of relying on suchmeasureshasbeen toweakenthe financialsystem and misallocate resources.Theleverageratio deservesseriousconsiderationasthe principal tool injudgingthe capital strength of financial firms.TheBasel discussion wouldbe well served to focuson the appropriatelevelsof tangiblecapitalfor bankingfirmstohold and theright transitionperiod to achievetheselevels.Finally, weshould not accept even comfortingerrorsof logic whichsuggest that BaselIII requirementswill createstronger capital than thoseof Basel II, whichfailed.Instead, past industryperformanceand mountingacademicand otherevidencesuggest that wewouldbebest served to focuson a strongleverageratiostandard in judginga firm and theindustrys financialstrength.No bank capital program is perfect.Our responsibility asregulatorsand deposit insurersis tochoosethebestavailablemeasure that will contributeto financial stability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 42Note:ThomasM. Hoenig wasconfirmedbytheSenateasViceChairman oftheFederal Deposit InsuranceCorporation on Nov. 15, 2012.He joinedtheFDIC onApril 16, 2012,asa member of the FDIC Board ofDirectorsfor a six-year term.He isamember of theexecutiveboard of theInternationalAssociationofDeposit Insurers.Prior toservingon the FDIC board, Mr. Hoenig wasthe President of theFederal Reserve Bank of KansasCity and a member of the FederalReserveSystems Federal Open MarketCommittee from 1991to2011. Mr.Hoenig waswiththe Federal Reserve for 38years, beginningasaneconomistand then asa senior officer in banking supervision during theU.S. banking crisisof the 1980s.In 1986, he led theKansasCity Federal Reserve BanksDivision of BankSupervisionand Structure, directingtheoversight of more than 1,000banksand bank holdingcompanies withassetsranging from lessthan$100million to $20billion.He became President of theKansasCityFederal Reserve Bank onOctober 1,1991.Mr. Hoenig is a nativeof Fort Madison, Iowa. He receiveda doctorateineconomicsfrom IowaStateUniversity.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 43―A comfortable position for German banks‖TheBundesbank currentlyseesno signswhatsoeverof a credit shortage or a tighteningoflendingstandardsin Germany.―Germanbanksare in a pretty comfortableposition at themoment.By and large, neither their liquiditynor their capital situation are causingthem any problems,‖DeputyPresident Sabine Lautenschlägersaidearlierthisweek at the InternationalerClub Frankfurter Wirtschaftjournalisten(International club of Frankfurt-basedbusinessjournalists).What is more, bankswerebenefiting from their strongindustrial andSME customer base.―Germanbanksfurther improved their resiliencein 2012,‖ MsLautenschlägerexplained, referring to theresultsof the Basel III impactstudypublished sometimeago.This study looked at how the sampleof bankswouldhave faredif BaselIII had already been fullyphased in asat thecut-off date.Theimpact studyrevealsthat the capitalshortfall of the eight largeGermanbankshasdecreasedby€15billion, or30%, ascomparedwiththelast cut-off date.Another gratifying outcome of thestudyis that, on average, the 33participatingGerman institutionsalreadymeet the future minimum ratioof 4.5% for core tier 1capital.SabineLautenschlägercommented that this trend had continued ―withthesameintensity‖ in the second half of 2012,withbanks raisingcapitalin thetensof billions.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 44Challengesfacing banksin the futureThe ability of banks to carry on generating sufficient income on a highercost basewasa key factor in deciding whether their businessmodelsweresustainableover thelongrun, MsLautenschlägerexplained.Persistentlylow interestratesand the fierce competition among banksweredragging on earnings.―Theweakearningstrend will presenta major challengefor banksandsupervisorsalike,‖ the DeputyPresident added.Ms Lautenschlägerstruck a positivetone over the scheduledglobalimplementationof BaselIII and said sheexpectedtheother majorfinancial centresto followsuit.―Onlythen will Basel III be able to fulfil its protectivefunction andprovidea suitableresponsetothe 2008financial crisis.‖Appropriate supervisionand resolutionmechanismsfor bankswithaninternational focusnecessitatedgreater coordination and improvedcooperation.Specialarrangementsat thenationallevel wouldbeabreedinggroundforrisksto financial stability, MsLautenschlägerremarked.Banking union – questions still unansweredSabineLautenschlägersaid that many questionsstill remainedunanswered over theestablishment of thesingleEuropean supervisorymechanism.Most notably, a clear set of rulesgoverning the cooperation betweennational supervisorsand theECB wouldhave to be drawnup.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 45Developing a common approach to supervision, building up appropriatereporting procedures and recruiting staff were tasks that would certainlykeepsupervisorsbusyover thenext few months.But, MsLautenschläger added, there wasonethingthat supervisorscould not change, that beingthe legal basis.Alegal framework for bank supervisorsthat allowedmonetary policy tobestrictlysegregated from supervisory dutieswassomethingthat onlyEU governmentsand parliamentscould create.―This is a processthat will probablytake years. But I believe the effortwill be worthwhile,‖ shetold journalists.Ms Lautenschlägeralsospokeout in favour of a singleEuropeanresolutionmechanism.It did not make senseto overseebanksat the European level whileleavingtheir resolution to national authorities.Asingleresolution mechanism should allowa largebank toberestructuredand resolved without seriously jeopardisingfinancialstability, she added.At the same time, it had tobe guaranteed that anyresultinglosseswouldbefairlydistributedaccordingto sourceand responsibility.―If investorsreceivea premium for risk, theyshould alsobe prepared tobear the risk itself.Taxpayers should be left out of the equation altogether, wherepossible.‖Legacyrisks should not be redistributedLegacyrisks– that is, financial risksthat aroseat national banks on thewatchof national supervisors– should, however, be borneby thoseBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 46responsiblefor them and not be mutualised, MsLautenschläger pointedout.And there wasalsothe question of whetherthe lossesresultingfromfuturerisks should beshouldered solely at the European level. Afterall, banks‘balancesheetsalsoreflecteda largenumber of nationalfactorssuch astaxesor economic policymeasures.―As long aseconomicand fiscalpoliciesare not coordinated, it mightmake sensefor liabilityrisksto be divided betweenthe national andEuropean levels,‖ sheconcluded.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 47Remarks by the SuperintendentJulie Dickson,Office of the Superintendent ofFinancial Institutions Canada (OSFI)tothe 2013Financial ServicesInvitational Forum, Cambridge, OntarioIntroductionOSFI recentlyreleaseditsPlan and Prioritiesfor 2013-2016,and tonight Iam goingtohighlight and discussa few of our key prioritiesand whywechosethem: specificallyour focuson theincreasedthreat of cyber attacks;lowinterestrates (includingreal estatelending);and governanceand riskappetite.Cyber securityAt OSFI, cyber risk hasbecome one of our top concerns.Agrowingnumber of NorthAmerican bankshavebeen hit withdenial ofserviceattacks,in some casescausing websitesto godown, therebycreatingproblemsfor customerstrying todo everyday transactions.Denial of service attacksare costlyto defend against and a form ofharassment and inconvenience.But more importantly, theycan be a prelude tomore serioustypes ofcyber attacks.Our concern is growingdue to therapidevolution of cyber attacksintermsof frequency, firepowerand targets.This driveshome theneed for all financial institutionsto focuson thisthreat.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 48At OSFI, wehavesignificantlyincreased our supervisoryresourcesin theOp-riskarea, and have launcheda number of initiatives,suchasconducting in-depthreviewsof institutions‘current cyber protectionpractices.There aremany stakeholdersinvolved in thiseffort and a clear focus onthisissueby all will serveuswell.Low interest ratesWhenlowinterest ratesfirstappeared, theimpactwasmostnoticeableonpension plansand insurancecompanies.But asustainedlowinterestrateenvironment (especiallycombinedwithaflat yield curve) affectsthebankingsector aswell.Banks loseflexibilityto adjustthe customer deposit rate down, henceintroducinga deposit rate floor.Net interest marginsare squeezed, negativelyaffectingrevenues.Combined withtepid economicgrowth, reduced demand for loansisfurther affectingbanks.Thisenvironment can provideincentivesfor bankstogrowtheir earningsasset baseby trying to gain market share(a zero sum game), increasefeeincome activities, reduce expenses,enter new markets, and increasetheproportion of higher-yielding assets(both in the lendingand investmentportfolios).Productsand businessesthat are over-reliant on lowfinancing coststendtogrow.And borrowersare strongly incentedto increaseleverage.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 49For all thesereasonswearevery focusedon how banks are reactingtocurrent conditions.We are alsocognizant that the longer thelowinterest rate environmentpersists,themore interest rate risk can be built up.No one can predict when, or how fast, rateswill start to climb (or indeed,whethertheywill fall further).Yet dependenceon low interestratescan become significant, meaningthat transition to higher ratescould be very painful.Thereal estatelendingmarket hasbeen a big area of focusfor OSFI,becauseof thesignificant incentivesfor consumers to borrowand forbanksto maintain revenues, thesize of mortgage lendingportfolios, theconcernsabout some marketsbeingovervalued, and thepossibilitythatcustomers‘debt serviceability could be masked bylow interest rates.Our workhasinvolved major reviewsof bank lendingportfolios, whichwasone factor leadingto the issuanceof GuidelineB-20.GuidelineB-20includesa set of best practicesfor prudent residentialmortgagelending, in all economic conditions.Our guideline, aswell asthestepstakenby the Ministerof Financetoplacerestrictionson mortgage insurance, have ledtosome welcomechangesin the market: slowergrowthin household credit, and a morebalancedpicture overall.Wearewatchingthisveryclosely,and it istooearlytosaywhetherthejobin this area is done.One other area where risks can hide isin the modelsthat are used bysome banks to determine the amount of capital they have to hold formortgageloans.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 50Accordingly, OSFI hasbeen increasingscrutinyin this area.Investorsarealsofocusedon this, and a number of them haveaskedquestionsabout thecalculationof risk weights,given the limitedamountof information that the bankspublicly disclosein this regard.In Canada, the averagemodel risk weightscalculated by banksforuninsured mortgagesare in themid-teens.Thelack of information availableon risk weightsis somethingwearehopingtoaddress.There will be enhanced disclosurebydomestic systemicallyimportantbanksin thecoming year, pursuant torecommendationsfrom theEnhanced DisclosureTaskForce, whichwascreatedat therequestof theFinancial Stability Board.Someothercountriesareexperiencingfrothyrealestatemarketsandhaveintroduced floorson risk weights— sometimesaround 15per cent.Giventhat inCanadatheuninsuredmortgageswouldtendtobeofhigherqualitythan the averageloanportfolio in other countries (becauseuninsured loansin Canada have maximum loan-to-valueratiosof 80percent), weare generallycomfortable withthe capital being held by banksusingmodels.OSFI isalsoawarethat floorscan become safeharboursand lead banksand supervisorstopaylessattention tothe ―appropriate‖ risk weight,especiallywhenit should be well abovethefloor for a particular bank.Thus, our focus will continuetobe on scrutinizingmodels currentlyinuse.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 51Risk appetiteOSFI introduced a new corporate governanceguideline in 2012,and in2013wewill be lookingat how well it isbeingimplemented, withaparticular focuson risk appetite.It is at timeslike thesewhena regulator getsa good feel for whetherabank reallyhasa solid risk appetiteframework.What I mean is that institutionsare being incented to move further alongtheriskcurvedue tomore gradual economic growth, and coolingin themortgagemarket.Now iswhenproductscan be developed to appeal toyield-consciousinvestors.Now iswhenconditionsmight alsomaketheenvironment look saferthanit is — volatilityindicatorshave generallybeen at very lowlevels, similartothosejust beforethe 2008financial crisis.Now iswhenlowinterestratesandthepsychologyaroundthem– i.e. thatthereislittlerisk,alongwiththemisconception that ratescannot gobackup in rapid fashion – can lead both borrowersand lenderstooverlookcertainrisks.And the relativecurrent calm in Europe — despite the flare-upin Cyprusin March— can causesome to become complacent about therisks andthechallengesthat lieahead.Indeed, prudent global bank supervisors are testing the impact of a rapidincreasein rates(while rates could go down even further, there is not a lotmore room tomove in that direction).Bank supervisorsare testingtheimpact of a rapid risein rates,notbecausepeople think thiswill happen; rather, it is becauseof the need tobeprepared for all contingencies.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 52Such testing alsoforcessupervisorsto think about the reasonsfor anysuch scenarios:If rates rise as growth resumes, the outcome is usually better than if ratesrise due to a sudden aversion to risk or serious concern about the future –whichcould be manifestedasan increasein global risk premiums.An institution‘srisk appetiteframeworkshould enableitsboard andmanagement todetermine just howmuch risk an institutioniswillingtotolerate— not only in termsof thebusinesstheyput on their books, butalsoin termsof their tolerancefor gettingcloseto any regulatoryrequirementsor limits,and even their tolerance for behavioursthat canlead to big losses,such asill-equippedriskmanagement groupsandfailure to imposean effective―three linesof defense‖ model.In the ―three linesof defensemodel management is the first lineofdefense,the variouscontrolsand oversight functions(such asriskmanagement) are thesecond lineof defense,and internal audit isthethird lineof defense.Thenatural geneticsof a bank are sometimestogive the businesslinesconsiderable leewayand tosee risk management and internal audit asstandingin the wayof progress.This ―wiringreflectsthe fact that the businessiswherethemoney ismade– at least in theshort term.Abank cannot consistentlymake money without regard for sound riskmanagement.So, structuresand processesneed to be built asa counterbalance,and toreinforcea broader and longer perspective.Riskappetitestatementsare part of the new suite of toolstoaid inensuring that the bank management and theboardhave a 100per centBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 53agreement on the balanceof power in the institutionand theoverall riskstance.Riskappetitestatementswill be particularlypowerful in the future asbanksexperienceunexpectedlossesand surprises.Thetool should help ensure that management isheld accountableandthat boardshaveplayed their rolein havingset out clear expectationsandaccountabilities.ConclusionOSFI‘splanandprioritiesattempt toconveythemostimportant issuesasweseethem, and indicatewheresignificant time will be spent by banksupervisors.Theeffectsof low interest rateshave set in motion sector-shapingforcestowhichwemust pay attention.Cyber risk isanotherissue: Left unchecked, it could seriouslyimpactbankingoperations.Effectivegovernanceand risk appetitestatementswill help banksdetermineacceptableand unacceptablerisk exposuresand to buildsystemsand processestokeep them on track, sothat Canadianscancontinueto enjoy a safeand sound financial system.Thank you.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 54Dear Member,Lifeis becoming more complex for risk managers.We must have a―forward-lookingperspective‖, remember?We have all thesenew lawsand regulations…… but wealsohave rules, proposalsand reportstoconsider.Have you everdiscoveredthecommon elementsof thevariousinitiatives,includingthe Volcker rule in the United States,the proposalsof theVickers Commission for the United Kingdom, the LiikanenReport totheEuropean Commission?LeonardoGambacorta andAdrian van Rixtel from the MonetaryandEconomicDepartment of the BISwill help ustoday to seethecommonelementsand the differences!This is a great analysis! We read:TheVolcker rule isnarrow in scope but otherwisequitestrict.It is narrow in that it seekstocarve out onlyproprietarytrading whileallowingmarket-makingactivitieson behalf of customers.Moreover,it hasseveralexemptions, includingfortransactionsinspecificinstruments,such asUS Treasuryand agencysecurities.It is strict in that it forbids the coexistenceof such tradingactivitiesandother banking activitiesin different subsidiarieswithin thesame group.It similarlypreventsinvestmentsin, and sponsorship of, entitiesthatcould expose institutionsto equivalent risks,such ashedge fundsandprivateequityfunds.That said, it imposesvery few additionalrestrictionson thetransactionsof banking organisationswith other financial firmsmore generally(egsuch asthrough constraintson lendingor funding among them).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 55BiiiCPA)However,it is worthrememberingthat the current US legislationdoesconstrain theactivitiesof depositoryinstitutions.TheLiikanenReport proposalsaresomewhat broader in scope but lessstrict.Theyare broader becausetheyseek to carve out both proprietarytradingand market-making, without drawinga distinctionbetweenthe two.Theyare lessstrict becausetheyallowtheseactivitiestocoexist withotherbankingbusinesswithinthesamegroup aslongasthesearecarriedout in separate subsidiaries.Theproposalslimit contagion withinthegroup by requiring, inparticular, that the subsidiaries be self-sufficient in termsof capital andliquidityand that transactionsbetweenthe legal entitiestakeplace onmarket terms.Just like theVolcker rule, theproposalsdonot envisagesignificantrestrictionsbetweentheprotected bankingunit and other financialfirms, except that theyrequire the separation of exposuresto entitiessuchashedge fundsand special investment vehicles(SIVs) in the tradingentity.TheVickersCommission proposalsare evenbroader in scope but have amore articulatedapproachtostrictness.BIS Working Papers, No 412Structural bank regulation initiatives:approachesand implicationsLeonardoGambacorta andAdrian vanRixtel, Monetaryand Economic DepartmentBasel iii ComplianceProfessionalsAssociation (www.basel-iii-association.com
    • P a g e | 56IntroductionIn responseto the global financial crisis, several advanced economieshaveeither adopted or are consideringstructural bank regulationmeasures.Thecommon element of the variousinitiatives,includingthe ―Volckerrule‖ in theUnitedStates, the proposalsof the VickersCommission fortheUnited Kingdom, the Liikanen Report totheEuropean Commissionanddraft legislationin Franceand Germany, isamandatoryseparationofcommercial bankingfrom certain securitiesmarketsactivities.Theproposalsmark a paradigm shift.Sincethe 1970s,in parallelwiththe deregulationof financial markets,restrictionson banks‘businesslineshave been relaxed.There wasa broad consensusthat bankswhichoffer a full rangeoffinancial servicescan providethe largest economicbenefitsin a rapidlygrowingglobal economy.Diversificationof businesslines,innovationsinriskmanagement, marketbased pricing of risksand market disciplinewereseen aseffectivesafeguardsagainst financial risksassociatedwith therapid expansion oflargeuniversal banks.The financial crisis has triggered a reassessment of the economic costsand benefits of universal banks‘ involvement in proprietary trading andother securitiesmarketsactivities.With hindsight, manylargeuniversal banksshiftedtoomanyresourcestotradingbooks, supportedby cheap funding.Thecomplexityof many banks weakenedmarket discipline, whiletheirinterconnectednessincreasedsystemic risk, contributingto contagionwithinand acrossfirms.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 57While thecrisishasshowntheneed to strengthenmarket-basedpricing ofriskandmarketdiscipline,theheavyburdenofbank lossesimposedontaxpayers hasraised questionsabout theseparationof certain bankingactivities.Theproposedchangesdonot goasfar asthepreviousstrict separationofcommercial from investment banking that existed in some jurisdictions,such asthe United States.But for many countries, notablya number of continental European ones,restrictionson universalbanking wouldbe new.Anumber of questionsarise.How effectivecan thesemeasuresbe in improving financial systemsoundness?What can their impact be on banks‘profitabilityand businessmodels,both nationallyand internationally?This paper explorestheseissues.Section 2considersin more detail the rationalebehind themeasuresaswell astheir similaritiesand differences.Section 3 providesa basisfor evaluatingtheir effectivenessin promotingfinancial stability.Section 4 discussestheir implicationsfor banks‘businessmodels andprofitability.Thelast sectionconcludes.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 582. The initiatives: basic rationale and featuresThebasic rationalefor thestructural measuresis toinsulate certain typesof financial activitiesregarded asespeciallyimportant for therealeconomy,or significant on consumer/depositorprotectiongrounds,fromtherisksthat emanate from potentiallyriskier but lessimportantactivities.The line is generally drawn somewhere between ―commercial‖ and―investment‖ banking businesses, restricting the universal bankingmodel.Such a separation can, in principle, help in several ways.First, and mostdirectly, it can shield the institutionscarrying out theprotected activitiesfrom lossesincurredelsewhere.Second, it can prevent any subsidiesthat support the protectedactivities(egcentral bank lendingfacilitiesand deposit guarantee schemes) fromloweringthecost of risk-takingand encouraging moral hazard in otherbusinesslines.Third, it can reducethe complexityand possiblysize of bankingorganisations,making them easier tomanage, more transparent tooutsidestakeholdersand easier toresolve; this in turn could improve riskmanagement, contain moral hazard and strengthenmarket discipline.Fourth, it can prevent the aggressive risk culture of the riskier activitiesfrom infecting that of more traditional banking business, thus reducingthescope for conflictsof interest.In addition, some observershave noted that smallerinstitutionswouldreducethe risk of regulatory capture.All thesemechanismswouldalsohelp tolimit taxpayers‘exposure tofinancial sector losses.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 59Beyond this basic similarity, structural reform initiatives differ in scope(where they draw the separation line) and strictness (how thick that lineis);TheVolcker rule isnarrow in scope but otherwisequitestrict.It is narrow in that it seekstocarve out onlyproprietarytrading whileallowingmarket-makingactivitieson behalf of customers.Moreover,it hasseveralexemptions, includingfortransactionsinspecificinstruments,such asUS Treasuryand agencysecurities.It is strict in that it forbids the coexistenceof such trading activitiesandother banking activitiesin different subsidiarieswithin thesame group.It similarlypreventsinvestmentsin, and sponsorship of, entitiesthatcould expose institutionsto equivalent risks,such ashedgefundsandprivateequityfunds.That said, it imposesvery few additionalrestrictionson thetransactionsof banking organisationswith other financial firmsmore generally(egsuch asthrough constraintson lendingor funding among them).However,it is worthrememberingthat the current US legislationdoesconstrain theactivitiesof depositoryinstitutions.TheLiikanenReport proposalsaresomewhat broader in scope but lessstrict.Theyare broader becausetheyseek to carve out both proprietarytradingand market-making, without drawinga distinctionbetweenthe two.Theyare lessstrict becausetheyallowtheseactivitiestocoexist withotherbankingbusinesswithinthesamegroup aslongasthesearecarriedout in separate subsidiaries.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 60Theproposalslimit contagion withinthegroup by requiring, inparticular, that the subsidiaries be self-sufficient in termsof capital andliquidityand that transactionsbetweenthe legal entitiestakeplace onmarket terms.Just like theVolcker rule, theproposalsdo not envisagesignificantrestrictionsbetweentheprotected bankingunit and other financial firms,except that theyrequire the separation of exposuresto entitiessuchashedgefundsand special investment vehicles(SIVs) in thetradingentity.TheVickersCommission proposalsare evenbroader in scope but have amore articulatedapproachtostrictness.Theyare broader in that theyexcludea larger set of banking businessfrom theprotectedentity, includingalsosecuritiesunderwritingandsecondarymarket purchasesof loansand other financial instruments.Avery narrow set of retail banking businessmust be withintheprotectedentity(retail deposit-taking, overdraftstoindividualsand loanstosmalland medium-sizedenterprises(SMEs));and another set may beconductedwithin it (egsomeother formsof retail andcorporate banking,includingancillaryoperationsto hedgerisks tosupport them).Theapproach to strictnessismore articulatedbecauseit involvesbothintragroup and inter-firm restrictions(the―ring fence‖).As in the LiikanenReport, protected activitiescan coexistwithothersinseparatesubsidiarieswithinthe same group but subject tointragroupconstraintsthat aresomewhat tighter, includingon the size of thelinkages.Moreover,a seriesof restrictionslimit the extent to whichthe bankingunit within the ring fencecan interact with other financial sector firms.An in-depthexploration of theeconomicunderpinningsof thereforms is provided in Vickers(2012).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 61Recent French and German reform proposalscan be seen asadaptationsof the Liikanenproposal.Thenew Frenchbankinglaw proposal adoptsthesubsidiarisationmodel, but allowsthedeposit-takinginstitutionto carry out moreactivities, includingmarket-makingwithin limits.Anew draft law on the separation of retail and some investment bankingactivitiessubmittedtothe German Parliament considersseparationofretail banking if assetsdevoted to proprietary or high frequencytradingand hedgefund financingoperationsare relatively largein relationtothebanks‘balancesheet.3. Implications for financial stability and systemic riskDothevariousstructural regulatoryinitiativesstrengthen financialstability?Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 62Themechanismslistedabove have intuitiveappeal.The question, though, is how far the various measures would be effectivein realising the hoped-for benefitsand whether theymay have unintendedsideeffects.While it is difficult toprovidean answer,it is possibletolayout therelevant considerations.From a financial stability perspective, a preconditionfor theinitiativestobe helpful is that banks whichcombinecommercial and securitiesbusinessarelesssafeorthat their failureismorecostlytothecommunity.Theevidencesuggeststhat the costsof failure of universal bankscan belarger, sinceuniversal banking encouragessizeand complexity.Theevidenceon theprobabilityof failureis much more indirect andmixedbut, on balance, pointsin a similar direction.For instance, a general conclusion is that growingrelianceonnon-interestincome – a very rough proxy for more investmentbanking-like activities– hasnot resulted in lowerearningsvolatilityor adeclinein bank systematic risk, asderived from stock market returns.Similarly, Box 1providestentativeevidencethatprofitsofsomewhatmorediversified banksarehigher, but alsomore volatile.Moreover, risk diversification benefits appear to be mostly restricted tocertain ranges of income sources or to geographical and loan portfoliodiversification.Against thisbackdrop, a number of questions about thedesign ofstructural regulationarise.Afirst question concernswheretheseparation lineisdrawn.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 63Here, the philosophybehind theproposalsis quitedifferent.TheLiikanenReport optsfor combining proprietarytradingandmarket-making activities on the grounds that the line between the two istoo fuzzy and hard to enforce – a controversial issue with the Volcker rulein theUnited States.And the VickersReport takesa verynarrow view of the typesof activitythat needtobeprotectedonthegroundsthat disruptionstherecanhavealargeimpact on economic activity.Moreover,while theVickers Report arguesfor more stringent capitalrequirementsfor theprotected activities,on importancegrounds, theLiikanenReport arguesfor potentiallymorestringent onesforthetradingbusiness(and possiblyfor real-estaterelated lending), on risk grounds.It is not unequivocallyclearthat the concentrationof tradingactivities inseparateentitieswill enhancefinancial stability.Thesefirmsmay have lessstable, wholesalemarket-basedfundingstructures,while still beinghighly interconnectedwithother parts of theglobal financial system.This could give rise toconsiderablecontagion risk, asdemonstrated bytherepercussionsof the failure of Lehman Brothers on global bankfundingmarkets.Asecond question concernsthethicknessof the line.How effectiveisit in insulatingthe protected partsof the bankingbusiness?Onetypical criticism of allowingthe activitiesto coexist within the samegroup is that, especiallyat timesof stress,the linewill provenotsufficientlystrong asreputational considerationsloom large.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 64In turn, any expectation that the linewill turn out tobe ineffectivewouldweakenmarket discipline.Moreover,onlythe Vickers Report proposesmajor additional restrictionson theinteractionsbetweenthe protectedbanking unitsand the rest ofthefinancial system.Their effectivenessisyet tobe tested.Athird questionconcernsthe possibilityof sidesteppingthelinealtogether.Theworryis that risky activitiescould migrate outsidethe regulatoryperimeter.In fact, one reason whythe LiikanenReport optsfor subsidiarisationrather than full separationis tolimit thisrisk.Migrationwouldbe a worryif thoseactivitiesproved to be systemic innature.All thisputsa premium on effectiveresolutionmechanisms.Whilestructural separation may help resolvability, the benefitsof theproposalsdohingeon the adequacyof the resolutionschemesin place.TheLiikanenReport, for instance, suggestsseveral complementarystepsin this area.Effectiveresolution schemesare especiallyimportant if, contrary toexpectations,the businesslinesleft outsidethe protectiveumbrellaresultin systemic disruptions.In this case, the pressure to ―bail out‖ the legal entities involved could bevery strong: this would put taxpayers‘money on the line ex post and raisemoral hazard concernsex ante.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 65Yet anotherquestionconcernstheinteractionbetweennationalstructuralbank regulation and international bankingregulation, such asBasel III.Thetwotypes of regulation differ in approach and scope.Thelattertakesbanks‘businessmodelsasgivenand imposescapital andliquidityrequirementsthat depend on theriskiness of a bankinggroup‘sbusiness.Theformer imposesconstraintson specific activities and typesofbusiness.From this angle, the two approachescan be seen ascomplementary.Indeed, certain aspectsof structural regulation– restrictionson leveragefor ring-fenced institutions– may reinforceelementsof Basel III.At the same time, there may be challenges.Onerisk, already alluded to, is that banksmay shift activitiesoutsidetheperimeter of consolidated regulation in responseto structural regulation.Another riskisthatstructuralregulation, especiallyif nationalapproachesdiffer, will createbusinessmodels that are difficult to supervise.For example, resolution strategiesmay berather complextodesign forgloballyoperatingbanksthat have tofaceincreasingheterogeneity inpermittedbusinessmodelsat thenational level.Finally, structural regulation may lead to different capital and liquidityrequirementsfor thecore banking and tradingentitieswithin a singlebankinggroup.Although thismay be intended, in practiceit hasimplicationsforregulatorystandardsapplied at the consolidatedlevel.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 66Somenew evidence on risk diversification and economies ofscopeThis box presentssome new preliminaryevidenceon the impact ofcombining different businesslineson therisk return profile of bankingorganisations.Anovel aspect is that the analysis allowsfor thepossibilityof non-lineareffects,sothat the benefitsmay exist only withincertain ranges.Theevidenceis basedon a sample of 108 international diversifiedbanks.Product differentiationis proxied by theratio of non-interest income(traderevenues, feesand commissionsfor services) to total income.On balance, theevidenceindicatesthat benefitsdoaccrueup to a certaindegreeof diversificationin termsof return on equity(ROE).However,bank profitabilitytendstobe more volatile for more diversifiedbanks(for details of the econometric analysis, seeAnnex B).The twolinesin the upper part of the graph below represent the result of apanel regression of bank ROE on the ratio of non-interest to total income(diversificationratio) and itssquare.Theregressionincludesfixed effectsfor each bank, aswell asa countryyear interactionterm tocontrol for idiosyncratic and macro factors.Thecurvesare drawnon thebasis of thetwoestimatedparameters.Bluereferstothepre-crisisperiod (2000–07),whileredindicatesthecrisisperiod (2008–11).Thesymbolsindicateaveragevaluesobtainedby grouping banksbyjurisdictionin the twosub-periods.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 67Theresultsindicatethat revenue diversificationdoesincreaseROE, butonlyup toa point, after whichROE declines.While the optimal mix may have shiftedsomewhat towardsa smallershareof non-interest income in the post-crisisperiod, the resultsof thisexercisesuggest that economies of scope do exist onlyup toa certaindegreeof product diversification.Thegreenlinein thelowerpanel representstheresult of across-sectionalregressionof banks‘coefficientsof variation of ROE – a proxy for risk –on thediversificationratio, itssquare and country fixed effects.Thegreen symbolsindicateaveragevaluesobtained by groupingbanksbyjurisdictionover the period2000–11.Theeconometric analysisfindsthat ROE volatilityalsoincreases,up toapoint, with revenue diversification, after whichit declinesagainBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 68Toread this excellent paper:http:/ / www.bis.org/ publ/ work412.pdfBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 69Challengesfor bankingregulation and supervision inthe monetary unionSpeechby Dr JensWeidmann,President of the DeutscheBundesbank, at theDeutscherSparkassentag2013,Dresden.1. IntroductionMr Fahrenschon, Mr Genscher, Mr Steinbrück, Ladies and GentlemenIt givesme great pleasuretospeak toyou today at the Sparkassentag2013.For more than three years now,the financial, economic and sovereigndebt crisishasbeen thedominant topic in the European monetary unionand, at thesame time, itsbiggest test.Dated from the outbreak of the crisison the US real estatemarket in thesummer of 2007, this is already thefifth year in whichwehave been incrisismode.That said, Germanyis still in relatively good shape – despiteundergoingbyfar itsworstpostwarslump in 2009and despitebeing one of thefirstcountriestobe affectedby the spillover from thecrisis on theUS realestatemarket.Germanyhashad to useconsiderable financial resourcestostabilisethefinancial system.Savingsbanks,too, felt the effectsof thecrisis– although theydid sodirectlyonly in a few cases;mostly it wasthrough their investments.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 70Even so, savingsbanks had a stabilisingeffect during the crisis.Theywerea robust and reliablesource of lending.And theystrengthenedtheir capital base.That is a major preconditionfor overcoming the challengesthat areonthehorizon – such assustained pressure on marginsand increased riskprovisioningfor thenext economicdownturn, whichis bound to come atsometime.Thevariousaspectsof the crisis– first, onlya financial crisis, then aneconomiccrisisand, finally, the sovereign debt crisis– whichis still withus– have prompted a largenumber of discussions,changesandupheavals.This appliesto the role of central banksand tothe expectationof whatcentral bankscan and should– or cannot and should not – doto helpresolve the crisis.It alsoapplies tothefinancial system and thewayit is perceivedby thepublic at large.Mr Steinbrück will undoubtedlyexplainin more detail soon how hewishesto―tamethefinancial markets‖.Overcomingthe crisisrequires considerableeffortsin many areas.But, asimportant asthe issuesof government debt, monetary policy andcompetitivenessare, I wouldnow like toturn my attention tobankingregulation and supervision.2. Reform of financial market regulation – objectives andmeasuresBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 71Roughlyten yearsago, theprincipal issuein banking regulationwasBasel II and the regulatorychangesit brought about.At thetime, onlyveryfewofthoseinvolvedcouldhaveguessedthat,justashort while later, thepolitical agendawouldbe dominated byprobablythemost all-encompassingchangesever tothe regulatoryframework of thefinancial marketsin theshape of Basel III and further regulatoryinitiatives– and all starting off with an awe-inspiringzeal for reform.BaselII took five years from thefirst consultation paper up to apolicyagreement on thenewprinciples.Basel III onlyneeded oneyear for that.Thenew regulatorymeasures,whicharedesigned to havea longer-termimpact, are focused lesson the acutemanagement of the crisis and aregeared more to preventingnew crisesfrom emerging in the future in thefirst place.The changesinitiated since the G20 meeting in Washington in November2008, have the key objective of making financial systems more stable andthereforemore resistant toshocks.Furthermore, the aim is that the taxpayer nolonger hasto step in tocorrectdifficultiesin the financial system.And it wasalsoimperativeto ensure that the financial system hasa clearvalueadded for theeconomy asa whole.There is good empirical evidencethat growthin the financial sectoralsostrengthensa country‘soverall economicgrowth.On the other hand, studiesby the IMF indicatethat, along withincreasingfinancial sector growth, thiseffect becomesweaker and mighteven gointoreverse.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 72It is not necessary to agree with Paul Volcker‘s deliberately provocativelyworded opinion that there hasn‘t been a useful innovation in the financialindustry since the invention of the ATM, and derivativesdo not have to beregarded asfinancial weaponsof massdestruction.Nevertheless, if the financial sector is too large, there is evidently anincrease in the risks to stability and the percentage of less beneficialtransactions.Cyprus is undoubtedly a telling example and provides an urgent warningthat the supervisory and regulatory requirements have to keep pace withthesize of thefinancial system relativetoeconomicpower.Astableand efficient financial system that enhancesgrowthandprosperitycan be achieved onlywitha wholepackageof measures.With this in mind, theG20, at their meetingin Washington at the end of2008,defined variousfields in whichtherewasa particular need foraction.Let me outlinea few major points.•Risksand mutual interdependencies in the financial system have tobemore transparent.•Banksshouldhold more and higher-qualitycapital soasto bettershoulder lossesthemselves.•Systemicallyimportant financial institutions– the hubsof thefinancialsystem – must meet special, stricter requirements,for example, withregard to capital adequacyand risk management.•In the event of difficulties,it must alsobe possibleto resolve orrestructure large, international and particularlyinterconnectedbanks.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 73•Areasof thefinancialsystem whichhavehithertobeensubjecttono– orvery little– regulation, but which perform taskssimilar tothoseof banksand are linked directlyor indirectlytothebanking system, should bebetter regulated – theshadow banking system and derivativestradingarekey issueshere.At this point, I wouldlike to refer toa fundamental point that isparticularlyimportant tome.Theconnectinglink betweenthestated aims and the meansof achievingthem is a strengtheningof the principleof liability.In hisPrinciplesof EconomicPolicy, Walter Eucken declaredtheprincipleof liability tobe a constituent principleof the market economy,referringto theestablishedlegal principlethat ―thosewhobenefit shouldalsobear thecosts‖.Ensuring that playersin the financial system have to, and areable to,better bear lossesand risksthemselves in future will make thefinancialsystem more stableand more focused on transactionsthat are beneficialtothe economy asa wholeand make thetaxpayer the last rather thanthefirst lineof defenceagain in the event of crises.Liabilityis thereforea steptowardsovercoming thecrisis and not anegative concept – quitethe opposite!It isthecounterpart ofthefreedomtotakedecisionsasanentrepreneurorinvestorin a self-determined manner.Freedom of choiceand liabilitythereforebelong together asa conceptualpair or twosidesof the same coin.That appliesincidentallyto the financial system just like it doestothemember stateswithinthe monetary union.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 74Someof the measurestaken during the crisisunderminetheprincipleofliability rather than strengtheningit.It is against that background that weshould alsoassessthenewlyresurfaced debatein Europeon theright coursein fiscal policy.Of course,a major roleis played by thepoliticalacceptabilityof thereform coursethat hasbeen embarked on.At least withregardtotheprogrammecountries,however,moretime alsomeansgreater recourseto European solidarity: more fundsare neededfrom therescuepackageor maybe eventransfersthat havetobeacceptedpoliticallyby the ―donor countries‖.The non-programme countries, in turn, should not repeat the mistakes of2004 and not interpret the strengthened Stability Pact too flexibly when itis first put to thetest.France, in particular, has an important role in setting an example in termsof the credibility of the rules and confidence in the sustainability of publicfinances.But back to regulation.At times, concernsare raisedor thecriticism is made that theimplementationof thesenoble intentionsis not making much headwayandthat enthusiasm for reform haswanedsignificantly.I can quiteunderstand a certain amount of impatience.For example, withregard to the shadowbankingsystem, an totalintegratedpackagewithrecommendationsonregulationwillnotbereadyuntil September and it will be even longer beforeconcretedecisionshavebeen made and enshrined in law.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 75Thereform objectiveof clearingall standardised OTC derivativesthroughcentral counterpartiesand recordingthem by theend of 2012hasnot beenachieved.There arestill several stickingpoints– startingwitha lack of standardsand ranging asfar asdata protectionproblems, and, in particular, theimpassein negotiationsoncross-bordercoordinationbetweentheUnitedStatesand Europe.Progresshasalsobeen mixed on the―toobig to fail‖ issue– morespecificallytheimplementation of internationallyagreed standardsforresolution regimes.Here wehavetocontend with acertain tendencytowardnationalprotection and the fragmentation of the financial markets.Otherwisethere isthe threat of competitive distortionsand new riskstostability.Just recently, Börsenzeitunggavea categoricaland lucid warningagainsta new nationalismon thepart of the supervisors.TheUS proposalson regulatingthecapital and liquidityof foreigninstitutionsare a prime negative exampleof this.Agreat deal thereforestill needstobe done and wehave to maintainpoliticalinterest in a stablefinancial system.Regulation is not an end in itself, however.Thecostsand benefitsof theplannedmeasures,includingtheirside-effectsand interactions,have tobe weighedup against one another.This type of analysis is time-consuming and input-intensive, especiallysince the particular given country-specific aspects also have to be takenintoconsideration whenthemeasuresare actuallyimplemented.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 76And many of theimplicationsare not immediatelyobvious,but still havethepotential tobe highlycharged.Oneexampleof thisis theplanned financial transactiontax and itsimplicationsfor monetary policy.While a fundamental consensushasbeen achieved on theintroduction ofthetax, theunintendedside-effectsmight be considerable.In its currentlyenvisaged form, thetax wouldalsocover collateralisedmoneymarket transactions,knownasrepotransactions,andwouldcauseconsiderable harm tothe repomarket.Therepomarket playsa key role in the redistributionof liquidityamongcommercial banks,however.If the market isnot ableto function properly, therelevant transactionswill be shifted to the Eurosystem and central banks will remain heavilyinvolved in the redistributionof liquidityamongbankslongafter thecrisis isover.From a monetary policystandpoint, therefore, a very critical view hastobetakenofthefinancialtransactiontaxinitscurrent form, andthisshowshow important it is toscrutinize regulatory measuresbeforetheyareintroduced.But, again, that takestime.However, this does not mean that regulatory reform has been a completefailure, because a whole seriesof measures is now in place with which theprincipleof liability is being strengthened.Let me justmention the exampleof stricter capital requirementsin theform of Basel II.5and BaselIII.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 77At the end of February thisyear, political agreement wasreachedin theEuropean Union concerningtheimplementationof Basel III throughtheCapital RequirementsDirective IV and the Capital RequirementsRegulation.TheEuropean Parliament alsogave thedraft legislationitsseal ofapproval just last week.It may seem ambitious,but implementationof Basel III will thereforebepossiblein Europe from the beginningof 2014.Basel III will take full effect in 2019.Banks are using theinterim period to raisetheir capital to therequiredlevel.In thecaseof credit growth, however,thereis theopposite fear is that thereforms are proving too successful.Deleveragingisstill urgentlyrequired to overcome the crisis.However,thisdeleveragingprocessisalsoacontributoryfactorinthelowgrowth ratesfor lendingin some European countries.Developmentsin lendingthereforereflect a necessary correction and arenot in themselvesan indication of theneed for further economicpolicyaction.Incidentally, thecost-benefit analysesconductedbeforethe adoption ofBasel III show that these measureswill, at most, have a very limitedimpact in termsof dampeningeconomicgrowth.Sadly, however, there are still those in the banking industry – especially inthe United States, but also in Europe – who are campaigning against theintroduction of higher capital requirements.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 78In a recentlypublishedbook, Bonn-based economist MartinHellwigexaminedthe argumentswhichare advanced in this context.According to Mr Hellwig and his co-author,there isnosimpler and morecost-effectiveapproachto crisisprevention than reducinglargebanks‘dependencyonborrowedmoney– in otherwords,increasingtheir capitalrequirements.At the same time, it is alsotrue that the largenumber of differentregulatoryinitiativesmakes it difficult tomaintainan overview andevaluatetheconsequences.Actingontheprinciplethat it isbettertobethoroughthanhasty, it wouldthereforebe necessary toestimatethe overall impact of the regulatoryagenda and evaluateit in a cost-benefit analysis.Above and beyond all theseregulatory reforms, Europe hasanother toppriorityon itsagenda – the banking union and theorganisationofbankingsupervision.3. Banking supervision – on the road to a European bankingunionThecrisishashighlighted theneed for a general overhaul of thefinancialmarket architectureof monetaryunion.Thebanking union isclosingan open flank that wasalreadyidentifiedbut not closedwhenthe currencyunion wasset up.If doneproperly, thebanking union must have twopillars– a singlesupervision and a singleresolutionand restructuringmechanism.TheSSM (singlesupervisorymechanism) and SRM (singleresolutionmechanism) aretwomore ingredientsto the alphabet soup that isBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 79European crisispolicy, but, in my opinion, theyare twovery importantingredients.Creatinga bankingunion involvesa largeamount of institutionalconstruction work.Preparation of the relevant legal groundworkis in full swingat EU levelfor both pillars.In all likelihood, thesinglesupervisorymechanism at leastwill be abletocommenceoperation in thesecond half of 2014.3.1Single supervisory mechanism (SSM) under the ECBTheaim of thesinglesupervisorymechanism (SSM) is toensure that thesamehigh standard of supervision appliesthroughout Europe, thusconsistentlycontainingexcessive risks.It aimstomake developmentsand risksin national banking systemsmore transparent and prevent domesticproblemsbeing glossedover.It will alsobe better ableto monitor cross-borderinteractionsthan thesum total of national supervisors.TheSSM will not onlysupervisethemost important banksdirectly.Not just thebank‘sabsolutesize or cross-borderactivitiesare ofrelevance, but alsoitssignificancefor the respectiveeconomy.Thethree most important banks of eachmember state will thereforebeamongthe institutionswhicharesuperviseddirectly, irrespectiveof theirabsolutesize.In total, some130banks throughout Europe will thereforebe under thedirect supervision of theSSM.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 80TheSSM isto be placedunder the auspicesof the ECB.TheBundesbank isunhappywith this arrangement, asit givesrise topotential conflictsofinterest betweenmonetarypolicy andsupervisionontheGoverning Council.As KlaasKnot put it, ―lettingbanking supervision get startedwithin theECB sothat it at leastgetsoff the ground.‖However,I very much hopethat this solutionis not thefinal stageofdevelopment andthat, in themediumterm at least, theEU treatieswillbeamended toensurea clearseparation of monetary policy and supervisoryresponsibilities.In termsof thedistribution of responsibilitieswithinGermany, it iscrucial that the Bundesbank remain firmly involved in bankingsupervision sothat wecan shareour extensiveexpertiseand utilisethefindingsfrom supervisory activitiesfor other tasks.This is even more important sincethe Bundesbank recentlytook on aneven more significant role in the monitoring of financial stability inGermanythrough the Financial StabilityCommittee.In this context, weare alsokeepinga watchful eye on thesituationin thereal estatemarket, whichis nodoubt a topic in your discussions,too.For onething, the crisishasonceagain underlined the risk ofexaggerationson the real estatemarket.Arecent Bundesbank discussion paper1even concludesthat the ―GreatRecession‖ of2008/ 2009andtheweakrecoverythat followedwerelargelyduetoproblemsin the real estate sector and, moreover, that negativeshockson thereal estate market have a more significant impact on thereal economy than positiveshocks.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 81For another,therehasbeenamarkedrisein realestatepricesin Germanyrecently– by around seven per cent in major citiesin thelast twoyears,for example.However,the Bundesbank doesnot currentlyperceive anycredit-drivenbubble.3.2 Resolution mechanismToachieve itsfull potential, the singlesupervisory mechanism needstobeaugmented by a singleresolutionmechanism (SRM).As in the caseof theSSM, a solution that satisfiesthe requirementsofEuropean law ultimatelycallsfor an amendment of theEU treaties.This hasbeenquiterightlybeen emphasisedby Federal MinisterofFinance.Essentially, theSRM is an important embodiment of the principleofliability.After all, liabilityalsomeansthat,incaseofdoubt, it shouldbepossibletoresolve bankswithout significant economicharm totheeconomy asawhole– and to seethis through if theworstcomestotheworst.Resolvingand closinga bank is by no meansa cure-all and it is certainlynot an easytask.Where possible, thingsshould not be allowedtogo that far in the firstplace.And that iswherestrict capital requirements,effectivesupervision anddeposit businessshielded from riskier businesslinescome intoplay.Thebanking union alsoneedsto be supported by an appropriateregulatorystructure.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 82In other words,banksmust be required tohold sufficient capital forclaims on government and not be allowedto accumulatethem on toolargea scalein future.It wouldbe dishonest to assert that all these measureswill make itimpossiblefor banksto get intodifficultiesin the future.Therefore, if that actually does happen at some time, having a reliableprocedure in place that creates planning certainty will be all the moreimportant.With this in mind, the main task of the single resolution mechanism thatis currently being developed is to ensure the correct sequence of liabilityis applied in such a process.If a bank is tobe restructured or resolved, equityinvestorsshould be thefirst port of call, followedby theprovidersof debt capital, and only thenthedepositors,takingdueaccount of deposit guaranteesin therespectivemember states.National and European taxpayersshould only be calledupon asa verylast resort.If public fundsare used, thequestion arisesastohow liabilityis to beapportioned betweentheEuropean level and themember states.Joint liabilityof all member statescan onlyexist at EU level for thoseinstitutionsdirectlysupervised by the SSM.In such a case,it is alsoappropriate, however.Having saidthat, it isunclear whetherthemember statesare tobedischarged of all liability or whethera certain percentageof the costsisstill to be apportionedto them.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 83Thelatteris suggestedbyfact that, in thecurrent frameworkof monetaryunion, member statesare still abletoexert a perceptibleinfluenceonfinancialstabilitythroughtheirnationaleconomicand financialpolicies–say, encouragingtheemergenceof a real estatebubblethrough special taxbenefits.Thisshouldbekept separatefromthetreatment ofbalance-sheet burdensthat arosewhile thevariousbanking systemswerestill under nationalsupervision.If the unity of liability and control is also taken seriously on this point,too, the member states in question should themselves also be liable fortheseburdensaswell.As the caseof Spain shows, the ESM is readytostep in if raisingthenecessaryfundson thecapital market provesdifficult.Ultimately, what todo withlegacydebtsis a supervisoryproblem, not aquestion that hasto be answeredby politicians.If politiciansactuallydo decideto communitise legacydebts, it will benothingother than a financial transfer.Transparencyfor membersof the general publicand taxpayers then alsorequiresthat this transferbe disclosed assuch.Thesingleresolutionmechanism reducesuncertaintyand mitigatestherisk of contagion effects.Thediscretionaryapproach taken in thecaseof Cyprus istherefore not ablueprint for similar situationsthat mayarisein other countries.Eventsin Cyprushave shown that a bail-in ispossible.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 84But theyhave alsohighlightedthe importanceof establishinga clearsequenceof liability and an orderlyprocedure, especiallyif turbulenceduetodepositoruncertaintyistobe avoided.After all, thedebateon to theextent of depositorinvolvement has causedmajor uncertainty– in other countries, too.This wasall the more thecaseasthere wasdiscussionabout thepossibilityof using depositsthat were actuallyprotected bythe Cypriotdeposit guarantee scheme.In connection withthe securityof customer deposits at banks, thequestion of whethera bankingunion should not includea singleEurope-widedeposit guaranteescheme isalsoregularlyunder ofdiscussion.TheGerman SavingsBank and Giro Association hasrepeatedlyexpresseditsvery critical stanceregardinga singleEuropean depositguaranteescheme.And, indeed, it isimportant not toput thecartbeforethehorseintacklingsuch projects.Given the current degree of integrationamong member statesandfinancial systems, a singleEurope-widedeposit guaranteescheme wouldnot be practical.Even morethan isthecasefor thecostsof resolution and restructuring, itis true to saythat bank balancesheetsreflect economic developmentsintheindividualmember statesthat arecurrentlybeyond European control.Otherwise,taxpayerswhoarenot involved wouldbe made liableformistakesin other countries without beingresponsiblefor thosemistakes.It is much more important to set up thesinglesupervisorymechanismand singleresolution mechanism and put them on a firm footing.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 854. ConclusionIn summarisingmy thoughts, I wouldlike to stressthat, yes, reformingfinancialmarket regulationisstill amajor task,but it ismakingheadway,both in Europe and internationally.This meansthat, step by step, weare approachingthe goal of bringingabout an overall reduction in the risksto individual economiesand themonetaryunion whichstem from the financial systemswithoutunderminingtheir efficiency.Akey taskin designingspecific reformsis togive a more scope again totheprincipleof liability.TheBundesbank isdiligentlypursuingthis aim by bringingitsexpertisetobear and, if it isnecessary, is in for thelong haul.Thank you for your attention.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 86MONETARY ANDFINANCIALDEVELOPMENTSMarch 2013Price Conditions: Headlineinflation, asmeasured by theannualpercentagechangein the Consumer PriceIndex (CPI) wasmarginallyhigher at 1.6% in March2013(February: 1.5%).Inflationin thetransport categoryroseby 1.0% (February: 0.4%), duemainlytotheupwardadjustment in theprice of RON97petrol toRM2.90per litre from RM2.70per litre.Meanwhile, prices in the clothing and footwear category declined at aslower rate of 0.5% (February: -1.2%) due to the upward adjustment inpricesafter the ChineseNewYear sales.Inflationin thefood and non-alcoholic beveragescategory, however, remainedunchanged at 3.3%.Monetary Conditions: Interbank rates were stable in March. In terms ofretail lending rates, the average base lending rate (BLR) of commercialbanksremained unchanged at 6.53%.Retail deposit rateswerealsorelativelystableduring the period.Broad money (M3) grew by 9.1% in Marchon an annual basis,underpinned by the extensionof credit totheprivate sector.On a monthlybasis,the expansion wasmoderated somewhat byGovernment fundraising.Net financingtotheprivatesectorgrewat aslowerpaceinMarch(11.0%)duetoa moderation in thegrowth of both outstanding banking systemloansand net issuancesof privatedebt securities(PDS).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 87While the growthof businessloansoutstandingmoderated during themonth followinglargerepayments, loansdisbursed to businessesremainedstrong withmore loansextendedmainlytothe manufacturing;wholesaleand retail, restaurantsand hotel; finance,insuranceandbusinessservices, and construction sectors.Loanstohouseholdsalsogrew at a more moderate pace.Theoverall loandemand, however, remainedstrongwithhigher loanapplicationsfrom both businessesand households.BankingSystem: Capitalisationremained strongunder the new Basel IIICapitalAdequacyFrameworkwithcommon equitytier1capitalratio,tier1capital ratio and total capital ratioof 12.2%, 13.1% and 14.5%respectively.Thelevel of net impaired loansimproved to 1.3% of net loans,while theloanlosscoverageremainedwell above 90%.ExchangeRatesand International Reserves: In March, theringgitbroadly appreciated against the currenciesof Malaysia‘smajor tradingpartnerswiththe exception of the Chineserenminbi, against whichtheringgit depreciatedby 0.1%.Ringgit‘s strength was due mainly to the release of positive domestic andglobal economic data, which contributed to favourable investor sentimenttowardsdomestic and regional financial assets.Theringgit appreciation, however, waspartiallyoffsetby uncertaintiessurroundingthebanking crisisin Cyprus.In April, theringgit continued to appreciate againstthe currenciesofMalaysia‘smajor tradingpartners.Theinternational reservesof Bank Negara Malaysiastood at RM432.1billion (equivalent toUSD139.9 billion) asat 15April 2013,sufficient toBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 88finance9.9 monthsof retainedimportsand are 4.6timestheshort-termexternaldebt.Bank Negara Malaysia 30April 2013Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 89Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
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    • P a g e | 93ChairmanBen S.BernankeAt the 49thAnnual Conferenceon Bank Structure andCompetition sponsored by theFederal Reserve Bankof Chicago, Chicago, IllinoisMonitoring the Financial SystemWe are now more than four yearsbeyond the most intensephaseof thefinancial crisis,but itslegacyremains.Our economy hasnot yet fullyregained the jobslost in the recession thataccompaniedthe financial near collapse.And our financial system--despite significant healing over the past fouryears--continues to struggle with the economic, legal, and reputationalconsequencesof theeventsof 2007to2009.Thecrisisalsoengenderedmajor shifts in financial regulatorypolicyandpractice.Not sincetheGreat Depression have weseen suchextensivechangesinfinancial regulationasthose codifiedin the Dodd-Frank Wall StreetReform and Consumer ProtectionAct (Dodd-FrankAct) in theUnitedStatesand, internationally, in theBasel III Accord and a rangeof otherinitiatives.Thisnewregulatoryframeworkisstill underconstruction, but theFederalReservehasalreadymade significant changestohow it conceptualizesand carries out both itsregulatoryand supervisoryroleand itsresponsibilityto foster financial stability.In my remarkstoday I will discusstheFederal Reserves effortsin anareathat typicallygetslessattentionthanthewritingandimplementationof new rules--namely, our ongoing monitoring of thefinancial system.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 94Of course,the Fed hasalwayspaid closeattentiontofinancial markets,for both regulatory and monetary policy purposes.However,in recent years, wehavebothgreatlyincreasedtheresourceswedevotetomonitoring and taken a more systematic and intensiveapproach,ledbyourOffice ofFinancialStabilityPolicy andResearchanddrawingonsubstantial resourcesfrom acrosstheFederalReserveSystem.This monitoring informs the policy decisions of both the Federal ReserveBoard and the Federal Open Market Committee as well as our work withother agencies.Thestep-up in our monitoring is motivatedimportantlybya shift infinancial regulationand supervisiontoward a more macroprudential, orsystemic, approach, supplementingour traditional microprudentialperspectivefocused primarily on thehealth of individual institutionsandmarkets.In thespirit of thismore systemic approachtooversight, theDodd-FrankAct created the Financial Stability Oversight Council (FSOC), whichiscomprised of theheadsof a number of federal and state regulatoryagencies.TheFSOC hasfostered greater interactionamong financial regulatoryagenciesaswell asa senseof common responsibilityfor overall financialstability.Councilmembersregularlydiscussriskstofinancial stability andproducean annual report, whichreviewspotential risksand recommendsways tomitigatethem.TheFederal Reserves broad-based monitoring effortshave beenessential for promotinga closeand well-informedcollaborationwithother FSOC members.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 95AFocus on VulnerabilitiesOngoingmonitoringof the financial system isvital to themacroprudential approach to regulation.Systemic riskscan onlybe defused if theyare first identified.That said, it is reasonable to ask whether systemic risks can in fact bereliably identified in advance; after all, neither the Federal Reserve noreconomistsin general predicted the past crisis.Torespond tothis point, I will distinguish, asI have elsewhere,betweentriggersand vulnerabilities.Thetriggers of anycrisis aretheparticular eventsthat touch off thecrisis--theproximatecauses, if you will.For the2007-09crisis,a prominent trigger wasthe lossessufferedbyholdersof subprime mortgages.In contrast, the vulnerabilities associated with a crisis are preexistingfeatures of the financial system that amplify and propagate the initialshocks.Examplesof vulnerabilitiesincludehigh levelsof leverage, maturitytransformation,interconnectedness, andcomplexity, all ofwhichhavethepotential tomagnify shocksto the financial system.Absent vulnerabilities,triggersmight produce sizablelossestocertainfirms, investors,orassetclassesbut wouldgenerallynot leadtofull-blownfinancial crises;thecollapseof the relativelysmall market for subprimemortgages,for example, wouldnot havebeen nearly asconsequentialwithout preexistingfragilitiesin securitizationpracticesand short-termfundingmarketswhichgreatly increased its impact.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 96Of course, monitoring can and doesattempt to identify potentialtriggers--indicationsof an asset bubble, for example--but shocks of onekind or another are inevitable,soidentifying and addressingvulnerabilitiesis keyto ensuringthat thefinancial system overall isrobust.Moreover,attempts toaddressspecific vulnerabilitiescan besupplementedby broader measures--suchasrequiring banksto holdmore capital and liquidity--that makethesystem more resilient toarangeof shocks.Twoother related pointsmotivate our increasedmonitoring.Thefirst isthat the financial system is dynamic and evolving not onlybecauseof innovation and the changingneedsof the economy, but alsobecausefinancial activitiestend to migrate from more-regulatedtoless-regulatedsectors.An innovativefeatureof the Dodd-FrankAct isthat it includesmechanismsto permit the regulatorysystem, at leastin somecircumstances, to adapt tosuchchanges.For example, theact givesthe FSOC powerstodesignatesystemicallyimportant institutions,market utilities,and activitiesfor additionaloversight.Such designationisessentiallya determinationthat an institutionoractivitycreatesor exacerbatesa vulnerability of thefinancial system, adeterminationthat canonlybemadewithcomprehensivemonitoring andanalysis.Thesecond motivation for more intensivemonitoring is the apparenttendencyfor financial market participantsto take greater riskswhenmacro conditionsare relatively stable.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 97Indeed, it may be that prolonged economic stability isa double-edgedsword.Tobe sure, a favorableoverall environment reducescredit riskandstrengthensbalancesheets,all elsebeingequal, but it could alsoreducetheincentivesfor market participantsto take reasonableprecautions,whichmay lead in turn toa buildup of financial vulnerabilities.Probablyour best defenseagainst complacencyduring extendedperiodsof calm is careful monitoring for signsof emergingvulnerabilitiesand,whereappropriate, thedevelopment of macroprudential and other policytoolsthat canbe used to addressthem.TheFederal Reserves Financial StabilityMonitoring ProgramSo, what specificallydoesthe Federal Reserve monitor?In the remainderof my remarks, Ill highlight and discussfourcomponentsof the financial system that are among thosewefollowmostclosely: systemicallyimportant financial institutions(SIFIs), shadowbanking, asset markets, and thenonfinancial sector.Systemically Important Financial InstitutionsSIFIs are financial firms whosedistressor failure hasthepotential tocreatebroaderfinancialinstabilitysufficient toinflict meaningful damageon thereal economy.SIFIs tend tobe large, but sizeisnot theonlyfactor used to determinewhethera firm is systemically important; other factorsincludethefirmsinterconnectednesswith the rest of the financial system, the complexityand opacityof itsoperations, thenature and extent of itsrisk-taking, itsuseof leverage, its reliance on short-term wholesalefunding, and theextent of its cross-border operations.Under the Dodd-Frank Act, the largest bank holding companies aretreatedasSIFIs; in addition, asI mentioned, theact givestheFSOC theBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 98powertodesignate individual nonbank financial companiesassystemicallyimportant.This designationprocessis under way.Dodd-Frank alsoestablishesa framework for subjectingSIFIstocomprehensivesupervisoryoversight andenhancedprudential standards.For all such companies, the Federal Reserve will have accesstoconfidential supervisoryinformation and will monitorstandard indicatorssuch asregulatory capital, leverage, and fundingmix.However,some of thesemeasures, such asregulatory capital ratios, tendtobe backward lookingand thusmay be slow to flagunexpected, rapidchangesin the condition of a firm.Accordingly, wesupplement the more standard measureswithothertypesof information.Onevaluablesourceof supplementaryinformation is stresstesting.Regular, comprehensivestresstestsare an increasinglyimportantcomponent oftheFederalReservessupervisorytoolkit, havingbeenusedin our assessment of largebank holdingcompanies since2009.Toadminister a stresstest, supervisorsfirstconstruct a hypotheticalscenario that assumesa set of highly adverseeconomicand financialdevelopments--for example, a deep recessioncombined withsharpdeclinesin thepricesof housesand other assets.Thetestedfirmsandtheir supervisorsthenindependentlyestimatefirmsprojectedlosses, revenues,and capital under the hypothetical scenario,andthe resultsare publicly disclosed.Firms are evaluatedboth on their post-stresscapital levelsand on theirabilityto analyze their exposuresand capital needs.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 99Stresstestingprovidesa number of advantagesover more-standardapproachestoassessingcapital adequacy.First, measuresof capital based on stresstestsare both more forwardlookingand more robust to"tail risk"--that is,toextremelyadversedevelopmentsof the sort most likely tofoster broad-basedfinancialinstability.Second, becausetheFederalReserveconductsstresstestssimultaneouslyon themajor institutionsit supervises, theresultscan be used both forcomparativeanalysesacrossfirmsand tojudge thecollectivesusceptibilityof major financial institutionstocertaintypes of shocks.Indeed, comparativereviewsof largefinancial institutionshave becomean increasinglyimportant part of the Federal Reserves supervisorytoolkit more generally.Third, the disclosureof stress-testresults,whichincreasedinvestorconfidenceduring the crisis, can alsostrengthen market disciplineinnormal times.Thestressteststhusprovidecritical informationabout keyfinancialinstitutionswhile alsoforcing thefirms toimprovetheir abilitytomeasure and managetheir risk exposures.Stress-testingtechniquescan alsobeused in more-focusedassessmentsof thebankingsectors vulnerability tospecificrisksnot captured in themain scenario, such asliquidityrisk or interest rate risk.Like comprehensivestresstests, such focused exercisesare an importantelement of our supervisionof SIFIs.For example, supervisors are collecting detailed data on liquidity thathelp them compare firms susceptibilities to various types of fundingstressesand toevaluate firms strategiesfor managingtheir liquidity.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 100Supervisorsalsoareworking with firms toassesshow profitability andcapital wouldfare under variousstressful interestrate scenarios.Federal Reserve staff members supplement supervisoryand stress-testinformation with other measures.For example, though supervisorshave long appreciated thevalue ofmarket-basedindicatorsin evaluatingtheconditionsof systemicallyimportant firms(or, indeed, any publicly traded firm), our monitoringprogram usesmarket information toa much greater degreethan in thepast.Thus, in addition tostandard indicators--suchasstock pricesand thepricesof credit default swaps,whichcapture market viewsaboutindividual firms--weuse market-basedmeasuresof systemic stabilityderivedfrom recent research.Thesemeasuresusecorrelationsof asset pricestocapture themarketsperceptionof agivenfirmspotential todestabilize thefinancialsystem ata timewhenthebroader financial marketsare stressed; other measuresestimatethe vulnerability of a given firm to disturbancesemanatingfromelsewherein the system.Thefurther development of market-based measuresof systemicvulnerabilitiesand systemic riskis a lively area of research.Networkanalysis, yet another promisingtool under activedevelopment,hasthepotential tohelp usbetter monitor the interconnectednessoffinancial institutionsand markets.Interconnectednesscan arisefrom common holdingsof assetsor throughtheexposures of firms to their counterparties.Networkmeasuresrely on conceptsused in engineering,communications,and neurosciencetomap linkagesamong financialfirmsand market activities.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 101Thegoalsare toidentify keynodesor clustersthat could destabilizethesystem andtosimulatehowashock, suchasthesuddendistressofafirm,could be transmittedand amplified through the network.Thesetoolscan alsobe usedtoanalyze the systemic stabilityeffects of achangein thestructure of a network.For example, margin rules affect the sensitivity of firms to the conditionsof their counterparties; thus, margin rulesaffect the likelihood of financialcontagion through various firms and markets.Shadow BankingShadowbanking, a second area wecloselymonitor, wasan importantsourceof instability during the crisis.Shadowbanking comprisesvariousmarketsand institutionsthat providefinancial intermediationoutsidethetraditional, regulated bankingsystem.Shadowbanking includesvehiclesfor credit intermediation, maturitytransformation, liquidityprovision, and risksharing.Such vehiclesaretypicallyfunded on a largely short-term basisfromwholesalesources.In the run-up to the crisis, theshadowbankingsector involved a highdegreeof maturitytransformation and leverage.Illiquid loanstohouseholdsand businessesweresecuritized, and thetranchesof thesecuritizationswith thehighestcredit ratingswerefundedbyvery short-termdebt, such asasset-backedcommercial paper andrepurchaseagreements(repos).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 102Theshort-term fundingwasin turn provided by institutions,such asmoneymarket funds, whoseinvestorsexpected payment in full ondemand and had littletolerance for risk toprincipal.As it turned out, theultimateinvestorsdid not fullyunderstand thequalityof theassetsthey werefinancing.Investorswerelulledby triple-Acredit ratingsand by expected supportfrom sponsoring institutions--support that was, in fact, discretionaryandnot alwaysprovided.When investorslostconfidencein the qualityof the assetsor in theinstitutionsexpected to provide support, theyran.Their flight createdseriousfunding pressuresthroughout thefinancialsystem, threatenedthesolvency of many firms, and inflictedseriousdamageon thebroader economy.Securitiesbroker-dealersplay a central role in many aspectsof shadowbankingasfacilitatorsof market-basedintermediation.To finance their own and their clients securities holdings, broker-dealerstend to rely on short-term collateralized funding, often in the form of repoagreementswithhighly risk-averselenders.Thecrisisrevealed that thisfundingis potentiallyquitefragile if lendershavelimitedcapacityto analyze the collateral or counterpartyrisksassociated withshort-term secured lending, but rather look at thesetransactionsasnearlyrisk free.As questionsemerged about the nature and value of collateral, worriedlenderseithergreatlyincreasedmargin requirementsor,morecommonly,pulledback entirely.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 103Borrowersunableto meet margin callsand financetheir asset holdingswereforced to sell, drivingdown asset pricesfurther and settingoff acycle of deleveragingand further asset liquidation.Tomonitorintermediationbybroker-dealers,theFederalReservein 2010created a quarterlySenior Credit Officer OpinionSurvey on DealerFinancingTerms,whichasksdealersabout thecredit theyprovide.Modeledon the long-established Senior Loan Officer Opinion Survey onBank LendingPracticessent to commercial banks,the survey of seniorcredit officers at dealerstracks conditionsin marketssuch asthoseforsecuritiesfinancing, prime brokerage, and derivativestrading.Thecredit officer survey isdesigned to monitor potential vulnerabilitiesstemmingfrom thegreater use of leverageby investors(particularlythrough lendingbacked by less-liquid collateral) or increasedvolumesofmaturitytransformation.Beforethefinancialcrisis, wehad onlyverylimitedinformationregardingsuch trends.We have other potential sourcesof informationabout shadow banking.TheTreasuryDepartments Officeof Financial Research and FederalReservestaff are collaboratingto construct data setson triparty andbilateral repotransactions,which should facilitatethedevelopment ofbetter monitoring metrics for repoactivityand improvetransparencyinthesemarkets.We alsotalk regularlyto market participantsabout developments,payingparticular attention tothe creationof new financial vehiclesthat fostergreater maturity transformation outsidethe regulatedsector, providefundingfor less-liquid assets,or transform risksfrom formsthat are moreeasilymeasuredtoforms that are more opaque.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 104Afair summary isthat, while the shadow banking sector is smaller todaythan beforethecrisisand some of its least stablecomponentshave eitherdisappeared or been reformed, regulatorsand theprivatesector need toaddressremainingvulnerabilities.For example, although money market fundswerestrengthenedbyreforms undertakenby the Securitiesand ExchangeCommission (SEC)in 2010,thepossibilityof a run on thesefundsremains--forinstance, if afund should "break thebuck," or report a net asset value below99.5cents, astheReservePrimary Fund did in 2008.Theriskisincreasedbythefactthat theTreasurynolongerhasthepowertoguarantee investors holdingsin money funds, an authoritythat wascritical for stoppingthe 2008run.In November 2012, the FSOC proposed for public comment somealternativeapproachesfor the reform of money funds.TheSEC iscurrentlyconsideringtheseand other possiblesteps.With respect to thetripartyrepoplatform, progresshasbeen made inreducingthe amount of intradaycredit extendedbytheclearingbanks inthecourse of the dailysettlement process,and, asadditionalenhancementsare made, the extension of such credit should be largelyeliminated by the end of 2014.However,important risks remain in theshort-term wholesalefundingmarkets.Oneof the keyrisksis how the system wouldrespond to the failure of abroker-dealer or other major borrower.TheDodd-Frank Act hasprovidedimportant additional toolstodeal withthisvulnerability, notablytheprovisionsthat facilitatean orderlyresolutionof a broker-dealeror a broker-dealer holding companywhoseimminent failure posesa systemic risk.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 105But, ashighlightedin the FSOCsmost recent annual report, more workisneededtobetterprepareinvestorsandothermarket participantstodealwith the potential consequencesof a default by a largeparticipant in therepo market.Asset MarketsAsset marketsare a third area that wecloselymonitor.We followdevelopmentsin marketsfor a widerangeof assets, includingpublic and private fixed-incomeinstruments,corporateequities, realestate,commodities,and structured credit products,amongothers.Foreign as well as domestic markets receive close attention, as do globallinkages, such as the effects of the ongoing European fiscal and bankingproblemson U.S.markets.Not surprisingly, wetry toidentifyunusual patternsin valuations,suchashistoricallyhigh or low ratios of pricesto earningsin equitymarkets.We usea varietyof modelsand methods;for example, weuseempiricalmodelsof default risk and risk premiumsto analyze credit spreadsincorporatebond markets.Theseassessmentsare complementedby other information, includingmeasuresof volumes, liquidity, and market functioning, aswell asintelligencegleanedfrom market participantsand outsideanalysts.In light of the current lowinterest rate environment, wearewatchingparticularlycloselyfor instancesof "reaching for yield" and other formsof excessiverisk-taking, whichmay affect asset pricesand theirrelationshipswithfundamentals.It is worthemphasizingthat lookingfor historicallyunusual patternsorrelationshipsin asset pricescan be useful even if you believe that assetmarketsare generallyefficient in setting prices.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 106For thepurposeof safeguarding financial stability, weare lessconcernedabout whether a given asset price isjustified in some averagesensethanin thepossibilityof a sharpmove.Asset pricesthat arefar from historicallynormal levelswouldseem tobemore susceptibletosuch destabilizingmoves.From a financial stability perspective, however, theassessment of assetvaluationsis onlythefirst step of theanalysis.Also to be considered are factorssuchasthe leverageand degree ofmaturitymismatch beingusedby theholdersof the asset, the liquidityoftheasset, and the sensitivityof the assetsvaluetochangesin broadfinancial conditions.Differencesin thesefactorshelp explainwhythecorrection in equitymarketsin 2000and2001didnot inducewidespreadsystemicdisruptions,while the collapsein housepricesand in thequalityof mortgagecreditduring the2007-09crisis had much more far-reachingeffects:Thelossesfrom thestockmarket declinesin 2000and 2001werewidelydiffused, while mortgagelosseswereconcentrated--and, through variousfinancial instruments,amplified--incriticalparts of the financial system,resultingultimatelyin panic, asset fire sales,and the collapseof creditmarkets.Nonfinancial SectorOur financial stabilitymonitoring extendsto thenonfinancial sector,includinghouseholdsand businesses.Researchhasidentified excessivegrowthin credit and leveragein theprivatenonfinancial sector aspotential indicatorsof systemic risk.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 107Highlyleveragedorfinanciallyfragile householdsandbusinessesare lessableto withstand adversechangesin incomeor wealth, includingthosebrought about bydeterioratingconditionsin financialandcredit markets.Ahighly leveraged economy isalsomore pronetoso-calledfinancialacceleratoreffects,aswhenfinanciallystressed firms are forced to layoffworkerswho, in turn, lackingfinancial reserves,sharplycut their ownspending.Financial stressin the nonfinancial sector--for example, higher defaultrateson mortgagesor corporatedebt--canalsodamage financialinstitutions,creatinga potential adversefeedback loop astheyreducetheavailability of credit and shed assetsto conserve capital, therebyfurtherweakeningthefinancial positionsof householdsand firms.The vulnerabilities of the nonfinancial sector can potentially be capturedby both stock measures (such as wealth and leverage) and flow measures(such asthe ratio of debt serviceto income).Sector-widedata are available from a number of sources,importantlytheFederal Reservesflowof fundsaccounts,whichis a set of aggregateintegratedfinancial accountsthat measuressourcesand usesof fundsformajor sectorsaswell asfor the economy asa whole.Theseaccountsallowustotrace the flow of credit from itssources,suchasbanks or wholesalefundingmarkets,tothehousehold and businesssectorsthat receiveit.TheFederal Reservealsonowmonitorsdetailed consumer- andbusiness-leveldata suitedfor pickingup changesin thenature ofborrowingand lending, aswell asfor trackingfinancial conditionsofthosemost exposedtoa cyclical downturnor a reversal of fortunes.For example, duringthehousing boom, the aggregate data accuratelyshowedthe outsized pace of home mortgageborrowing, but it could notBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 108reveal the pervasivedeterioration in underwritingthat implied asubstantial increasein the underlying credit riskfrom that activity.Morerecently, gainsin household net worthhave been concentratedamongwealthier households, whilemany householdsin themiddleorlowerpartsof the distribution have experienceddeclinesin wealthsincethecrisis.Moreover,many homeownersremain "underwater," with their homesworthlessthan theprincipal balanceson their mortgages.Thus, more detailed information clarifiesthat many householdsremainmore financiallyfragile than might be inferred from theaggregatestatistics alone.ConclusionIn closing, let me reiteratethat while the effectiveregulation andsupervision of individual financial institutionswill alwaysbe crucial toensuring a well-functioningfinancial system, the Federal Reserve ismovingtowardamoresystemic approachthat alsopayscloseattentiontothevulnerabilitiesof thefinancial system asa whole.Towardthat end, weare pursuing an activeprogram of financialmonitoring, supportedby expanded researchand data collection, oftenundertaken in conjunction with other U.S.financial regulatoryagencies.Our stepped-up monitoring and analysisis alreadyprovidingimportantinformation for the Board and the Federal Open Market Committeeaswell asfor thebroader regulatory community.We will continue to worktoward improving our ability to detect andaddressvulnerabilitiesin our financial system.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 109Erkki Liikanen: Banking structure and monetary policy – whathave we learned in the last 20 years?Presentation by Mr Erkki Liikanen,Governorof the Bank of Finland andChairmanof theHighlevel ExpertGroup on thestructure of theEUbankingsector, at theconference―Twentyyears of transition –experiencesand challenges‖,arrangedbythe National Bank ofSlovakia, Bratislava.How istoday‘s perspectiveonmonetarypolicy different from what prevailed 20years ago?Twentyyears ago, the worldof todaywasbeingformed in manyways.1993wasthe year whenthe Economic and MonetaryUnion project wasbecomingpolitical reality: theMaastricht treatyhad been signedand wasin theprocessof beingratified.It wasalsothetime whenthe mainstream approach to monetary policywasbeginningto convergetothe flexibleinflationtargetingframework.Anumber of countrieshad then just adopted anexplicit inflationtargetingstrategy.In the sphere of banking regulation, too, a new era wasbeginning.Asignificant reorientationwasgoingon, awayfrom regulating theconduct of banks and towardsthe new risk-basedapproach.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 110Theregulatory trend, based on increasedfreedom for banksbut subjecttorisk based capital requirements, wouldcontinueall the wayto theeruption of the financial crisisin 2008.In theEU, thesecondbankingdirectivetookeffectfrom thebeginningof1993,creatinga singlemarket in banking.Thedirectivesought to prevent discriminationand to increase efficiencythrough competition.There wasdiscussionontheimplicationsof thisfor supervision, but littleaction.So, whileEuropean bankingmarketswerebeingintegrated, financialsupervision remained a national competence.In the U.S., deregulation wasalsomoving forward.For instancethe Glass-SteagallAct, separatingbanking from securitiesand insurance, wasunder growingcriticism and wouldbe ultimatelyrepealedin 1995.One reason for the dissatisfaction with the Glass-Steagall system in theUS was competition from European banks which were less restricted inwhat theycould do.Twentyyears ago, the striking improvement in macroeconomicperformance,laternamed―thegreat moderation‖ bychairmanBernanke,wasspreadingtothe wholedeveloped world.Thealmost surprising successof monetary policy in improving pricestability and reducingfluctuationsin economic activity, while alsokeepinginterest ratesat historicallylowlevels, wasinterpretedasa majorvictoryfor theart of economicpolicymaking.Now weknow that there wastroublebrewingunder the surface.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 111Theunderpinningsof global financial stabilitywerebecoming weaker.Global indebtednessincreased, fuelledby current account balancesandthe―deepening‖ of international financial markets(read: recycling thesamefundsseveral timesover).Thedecline of inflation wasnot only due to monetary policy, but alsotheavalancheof cheap consumer goodsfrom theemerging economiessuchasChina contributed to it.For banks, the new financial environment wascharacterizedby lowinterest ratesand lowperceived risks.It alsoturned out that the new risk-basedcapital requirementsallowedthe banks to expand their balancesheetsenormouslywithout increasingtheir equitycapital in the same proportion.So, graduallythe largebanking groupsstarted to increasetheir tradingportfolios.This development happened in a gradual fashion in the 1990‘sbutaccelerateddramaticallyfrom about 2004.Banks redirected their businessfocusfrom interest marginstofee-basedandtrading activities.Universal banking, asit had been knownin Europe, startedtochange.Theasset mix of thelargest banks changedsothat securitiesportfoliosactivitiesgrew more and more important.Onlynow, from theperspectivegiven by theworstfinancial crisis sincetheSecond World War, doweseeclearlythefragility and weaknessof theregulatoryarrangementswhichcame intoforce in the 1990s.From today‘spoint of view, theyperformed wellonly aslong asnomajorsystemic risksmaterialized.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 112Even worse,theyallowedriskstoaccumulate in the financial systemwhichwereonly waitingtobe realized.Thencame 2007andthecollapseof theUS property market;2008and thecollapseof interbank moneymarketsfollowingthe Lehman Brotherscrisis;and 2009withThe Great Recession.Thepainful processof competitivedeleveragingstarted.Thereassessment of economicpoliciesfollowedin the lasttwodecadeshasalsostarted.Especiallyfinancial regulationhasbeenreconsideredand is beingstrengthened.We needto think of monetary policy, too, especiallyin itsconnection tofinancial stability.Monetary policy and financial stabilityThere is a common dictum that a stable financial system is a necessarycondition for successful monetary policy, and that price stability in turncreatesthe best preconditionsfor financial stability.I agree.Still, the experienceof this crisishasthought usa lot more.First of all, wenow know that pricestability doesnot by itself guaranteefinancial stability.Riskscan accumulate in thebankingsystem even if monetary policysucceedsin maintainingprice stability and controllinginflationaryexpectationsreallywell.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 113Second, wealsoknow that central bankscan maintain an admirabledegreeof pricestabilityeven whenfinancial stabilityis under a lot ofstrain.Dothesetwopointsmean that financial stability and monetary policyarenot connected after all?No.Theyare very closelyrelated.Independence of monetary policyOneof the lastinglessonslearned in thelast decadesis the value of theindependenceof monetary policy.The independence of central banks has been essential keeping inflationexpectations as well anchored as they have been in this crisis despite alltheturmoil in the financial markets.Independencehasalsomade it easierfor central banksto act quicklywhenit hasbeen necessaryin order tomaintainfinancial stability.It is especiallyimportant to avoid twothreats toindependence:fiscaldominanceand financial dominance.Fiscaldominanceisthe older concept of thetwo.It wouldarise if thegovernment financing constraint wouldbecome anoverridinginfluenceon monetary policy.Theideaof fiscal dominancewasformalizedby Tom Sargent and NeilWallacein 1981,but of coursethe worrythat deficit financingmay causeinflationhasmuch longer rootsin monetarythought.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 114Theideathat tight monetary policy may become impossiblewithoutaccompanyingfiscal adjustment wasalsowellunderstood whentheblueprintsfor the EMU werebeingprepared.ThisiswhytheMaastrichttreatyhaditsfiscalpolicyclausesandalsowhytheStabilityand GrowthPact wasconcluded.Also the prohibitionof direct central bank credit to the government andtheinstitutional independenceof thecentral banks are in effectprotectionsagainst fiscal dominance.Now weknow, of course,that the fiscalframeworkasput in placebeforethestart of the EMU wasnot strong enough to prevent fiscal problemsfrom emerging.Somehave argued that fiscaldominancehas takenhold in thein thebigindustrializedcountries during the crisiswhen thecentral banks haveused government bond purchasesin order tostabilize the markets(astheECB) or to produceadditional monetary stimuluswhenthe interest rateinstrument hasalreadybeen used tothemaximum (like theFederalReserveand the Bank of Japan).As to the euroarea, for me there is nownoevidenceof fiscaldominance.Fiscaldominanceimpliesthat monetary policy wouldbreak its pricestability objectivefor the sakeof maintainingthesolvencyof thegovernment sector.This is not the case.Price stabilityhasnot and will not be abandoned.We have well knownfiscal problemsin some of the euro area countries.Still, theECB‘sability togoon maintainingprice stabilityhasnot beenweakened.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 115In particular theinflation expectations,whichare themost essentialindicatorsof thecredibility ofmonetarypolicy, haveremainedwellin linewith the pricestability objective.Theparallel ideaof financial dominanceis more recent than fiscaldominance.Financial dominancerefers tothepossibilitythat thecondition of thebankingsystem could become a constraint, or dominant influence,onmonetary policy, effectivelyforcing the central bank topursuesecond- orthird-best monetary policiesin order tomaintainfinancial stability.Is thespill-over from financial instabilityto monetary policy a realisticthreat?Can financial stabilityconsiderationslead the central bankstotoleratetoohigh inflation, just to keep the banking sector afloat?In principleit is easyto see whyit could be.Onecanimagineacentralbank whichwouldhavetotightenitsmonetarypolicy for pricestabilityreasons,but isprevented from doing sofor thefearthat thevalueof theassetsof thebankingsystem woulddecreaseanda financial crisiscould ensue.Episodeswhichfit the description of financial dominancehave beenobserved in emergingeconomiesafter some banking crisesin thepast.But lookingat recent experience, thishasnot been the casein thedeveloped economies.Thebust of thecredit boom hasnot ledmonetary policy totolerate ahigher-than-mandatedrate of inflation.Instead, in the largedeveloped economiesat least, theburstingof theBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 116bubblehascoincidedwith a sudden contractionof privatedemand and adeep recession.Thenegativeeffect of thebust on economicactivityhasactuallyreducedinflationarypressuresand in some cases(such asin Japan in the1990‘s)created a real danger of deflation.Themain problem hasthenbecomehowtoprevent thecredit contractionfrom startinga deflationaryspiral.In such conditions,the same monetarypolicy will then both easethestrain onthe bankingsector and support price stability.Thisobservationdoesnotmeanthat financialinstabilitywouldnotposeaseriouschallengetomonetary policy.On the contrary, thedownwardimpact of a bust, if it is large, may bemore difficult tocontrol than the precedingperiod of credit expansion.There was a famous discussion on how monetary policy should relate toasset prices in the Jackson Hole conference of 2007, where Rick Mishkinintroduced thetopic.At that time, the prevalent thinkingin central bankingcircleswaswhatprofessor Issinglater called ―theJacksonHole consensus‖, meaning thatit is better for monetary policy onlyto ―clean‖ (up afterwards)than to―lean‖ (againstthe wind).After thehard lessonswelearned over thelast five years thecaseforbenign neglect of asset boomsand only pickingup the piecesafterwardsis not sostrong anymore.Thecrisisexperiencesupportsrather theidea that financial excessesarebetter prevented astheyhappen than onlymanaged after theyhavecauseda recession.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 117This wouldbe thebest wayto prevent ―downwardfinancialdominance‖whichcould ariseif monetary policy could not effectivelycounteractcredit contraction.Unconventional toolsand the independence of monetary policyRecent experienceshowsthat thecentral banks‘box of potential toolsisactuallyvery deep, and if it hasbecomenecessarytoutilizeunconventional tools,asin thepresent crisis, thesenew toolshave beendeveloped and deployed.In the caseof theECB, the new toolshave included the transitiontofullallotment auctions,thelong term refinanceoperationsup tothree years,wideningof the scope of eligible collateral, and the variousbondpurchaseprogrammes.Themost recent oftheseistheOMT programmeannouncedlastsummerbut not yet commenced in practice.Thedevelopment of new toolshasbeen justified.The slip of the depressed economies to dangerous deflation has beenaverted, and the debt and banking problems have not developed intosystemic financial meltdownsin the affected countries.We have seen that central bankscan pursuesuccessful price stabilitypolicy alsounder very difficult conditions.Theeventsaround the worldsincethecollapseof Lehman Brothersareevidenceof that.Deflationhasbeen avoided despitea severe recession in many countries.However,there are alsocertain problemswithrelying on theenlargedtoolkit of the central banks.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 118Theabilitytoact in crisishasled to thecentral banksbeingeven called―theonlygame in town‖.We should resist thisideaand bewareof thedanger that problemswhichare fundamentallypolitical could be pushedtocentral banksto solve.Adivision of responsibilitiesbetweenappointed officialsand electedpoliticiansshould be preserved.Monetarypolicycannot administer the needed structural transformationin thereal sector of theeconomy or solve excessivedeficit problemsofgovernments.There aresituationswherethe central banks just haveto act and do theirbest to stabilize the economy, even if they wouldhave to use tools whichgobeyond just adjustingthe short rate of interest or the aggregateliquidityof thebanking system.Thepresent financial crisishasconstitutedone such situation.Avoiding the bustswhichseem to followcredit boomsand periodsof―financial exuberance‖wouldmake thetasksof monetary policy mucheasierand protect the independenceof central banks.But there are alsodifficultieswith theleaningagainst the wind.Onehasto dowiththe problem of detectingthe credit cycle in time, andcorrectlytiming themonetary policy response.Another problem is that price stability might get lessattention.To mitigate these problems, something else besides more vigilant interestrate policy is needed to prevent low and stable interest rates from leadingtoexcessesin banksand financial markets.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 119Onedevelopment can be thedevelopment of macro-prudentialinstrumentswhichare designed to improve the stability of the financialsystem asa whole.Themajor workin this fieldwasdonebythedeLarosière group.Otmar Issingwasa member of thegroup.Especially interesting are those macro-prudential instrumentswhich havea time dimension so that they can be adjusted according to the changingsituationin the credit markets.Such instrumentsinclude, in particular, thecountercyclical capitalrequirements,aswell astheadjustablerestrictionson Loan-to-Valueratios.TheCRD IV directivewill make theformer instrument obligatoryin theEU countries; implementationof the latter is left to national discretion.Now it is very important to establishan effectivetoolkit for bothEuropean and national authorities.We must alsocreateinstitutional conditionswhichdonot prevent thesetoolsto beused when needed.Therefore, weneed cleardecision makingcompetencesat all levels.Theconnectionbetweenmacro-prudential policy and itstime dimensionwith monetary policyis sointimatethat central banksmust be closelyinvolved in macro-prudential analysis and decisionmaking.Macro-prudential policy is important, but it needsto be supportedbystructural reformswhichwouldmake thebanking system more resilient,and - I emphasise- lesspronetounstablebehaviour.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 120TheStructural reform proposalsIn order toprevent the present crisisfrom being ever repeated,governmentsand authoritieshave started a large-scaleoverhaul offinancial regulation.Theregulatory agenda can be broadly dividedintothe followingareas:•Strengtheningof the prudential regulation of solvencyand liquidity• Improvingtheinstitutionalbasisforsupervisionandcrisismanagement•Introduction of macro-prudential instrumentstoprevent systemic risksin thebankingsystem and financial markets• Regulatingthe structureof the banking sectorThestructural reform proposalswhichappear asthe last item on thislistaim toseparate the riskiest securitiesand derivativesbusinessfrom thedeposit banking activities.This is theessential content of theproposalsby theEU High LevelExpert Group, whichI chaired, publishedlast autumn.It is alsoat thecore of the Volcker rule whichis beingimplemented intheUS, and the Vickersproposal in theUK.Thecurrent legislativeproposalswhichare underwayin FranceandGermanyare alsoin thesamevein.Aparticular concern of theseproposalshasbeen tolimit theextent ofexplicit or implicit public guarantees,sothat theywouldnot induceadditional risk taking.This kind of competitivedistortion could result in securitiestradinggettingconcentratedin the largest deposit banks, and thesedepositBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 121banksbecoming enormousrisk concentrations built on implicit or evenexplicit public guarantees.Separation proposalstry to isolatesecurities businessfrom thesourcesofthisdistortion and reducethe incentivesto excessiverisktaking and riskconcentration.In must be emphasized that the structural reform weproposed is not acure-all but should be seen asa part of a comprehensive regulatoryagendawhich isalreadymoving forward.This includesbetter solvencyand liquidityrules.Also, theEU will finallyget supervisionand resolution frameworksat theunion level.Thedifferent componentsof thecurrent regulatory agendacomplementand support each other.In thisEuropean context, thestructureandstabilityof thebankingsectoris of vital importanceto the economy.It is imperativeto improve itsresiliency.TheHigh Level Expert Group report containsfive mainrecommendationson how to reform thebankingsector.I will just refer tothreeof them here:•Thefirst is toseparate any significant proprietary tradingin securitiesandderivativesfrom deposit banks.These activities could be carried out in a separately capitalized andfunded subsidiary, a trading entity, which could belong to the samebankinggroup asthedeposit bank.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 122We proposedthat alsomarket making be allocated to thetradingsubsidiary in order toprevent the useof tradinginventoryto circumventthe prohibition on proprietary trading.•The use of trading subsidiaries would allow the banking groups to offer―one-stop banking‖ to their clients, but without the possibility of fundingtradingactivitieswithinsuredretail deposits.Financial linkagesbetweenthe deposit bank and the trading unit wouldhaveto be restrictedin accordancetonormal largeexposure rules.•Another of our proposalsisto develop specific, designatedbail-ininstrumentsto improve the lossabsorbencyof banks.Arequirement to issuesuch bail-in debt wouldhelp ensure theparticipationof investorstothe recapitalizationof a bank if this shouldbecomenecessary.Such designatedbail-in instrumentswouldclarifythe hierarchyof debtcommitmentsand allowinvestorstopredict theeventual treatment of therespectiveinstrumentsin caseof recapitalizationor resolution.•Thegroup alsoproposedthat thecapitalrequirementsontradingassetsand real estaterelated loansbe reviewed.Both of theseasset categoriescame to have very low risk weightsin theBasel II regime, mostlybecausethewayinternal models wereapplied.Why banking structure mattersfor monetary policyLet me recapitulatemy main points.First, for monetary policy, financial stabilityis very important.While monetarypolicyhasproventobeabletopursuepricestabilityevenunder rather strained financial conditions,the central banksare not ableBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 123toinsulatethe real economy completelyfrom theafter-effectsof financialcrises.Amore stablebanking sector whichis lessprone tocrisiswill reducethelikelihoodof crisesand thereforeprotect thebalancesheetsof the centralbank from financial risksand therebyprotect itsindependenceandcredibility.Second, themost important part of stability policy is crisisprevention.Improvinglossabsorbencyof banks and thecrisismanagement powersof the authorities arenecessary, but it is even more important to makesure that excessivegrowthof credit and indebtednesscan bebettercontrolledin the future.In this way, credit crunchesand bankingcrisescan be made lesslikely –andmilder, should theyhappen.Third, financial stability wouldbenefit from structural reform of thebankingsystem.By separatingthe most riskysecurities and derivativeactivitiesfromdeposit banking, thespill over from deposit protection tospeculativerisktakingwouldbe prevented.This would reducethe distorted incentivestoexpand tradingactivitiesand concentraterisksin deposit banksbecauseof their privilegedpositionin the deposit market.Finally,thestructural reform ofbankingisacomplement, not asubstitutefor other regulatory improvements.For central banks, thedevelopment of macro-prudential policiesandinstrumentsisespeciallyrelevant.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 124Thosemacro-prudential instrumentswhich can be adjustedover time tomanagethe conditionsin the credit market will offer a waytobettercontrol the accumulation of excessriskand help prevent future crises.Theseinstrumentsoperatesocloseto monetary policythat central banksshould be very closelyinvolved, if not themselvesresponsible, indeveloping and using them.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 125APRA releasessecond consultationpackage on Basel III liquidity reformsTheAustralian Prudential RegulationAuthority (APRA) hastoday releaseda secondconsultation packageoutliningits proposed implementationof theBasel III liquidityreformsfor authoriseddeposit-takinginstitutions(ADIs) in Australia.Thepackage includesa discussionpaper, a reviseddraft PrudentialStandardAPS210Liquidity(APS210) and a draft Prudential PracticeGuideAPG 210Liquidity.Thepackageaddressesthemain issuesraised in submissionstoAPRA‘spreviousdiscussionpaper released in November 2011, and incorporatesrevisionsto the Basel III liquidityreformspublished by theBaselCommitteeon BankingSupervision (Basel Committee) in January2013.In the 2011discussion paper,APRA outlinedproposalstoimplement theBasel III liquidityreforms.Theseproposalsincluded twonew quantitativemeasures— a 30-dayLiquidityCoverageRatio(LCR) toaddressan acutestressscenarioand aNet StableFundingRatio(NSFR) to encourage longer-term fundingresilience.TheserequirementswouldapplytothoseADIsthat arecurrentlyrequiredtoconduct scenario analysisof their liquidityneedsunder differentoperatingcircumstances.This approach is unchangedin the updateddraft APS 210.In the 2011paper,APRA alsoproposed thatADIscurrentlysubject to thesimplequantitativeliquidityratio requirement, the minimum liquidityholdings(MLH) regime, wouldnot be subject to either of thetwonewBasel III global standards.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 126In responseto submissions,APRA hasmade minor adjustmentstotheMLH regime.Therecent revisionsto the LCR announcedby theBasel Committeeincludediscretionfor national authoritiesto includea widerrange ofliquidassetsin thedefinitionof high-qualityliquidassets(HQLA), somerefinementstothe assumed cash inflowand outflowrates,and a revisedtimetablefor phase-in of the LCR.In the packagereleasedtoday, APRA is not proposingto exercisediscretiontowidenthe definition of HQLA; hence,the definitionofHQLA in theupdated draft APS210is unchanged.In addition,APRA isproposingtoimplement theliquidityreforms onthepreviouslypublishedtimetable.APRA acknowledgesthisis a conservative approach, but one that is fullyconsistent withthe capabilitiesand needsof theAustralian bankingsystem.Accordingly, the LiquidityCoverageRatio will become effectivefrom 1January 2015and theNet StableFundingRatio from 1January 2018.The discussion paper released today also includes responses to the mainissues raised in submissionson APRA‘s 2011 proposals that have not beenaffected by the BaselCommittee‘srecent revisions.APRA Chairman Dr John Laker said that, in implementingtheBasel IIIliquidityreforms,APRA‘sobjectivesaretostrengthentheresilienceoftheAustralian banking system and improveAPRA‘s ability toassessandmonitorADIs‘ liquidityrisk.‗APRA believesADIsare well-placedto meet the new liquidityrequirementson theoriginal timetableand doing sowill send a strongmessageabout thesoundnessof theAustralian bankingsystem.‘Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 127Thediscussionpaper, draft prudential standard and draft prudentialpractice guidecan befound onAPRA‘s websiteat:www.apra.gov.au/ adi/PrudentialFramework/Pages/Implementing-Basel-III-liquidity-reforms-in-Australia-May-2013.aspxTheAustralian Prudential RegulationAuthority (APRA) is theprudentialregulator of thefinancial servicesindustry. It overseesbanks, creditunions,buildingsocieties, general insuranceand reinsurancecompanies,life insurance, friendlysocieties, andmost membersof thesuperannuation industry. APRAis funded largely bytheindustries that itsupervises. It wasestablished on 1July1998. APRAcurrentlysupervisesinstitutionsholding$4.2trillion in assetsforalmost 23millionAustraliandepositors, policyholders and superannuation fund members.Discussion PaperImplementing Basel III liquidity reformsin AustraliaMay 2013In November 2011,APRA released a discussion paper and draft prudentialstandardoutliningitsproposalstostrengthen theliquidityriskmanagement frameworkfor authoriseddeposit-takinginstitutions (ADIs)in Australia.The discussion paper gave effect to reforms, announced by the BaselCommittee on Banking Supervision (Basel Committee) in December2010, to strengthen liquidity buffers so as to promote a more resilientglobal banking system.In January 2013,theBasel Committeereleased amendmentstoone of thekey elementsof these reforms— the LiquidityCoverageRatio (LCR) —in itsdocument Basel III: The LiquidityCoverageRatio and LiquidityRiskMonitoring Tools.APRA is now in a position tocompleteitsconsultationson themainelementsof the Basel III liquidityframework.This consultationpackage outlinesAPRA‘s proposed amendmentstoits2011proposalson the implementationof the LCR in Australia.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 128It alsoaddressesthemain issuesraisedin submissions,and in otherdialoguewithindustry and other interestedparties,on those ofAPRA‘searlier proposalsthat have not been affectedby theBasel Committee‘srecent revisions.Theconsultationpackageincludesan updated draft of PrudentialStandardAPS210Liquidity(APS210)and draft Prudential PracticeGuideAPG 210Liquidity(APG 210).Qualitative requirementsTheBasel III liquidityframeworkis underpinnedby qualitativerequirementsfor liquidityriskmanagement, based on theBaselCommittee‘sPrinciplesfor Sound LiquidityRisk Management andSupervision(Sound Principles) (2008).APRAproposedtoincorporatethesequalitativerequirementsin arevisedAPS 210.Theyincluded requirementsfor enhanced Board oversight of anADI‘sliquidityrisk management framework, for an articulationof the Board‘stolerancefor liquidityrisk, for quantificationand allocation of liquiditycostsand benefits,and other matters.SubmissionsweresupportiveofAPRA‘s qualitativerequirementsand they areunchanged in theupdateddraft APS210.Quantitative requirements: scenario analysisADIsTheBasel III liquidityframeworkinvolvestwonew minimum globalstandards:- a 30-dayLCR to addressan acutestressscenario;and- a Net StableFundingRatio (NSFR) to encourage longer-termfundingresilience.APRA proposedtoapplythesequantitativeliquidityrequirementstothoseADIsthat arecurrentlyrequired toconduct scenarioanalysisoftheir liquidityneedsunder different operatingcircumstances(‗scenarioanalysis‘ADIs).This approach isunchangedin theupdateddraft APS 210.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 129TheBasel Committeeis continuingto review theNSFR, which doesnotcomeintoeffect until 1January 2018.APRA hasnot made any amendmentstoits proposedimplementationoftheNSFR, but will ensure that concernsraisedin submissionsare fedintothe Basel Committee‘sdeliberations.TherevisionstotheLCR recentlyannounced by theBasel Committeeinvolve:- discretionfor national authoritiestoincludea wider rangeof liquidassetsin the definitionof high-qualityliquid assets(HQLA);- some refinementstotheassumed cash inflowand outflow rates;and- a revised timetablefor phase-in of the LCR.Definition of HQLANational authoritieshave discretion to include certain additional assetsina new ‗Level 2B‘ category of HQLA, subject to haircuts and provided theassetsfullycomplywith thequalifying criteria.These assets are residential mortgage-backed securities (RMBS) with along-term credit rating of AA or higher, corporate debt securitieswith along-term credit rating betweenA+ and BBB–, and certain listednon-financial equities.APRA is not proposing to exercisethis discretion.Accordingly, the definitionof HQLA in the updated draft APS210isunchanged.APRA hasconsidered themarket characteristicsofAustralian dollar debtsecuritiespotentiallyeligible asLevel 2B assetsagainstthe qualifyingcriteria that such assetsmust tradein large, deep and activemarkets,beliquidduring a time of stressand, in most casesbe eligiblefor useincentral bank operations.In APRA‘s view, therelevant securitiesdonot meet all of thesecriteria.Further,APRA doesnot consider that theinclusion of equitiesasLevel2B assetswouldcontributeto the resilienceof theAustralian bankingsystem.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 130Equities arenot repo-eligiblewiththe Reserve Bank ofAustralia (RBA);hence, a large-scaleforced saleof equityportfoliosby one or moreAustralian bankscould significantlyexacerbatea stressevent.However,some of the debt securities includedin the definition of Level2Aand Level 2B assetsare repo-eligiblewith theRBAfor normal marketoperationsand areeligible collateralfor theCommittedLiquidityFacility(CLF).ADIswith accesstothe CLF are likelytohold thoseassetsaspart of awell-diversifiedliquid assetsportfolio.Cash inflow and outflow ratesAPRA is proposing toadopt the revisedBasel III assumed cash inflowand outflowrates,withonlyone minor modification relatedto maturingcentral bank fundingtransactions.In its2011discussionpaper,APRA proposedsomeother modificationstotheBasel III assumed cash inflowand outflowrates.Theserelatedtothetreatment of self-managedsuperannuationfunds,high run-offlessstableretail and qualifying small and medium enterprise(SME) deposits,contingent fundingobligations,and recognition of headofficeliquiditysupport toAustralian branchesof foreign banks. Thesemodificationshavenot beenmateriallychangedin theupdateddraft APS210.Quantitative requirements: minimum liquidity holdingsADIsIn its 2011discussion paper,APRA proposed that ADIscurrentlysubjecttoa simplequantitativeliquidityratiorequirement, theminimumliquidityholdings(MLH) regime, wouldnot be subject to either of theBasel III global standards.APRA proposedtoleavethe MLH regime broadlyunchangedbut torevisethedefinitionof assetsthat are eligiblefor inclusion in anADI‘sminimum liquidityholdings.Submissionsraisedconcerns about thetreatment of industrysupportschemesandthereviseddefinitionofassetseligibleforinclusioninMLHportfolios.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 131APRAhasmade some amendmentsin updateddraft APS210in responsetothesesubmissions.Reporting and prudential disclosure requirementsReportingrequirementsfor scenario analysisADIshave been the subjectof a separateconsultationprocess, based onAPRA‘s November 2012discussion paper, Liquidityreportingrequirementsfor authoriseddeposit-takinginstitutions.Since the Basel Committee is continuing to review the NSFR, APRA hasdecided to remove the NSFR from the standardised reporting frameworkat this stage.TheBasel Committeeis alsocontinuingto develop disclosurerequirementsfor bank liquidityand fundingprofiles.APRA intendstoconsult separately on its disclosure requirementsonce global disclosurestandardsare finalised.Implementation timetableIn its 2011discussion paper,APRA proposed tointroducetheLCRrequirement from 1January2015,in linewith the-then internationallyagreedtimetable.As noted above, therevisedtimetablerecentlyannounced bythe BaselCommitteeallowsfor a phase-inof the LCR, with a minimumrequirement of 60per cent from the original start-daterisingin equalannual stepsof 10percentagepointsto reach 100per cent on 1January2019.Thegraduated approach isdesignedtoensure that the LCR can beintroduced ‗…without disruption to theorderly strengtheningof bankingsystems.‘APRA is not proposing to adopt the phase-in arrangements.Thesearrangementswereintroduced in light of theconsiderable stressfacingbankingsystems in some regions.Australia, however,is not one of thoseregions.Moreover,most largeinternationallyactivebanks arealreadycompliantwith the LCR.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 132Finally,APRA is cognisant of concerns,raisedby the InternationalMonetaryFund in its2012Financial System StabilityAssessment ofAustralia, that the continuedrelianceofAustralian banks on offshorefundingleavesthem exposed to disruptionstofunding markets.Accordingly, APRA proposestoretain itsoriginal implementationtimetablefor theLCR.This is a conservativeapproach, but one that is fullyconsistent withthecapabilitiesand needsof theAustralian bankingsystem.ADIsare, in anyevent, wellplaced tomeet therequirement and, in doingso, will send a strongmessage about thesoundnessof theAustralianbankingsystem.APRA invites written submissions on its proposed response to the BaselCommittee‘s recent revisions to the Basel III liquidity framework, as setout in theupdateddraft APS 210.It alsoinviteswrittensubmissionson the draft APG 210.Followingconsiderationof submissionsreceived, APRA intendsto issuethefinalAPS210andAPG 210in mid-2013.Thenew prudential standard is intendedto come intoforce on 1January2014;theLCR and NSFR requirementsare intended to commenceon 1January 2015and 1January2018,respectively.Chapter 3 – LCR — high-quality liquid assetsThedetermination of the LCR hastwocomponents:- thevalue of thestock of HQLA in stressedconditions;and- total net cashoutflows, calculatedaccordingtospecifiedscenarioanalysis.This chapter dealswiththe first of thesecomponents.3.1Original Basel Committee measuresUnder the BaselIII liquidityframework,assetsqualifying asHQLA forLCR purposesmust beunencumbered, easilyand immediatelyconvertedBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 133intocash withlittleor nolossof value under stressed market conditionsand, ideally, be eligiblefor repurchaseagreementswith thecentral bank.In theBaselCommittee‘soriginal measures,HQLAwerecategorisedintotwobucketsbasedon the liquiditycharacteristicsof the assets8.Thehighest qualityliquid assets,whichAPRA will refer toasHQLA1,can comprise an unlimitedportion of thetotal stock of HQLA.Theseassetsare limitedto:- cash;- central bank reserves(tothe extent that thesereservescan bedrawndownin timesof stress);and- marketablesecuritiesrepresentingclaimson or claimsguaranteed bysovereigns, quasi-sovereigns,central banksand multilateraldevelopment banks, that have undoubtedliquidity, even duringstressed market conditions,and that areassigned a zero risk-weightunder the Basel II standardised approach to credit risk.HQLA2 are assetswitha proven record asa reliable source of liquidityeven during stressed market conditions,and comprise:- marketablesecuritiesrepresentingclaimson or by sovereigns,quasi-sovereigns, central banks and multilateral development banks,whichare assigneda 20 per cent risk-weight under the Basel IIstandardisedapproach;- corporatebonds(not issued by a financial institution or anyof itsaffiliatedentities)witha credit rating from a recognised externalcredit assessment institutionof at least AA-; and- coveredbonds(not issuedby theADI itself or any of itsaffiliatedentities)witha credit ratingof at leastAA-.HQLA2 are limitedto40per cent of the total shock of HQLA and attracta minimum 15per cent haircut.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 134Following a review of a range of marketable instruments denominated inAustralian dollars (AUD) against the Basel III criteria for HQLA, APRAadvised that:- theonly assetsthat qualify for HQLA1 are cash, balancesheld withtheRBA, and CommonwealthGovernment and semi-governmentsecurities;and- thereare no assetsthat qualify asHQLA2.APRAalsoadvisedthat it willkeepthispositionunderreview, takingintoaccount relevant market developments10.2. Recent Basel Committee revisionsRecent revisionsto theLCR announced by theBasel Committeeintroduced a third bucket (Level 2B assets) for categorisingHQLA,whichnational authoritieshave discretionto includein LCR calculationsif the assetsfullycomplywiththe qualifying criteria. Level 2B assetsarelimitedto:- RMBS ratedAA or higher not issued by the bank itselfor any of itsaffiliatedentities;- corporatedebt securitiesrated betweenA+ and BBB- not issuedby afinancial institutionor anyof itsaffiliatedentities;and- ordinarysharesnot issuedby a financial institution or any of itsaffiliatedentities.Level 2B assetsare subject tohigher haircutsthan HQLA2, and toa limitof 15per cent of total HQLA.Thequalifying criteria includethat the assetsmust tradein large, deepand activerepoor cashmarketscharacterisedby a lowlevel ofconcentration, and must have a proven record asa reliablesource ofliquidityevenduring stressedmarket conditions.Consistent withitsreview of the eligibility of marketableinstrumentsforHQLA2, APRA hasconsideredthe rangeof possibleAustralian dollarLevel 2B debt securities against the qualifying criteria.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 135Thishastakenintoaccounttheamount oftheseinstrumentsonissue,thedegreetowhichtheinstrumentsarebroadlyor narrowlyheld, and thedegreetowhichtheinstrumentsaretraded in large, deep and activemarkets.APRA hasgiven particular attentionto the liquidityof theseinstrumentsduring themarket disruptionsof 2007–2009in themore acutephasesoftheglobal financial crisis.Basedonthisreview,APRAhasconcludedthattherearenoeligible Level2B debt securitiesin Australia.APRA notes,however, that sometypes of debt securities included in thedefinitionof Level 2Aand Level 2B assetsare repo-eligiblewiththe RBAfor normal market operationsand areeligiblecollateral for the CLF fromtheRBA.Theseincludecertainsovereign, supranational and foreign agencyAustralian dollar-denominatedbonds, RMBSratedAAA or higher, andsome corporatedebt securities.ADIswith accesstothe CLF are likelytohold these assetsaspart of awell-diversifiedliquid assetsportfolio.APRA hasalsoreviewedtheeligibilityof unencumbered non-financialequitiesfor inclusionin Level 2B assets.Although themarket for manylistedequities inAustralia is liquid, APRA doesnot consider that theinclusionof equities asLevel 2B assetswouldcontribute to the resilienceof theAustralian banking system.Equities arenot repo-eligiblewiththe RBA and any large-scaleforcedsaleof equityportfolios by one or moreAustralian bankscouldsignificantlyexacerbate a stressevent.Accordingly, APRA isnot proposing to exercise the discretion available toit to introduce the third bucket of HQLA and it hasnot included Level 2Bassetsin the definitionof HQLA in theupdateddraft APS210.However,aswithHQLA2 assets,APRA will keep this position underreview, taking into accountrelevant market developments.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 136HQLAfor a consolidated banking groupAPRA acknowledgesthat other national authoritiesmay exercisetheirdiscretiontoincludeLevel 2B assetsfor LCR purposesin theirjurisdictions.In such cases, APRA may allowanADI withmaterial bankingsubsidiariesin such jurisdictionsto hold some amount of Level 2B assetstomeet theLCR requirementsimposedby thehost supervisor. Nochangeto draft APS210is required.However,until it isable to gain confidencein the liquidityof foreigncurrencyLevel 2B assetsin stressedcircumstances,APRA doesnotbelievethat such assetsshould be recognised in LCR calculationsfor theconsolidated(Level 2) banking group.At the group level,ADIs will be required to hold sufficient liquid assetsthat satisfy the HQLA1, HQLA2 and, whererelevant, Alternative LiquidAssetscriteriatoensure that theminimum LCR level of 100per cent ismet.This approach is set out inAttachment Aof updateddraft APS 210.Use of HQLA in a time of stressIn its recent revisionsto the LCR, the BaselCommitteere-affirmedthatthestock of HQLA isavailablefor useduring a period of financial stress.APRA endorsesthisapproach, whichis reflectedin updateddraft APS210.APRA acknowledgesthat, in a timeof stress,anADI may need toliquidatepart ofitsstockofHQLA and/ ordrawonitsCLF withtheRBA,usingthe cash generatedtocover cashoutflowsand, thereby, fallingbelow the 100per cent LCR requirement.Theupdated draft APS 210 requiresthat anADI must inform APRAimmediatelyin the event that it becomesawareof the circumstancesthatwill result in a breach of its LCR requirement.APRA‘s supervisoryresponseto a breach of anADI‘s LCR requirementwill be appropriatetothecircumstances.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 137Operational requirements for the management of HQLATheBaselCommittee‘soriginalLCR measures,whichAPRAproposedtoadopt, imposed operational requirementsfor the management of HQLA.Theseincluded that thestock must be under control of thespecificfunctionor functionschargedwithmanagingthe liquidityriskof thebank.In its recent revisions,the BaselCommitteehasrefinedand clarified itsoperational requirements.Theamendedwordingis that thestock of HQLA must be under thecontrol of the function charged withmanaging the liquidityof the bank,meaningthe function hasthe continuousauthority, and legal andoperational capability, tomonetise any asset in the stock.APRA proposestoadopt the amended wording.This is expected to result in some assetsthat werepreviouslyexcludednowbecomingeligible for inclusion in the stock of HQLA.3.3 Other mattersraised in submissionsAlternative liquid assettreatment — The CLF review processIn recognitionof jurisdictionswithan insufficient supplyof HQLA, theBasel III liquidityframeworkincorporatesscopefor alternativetreatmentsfor theholdingof HQLA.Onealternativetreatment is toallowbankinginstitutionstoestablishcontractual committedliquidityfacilitiesprovided by their central bank,subjecttoan appropriate fee, with such facilitiescounting towardstheLCR requirement.As the current supply of HQLA inAustralia is not adequatetosatisfyADIs‘LCR requirements,APRA and theRBA announced in December2010that anADI will beabletoestablisha secured CLF withtheRBAforthepurposesof meeting itsLCR requirement inAustralian dollars.TheCLF will besufficient insizetocover anyshortfall betweentheADI‘sholdingsof HQLAand itsLCR needs(both inAustralian dollars).Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 138APRA haspreviously statedthat ADIs will be requiredtodemonstratethat theyhavetakenall reasonablestepstowardsmeeting their LCRrequirementsthrough their own balancesheet management, beforerelying onthe CLF.APRAwillbereviewingeachADI‘sliquidityriskmanagement frameworkand funding practicesasthebasisfor approving the size of the CLF forLCR purposes.Comments receivedSubmissionssought further information onAPRA‘smethod of approvingaccessto the CLF.Submissionsalsoraisedconcern that overlyconservativefundingobligationswouldlimit the industry‘sability toprovide maturitytransformation, shiftingliquidityriskintounregulated partsof thefinancial servicessector.Submissionsalsorequestedfurtherguidanceonthepracticaldefinitionofa ‗minor LCR shortfall‘for CLF and self-securitisationpurposes. APRAhadpreviouslyproposedthatwhereanADI expectedtohaveonlyaminorLCR shortfall without a CLF, theADI wouldneedtomanage itsliquidityrequirementson its own resources,rather than relying on a CLF.Somesubmissionsraised the concern that this approachmay createcompetitivedisadvantagesfor somescenario analysisADIsin regard toCLF access.Other submissionsargued that the useof self-securitisedassetsascollateral for the CLF may createcompetitivedisadvantagesfor MLHADIs, sincesuchassetsarenot countedaspart of their minimumliquidityholdings.APRA‘sresponseAPRA does not propose to elaborate on the process for providing accessto, or the appropriate composition of eligible assets for, the CLF in APS210.Theseissueswill be dealt withunderAPRA‘s supervision framework.APRA hascommenced itsengagement withADIson theprocessforBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 139setting CLF size and composition within the LCR and will expand thisengagement over coming months. APRA will also consider the need topublish further guidanceon accesstotheCLF in due course.Chapter 4 – LCR — net cash outflowsThesecond component inthedeterminationof theLCR requiresADIstocalculate their total net cash outflowsover thenext 30 calendar daysundera stressscenario.Theoriginal Basel III liquidityframework providedmany of thecashflowassumptionstobe usedfor this purposeandAPRA proposedtoadopttheseassumptions,except for minor modificationsor clarifications.TheBasel III cashflowassumptionsare based on thebehaviour, duringastressedperiod, ofthecounterpartiesprovidingfundingtotheADI andofthosetowhichtheADI providesfacilities(either credit, liquidityorcontingency).In its recent revisions,the BaselCommitteehasmade a number ofamendmentstothecalculationof net cashoutflows. Theseincludeadditionalcashoutflowcategories, revisionstothecashoutflowratesandsome reviseddefinitions.This chapter discussesAPRA‘sproposed responseto theseamendments.It alsoprovidesAPRA‘sresponsetosubmissionson its2011proposalsonnet cash outflowsthat are unchanged bytheBasel Committee‘srecentrevisions.4.1Recent Basel Committee revisionsThis section addressesthemain Basel Committeerevisionstothecashoutflowassumptions. Anumber of minorrevisions,which arenotdiscussed here, havebeen incorporatedintotheupdated draft APS210.Fully guaranteed retail depositsThe revised Basel III liquidity framework includes an additional retaildeposit category for deposits that are fully insured under a pre-fundeddeposit insurancescheme.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 140Thedeposit insurancescheme in Australia, the Financial ClaimsScheme(FCS), is not pre-fundedand, assuch, thiscategoryisnot relevant fordomesticdepositsNon-financial corporate, sovereigns, central banksand publicsector entity (PSE) depositsTherevised frameworkhasreducedtheassumed cash outflow ratefornon-operationalnon-financialcorporate,sovereign,centralbank andPSEdepositsfrom 75 per cent to40per cent.APRA proposestoadopt this amendment.Liquidity facilitiesfor non-financial corporatesTherevised frameworkhasreducedthecash outflowrate for liquidityfacilitiesprovidedtonon-financial corporate customersfrom 100per centto30per cent. APRA proposesto adopt thisamendment.Collateral outflowsattributable to market movesTheoriginal Basel III liquidityframework gavenational authoritiesdiscretionin settingthemethodologyfor thecalculationof collateraloutflowsrelated to market movementsof derivativepositions.Therevised frameworkhasremoved thisdiscretionand providesastandardisedmethod for thiscalculation.APRA proposestoincorporatethe standardisedmethod intoAPS 210.This method requiresADIsto take the largest absolute net 30-daycollateralflowrealisedinthepast 24monthsandmodel thisbalanceasanoutflow.TherevisedBaselIII rulestext alsostatesthat ‗supervisorsmayadjustthetreatment flexiblyaccordingto circumstances‘.APRA acknowledgesindustry arguments, discussedlater in thischapter,that a liquiditystressevent ismuch more likely tobe associatedwith afallingAustralian dollar than a risingone.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 141Accordingly, APRA invites feedback from industry as to an alternativeoutflow treatment that would acknowledge this probable direction butwouldbe consistent with the Basel Committee‘sintent.Committed but unfunded inter-financial liquidity and creditfacilitiesTherevised frameworkhasreducedthecash outflowrate for committedbut unfunded liquidityand credit facilitiesprovided tobankinginstitutionsthat areprudentiallysupervisedfrom 100per cent to 40percent.APRA proposestoadopt this amendment.Additional derivativesrisksTherevised frameworkincludesanumber of additional collateral outflowcategoriesdesignedtoensure that risksassociatedwithderivativepositionsare correctlycaptured in the LCR.Thecash outflowratefor these categoriesis 100per cent of the measuredvalue.APRA proposestoadopt theseamendments.Derivatives secured by HQLATherevised frameworkhasclarifiedthat wherea derivativecashflow issecuredwithHQLA1,acashoutflowrateof zeropercent istobeapplied.APRA proposestoadopt this amendment.Maturing secured funding transactionsTherevised framework hasreduced theoutflowrateon maturing securedfundingtransactionswithacentralbank from 25percent tozeropercent.In the event that a secured funding transactionbacked by CLF eligiblecollateralmaturesduring astressevent, anADI withaCLF willbeabletore-executethesecured funding transactionbecauseof theRBA‘scommitment under the CLF.This will result in an outflowagainst this transactionof zero per cent.However,if thesame transactionmatured for anADI that did not have aBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 142CLF, thatADI wouldhave noguaranteed abilitytoroll thetransaction,resultingin a possibleoutflowrateof 100per cent.APRA proposes to include an additional category for maturing securedfunding transactions backed by CLF eligible debt securities (where theADI has capacity available under its CLF limit) with an outflow rate ofzero per cent.Followingconsultationswiththe RBA, APRA proposesthat all othermaturing securedfunding transactionswith the RBAthat are not backedbyHQLAwill receivean outflow rateof 100per cent.Fully insured unsecured wholesalefundingTherevised frameworkincludesan additional outflowcategoryfor fullyinsurednon-operational, non-financial, unsecured wholesaledeposits.APRA proposestoadopt the outflowrateof 20 per cent.4.2 Other mattersraised in submissions4.2.1 Cash outflowsRetail and qualifying small and medium enterprises(SME) depositrun-offWithinthe LCR, retail deposit balancesare classified aseither ‗stable‘or‗lessstable‘.Stable deposit balances are those that are considered to have the lowestpropensity to be withdrawn during times of stress and, hence, receive alowthreeor five per cent cash outflowrate.Lessstabledepositsare consideredtohave a higher propensityto bewithdrawnand asaresult, dependingondeposit characteristics,receivea10per cent or higher cashoutflow rate.APRA proposedtoadopt the Basel III treatment of stabledepositsand,consistent withthe Basel III approach, tointroducetwohigher run-offcategoriesfor lessstabledeposits, withrun-off ratesof 10per cent and 30per cent, respectively.APRAproposedasimplescorecardapproachtodeterminewhichof thesetworun-off ratesapplied.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 143SME deposits that satisfycertain criteriaregarding balanceandbehaviour, asoutlinedin draft APS 210, are consideredretail for LCRpurposes.Comments receivedClarificationwasrequested on thetreatment of depositswitha totalbalanceabovethe guaranteelimit of theFCS, whichisAUD 250,000foraccount-holderperADI.Submissionssought tounderstand whetherthe amount below the limitwouldreceiveastableoutflowrateandtheamountabovethelimit receivea lessstableoutflowrate.Submissionssuggestedincludingclient relationship characteristics,suchasthe term of a relationship, the number of productsand theuseof arelationship manager, to assist categorisationof the deposit.Theyalsoproposed that dormant accountsbe classified asstabledue totheir expected inactivityin a stressevent and that self-managedsuperfund (SMSF) depositsbeeligible tobe classified asstabledepositsasthetrusteeoverseeing the SMSF deposit account is not necessarilyafinanciallysophisticatedindividual.Somesubmissionsargued that the categoriesfor stableand lessstabledepositsweretoo broad and proposed thatAPRA providemore precisedefinitionsof thevariouscriteriathat definethese categories.It wassuggestedthat theoutflowrate of30percentforhigher run-offlessstabledepositswastoohigh asit did not reflect industryexperienceorassessmentsof expected run-off under stress.Alternatives proposed were that the outflow rate be lowered or that anadditional lower cash outflow category between 10 per cent and 30 percent be introduced.Anumber of submissionsobjectedtotheinclusionof internet accessasacriterion in the lessstabledeposit scorecard.Thesesubmissionsarguedthat meansof accesswasnot a strongindicatorof withdrawal propensityand it should be removedfrom theBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 144scorecard;instead, greater emphasisshould be placed on deposit size asthiswasmore consistent withADI experience.Somesubmissionsconsidered that the FCSlimit should be the soledeterminant of a higher outflow rate asdepositsbelow the limit would beexpectedto be withdrawnat a much lowerrate giventhat theyareguaranteed.Other submissionsopposed the implicationin thescorecardthat adeposit couldgeta30percent outflowrateevenwhencoveredbytheFCSif it met the other scorecard criteria.Concernwasalsoexpressedthat all New Zealandtransactional accountswhereestablishedcustomer relationshipscannot be evidenced wouldneed to be classifiedashigher run-off lessstabledeposits underAPRA‘sproposed approach asthe New Zealandgovernment guaranteeis nolonger available.Anumber of submissionsargued for amendmentsto thetreatment offundsreceived via an intermediaryasthat treatment wouldresult indifferential outflow ratesbeingapplied byADIsto an equivalentcustomer dependingon the source of thedeposit.Thisissuewasraised, in particular, in relationtodeposits receivedfromSMSF customersrather thanvia APRA-regulated superannuation funds.Another issueraisedwasthat SME customerswithno depositscould notbeclassifiedunderAPRA‘s proposed approach asthedefinition of SMEin draft APS210is linked to deposit size.This is an issuefor SME customerswhodonot havedeposit productswithanADI but haveotherdealingswiththeADI that wouldbecapturedbytheLCR.Another issueraisedconcerned the possibleofferingof thematuring31-daynotice period term deposit whichhasrecentlybeen thesubject ofanAustralian Securities and InvestmentsCommission consultation, andwhetherthe abilityof a depositortowithdraw a deposit in theproposedterm deposit grace period wouldresult in the entire portfolio beingconsideredin breach of the requirementsfor retail fixed-term depositsinBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 145Attachment Atodraft APS 210, and needingto be modelled asat-calldeposits.APRA‘sresponseAPRA agreesthat theFCS limit may be a determinant of customerbehaviour.Consistent withthis,for any deposit meetingthe criteria of paragraph 36in Attachment Aof updateddraft APS210,that portion of thedepositcoveredby the FCScan be treated asstableand any balanceabove thelimit is tobe treated aslessstable.For stable deposits, APRA considers that paragraph 36 of Attachment Aadequately describes the characteristics of stable deposits and does notneed amending.For definingthedifferencebetweenlessstableand higher run-off lessstabledeposits,APRA agreesthat client relationship characteristicsmayplaya part but it doesnot proposetoincludethesein the scorecardastheyare alreadyused in thedefinition of stabledepositsand theirinclusionin the scorecard wouldintroduceambiguitiesbetweenlessstableand stabledeposits.For dormant accounts, APRA considers that a depositor‘s response to aliquidity stress situation is uncertain at best and that dormant accountsare not necessarily a good indicator of a stabledeposit.Hence, dormant depositsare tobe treated equivalentlyto other deposits.As explained in itsNovember 2011discussion paper,APRA considersSMSFdepositorstobeself-selected, financiallysophisticatedindividuals,whichis an indicator of a greater propensityto withdraw fundsin a stresssituation.As such, SMSFdepositsare appropriatelycategorised aslessstable.APRA hasconsidered its proposed scorecardcriteria for lessstabledepositsagainst theargumentsmade in submissionsbut hasnotidentifiedcompellingreasonstochangethesecriteria.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 146However,APRA will amend the wordingof the scorecard category‗Deposit is primarilyinternet accessed‘to‗Deposit is an on-lineaccount‘in order to better reflect itsobjective.Depositsthat wouldbe expectedto fall intothiscategoryarethosewheretheinternet is integraltothedesign, marketingand usageof theproduct.It is not intendedtocapture depositswherethe internet issimplyone ofseveral meansof accessingand transactingon the account.Further guidanceon thesedeposit classificationscan be found in thedraft APG 210.In thecaseof depositsin jurisdictions(suchasNew Zealand) that donothavegovernment deposit guarantees,the absenceof a deposit guaranteeeffectivelyremovesa size criterion from thescorecard and lowersthehurdlefor higher run-off deposits.APRA considersthat having a size criterion in thescorecard isappropriate.Hence, the first categoryof thescorecard will be alteredtoread ‗Depositbalanceis greater than any government deposit guarantee limit whereitexistsand, in itsabsence, wherethedeposit balanceis greater than theequivalent ofAUD 250,000‘.This will alsoaddressthe concernsregardingNew Zealand depositsmentioned above.In addition, APRA hasreduced the outflowrate for higher run-off lessstabledepositsfrom 30per cent to 25per cent.This providesa more appropriatecalibrationwithother categoryoutflowrates, such asoperational deposits.For depositssourced via an intermediary, wherethe intermediary retainsinvestment responsibility or hasa fiduciaryduty tothe underlyingcustomer,APRA considersit is appropriate to assume the intermediarywill observe theresponsibilityand duty in a time of liquiditystress.This fiduciaryduty isnot removed whencustomershave an investmentdiscretionwhen initiatingan intermediateddeposit.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 147Accordingly, these depositsare most appropriatelyclassifiedasbeingsourcedfrom a financial institution, regardlessof thenature of thecustomer placingfundswiththe intermediary.This interpretation will not affect SMSF deposits;SMSF depositsareconsideredtobe thoseof a natural person and not sourced via anintermediaryWhere an SME client hasnodepositswithanADI, APRA proposesforcontingent obligationpurposesto usethedefinitionof an SME inPrudential StandardAPS 113CapitalAdequacy: Internal Ratings–basedApproach to Credit Risk (APS113).Paragraph 47 ofAPS113statesthat ‗Toberegarded asa retail exposure,thetotal business-relatedexposure of theLevel 2 group to asmall-businessobligor or group of connected small-businessobligorsmust be lessthan $1million.‘For 31-daynotice period term depositsthat are in a grace period, anADIwill be expected to model theterm deposit on an equivalent basistoademand deposit, consistent with the requirementsof paragraphs40and41in Attachment Aof updated draft APS210.In addition, a 100per cent outflow rateis to apply to any31-daynoticeperiod deposit that hasbeen called.Unsecured wholesalefunding run-offIn the LCR, unsecured wholesalefundingis fundingprovided bynon-financial corporate, sovereigns,central banks and PSEson anunsecuredbasis.Thecash outflowratesagainst thesecategoriesof depositsare set out intheBasel III liquidityframeworkandAPRA proposestoimplement themwithout amendment.Comments receivedSomesubmissionsraised the concern that industryexperienceofunsecuredwholesalerun-off ratesin a stressscenario in Australia islackingand availableinternational data suggest a lowerrun-offexperiencethan theLCR assumptions.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 148Thesesubmissionsarguedthat cash outflow ratesshould be identifiedthrough empirical calibration.The issue was also raised that small changes in the size of an account orinterpretation of account type will have a material impact on the outflowassumption to be applied in the LCR, particularly given the difference inthe cash outflow assumptions for operational deposits and other types ofdeposit from corporations.It wassuggestedthat whereaccountsaremanaged through the activeparticipationof a relationship manager, this should significantlyreducethepropensity for deposit withdrawal in a stressevent.Clarity wasalsorequestedon the definitionof operational deposits,particularlyon the possibleinclusionof definingcriteria such astransactionvolume, interest rate level and customer relationship.Submissionsalsoarguedthat correspondent banking (Vostro) accountsare operational depositsand shouldbe includedin this category.APRA‘sresponseTheBasel III cash outflowratesare intended toprovidea globallyconsistent representation of an idiosyncratic and/ or systemic liquiditystressevent.Thecashoutflowratesrepresent aplausibleestimateofbehavioursacrossa rangeof categoriesthat are intentionallyspecified at a conservativelevel.TheBasel III liquidityframeworkprovidessimplicityand ensuresagloballyconsistent application.APRA acknowledgesthe significant differencein outflow ratesfor anindividual deposit dependingon itsclassification.However,in APRA‘s view, theoutflow categories and outflowrateswillachievean appropriate outcome from a total portfolioperspective.Recent Basel Committeerevisionstothecashoutflowratesof unsecuredwholesalefunding, whichAPRA proposestoadopt, werediscussedearlierin this chapter.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 149TheBasel Committeehasdetermined that Vostro accountsdonot haveoperational deposit statusandAPRA agrees.Thecriterion for an operational deposit isthat the depositorhasasubstantivedependencyon thecontinued operation of the account thatactsasa practical impediment toclosingor moving the account.That is, the account is sointegral to thebusinessoperationsof thedepositorthat it isunlikely the depositorwouldbe able totransferthisactivityto anotherADI within30days.This is not consistentlythe casewith correspondent bankingaccountsand, for this reason, they are not included.Unsecured financial institution funding run-offUnsecured financial institution fundingin the BaselIII liquidityframeworkis divided intothree categories:operational depositsthatreceiveeither a fiveor 25per cent cash outflow rateand other depositsthat receivea 100per cent cash outflowrate.Comments receivedA number of submissions sought clarity on the definition of a financialinstitution, expressing concern that the definition in draft APS 210 wastoobroad.Submissionsalsoarguedthat lowercashoutflowratescould be includedfor certain types of financial institutionssuch ashealth insurersorgovernment sector financial institutions,astheseentitiesareperceived tobelesssophisticated than others such asbanks.Submissionsnoted theomission of a Basel III run-off rate for financialinstitutionoperational deposits in thecash outflowtableinAttachment Aof draft APS210.Submissionsalsoarguedthat financial institutionintercompanydemanddepositswouldnot be withdrawn in a crisisand should receivea cashoutflowrate of lessthan 100per cent.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 150APRA‘sresponseAPRA hasrecentlyreleased Prudential StandardAPS 001Definitions,whichincludesa definitionof financial institutions.Most entitiesnoted asbeingfinancial institutionsin thepreviousdraft APS 210arecoveredinthat definition.APRA will use that definitioninAPS210but, for thesake of clarity, willmake specific referencetomoneymarket corporations, financecompanies, superannuation / pension funds, public unit trusts/ mutualfunds,cash management trustsand friendly societies.Amendmentshavebeen made to ‗Table3 – Cash outflow categories‘inAttachment Aof theupdated draft APS210toclearlyidentify operationaland non-operationaldepositsof financial institutionsand their cashoutflowrates.APRA doesnot proposeto includeadditional financial institutionrun-offcategories;all financial institutionnon-operationaldepositsreceivea 100per cent cashoutflowrate if their residual maturityor noticeperiod iswithin30days.Other liabilitiesTheBasel III frameworkidentifiesspecific cash outflowassumptionsforother liabilities,committed credit and liquidityfacilitiesprovidedtotheADI‘s customers, and itemswhereincreasedliquidityneedsare likely toberequired under theLCR scenario.APRA proposed to adopt theseassumptions.Comments receivedSomesubmissionssuggested that the definitionof a liquidityfacility wastoobroad and could be interpretedtoincluderevolving credit facilities,whichwasinconsistent with the Basel III liquidityframework.Concernswereraised that the cashoutflowrate for a financial institutioncommitted and uncommittedliquidityfacility wastoohigh in itself andhigh in comparison to the equivalent cash outflowratesfor othercounterpartytypes.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 151Thesesubmissionsarguedthat the cash outflowratesdid not reflect theexpectedbehaviour of thesetypesof facilitiesduring a period of stress.APRA‘sresponseTherecent BaselCommitteerevisionsincludeaminor clarificationtothedefinitionof a committed liquidityfacilitytoensurethat facilitiesprovided to hedge funds,money market fundsand special purposefundingvehicles arecaptured in their entiretyasliquidityfacilities.APRAproposestoincorporatethefull definitionof aliquidityfacility intoAPS 210.This inclusion will alsoprovideclarityon itemsthat should be modelledasliquidityfacilitiesandthosethat shouldbemodelledascredit facilities.Financial institutionsgenerallyhave more exposure toliquidityrisk thannon-financial corporations.Afacility provided to a financial institution would represent a ‗wrong-way‘risk during a systemic crisis and would be subject to a greater propensityfor drawdown.This justifiesa higher cash outflowratefor such a facility. contingent funding obligationsTheBasel III frameworkleavesto national discretionthe run-offassumptionstobe applied to contingent funding obligationsthat arenotcommitted credit and liquidityfacilities.In its 2011discussion paper,APRA proposed torequireADIsto includethefollowingcontingent obligationsasa cash outflow:Revocablecredit and liquidityfacilities;Guarantees, lettersof credit and other trade financeinstruments;Debt buybacks – domestic Australian debt securities;Structured products,managed fundsand other non-contractualobligations;andIssuerswithan affiliateddealer or market maker.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 152APRA received a number of submissionson contingent fundingobligationswhichare addressed in this section.Buyback of debt securitiesComments receivedSubmissionson thebuyback of securitiesargued for relief from theapplication of a cash outflowratewherethere is a policy enforced by theADI to either not honour debt buyback requestsin timesof stress,placelimitson thequantum of debt buybacks, or require that Group Treasurysign-offon buybacksover a certain threshold.Thesesubmissionsarguedthat these criteria should be sufficient toevidencea behaviour of not honouring buybacks in all circumstances.APRA‘sresponseAPRA expectsthat in a time of stress, even with apolicy tolimit debtbuybacks in place, some buyback requestsmay still be honoured due toreputationalconsiderationsorbecauseit maytakeaperiodoftimefor thefull extent of theliquiditystressto be realisedand restrictionson debtbuybacks activated.APRA will maintain itsbuyback assumptionsof 10per cent of short-termdebt securitiesand 5per cent of long-term debt securitiesissuedin thedomesticAustralian market.An ADI can applytoAPRA for an agreedlowerdebt buyback rate wheretheADI can demonstrate that:(a)it has adopted tangible measures in policy and practice (e.g. throughthe implementation of hard limits on buybacks) to reduce the incidenceof buybacks; and(b) thesemeasures are operating effectively on an ongoing basis.Unconditionally revocable uncommitted facilitiesComments receivedBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 153Concernswereraised that the cashoutflowassumptionsforunconditionallyrevocableuncommitted facilitiesweretoohigh for allcategoriesof borrowersand that thedifferencebetweenretail/non-financial wholesalecustomersand financial institutionswaslarger than expectedbehaviour in a stressevent wouldsuggest.Somesubmissionsargued that wherethere are contractual termsthatconstrain drawdown, a loweroutflowrateshould be applied; wherethetermsexcludedrawdownin 30days, thesefacilitiesshould receivea zeroper cent cashoutflowrate.Submissionsalsoarguedthat applying thesame outflowrateforuncommitted and committed facilitiesisunreasonableasADIs havetheabilitynot to honour thedrawdownrequest on unconditionallyrevocableuncommitted facilities.In a liquiditystresssituation, it wasargued, suchfacilitieswouldbecancelledby the provider;hence nocash outflow assumptionshould beapplied.APRA‘sresponseAPRA remainsof theview that reputational considerations,businessbudget targetsand thepossibilityof a delayed responsetoan emergingliquiditystressmay mean that ADI lendingstaff and treasurerswill notnecessarilyrespond to a liquiditystressevent by cancellingorwithdrawingthesefacilities.Nevertheless, from a liquiditycost-benefit perspective,APRA acceptsthatsome uncommitted facilitiescould require a smaller liquidityreservethancommittedfacilities.APRA will thereforeamend the cashoutflow rate for unconditionallyrevocableuncommittedfacilitiesto fiveper cent for all categories.TradefinanceAPRA proposedthat ADIs includea cash outflowin the LCR for tradefinancefacilitiesbased on actual monthly experienceover 12monthsofdata, tobeupdatedon at least an annual basis.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 154Submissionsexpressedconcern that holdingliquid assetsagainstuncommitted tradefacilitiesfor typical Asian businesses,based onoutflowsmodelledon the past 12 monthsof goingconcern behaviour,wouldbe excessiveand unnecessary.It wasargued that in a liquiditystressevent, thesefacilitieswouldbewithdrawn or suspended; hence, a zeroper cent outflowshould beapplied.APRA‘sresponseTherecent BaselCommitteerevisionsincludeguidancethat the cashoutflowratesmodelledagainsttrade financefacilitiesshould be betweenzero and fiveper cent.APRA expectsthat itsproposedmethodologyfor the modellingof cashoutflowsagainst thesefacilitieswill result in a cashoutflowrateconsistent withthe BaselCommittee‘sguidance.As such, no amendment to the methodology is proposed.Guarantees not related to trade financeAPRA proposedthat cash outflowsfor guaranteesnot relatedtotradefinancebe modelledin the LCR using the averageof actual monthlyoutflowsover a recent 12-month period.Comments receivedSubmissionsexpressedconcern thatAPRA‘s proposed methodology didnot recognisethat the cash outflowcan be contingent upon a non-ADIrelatedcredit default event, rather than aliquiditystressevent for theADI.APRA‘sresponseAPRA considersthat this argument is reasonable.It will amendAPS 210 to reflect that whereoutflowsunder suchguaranteesarewhollycontingent oneventsindependent of theADI (i.e. adefault by a third party), the outflowrateis to bemodelled as50per centof the averageof actual monthly outflowsin a recent 12-month period.Structured products,managed funds(that are marketed withtheobjectiveof maintaininga stablevalue) and other non-contractualobligations.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 155APRA proposedthat thesenon-contractual obligationsbe modelledintheLCR witha minimum fiveper cent cash outflow rate.Comments receivedSubmissionsrequestedclarificationon theparticularobligationsthiscategoryisseekingtocapture.APRA‘sresponseThis categoryis intended tocaptureADI-sponsored investment vehiclesor structured productsthat may require liquiditysupport.Theglobal financialcrisishasprovided many examplesof specialisedinvestment vehicles,previously consideredto be remote from thesponsoringbank, that required support.Managedfundsneedingtomaintain a stablevaluecan alsofall intothiscategory.In addition, some structured investment productsmay require additionalliquidityin timesof stressascustomersseek toliquidatetheirinvestmentsdue totheimpact of market volatilityon the valueof theseinvestments.APRA acknowledgesthat theseinvestment vehicles and structuredproductsare not widespreadinAustralia and thiscategorymay not berelevant for manyADIs.Market valuation changeson derivative transactionsThis outflow categoryseekstocapture thepotential for substantialcollateral outflowsrelatingto changesin the market valueof derivativepositionsduring a liquiditystress.APRA had proposedthat ADIs must model a cash outflowagainst thesepositions.As noted earlier in this chapter, the recent Basel Committeerevisionshaveremoved national discretion for thiscategoryand haveset out aBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 156standardisedapproachfor liquidityriskfor market value changesinderivativespositions.ADIsare alsorequired to consider the additional collateral that wouldneed to be postedin theevent of a 3-notchcredit rating downgrade.Submissionsargued that in a systemic liquiditystressevent inAustralia,theAustralian dollar wouldbe more likely todepreciatethantoappreciate.This would result in cash inflowsforADIsthat source offshore fundingdenominatedin major currenciesand that have currencyswapswith‗Credit SupportAnnex‘ agreementsagainstthem.Therefore, a conservative liquidityapproach wouldmodel no cashoutflowsfor such an event.Submissionsalsosuggestedthat thestresseventsmodelledin the LCRshould be consistent witha liquiditystress, not themarket risk stressscenarios outlined in Reporting StandardARS116.0 Market Risk, whichAPRA had proposed.APRA‘sresponseAPRA agreesthat anAustralian dollar depreciationisa plausibleassumption for a systemic liquiditystressevent specific totheAustralianbankingsystem.As noted above,APRA proposestoadopt theBasel Committee‘sstandardisedapproachto the calculationof outflowsagainst marketvaluation changes.However,APRA invitesfeedback from industry astoan alternativeoutflowtreatment that wouldacknowledgetheprobabledirection of theAustralian dollar during a stressevent but wouldbe consistent withtheBasel Committee‘sintent. APRA alsoadvisesthat, astheLCR stressscenario coversboth systemic and idiosyncratic events, the3-notchBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 157downgradeisto be considered asan idiosyncraticevent and modelledassuch.4.2.2 The LCR and currency mismatchesIn its 2011discussion paper,APRA proposed that ADIs be ableto meettheir liquidityneedsin each material currencyand maintain HQLAconsistent withthe distribution of their liquidityneedsby currency.APRA alsoproposedthat ADIs must specificallyaddresscurrencymismatchesin their Board-approvedstatement of liquidityrisk tolerance.Comments receivedSubmissionsrequestedthat APRA clarify itsrequirementswithrespect tocurrencymismatches.In addition, submissionssuggested that theCLF should be allowedtocover someportion of foreign currencycash outflowsand liquidityneedsin theconsolidated(Level 2) banking group aslocallyincorporatedADIsoperatingin foreign jurisdictionsmay have limited abilitytosell liquidassetsin thosejurisdictionsin a time of stress.This could be the caseasa result of limitedability toparticipate in themarket operationsof the relevant central bank.APRA‘sresponseAPRAconfirmsthat theLCR istobemetbyanADI onbothaLevel 1andconsolidated(Level 2) bankinggroup basis.Forbranchesofforeignbanks,theLCR must bemet onadomestic booksbasis.This minimum requirement isto incorporate exposuresin all currencies.APRA alsoconfirmsthat ADIs must be ableto meet their liquidityneedsin each material currencyand maintain HQLA consistent withthedistribution of their liquidityneedsby currency.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 158APRA doesnot see it asappropriate for the CLF to cover non-Australiandollar outflows;other supervisorswill defineHQLA specific totheirjurisdictionand domestic currencythat ADIs will be abletohold to meetnet cash outflowsin that currency.4.2.3 Home/host liquidity requirements for the LCRAPRA‘s 2011discussion paperproposed that, in arriving at theirconsolidated(Level 2) bankinggroup LCR, ADIsapplythehostjurisdictioncashflow treatmentsfor retail and SME deposits in thosejurisdictionsasthis reflectsthebehaviour of localdepositors.This wasspecifiedin theBasel III liquidityframework.In addition, wherethehost regulator electstouse one of the alternativeliquidassetstreatmentsallowedbyBaselIII,APRA statedthat it is likelytorecognisethisfor thepurposesof calculatingthe localcurrencyLCR.Where anADI hasa material banking subsidiary in a jurisdictionthatdoesnot implement the BaselIII framework,APRA proposed to applythecashflowassumptionsoutlinedin draft APS 210.Comments receivedConcernwasexpressedthat theuseofAPRA‘s cashflowassumptionsinnon-Basel III jurisdictionsmeant that different assumptionswouldneedtobe applied tothesamedeposit to meet the requirementsof differentregulators.Submissionsstated a preferencetoapplytheassumptionsof thenon-Basel III jurisdictionhost regulator tocalculatethe consolidatedbankinggroup LCR, soasto avoid complexityand inefficienciesinliquidityrisk modellingin that jurisdiction.It wasalsoclaimed that thisproblem could extend toBasel IIIjurisdictionsthat have not clarified their proposed rulesforimplementationof theLCR.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 159APRA‘sresponseTheBasel Committeeexpectsthat all Basel III jurisdictionswill havetheir LCR requirementsin placeby 1January2015.Hence, there should be no concerns regarding unclarified rules amongstBasel III jurisdictions. APRA also considers that it would be inconsistentto allow stressed cash outflow rates to apply for deposits in non-Basel IIIjurisdictionsthat are different to the LCR stressscenario.Hence,APRA doesnot see anyreason todepart from itsproposedapproach.4.2.4 LCR requirement for foreign bank branchesIn its 2011discussion paper,APRA proposed that foreign-ownedADIsinAustralia that are subjecttothe scenario analysisapproach will need tomeet the LCR requirementson a stand-alonebasis.However,in arrivingat a balanced approach for foreign bank branches,APRA proposedtorecognisea committedfunding linefrom head officefor inclusion asa cashinflowfrom day 16of the LCR scenarioundercertaincircumstances.Comments receivedSome submissions argued that it would be unduly restrictive not torecognise head office support until day 16, noting that APRA allowsrecognition of head office support in a shorter timeframe within the‗namecrisis‘scenarioin thecurrent APS210.Thesesubmissionsarguedthat it wouldbe reasonableto expect headoffice to provideliquiditysupport on a muchshorter noticeperiod.It wasalsoclaimedthat it wasunfair not toextendtherecognitionofheadoffice support toforeign-ownedADIs that operate inAustralia asboth asubsidiary and a branch.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 160Other submissionssuggestedthat theLCR for foreign branchesshouldbelowerthan 100per cent and that APRA should recognisethat branchesdepend on globallymanaged liquidity.Somesubmissionsalsoarguedthat foreign bank branchesshould beexempt from ‗goingconcern‘reportingasthisis a lessmeaningful taskduetothenature of some operationsand imposed a significant reportingburden.Somesubmissionssought clarity on functions,tasksand rolesthat maybecompleted at theglobal level rather than at theforeign branch level astheypertain to thequalitativerequirementsofAPS 210.APRA‘sresponseUnderAPRA‘s LCR requirement, all ADIs, includingbranchesof foreignbanks,must have sufficient Australian dollar liquidityto meet potentialAustralian dollar cash outflows.Therecognition of head office support for branchesfrom day16isintendedto ensure a minimum level of liquidityself-relianceby thesebranches.APRA doesnot believeit isprudent to placerelianceon a centrallymanaged liquiditypool aloneasthismay result in insufficient liquiditybeingavailablefor the localoperation.APRA is awareof practicesthat have thepotential totransferliquidityneedsbetweena local subsidiary and a relatedbranch, whichcouldpossiblyresult in increasedlevelsof relianceon parental support thanwouldotherwisebe thecase.Submissionsreceived did not addressthisissue. Consequently, APRAconfirmsthat it will not extend the recognition of head office support toforeign-ownedADIs that operateinAustralia under both asubsidiaryanda branch bankingauthority.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 161Local staff responsiblefor liquiditymanagement and oversight in foreignbank branchesmay fulfil liquidityriskmanagement governancerolesbyhavingtheappropriatelyapproved job mandatesand delegatedauthorities.As per paragraph 47 of updated draft APS210, APRA intends to continueto require the production of going concern reports by all ADIs, includingforeign bank branches.Theproductionof goingconcern reportsbyall ADIswill enableAPRA tomore fullyunderstand the maturitymismatch and funding task of theADIindustry inAustralia.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 162MichaelS.Gibson, Director, Division ofBankingSupervision and RegulationCross-Border ResolutionBefore the Subcommitteeon NationalSecurity and International Trade andFinance,Committeeon Banking, Housing,and Urban Affair, U.S.Senate, Washington, D.C.ChairmanWarner, Ranking MemberKirk, and othermembersof the Subcommittee, I appreciatetheopportunitytotestifytodayon the challengestoachievinganorderlycross-borderresolutionofafailedsystemic financial firm.In my remarks, I wouldlike to first reflect on theimprovementsthat have been madein the last fewyears in the underlying strengthand resiliencyof thelargestU.S. bankingfirms, andthenturntoadiscussionof whathasbeenaccomplishedand what remainsto be accomplished in facilitatingacross-borderresolution.ALook BackTherecent financial crisiswasunprecedentedin itsscope and severity.Someof theworldslargestfinancial firmsnearlyor completelycollapsed,sendingshock wavesthrough thehighly interconnected global financialsystem.Thecrisismade clear that our regulatoryframework for reducingtheprobabilityof failure of systemic financial firms wasinsufficient and thatgovernmentseverywhere had inadequatetools to managethefailure of asystemic financial firm.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 163Since2008, theUnitedStatesand theinternational regulatorycommunityhavemade meaningful progresson policyreformsto reducethe moralhazard and other risksassociatedwithfinancial firmsperceivedtobe toobig tofail.In broad terms, these reformsseek to eliminatetoo-big-to-fail in twoways:(1)by reducingtheprobability of failure of systemic financial firmsthrough stronger capital and liquidityrequirementsand heightenedsupervision, and(2)byreducing the coststothebroader system in the event of the failureof such a firm.My testimony todayrelatesprincipallyto thesecond of thesetwoaspectsof reform, but I want to begin by highlightingsome of the materialachievementswehavemadetoreducethelikelihoodoffailureofsystemicfinancial firms.TheBasel III capital and liquidityreformsare thefoundation of theglobal effortsto improvethe resilienceof the international bankingsystem.ThesereformsarebeingimplementedintheUnitedStatesandelsewhere.In addition, theFederal Reserve hassignificantlystrengtheneditssupervision of the largest, most complex financial firmssincethefinancial crisis.For example, theFederal Reserve now conductsrigorousannual stresstestsof thecapital adequacyof our largest bank holding companies.As a result of theseefforts, theoverall strengthof thelargestU.S. bankingfirmshassignificantlyimproved.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 164The aggregate tier 1common equity ratio of the 18 largest U.S. bankingfirms has more than doubled, from 5.6percent of risk-weighted assetsattheend of 2008to11.3percent at the end of 2012.In absoluteterms, thesefirmshaveincreasedtheir aggregate levelsof tier1common equityfrom just under $400billion in late 2008to almost $800billion at the end of 2012.Higher capital putsthesefirmsin amuch better positiontoabsorb futurelossesand continuetofulfill their vital rolein the economy.In addition, theU.S.banking systemsliquiditypositionrelativetopre-crisislevelshasmateriallyimproved.Accomplishmentsto Date on Cross-Border ResolutionCongressand U.S. regulatorshave made substantial progresssincethecrisisin improving theprocessfor resolvingsystemic financial firms.Thecore areasof progressincludeadoption and implementation ofstatutoryresolutionpowers,adoption and implementationof resolutionplanningrequirements,increasedinternational coordinationefforts, andtheFederal Reservesforeign bank regulatory proposal.TitleII of the Dodd-Frank Wall Street Reform and Consumer ProtectionAct (Dodd-Frank Act) created theOrderlyLiquidationAuthority (OLA), astatutoryresolution mechanism designedto improve the prospectsfor anorderlyresolutionof a systemic financial firm.In many ways, OLA hasbecome a model resolutionregime for theinternational community.TheFinancial StabilityBoard (FSB) in 2011adoptedtheKeyAttributesofEffectiveResolution Regimesfor Financial Institutions,a new standardfor resolution regimesfor systemic firms.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 165Thecore featuresof thisglobal standardare already embodied in OLA.By acting earlythrough thepassage of the Dodd-Frank Act, Congresspavedthewayfor theUnited Statesto bea leader in shaping thedevelopment of international policy for effectiveresolutionregimesforsystemic financial firms.TheFederal Reservesupportstheprogressmade by the Federal DepositInsuranceCorporation (FDIC) in implementingOLA, including, inparticular, by developinga single-point-of-entry(SPOE) resolutionapproach.SPOE is designed to focuslosseson theshareholdersand long-termunsecureddebt holdersof theparent holding company of thefailed firm.It aims to produce a well-capitalized bridge holding company in place ofthe failed parent by converting long-term debt holders of the parent intoequityholdersof thebridge.Thecritical operatingsubsidiaries of thefailed firm wouldbere-capitalized, to theextent necessary, and wouldremain open forbusiness.TheSPOE approach shouldwork tosignificantlyreduceincentivesforcreditorsand customersof the operatingsubsidiaries to run and forhost-countryregulatorsto engage in ring-fencingor other measuresdisruptiveto an orderly, global resolutionof the failed firm.TheDodd-Frank Act requiresall large bank holding companies todevelop, and submit to supervisors,resolutionplans.Thelargest U.S.bank holding companiesand foreign bankingorganizationssubmitted their first annual resolution planstothe FederalReserveand the FDIC in thethird quarter of 2012.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 166These"first-wave" resolution planshave yielded valuableinformationthat is being used toidentify, assess,and mitigatekey challengestoresolvabilityunder theBankruptcyCode and tosupport theFDICsdevelopment of backup resolution plansunder OLA.Theseplansare alsovery useful supervisorytools that have helped theFederal Reserve and the firmsfocuson opportunitiesto simplifycorporatestructuresand improvemanagement systemsin waysthat willhelp thefirms be more resilient and efficient, aswellaseasiertoresolve.Internationally, theFederalReservehasbeen an activeparticipant in theFSBs worktoaddressthechallengesof cross-border resolutions.For example, the Federal Reserve, together withtheFDIC, participatedin thedevelopment of the KeyAttributes.We are alsoan activeparticipant in the FSBs many committeesandtechnicalworkinggroupscharged withdevelopingpolicy guidanceon abroad rangeof technical areasthat affect the feasibility of cross-borderresolution.Moreover,asthe home-country supervisorof eight of the 28globalsystemicallyimportant banks (G-SIBs) identified by theFSB, the FederalReservehastheresponsibilityof establishingand routinely conveningforeach U.S.G-SIB a crisismanagement group.Thesefirm-specificcrisismanagement groups,whichare comprisedprimarilyof thefirmsprudential supervisorsand resolutionauthoritiesintheUnited Statesand keyforeign jurisdictions,are workingtomitigatepotential cross-borderobstaclesto an orderly resolution of thefirms.Last year, theFederal Reservealsosought public comment onaproposalthat wouldgenerallyrequire foreign banks witha largeU.S.presence toorganize their U.S.subsidiaries under a singleintermediateholdingcompany that wouldserveasa platform for consistent supervision andregulation.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 167Just asother countriesalready applyBasel capital requirementstoU.S.bank subsidiariesoperatingin their countries,our proposalwouldsubjecttheU.S. intermediateholdingcompaniesof foreign bankstothesamecapital and liquidityrequirementsasU.S. bank holding companies.We believethat theproposalwouldsignificantlyimprove our supervisionand regulation of theU.S.operationsof foreign banks, help protect U.S.financial stability, and promotecompetitiveequityfor all largebankingfirmsoperatingin the UnitedStates.Theproposal wouldenhancethe ability of the UnitedStates,asahost-countryregulator,tocooperatewithafirm-wide,global resolutionofa foreign banking organizationled by itshome-country authorities.ChallengesAhead on Cross-Border ResolutionDespitetheprogressthat is being madewithinthe FSB and in ourdomesticeffortswith the FDIC, developing feasiblesolutionsto theobstaclespresentedby cross-border resolutionof a systemic financialfirm remainsnecessaryand worktowardthis end isunder way.Thekey remainingobstaclesinclude:(1)adopting effectivestatutoryresolution regimesin other countries;(2)ensuringsystemic global banking firms have sufficient "goneconcern" loss-absorptioncapacity;(3)completingfirm-specific cooperation agreementswithforeignregulatorsthat providecredibleassurancestothosehost-countryregulatorstoforestall disruptivering-fencing;and(4) coordinatingconsistent treatment of cross-border financial contracts.First, although theUnitedStateshashad OLA in placesince2010,andtheFDIC hasmadegood progressin developingtheframeworkfor usingBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 168OLA overthepastthreeyears,most othermajor jurisdictionshavenot yetenactednational legislationthat wouldcreate a statutory resolutionregimewiththepowersand safeguardsnecessaryto meet theFSBs KeyAttributes.Mitigatingthe obstaclesto cross-borderresolution will, at a minimum,requirekey foreign jurisdictionsto haveimplemented national resolutionregimesconsistent with the KeyAttributes.Therefore, wewill continuetoencourage our fellowFSB memberjurisdictionsto move forward withsuch reforms asquicklyaspossible.Second, key tothe ability of theFDIC toexecuteitspreferred SPOEapproachin OLAis the availability of sufficient amountsof debt at theparent holding company of the failed firm.Accordingly, in consultation with the FDIC, the Federal Reserve isconsideringthemeritsof a regulatory requirement that thelargest, mostcomplexU.S. bankingfirmsmaintainaminimum amount of outstandinglong-term unsecured debt on top of itsregulatory capital requirements.Such a requirement could have a number of public policybenefits.Most notably, it wouldincreasetheprospectsfor an orderly resolutionunderOLAbyensuringthat shareholdersandlong-term debt holdersof asystemic financial firm can bear potential future lossesat thefirm andsufficientlycapitalizea bridge holding companyin resolution.In addition, by increasingthecredibilityof OLA, a minimum long-termdebt requirement could help counteract the moral hazard arisingfromtaxpayer bailoutsand improve market disciplineof systemic firms.Switzerland, the United Kingdom, and theEuropean Commission aremoving forwardwithsimilar requirements, and it may be useful toworktowardan international agreement on minimum total lossabsorbencyrequirementsfor globallysystemic firms.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 169Third, weneed to take additional actionsto promote regulatorycooperation amonghome and host supervisorsin the event of the failureof an internationallyactive, systemic financial firm. Importantly, OLAonlycan applyto U.S.-charteredentities.Foreignsubsidiariesand bank branchesof a U.S.-based systemicfinancial firm could be ring-fencedor wounddownseparatelyunder theinsolvencylawsof their host countriesif foreign authoritiesdid not havefull confidencethat local interestswouldbe protected.Further progresson cross-border resolution ultimatelywill requiresignificant bilateral and multilateral agreementsamong U.S.regulatorsandthe keyforeign central banksand supervisorsfor thelargest globalfinancial firms.It alsomay require that home-country authoritiesprovidecredibleassurancestohost-country supervisorstoprevent disruptiveformsofring-fencingof thehost-countryoperationsof a failed firm.Theultimatestrength of theseagreementswill depend on whethertheyhaveadequatelyaddressed theshared objectives,aswell astheself-interests,of therespectivehome and host authorities.Thegroundworkfor theseagreementsisbeinglaid, but manyof themostcritical issuescan beaddressed only after other jurisdictionshaveeffectiveresolutionframeworksin place.Fourth, wemust help ensure that a home-country resolution of a globalsystemicfinancialfirm doesnot causekeycreditorsand counterpartiesofthefirmsforeign operationstorun unnecessarily.Oneof the keychallengestotheorderlyresolution of an internationallyactive, U.S.-basedfinancial firm is that certain OLA stabilizationmechanismsauthorized under titleII of the Dodd-FrankAct, includingtheone-daystayprovision withrespect toover-the-counterderivativesBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 170and certain other financial contracts, maynot applyoutside the UnitedStates.Accordingly, counterpartiesto financial contractswiththeforeignsubsidiariesand branchesof a U.S.firm may have contractual rightsandsubstantial economicincentivestoterminate theirtransactionsassoonastheU.S. parent entersintoresolution.Regulatorsand the industry are focused on thepotential for addressingthisconcern through modificationstocontractual cross-default andnettingpracticesand through other means.TheFederal Reserve will continueto support theseefforts.ConclusionThefinancial regulatoryarchitectureis stronger todaythan it wasin theyears leadingup to the crisis, but considerable workremainsto completeimplementationof the Dodd-Frank Act and thepost-crisisglobal financialreform program.Akey prong of that program is making sure that government authoritiesin theUnitedStatesand around theworldcan effect an orderlyresolutionof a systemically important, internationallyactivefinancial firm.Much hasbeen accomplishedin this area, but much remainsto be done.In the coming years, theFederalReservewill be workingwithother U.S.financial regulatoryagencies,and with foreign central banksandregulators,to make an orderly resolutionof a global systemic financialfirm asfeasibleaspossible.Thank you for your attention. I am happy to answer anyquestionsyoumight have.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 171Hitting the limitsof "outside the box"thinking? Monetary policy in the crisisandbeyondSpeechby JaimeCaruana, General ManageroftheBank for International Settlements,toOMFIF (Golden Series Lecture), London, 16May 2013Central bankshavehad to"think outsidethebox" toaddressunprecedented financialinstability and toprovidemonetary stimulusintryingtimes.Monetaryaccommodationhasbeen criticaltostabilisethe financialsystem and the economy.But questionsremain about theefficacyof such policies aslongasbalancesheetsand structural headwindsare not more fullyaddressed.Monetaryaccommodation can only be ashelpful asthe balancesheet,fiscaland structural policiesthat accompanyit.Looking ahead, central banks will continueto facedaunting challengesastheynavigateinuncharted waters,includinghow best tointegratenewperspectiveson the financial cycle and global spilloversintotheirmonetarypolicy frameworks.Full speechLadies and gentlemen,It is a great pleasureto behere at OMFIF.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 172Thecrisisand itsaftermath haveposed formidablechallengesfor centralbanks.They have had to "think outside the box" to address unprecedentedfinancial instability and provide monetary stimulusin the face of theconstraint imposedby the zerolowerbound of policyrates.Looking ahead, thechallengesremain daunting. Central bankshave tonavigateunchartedwaters.In thenear term,thequestionishowmonetarypolicycanbestcontributetowhat hassofar beenanuneven recovery.Cant central banksdomuch more?Perhapsthe relevant question iswhethercentral bankscan make up forinsufficient action elsewhere.What monetary policycan substitutefor balancesheet repair by banksandborrowers?What monetary policycan removeimpedimentstoa workermoving froman overbuilt sector toa more promisingone?Thesekindsof question require a medium-term perspective, and in amedium-term perspectivemonetary accommodationwill prove onlyasgoodasthebalancesheet, fiscalandstructuralpoliciesthataccompanyit.From a longer-term perspective, a challengeis tobetter integratefinancial stabilityconsiderationsintomonetary policyframeworks.Therecent crisisbrought theglobal financial system totheverge ofcollapseand hashad dire social and economic consequences.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 173This hasraised fundamental questionsabout how to integratea modernunderstandingofthefinancialsystem intoourtraditionalmonetarypolicymodels.Theseareall exceedinglydifficult questions,the situation isdifferentfrom country to country and noone can claim to have a crystal ball thatprovidesdefiniteanswers.Yet, experiencedoesoffer at least some pointersfor thefuture.In the following, I will thereforestart by reviewingthemain insightssuggestedby monetary history, beforeturningtothe current challenges.Insightsfrom monetary historyThepast century saw considerablechangesin the conduct of monetarypolicy.Thesechangeswereoften the result of both historicaleventsand newwaysof thinkingabout the roleof central banks.Bytheend ofthe20thcentury, therewasaclearconsensusthat aremit ofmonetarypolicy focused on price stabilityhad manybenefits.This view reflectedlessonsfrom the painful experienceof double-digitinflationratesand erratic growth that prevailed in manycountriesworldwidein the1970s,and in some emerging market economieswellintothe 1990s.Themain reasonforthisdismalinflationandeconomicperformancewasthat monetary policy neglectedprice stability.Instead, central banks pursued other goals,whichturned out to beinconsistent withpricestability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 174In many advanced economies, for example, monetary policy wastooaccommodativeduring the 1970s,and central banks endedup pushingoutput beyond sustainablelevels.In emerging market economies, political pressuresto generateseigniorageincome and financepublic spendingprogrammesvia theprintingpresswerefrequent sourcesof high inflation.In all theseexperiences,theneglect of price stability did not improveeconomicperformance.Overtime, welearned, quitepainfully, that thereisnobeneficial long-runtrade-offbetweeninflationand growth.Indeed, we learned that high and volatile inflation ratesgo hand in handwith erratic growth, large exchange rate swings, and even economic andpoliticalcrises.Chastenedbytheseexperiencesofthe1970sand1980s,central bankshadtorethink their roles.At that time, the result wastoconsider a narrow mandate for pricestability.Tobe sure, thisrequired a very painful adjustment process.Central bankshad tosqueezeinflation out of their economiesat the costof recessions. But that cost waswell worththe price.Thosewhohadthecouragetotrywerevilifiedthen, onlytoberecognisedashavingdone the right thingyears later.Another lesson learnt during this period wasthat central bank autonomyis criticalto achieveprice stability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 175Onemainunderlying causeofinflationinstabilitywasthefailuretoshieldmonetarypolicymakers sufficientlyfrom short-term political cycles.Somecentral banks, such asthe Bundesbank and theSwissNationalBank, had led theway.Theyenjoyed a high degreeof effectiveindependenceand, on this basis,consistentlydeliveredlowerinflationthan their peersduring thepost-BrettonWoodsera.Thesearehard-earned lessonsthat should not be forgotten.Today, central banksare once again "thinkingoutsidethe box" asnewchallengeshave arisen.Evenbeforethecrisis,concernsamongcentralbankersweregrowingthatthepolicy environment waschangingin ways that calledfor a furtherevolution of central banking.In particular, thenarrow focuson near-term domestic price stabilitydidnotseem tobeenoughin anenvironment in whichthefinancial cycleandglobal spilloverswerebecoming more prominent.With respect to thefinancial cycle, wenow seethat monetary policyplayed an important part in the build-upof financial imbalancesduringthe2000s.After thebust of thedotcom boom, monetary policy in the advancedeconomiesremained accommodativefor manyyears. Interestrateswerelow,and credit and housepricessoared.Of course, the relevanceof the financial cycle for central banksisnot anentirelynew insight.Theforgingof manycentral banks, such asthat of theFederal Reservein1913, wasthedirect result of thebankingcrises of the 19th and early20thcentury.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 176It became lessrelevant in theearlypostwarperiod againstthebackground of tightlyregulatedfinancial systems put in placeafter theGreat Depressionand theSecond World War.But the far-reachingfinancial deregulationpursued sincethe1970sallowedthe financial cycle tore-emergeasa major macroeconomicforcethat grew ever stronger.Globalisation, too, hasbeen changingthe policy environment insignificant ways.In addition to the growing influence of global factors on domesticinflation dynamics, globalisation appears to have added fuel to themonetaryeasingin therun-up tothe recent crisis.Theunusuallylowpolicy ratesprevailingin the major advancedeconomiesaffectedothersvia a resistancetocurrencyappreciationpressures.Many emerging market economieskept interest rateslowerthan wouldhavebeen suggested by domestic macroeconomic conditionsalone.In turn, their accumulation of foreign exchangereservesput additionaldownward pressure on yieldsin theadvanced economies.Thenet result wasunusuallyaccommodativeglobalmonetaryconditions.Real interestratesaverageda mere 1.5% globallybetween2002and 2007while output grew robustlyat roughly4%.Managing the post-crisisrecoveryWhile thepre-crisisperiod alreadygavecentral banksmuch food forthought, the crisishasgiven them still more to chew on.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 177The financial crisishastested the crisis-management readinessof centralbanks, and the subsequent phase their ability to nurse the economy backtogrowth.Central bankshaverespondedin anunprecedentedwayinboth scaleandscope.Theyhaveprovidedampleliquidityin theirlenderof lastresort functions,havecommitted tolow - often effectivelyzero - interest rates, haveengagedin large-scalebalancesheet policies,have augmented this withenhancedforwardguidancelinked to real-economy outcomes, have put inplacetargetedlendingschemes,havepurchasedriskyassetsandsoon.Theresponseof central bankshashad important benefits.Thereisnoquestionthat inthemostacutephaseofthecrisisit preventedthefinancial system from imploding, whichwouldhave brought the realeconomydown.Low policyratesand theunprecedenteddeployment of balancesheetpoliciesboosted confidence and improved financial market conditions.And asdoubtsre-emergedin financial marketsmore recently, centralbank measureseffectivelyreduced perceivedfinancial tail risks.And yet, despitetheseunprecedentedactions,the global recoveryhasbeen lacklustre.Fiveyears intothe recovery, economic performanceis laggingpreviousonesat the same stage.Economicactivityiswell below itspre-crisistrend in the major advancedeconomiesand unemployment isstubbornly high.Thereis, understandably, frustration about thisapparent lack of traction.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 178This frustration hasledsome to call for ever more monetary policyactivism.But is it really justified?If a medicinedoesnot workasexpected, itsnot necessarilybecausethedosagewastoolow.Maybe instead the overall treatment, and the roleof the medicinewithinit, should be reconsidered.Most likelysomethingelseis needed.Balancesheet recessionsare special:it islessclearthan often thoughtthat monetary policy can foster a quick and robust recoveryin a balancesheet recession.When privatesector balancesheetsneed repair, accommodativemonetarypoliciesare lesseffective.When the problem is too much debt and agentsare in the mood toretrench, it isunrealistic to expect monetary policy to revive stronggrowthby loweringinterest rates.When financial institutionsare weak, it isequallyunrealistic toexpectthem toeffectivelytransmit monetary impulses.Moreover, it iswellknown by now that growthtendsto beweakerafterfinancial crisesthanafter ordinary economicdownturns.This is not just, or even primarily, a question of deficient demand.It reflectstheneed for the economy toreabsorb the aggregateand sectoralreal imbalancesthat built up during the preceding unsustainableexpansion, hidden under the froth of thefinancial boom.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 179Suchboomstypicallyleavein their wakenot onlytoomuchdebt, but alsotoomuch capital and labour in thewrongsectors.Therefore, thechallengefor countriesin thenext few years will be toreallocatelabour and capital among sectorsboth within and acrossnational borders.Structural reform toremove rigidities,not monetary policy, is the waytofacilitate this.True, monetarypolicycan buy time toimplement thenecessarybalancesheet repair and structural reforms.But it cannot substitutefor them. After five yearsof buying time, onehastoaskwhetherthat timehasbeen - or will be - used wisely.Refocusingthepolicymix to relymore on repair and reform and not tooverburdenmonetary policy iscrucial because thebalanceof risks ofprolonged very lowinterest ratesand unconventional policiesis shifting.Thecostsare growingin relation tothebenefits,for a number of reasons:First, prolongedmonetaryaccommodation givesborrowers,financialinstitutionsandpolicymakersanincentivetokeep"kickingthecandowntheroad", delaying necessary repair and reform.Certainly, progresshasbeen made in a very trying environment.But more needstobe done.Indeed, the slow progress in the implementation of structural reforms andin the deleveraging processmay signal that this delaying mechanism is atwork.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 180Persistent high unemployment ratesin many advanced economiesindicatethechallengesof labour rigiditiesand sectoral rebalancingthatstill face us.At the same time, although some private sector deleveraging is occurringin some countries, and the financial system is better capitalised, the totaldebt figuresare not reassuring.Sincethe end of 2007, total debt of the G20 non-financial sector, bothprivateand public, hasrisen by more than 30trillionUS dollars,whichrunscounter todeleveraging, at least asI understand the term.It is noteworthythat over thesameperiod global central bank assetshaveincreasedby roughly10 trillion USdollars.Second, prolonged accommodation canproduce other unintendedsideeffects.In the 1970s,thedesire to lift output and employment back topre-crisislevelsresulted in surginginflation.Onemight arguethat the situation todayis quitedifferent from then.Inflationhasremainedlowinmost jurisdictionsand closetocentral banktargets.However,monetary stimulusmay find itswayintoasset pricesandleveragebeforeinfluencinggoodsand servicesprice inflation.Moreover,prolonged very low interest ratescan distort market signals,mask underlying balancesheet weaknessesand undermine theearningscapacityof banks,the businessmodels of life insurancecompaniesandthesolvencyof pension funds.This may further misallocatecredit, weakenfinancial institutionsbalancesheetsand encourage excessiveand unwelcome risk-taking.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 181Another significant sideeffect arisesfrom global monetary policyspillovers.Persistently low interest rates in the major advanced economies generallyencourage capital flows to fast-growing emerging market economies andput upward pressure on emerging market exchangerates.This can complicatetheabilityof emergingmarket central banks topursuetheir stabilisationgoals.On the onehand, if central banksin emergingmarketskeep policy ratesvery low,capital inflowswouldbe discouraged, but domesticcreditgrowthwouldbe encouraged.If, on the other hand, theyraisepolicyrates,the risksof destabilisingcapital flowswouldrise.Sofar, wehave been seeinga combination of theseforcesat work.Despitesome slowingof capital flowsover thepast year, private sectorcredit and propertypriceshave been surgingin a number of theseeconomies,aswell asin someopen advanced economies.Finally, prolonged accommodation raisesriskstocentral banksthemselves.If economies remain weak and structural problems unresolved despiterepeated rounds of further monetary stimulus, the credibility of centralbanksmaysuffer, and credibilityisimportant for effectiveness.Let me insist here that resultsin the real economy will depend on theextent that needed repair and reformsare carried out.Resultswill dependtoa largeextent on factorsthat are not under centralbanks control.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 182Aviciouscircle can develop, with awideninggapbetweenwhat centralbanksare expectedtodeliver and what theyactuallycan deliver.This may ultimatelyunderminetheir credibility and, withit, theirlegitimacyand effectiveness.All this underscores the importance of being prepared for the eventualexit from the extraordinarily accommodative monetary conditions thathaveprevailed for thepast several years.While central bankssurelyhaveall the toolsavailableto technicallyengineeran exit, it cannot be taken for granted that it will be smooth.Theglobal bond market crash of 1994is a cautionarytaleof the risksinvolved in exitingfrom a prolongedperiod of lowinterestrates.At the same time, wealsohave to recognise that thesituation today israther different from back then in at least one critical dimension:centralbanksare much more transparent about their policy intentionsnow andtheir communication is much better.This should reducethe risk of major policysurprises.That said, thepolicy environment central bankshave to grapplewithtodayis alsomuch more complex in some important dimensions.Recordlevelsof debt have been issued at very low interest rates.Central banks,at leastfor now,areplaying animportant, if not dominant,rolein keyfinancial market segments.So, asinterestratesrise and central bankspare back and eventuallyreverselarge-scaleasset purchases, financial marketswill have much todigest.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 183Different national conditionswill require unsynchronised exits,whichmay raise additional complexities.Even in the current environment of enhanced central bank transparencyand credibility, a choppyexit isa material risk.It goeswithout saying that I wouldlovetobe proven wrongabout this,andthat a lot of work is being donetoreduceexit risks.Monetary policy and the financial cycleAswepeer furtherintothefuture, onekeychallengecentralbanksfaceishowtobetter integrate financial stabilityconsiderationsintotheirmonetarypolicy frameworks.Theeconomicand social damage of therecent crisis haspainfullyshownwhat is at stake.And central banksmust reflect on how they can forgea new consensusabout the wayforward.This is not just a narrow operational issue, for exampleabout how torespond to credit and asset price boomsand busts.It raises the much broader conceptual question of how to shift ourtraditional purely macroeconomic perspective towards a new, fullyintegratedmacro-financial perspective.As I seeit, thecrisishasnot discredited thecore elementsof pre-crisismonetarypolicy frameworks.The credibility of central banks as guarantors of price stability has beeninstrumental in anchoring inflation expectations, on both the downsideandtheupside, during the crisisand itsaftermath.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 184Astrong, credibleanchor helpsto counteract thedestabilisingforceshittingthe economyand financial markets.At the same time, the pre-crisismonetary policy frameworksdid notprevent the crisis from happening.Theexperiencein therun-up suggeststhat central banksneed to betterappreciatetheir rolein influencingthe financial cycle.For thispurpose, byfinancial cycle I refer tothe combined endogenousbehaviourof credit and asset prices, particularlyhouseprices.Regulatoryreform obviouslyplays a keyrolein mitigatingfinancialcycles,and wehavealready seen significant progressin this area: betterandhigher buffers, the introduction of countercyclical capital buffersunder thenew Basel III frameworkand the development ofmacroprudential frameworksand tools.Tobe sure, prudential and macroprudential measuresareclearlynecessary.But theyalonewill not be enough and can alsobecircumventedbyregulatoryarbitrage.This is whymonetary policy hasa complementaryroletoplay. Thepolicyrate representsthe universal price of leveragein a givencurrencyand cannot be bypassed easily.In thisrespect, central banks will need toreflect onhow best to respondtofinancial stability concernsin the future.Thecrisishasclearlyshownthat financial stabilityis essential for lastingprice stability.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 185Onelessonis that monetary policymay need to respond moresymmetricallytothefinancial cycle than in the past - tighteningmorestronglyin boomsand easinglessaggressively, andpersistently, in busts.In practice,thismeanspaying moreattentiontopolicychallengesbeyondtheconventional policy horizonsof twoor soyears.When financial stabilityconcernsgrow, policyhorizonsneed to belengthenedtotake accountof the fact that the financial cycle isconsiderably longer than the businesscycle.Analytical frameworksalsoneed tobetter reflect the characteristicsoffinancial cyclesand their interactionswithfinancial and macroeconomicstability.Central banks pre-crisis workhorsemodels generallyassignednomeaningful roleto macro-financial linkages.Thefinancial crisishasdemonstratedthat suchanalytical perspectivesare woefullyinadequate.Another dimension along whichcentral banksneedtoreflect is a betterappreciationof global monetary policy spillovers.Global feedbackeffectsamplified thepre-crisisfinancial boom, and wemight be seeingthis mechanismat workagain.In a highly globalisedworld, keepingones ownhouse in order surelyisnot enough.What doesthis mean in practice?It doesnot require central banksto coordinate their policies closely.But, at a minimum, it doescall for them toappreciate better the globalsideeffectsandfeedbacksthat arisefromtheir monetarypolicydecisions.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 186Thisisineachcentralbanks owninterest, especiallyif thespillovershavethepotential tofosterregionalfinancialinstabilitythat endsincrisis,withsignificant global repercussionsthat swingback tothe originatingcountries,like a boomerang.Aprecondition for this shift in perspectiveis a more global analyticalapproachthat factorsin interactionsand feedbacksappropriately.Finally,I donot want toleaveyou withtheimpressionthat fiscalpolicyisirrelevant in this discussion.Indeed, fiscal policy plays an important role in financial stability, too. Thefinancial crisishasdemonstratedtheimportanceof having the fiscalcapacityto support thefinancial sectorthrough bank rescuepackagesandthe real economy through fiscal buffers.But the financial crisishaspushed fiscal policy in many economiesontoan unsustainablepath.This is a lesson that wehave tokeep in mind for thefuture.Accumulatingbudgetsurplusesin goodtimesprovidesgovernmentswiththeabilityto respond flexiblyto a financial crisiswithout putting fiscalsustainability at risk.In other words,governmentsneed tofactor in the financial cycle and tobuild up additional fiscal buffers during good timesthat can be drawndownto providesupport in bad times.Summing upLet me sum up. There is littledisagreement that thepast five yearshavebeen unusuallychallenging.Central bankshaveplayed a critical rolein managing the crisis and itsaftermath.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 187Theyare now under huge pressuretopromote a sustainablerecoveryunder difficult circumstances.And, lookingahead, they will continue to find themselvesconfrontingmajor challenges.I have suggestedthat monetary historyprovidesa valuablecompasstonavigatethesetrickywaters:aclearfocusonlastingpricestability, amoresymmetrical approach tothe financial cycle, and abetter appreciationofglobal spillover effects- thesewouldappear tobe the key elementsofstronger monetary policy frameworks.At the current juncture, there is alsoa premium on central bankcommunication.Central banksneedtoclearlycommunicate the limitsof monetary policy,both to thepublic and toother policymakers.The private sector and policymakers, who have been facing their own setof daunting challenges in extraordinarily difficult times, will have to playa larger rolein thenext legof theglobal recovery.Crucially, thiswouldalsoallowcentral bankstonormalise monetarypolicy in a manner consistent with a return to sustainableand balancedgrowth.Thank you.Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 188DisclaimerThe Association tries to enhancepublic accessto information about risk andcompliancemanagement. Our goal is to keep this information timely and accurate. Iferrorsarebrought to our attention, wewill try to correctthem.This information:Basel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com- is of a general nature only and isnot intended to addressthe specificcircumstances of any particular individual or entity;- should not be relied on in the particular context of enforcement or similarregulatoryaction;- is not necessarily comprehensive, complete, or up to date;- is sometimeslinked to external sites over which theAssociation has no controland for which theAssociation assumesnoresponsibility;- is not professional or legal advice (if you need specific advice, you shouldalwaysconsult a suitably qualified professional);- is in no wayconstitutive of an interpretative document;- doesnot prejudge the position that the relevant authoritiesmight decidetotake on the same mattersif developments, including Court rulings, wereto lead it torevisesomeof the viewsexpressedhere;- doesnot prejudgetheinterpretationthat theCourtsmight place onthemattersat issue.Pleasenote that it cannot be guaranteed that theseinformation and documentsexactly reproduce officially adopted texts.It isour goal to minimize disruption causedby technical errors.However somedataor information mayhave been createdor structured in filesor formats that are noterror-freeand wecannot guarantee that our service will not be interrupted orotherwiseaffectedby such problems.The Association acceptsno responsibility with regard to such problemsincurred asaresult of using this site or any linked external sites.
    • P a g e | 189TheBaseliii ComplianceProfessionalsAssociation (BiiiCPA) is thelargest associationof Basel iii Professionalsin theworld. It is a businessunit of theBasel ii ComplianceProfessionalsAssociation (BCPA), whichis alsothe largest associationof Baselii Professionalsin theworld.Basel III SpeakersBureauTheBasel iii ComplianceProfessionalsAssociation (BiiiCPA) hasestablished the Basel III Speakers Bureau for firmsand organizationsthat want to accessthe Basel iii expertise of Certified BaseliiiProfessionals(CBiiiPros).TheBiiiCPAwill be the liaisonbetweenour certified professionalsandtheseorganizations,at nocost. We stronglybelievethat this can be agreat opportunityfor both, our certified professionalsand theorganizers.Tolearnmore:www.basel-iii-association.com /Basel_iii_Speakers_Bureau.htmlBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 190Certified Basel iii Professional (CBiiiPro)Distance Learning and Online Certification ProgramTheall-inclusivecost is $297What is included in this price:A.The official presentationsweuse in our instructor-led classes(1426 slides)You can find the coursesynopsis at:www.basel-iii-association.com/ Course_Synopsis_Certified_Basel_III_Professional.htmlB. Up to 3 Online ExamsThere is onlyone exam you need topass, in order tobecomea CertifiedBasel iii Professional (CBiiiPro). If you fail, you must study again theofficial presentations,but you donot need to spend moneytotry again.Up to 3 examsare includedin theprice.Tolearnmore you may visit:www.basel-iii-association.com/ Questions_About_The_Certification_And_The_Exams_1.pdfwww.basel-iii-association.com/ Certification_Steps_CBiiiPro.pdfC. Personalized Certificate printed in full color.Processing, printingand posting toyour office or home.Tobecome a CertifiedBaseliii Professional (CBiiiPro) you must followthestepsdescribedat:www.basel-iii-association.com/ Basel_III_Distance_Learning_Online_Certification.htmlBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
    • P a g e | 191Presentationsonly(not the full program)1. CBiiProwww.basel-ii-association.com/D istance_Learning_Online_Certification_CBiiPro_Presentations.htmBasel iii ComplianceProfessionalsAssociation (BiiiCPA)www.basel-iii-association.com
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