Risk management presentation May 20 2013


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Risk management presentation May 20 2013

  1. 1. P a g e | 1International Association of Risk and ComplianceProfessionals (IARCP)1200 G Street NW Suite 800 Washington, DC 20005-6705 USATel: 202-449-9750 www.risk-compliance-association.comTop 10 risk and compliance management related news storiesand world events that (for better or for worse) shaped theweeks agenda, and what is nextDear Member,Whichisthe differencebetween triggersandvulnerabilities?Dear Mr Bernanke, can you clarifyplease?He did, at the 49thAnnual Conferenceon Bank Structure andCompetition sponsored by theFederal Reserve Bank ofChicago, Chicago, IllinoisHe said:―Torespond tothispoint, I will distinguish, asI haveelsewhere,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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  2. 2. P a g e | 2Examplesof 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.‖Did you addressvulnerabilitiesthis week?Mr Bernanke continued:―Moreover, attemptsto addressspecific vulnerabilitiescan besupplementedby broader measures--suchasrequiring banksto holdmore capital and liquidity--that makethesystem more resilient toarangeof shocks.‖Read moreat Number 1below.Welcometo the Top 10list.BestRegards,GeorgeLekatisPresident of the IARCPGeneral Manager, ComplianceLLC1200G Street NW Suite800,Washington DC 20005,USATel: (202) 449-9750Email: lekatis@risk-compliance-association.comWeb: www.risk-compliance-association.comHQ: 1220N. Market Street Suite804,Wilmington DE 19801,USATel: (302) 342-8828International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  3. 3. P a g e | 3ChairmanBen S.BernankeAt the 49thAnnual Conferenceon Bank Structure andCompetition sponsored by theFederal Reserve Bankof Chicago, Chicago, IllinoisMonitoring the Financial System―We are now more than four years beyond themost 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.‖Erkki LiikanenBanking structure and monetary policy –what have we learned in the last 20 years?Presentation by Mr Erkki Liikanen, Governor oftheBank of Finland and Chairman of theHighlevel Expert Group on the structure of theEU banking sector, at the conference―Twentyyears of transition – experiencesand challenges‖,arranged by theNational Bank of Slovakia, Bratislava.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  4. 4. P a g e | 4The impact of the crisison financial integrationin Central and Eastern EuropeSpeechby Mr IgnazioVisco, Governor of theBank ofItaly, at the conference―Twentyyearsof transition – experiencesand challenges‖, hostedbytheNational Bank of Slovakia, Bratislava―Thetransitioncountriesof Central and Eastern Europe werenoexception:their quiterapid financial integration over thepasttwenty-yearsbrought about lastingeconomicbenefits,but alsoleft themrelativelyexposedtothe global financial turmoil, in particular throughtheir linkswithWestern European bankswhichhold dominant stakesintheregion‘smarkets.‖Revised rulesfor markets in financialinstruments (MiFID/ MiFIR)a)Proposal for a Directiveof the EuropeanParliament and of theCouncil on marketsin financial instrumentsrepealingDirective2004/ 39/ EC of theEuropean Parliament and of the Council (Recast) (MiFID)b)Proposal for a Regulation of the European Parliament and of theCouncilon marketsin financial instrumentsand amending Regulation[EM IR] onOTC derivatives,centralcounterpartiesandtraderepositories(MiFIR)International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  5. 5. P a g e | 5APRA releasessecondconsultation package for thesupervision of conglomerate groupsTheAustralian Prudential RegulationAuthority (APRA) hasreleased forconsultationproposed risk management and capital adequacyrequirementsfor thesupervision of conglomerategroups.Conglomerategroups, referredto asLevel 3 groups,are groupscomprisingAPRA-regulated institutionsthat perform material activitiesacrossmore thanoneAPRA-regulated industry and/ orin oneor morenon-APRA-regulated industry.GovernorElizabethA. DukeAt the Housing PolicyExecutiveCouncil, Washington, D.C.AView from the Federal Reserve Board:The Mortgage Market and HousingConditions―Sincejoiningthe Board in 2008amid a crisiscentered on mortgagelending, I have focusedmuch of my attentionon housingand mortgagemarkets,issuessurrounding foreclosures,and neighborhoodstabilization.In Marchof this year, I laid out my thoughtson current conditionsin thehousing and mortgagemarketsin a speechto theMortgageBankersAssociation.‖International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  6. 6. P a g e | 6TheNeedfor Robust SEC Oversight of SROsBy CommissionerLuisA. AguilarU.S. Securitiesand ExchangeCommissionWashington, D.C.Proposal for a structuralreform of EU banks―There are concernsthat largeEU banking groups, are difficult tomanage, monitor, and supervise.Furthermore, theymay alsobe difficult to resolve, due to theircomplexity, interconnectedness, geographic scope, and abilityto expandrapidly.Also, theunrestricted co-minglingof depositssubject to governmentguaranteeswith market and tradingactivitiesmay subject depositorstoadditional risks.‖International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  7. 7. P a g e | 7APRA releasessecond consultationpackage on Basel III liquidity reformsTheAustralian Prudential RegulationAuthority (APRA) hastodayreleaseda second consultationpackageoutliningits proposedimplementationof theBasel III liquidityreformsfor authoriseddeposit-takinginstitutions(ADIs) inAustralia.Thepackage includesa discussionpaper, a reviseddraft PrudentialStandardAPS210Liquidity(APS210) and a draft Prudential PracticeGuideAPG 210Liquidity.OTC derivatives statisticsat end-December2012Monetary and Economic DepartmentMay 2013―Notional amounts for interest rate derivatives, thelargest segment of the market, stood at $490 trillionat end-2012.While the overall figure wasmore or lessunchanged from end-June2012,breakdownsshowedoffsettingmovements.For swaps,notional amountsdropped in thesecond half of 2012by about2% to$370trillion, owingin part to the compressionof tradesthroughcentral counterparties(CCPs).‖International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  8. 8. P a g e | 8ChairmanBen 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  9. 9. P a g e | 9Of course,the Fed hasalwayspaid closeattentiontofinancialmarkets,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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  10. 10. P a g e | 10AFocus 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.Of course, monitoring can and doesattempt to identify potentialtriggers--indicationsof an asset bubble, for example--but shocks of onekind or another are inevitable,soidentifying and addressingInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  11. 11. P a g e | 11vulnerabilitiesis 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.Indeed, it may be that prolonged economic stability isa double-edgedsword.Tobe sure, a favorableoverall environment reducescredit riskandstrengthensbalancesheets,all elsebeingequal, but it could alsoreduceInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  12. 12. P a g e | 12theincentivesfor market participantsto take reasonableprecautions,which may lead in turn toa buildup of financialvulnerabilities.Probablyour best defenseagainst complacencyduring extendedperiodsof calm is careful monitoring for signsof emergingvulnerabilitiesand, whereappropriate,the development of macroprudential and otherpolicytoolsthat can be 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 thepowertodesignate individual nonbank financial companiesassystemicallyimportant.This designationprocessis under way.Dodd-Frank alsoestablishesa framework for subjectingSIFIstocomprehensivesupervisoryoversight andenhancedprudential standards.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  13. 13. P a g e | 13For 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 hypotheticalscenario, and the resultsare publicly disclosed.Firms are evaluatedboth on their post-stresscapital levelsand on theirabilityto analyze their exposuresand capital needs.Stresstestingprovidesa 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  14. 14. P a g e | 14Second, 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.Supervisorsalsoareworking 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 monitoringInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  15. 15. P a g e | 15program 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 theinterconnectednessof financial institutionsand markets.Interconnectednesscan arisefrom common holdingsof assetsor throughtheexposures of firms to their counterparties.Networkmeasuresrely on conceptsused inengineering, communications,and neurosciencetomap linkagesamong financial firmsand market activities.Thegoalsare toidentify keynodesor clustersthat could destabilizethesystem andtosimulatehowashock, suchasthesuddendistressofafirm, could be transmitted and 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  16. 16. P a g e | 16Shadow 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).Theshort-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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  17. 17. P a g e | 17Their 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.Borrowersunableto 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  18. 18. P a g e | 18Beforethefinancialcrisis, 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.Afair 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 inInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  19. 19. P a g e | 19thecourse 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.But, 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  20. 20. P a g e | 20Theseassessmentsare 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.For 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 thequalityofmortgagecredit during the2007-09crisis had much more far-reachingeffects:Thelossesfrom thestockmarket declinesin 2000and 2001werewidelydiffused, while mortgagelosseswereconcentrated--and, through variousfinancial instruments,amplified--incriticalparts of the financialsystem, resultingultimatelyin panic, asset fire sales,and the collapseofcreditmarkets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  21. 21. P a g e | 21Nonfinancial SectorOur financial stabilitymonitoring extendsto thenonfinancialsector, includinghouseholdsand businesses.Researchhasidentified excessivegrowthin credit and leveragein theprivatenonfinancial sector aspotential indicatorsof systemic risk.Highlyleveragedorfinanciallyfragile 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 the nature ofInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  22. 22. P a g e | 22borrowingand 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 notreveal 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  23. 23. P a g e | 23Erkki Liikanen: Banking structureand monetary policy – what havewe learned in the last 20 years?Presentation by Mr ErkkiLiikanen, Governor of the Bank ofFinland and Chairman of theHighlevel Expert Group on thestructure of the EU bankingsector, at the conference―Twentyyears of transition –experiencesand challenges‖,arranged bytheNational Bank ofSlovakia, Bratislava.How is today‘s perspectiveon monetarypolicy different from whatprevailed 20 years 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 an explicit inflationtargetingstrategy.In the sphere of banking regulation, too, a new era wasbeginning.Asignificant reorientationwasgoingon, awayfrom regulating theconduct of banks and towardsthe new risk-basedapproach.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  24. 24. P a g e | 24Theregulatory 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, wasspreadingtothewholedeveloped 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.Theunderpinningsof global financial stabilitywerebecoming weaker.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  25. 25. P a g e | 25Global 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 low perceivedrisks.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.Even worse,theyallowedriskstoaccumulate in the financial systemwhichwereonly waitingtobe realized.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  26. 26. P a g e | 26Thencame 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.Second, wealsoknow that central bankscan maintain an admirabledegreeof pricestabilityeven whenfinancial stabilityis under a lot ofstrain.Dothesetwopointsmean that financial stability and monetary policyarenot connected after all?International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  27. 27. P a g e | 27No.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.Theideathat 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  28. 28. P a g e | 28Now 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.In 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  29. 29. P a g e | 29Is 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 thebubblehascoincidedwith 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  30. 30. P a g e | 30On 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.This 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 tothreeyears, wideningof the scope of eligible collateral, and the variousbondpurchaseprogrammes.Themost recent oftheseistheOMT programmeannouncedlastsummerbut not yet commenced in practice.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  31. 31. P a g e | 31Thedevelopment 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.Theabilitytoact 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  32. 32. P a g e | 32Avoiding 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.Onedevelopment 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  33. 33. P a g e | 33We 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 moreresilient, and - I emphasise- lesspronetounstablebehaviour.The Structural reform proposalsIn order toprevent the present crisisfrom being everrepeated, governmentsand authoritieshave started a large-scaleoverhaul of financial 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 inInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  34. 34. P a g e | 34theUS, 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 thesedepositbanksbecoming 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  35. 35. P a g e | 35I 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.We proposed that 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  36. 36. P a g e | 36Whybanking 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 abletoinsulatethe 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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  37. 37. P a g e | 37Finally,thestructural reform ofbankingisacomplement, not asubstitutefor other regulatory improvements.For central banks, thedevelopment of macro-prudential policiesandinstrumentsisespeciallyrelevant.Thosemacro-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.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  38. 38. P a g e | 38Theimpact of the crisison financialintegration in Central and Eastern EuropeSpeechbyMr IgnazioVisco, Governor of theBankof Italy, at theconference―Twentyyearsoftransition– experiencesandchallenges‖, hostedbythe National Bank of Slovakia, Bratislava.I wishtothank for useful discussion and helpEmidio Cocozza, PaoloDel Giovane and ValeriaRolli.IntroductionTheglobal financialcrisishasbeen severeand widespread, and hasaffected different economiesin different and long-lastingways.Thetransition countries of Central and Eastern Europe werenoexception:their quiterapid financial integration over thepasttwenty-yearsbrought about lastingeconomicbenefits,but alsoleft themrelativelyexposedtothe global financial turmoil, in particular throughtheir linkswithWestern European bankswhichhold dominant stakesintheregion‘smarkets.Financial stability hasonce again become a fundamental objectiveofpolicy making, and central banksare beingheavily involved in thisendeavor.This callsfor a substantial overhaul in financial regulation andsupervision.Thefinancial system of tomorrow will be different from theone that hasdeveloped over the last twodecades.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  39. 39. P a g e | 39Global financial integration during the past decadeIn the decadebeforethefinancial crisisboth the sizeof the financialsystem and itsroleand pervasivenessin the economy increaseddramatically.Theprocesshasonlysloweddown sincethe crisis.In theeuroarea,theoverall amount offinancialresourcescollectedbytheprivate sector(bank credit, bondsissued domesticallyand stock marketcapitalization) rosefrom 160per cent of GDP in 1996to240in 2007, andthen declinedto230in 2011.Asimilar pattern is found for theUnitedStates,wherethe ratio rose from230percent in1996to330in 2007andthendeclinedto260in 2011(Fig. 1).Driven by thebreakthroughsin informationtechnologyandtelecommunicationsand theprocessof financial integration, thesupplyof derivativesproducts, the securitizationof banks‘assets,together withthegrowth of so-calledstructured financial instruments, expandedconsiderably.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  40. 40. P a g e | 40Thetotal outstandingnotional amount of over-the-counter(OTC) andexchange-tradedderivativeshasrisenfromabout 94trillionU.S.dollarsattheend of 1998to around 670trillion at the end of 2007, hovering aroundthat level afterwards(Fig. 2).An important dimensionof thisprocesshasbeen the increasedinternational financial integration.In the last decade industrial countries‘ gross external financial assets andliabilities more than doubled in proportion to GDP, reaching 440 per centat the end of 2007(Fig. 3).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  41. 41. P a g e | 41Thedevelopment of financial marketsin emerging economieshasalsobeen dramatic.Theoverall amount of financial resourcescollectedby the private sector(outstandingstocksof bank credit, domestic debt securitiesand equitymarket capitalization) increased from about 120to230per cent of GDPbetween1996and 2007for the averageof emergingAsia, and from about40toalmost 100per cent for the averageof CEE countries (Fig. 4).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  42. 42. P a g e | 42International financial integration – withforeign direct and portfolioinvestmentsand theinvolvement of foreign banks in domesticfinancialsystems– washelped bythe removal of earlier obstacles: macroeconomicinstability, vulnerableexternal positionsand inefficient institutional andregulatorysetups.Sincethe mid 2000s,this processwashugely supportedby exceptionallyfavorableglobal financial conditions,withabundant liquidity, lowriskaversion, and fallinglong-term interest rates.Financial integration in Central and Eastern EuropeThetransition countries in Central and Eastern Europe weretherecipientsof a largeinflux of internationalcapital, mostly flowingin fromWestern Europe.Between 2003 and 2008 capital inflows reached sustained levels – morethan 12 percent of GDP on average – well above the overall average foremergingmarket countries (about 6 percent) (Fig. 5).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  43. 43. P a g e | 43Transition countrieswereperceivedasattractiveoutlets:potential highreturns,underpinnedby relatively lowwagesand capital-outputratios,weremagnified bythe prospectsfor faster income convergenceentailedby theeconomicand institutional developmentsin thecontextof EU membership, and by theexpectationsof rapid interest rateconvergencelinkedtothe eventual euro adoption.Financial integration in the CEE hastended tobe quiteunique.International banksplayed a fundamental role indeed in spurringfinancial integrationin the region.In the years running up tothe global financial crisis, Western Europeanbanksexpanded rapidly, gaininglarge market sharesthrough theirsubsidiariesand branches,up to about 80 percent of total banking assetsby2008.Theentryof foreign intermediarieswithlong-term strategicgoalsandtheensuingprofound transformation of theownership structure of bankingsystemsin CEE countrieswasacrucialelement of disciplineandstabilityin breaking theviciouscycle of systemic bankingcrisesandmacroeconomicvolatility that had characterizedthe earlyyearsoftransition.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  44. 44. P a g e | 44It isgenerallyacceptedthat internationalfinancialintegrationhastendedtoplay a positiverolein the long-term economicconvergenceprocessinCEE transition countries:Long-term per capitaGDP growth in theregion beforethe crisiswaspositivelycorrelatedwith conventional measuresof financialintegration, such asthe ratio of grossforeign assetsand liabilitiestoGDP(Fig. 6).Thecorrespondingevidencefor other emergingareastendsto be lessclear cut.Theaforementionedfavourablefeature possiblyreflectsthe interactionwith institutional convergence, implicit in theEU accessionprocess, asakey contributingfactor.Thankstothis uniqueand favourablecombination, financial integrationin itselfmostlikelyactedasacatalystforthedevelopment ofthedomesticfinancial sector and the adoption of structural reformsto strengthen theinstitutional framework.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  45. 45. P a g e | 45Yet a balancedaccount of the processof financial integrationin thisregion should not overlook its drawbacksin termsof excessive, cheaplending, currencymismatchesand demand overheatingin theyearsrunningup tothe crisis.Between2003and 2008, many economiesrecordedrapid importgrowth, real estatebubblesand wageincreaseswell above productivitygains– sometimesrooted in overly optimistic expectationsof fastincomeconvergence.Inflationarypressuresspilled over intothetradablesector and worsenedexport performance.Balanceof paymentscurrent account deficitswidened(Fig. 7).Several countriesbuilt up high external debt levels (Fig. 8), largely privateand denominated in foreign currency, making them vulnerable to capitalflowreversalsand currencydepreciation.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  46. 46. P a g e | 46When theeffectsof the global crisisreachedthe CEE countries, theireconomieswerehit by a sharp declinein capital inflowsand the ensuingslowdownin bank credit (Fig. 9).Notwithstandingconcernsregarding a possiblemeltdownof domesticfinancial systems drivenby a run for theexit of foreign banks, aInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  47. 47. P a g e | 47fully-fledgedfinancial crisis– similar to the oneswhichoccurred in EastAsia in 1997–98– did not materialize.Overall, theregion even experienced, in the first phaseof thecrisis, a lessseverereversalof capital flowsthan other emergingareas.In some cases(Hungary, Latvia and Romania) largeinternationalfinancial support by theEU and themain international financialinstitutions(IFIs) wasa key factor in avoidingthe worst;coordinationeffortsby home and host country authorities, IFIs and multinationalbanks,in the context of theVienna Initiative, alsohelped preventcollectiveaction problemsthat could have triggered the dreadedmassivewithdrawal from thesemarketsby foreign banks.There is evidencethat foreign banksthat participated in the ViennaInitiativewererelativelystablelenders.Moreover,thedistinctivemodel of financial integrationin the CEE region– whereforeign banks operatemainlythrough their localsubsidiariesandbranchesin the retail market – probablyprovided a high degreeof risksharingandstabilityduringthecrisis, asparent banksweregenerallylesssensitivetoinformation asymmetry and counterparty credit risk and morecommitted tolong-term market prospects,given theimportant sunk costsassociatedtothesestructures.This comparesfavourably tothepattern prevailingin the other EUcountries,whereexternalborrowingbydomestic banksoccursmainlyviacrossborder wholesalemarkets.Thedifferent intensityof the boom-bust cycle observed acrossthe CEEcountriessuggeststhat, in addition totheinfluenceof specificstructuralfeatures(such asdifferencesin startingincome levels,international tradeand financial links),domestic policy had a role, although capital inflowsofthemagnitudesobserved in theregionin therun uptotheglobal crisiswouldcertainlyhavestrainedany toolkit availabletonational policymakers.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  48. 48. P a g e | 48Monetaryand exchangerate regimesmost likely played a critical roleindeterminingthe country‘sabilityto counteract the effectsof capitalinflows, asthere weredifferencesin the size of the internal and externalimbalancesbetweenfixed and floatingexchangerate countries.Indeed, countriesadoptinga fixed exchangeregime experiencedmorepronouncedcredit booms, higher inflationratesand larger accountdeficitsthan the averagefor floatingexchangesregimecountries.Yet, the assessment of thecontribution of the exchangerateregimeremainsan open issue, asit isunclear towhat extent themostpronouncedboom-bust cycle wasmainlydriven by thefixedexchangeregimeper seor by the inconsistencyof theoverall policy mix pursued incountrieswherethissettingwasin place;in particular, a stricter fiscalstanceand a better framework of macroprudential policy could have atleast partlycompensated for theabsenceof exchangerate flexibility.As for monetarypolicy, theexperienceof CEE countriestendstoconfirmthat in small, financiallyopen economiesit is a lesseffectivelever forrestraining credit booms.This is thecaseeven for floatingexchangeregimes, asanumbers offactors– currencysubstitutionin the form of balancesheet effectsassociated withinitial high euroization, or theshiftstoforeign-currency-denominatedlending– could restrain the effectivenessof monetarypolicy tightening, or even reverseitsintended effects.This underscorestheimportanceof maintainingprudent fiscal stancesduring credit booms.Indeed, in the run up to thecrisis,headlinefiscal positionsremainedbroadlybalanced in most CEE countries; yet theseoutcomeswerefrequentlythe result of exceptional revenuesassociatedtocyclicaldemand and asset price booms.Onceadjusted for thelatter underlying fiscal positionslooked much lesshealthy.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  49. 49. P a g e | 49Onerecognizes, in retrospect, theneed for aconservativeapproachin theassessment of tax revenuesduring a boom phase,and theuseful roleofautomatic stabilizers(particularlyincome taxesand welfarespending) inorder to increasefiscal policy flexibilityand dampen economicfluctuations.In additiontostandard macro policy tools,CEE countriesalsoadoptedawiderangeof prudential actionsbeforethe last global crisis.Prudential instrumentshave the potential to prevent or contain systemicfinancial risksin theupswings(affectingtheincentivesassociatedwithasset pricebooms, foreign exchangelending, excessiverisk takingandthe erosion of lendingstandards) and alsoto build buffersthat cancushionthe impact of downturns.In general the evidenceisthat thesemeasuresproduced theintendedeffectsin the short run, but theysometimesfailed to have a long lastingimpact on credit dynamics.Indeed, in some instancescircumventionthrough direct cross-borderfinancingand/ or lendingfrom nonbank (unregulated) financialintermediariesproved to be a major issue; this hasbeen thecaseforexamplefor measuresconsisting in direct limitson credit growth.Amore effectiverolein containing systemic financial riskshasbeenplayed by measuresspecificallydevisedtobuild liquidityandloss-absorbingcapital buffers,such asreserve and capital requirements.Moreover, when appropriately formulated, prudential regulations helpedto curb the growth of foreign exchange loans and to keep related defaultrateslowerduring thecrisis.Lessons learnt from the global crisis: in search of betterregulationGlobal financial deepeningand international integrationhasallowedgreaterrisk sharingandhasmadefinanceaccessibletolargernumbersofInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  50. 50. P a g e | 50countries,householdsand firms, thusbeinginstrumental to broadeningeconomicdevelopment.But an interlinkedand more connectedfinancial system heightenstherisk that contagion setsoff and spreadsmore widely.Most importantly, thecrisishasshownthat market participantswerenotcapableof masteringtheinherent complexityof the system that theythemselveshad contributedto develop.And it hashighlightedthelimitsof the ideathat self-regulationandmarket disciplineare sufficient to ensure stablefinancial systems.In thisregard, acceptingtheideathat benign neglectwastheright courseof action wasa critical mistakeon the part of regulators.Rather, financial regulation and supervision must keep pacewithdevelopmentsin the financial industry.Moreover,national authoritiesneed to beawareof the risk that theirpowersmay become narrow compared tothe sphere of influenceof theglobal financial players.Thecoordinationof financial supervisionacrossbordersand acrosssectorsis a key condition for the stabilityof theglobal financial system.Amajor effort is required, at a national but especiallyat an internationallevel, in order tostrengthenthe regulatory and supervisory framework.At the international level, under the politicalimpulseof theG-20, theFinancial Stability Board (FSB) and theBasel Committeeon BankingSupervision(BCBS) have introducedsubstantial regulatorychangestoprevent new financial crisesand increasetheresilienceof economicsystems.Much hasbeen alreadyachieved.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  51. 51. P a g e | 51Thequantityand qualityof capital that banksneed to hold hasbeensignificantlyenhancedto ensure that theyoperateon a safeand soundbasis.There alsohavebeen introducedinternational standardsfor bankliquidityand funding, designed to promote the resilienceof bankstoliquidityshocks.Initiativeshave been promoted to strengthenthe regulationof the OTCderivativesmarket, aimed at reinforcingmarket infrastructures,in ordertominimize contagion and spill-over effectsamong players that havebecome more and more interconnected.However,further progressis needed in important areas,asbank capitaland liquidityregulation must be accompaniedby improvementsininternalrisk control arrangementsand actionsaimed at correctingincentivestoexcessiverisk-taking.Moreover,a level playing field must beachieved, ascountriesrelaxingrules in order toattract financial intermediariesgeneratenegativeexternalitiesfor other countries.Thetransition to a uniform system of rulesand oversight of the financialsectormust be hastened.In the euro area, and in theEuropean Union at large, theplan for abankingunion is ambitious,but it goesin the right direction.It would, among other things, limit regulatoryarbitrage, help removenational bias in supervision, reducethephenomenon of ―regulatorycapture‖bypowerful cross-borderbanks, at thesametimereducingcostsof compliancefor cross-borderbanks and enhancingthe functioningoftheSinglemarket for financial services.TheenvisagedEuropean banking union wouldalsobenefit CEEeconomies:it wouldworkagainst thefragmentationof the Europeanfinancial marketsalongnational lines;moreover – by enhancingthefinancialresilienceof theeuroarea – it wouldreducetherisksof negativeInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  52. 52. P a g e | 52spill-overeffectsfrom the euro area to CEE banking systems.Final remarksTherecovery of CEE economies remainsfragile.With few exceptions, output hasnot yet returned to pre crisislevels,dragged by debt overhang and direct and indirect exposuretotheeurozonedebt crisis.Import demand by theeuro area remainsat depressed levels. Financialconditions, although improved comparedtotheend of 2011,remain volatile.Bankcredit dynamicsremain weak,reflectingsubdueddomesticdemandandhigh non-performingloans.Thebanking systemsof most CEE countries, however, remain wellcapitalized and can thereforewithstandthe lingeringdeterioration oftheir asset quality.Moreover,the financial legacyof the crisiswill not be transitory.Theevolution of theinternational banking sector over the comingyearswill continuetoshape financial conditionsalsoin CEE countries.Theregulatory and supervisory responsesadopted at global level willimplymore stringent prudential requirementsfor capital and liquidity.In responseto thesemore demandingrules,aswell asto spontaneousmarket forces,international banksare adapting their businessstrategies,unwindingpre-crisisunsustainablepracticesand shiftingtolonger-termfinancingsources.In this context themain European bankswithlargestakesin CEEmarketsare graduallyswitchingtomore decentralizedbusinessmodels,International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  53. 53. P a g e | 53wheresubsidiarieswouldhave to relymore on localsourcesoffunds,settinglendingconditionsaccordingly.Although orderlyand evendesirablefor the resiliencyof theglobalfinancial system, thisprocessmay exert significant pressureson emergingcountriesthat are highlydependent on external financingowingtounderdevelopeddomestic financial systemsand structurallylownationalsavingsrates.Indeed, this processcallsfor decisivereforms tobolster the developmentanddeepeningof localmoney and capital markets, includinglocalcurrencydenominatedbonds.This is a long-term and complexprocess, whichinvolvesa suitablelegalframework,adequateinfrastructures,a largeinstitutional investorbase,stablemacroeconomicconditionsand predictablepolicymaking, asexemplifiedin extensiveanalysis and ensuing guidelinescarriedout at theBank of InternationalSettlements(BIS), theWorldBank andtheG20.Several of theseconditionshave alreadybeen achieved in the processofintegration in theEU.Against thischangingfinancial environment, there is the riskthat, on thegroundsof preservingfinancial stability at domestic level, nationalregulatorscould adopt ring fencing measures,hamperingthesmoothfunctioningof theEU singlemarket.As thelong-term benefitsof free capital mobilityand internationalfinancial integrationremain sizable, this risk callsfor a stronger rolebytheEU institutions,notablytheEuropean Commission (EC) and theEuropean BankingAuthority (EBA), in monitoring thesemeasuresandenhancingcoordination among national regulators,in order toavoid afragmentation of theEuropean financial markets.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  54. 54. P a g e | 54Revised rulesfor markets infinancial instruments(MiFID /MiFIR)a)Proposal for a Directive of theEuropean Parliament and of theCouncilon marketsin financialinstrumentsrepealingDirective2004/39/ EC of theEuropean Parliament and of the Council (Recast) (MiFID)b)Proposal for a Regulation of the European Parliament and of theCouncilon marketsin financial instrumentsand amending Regulation[EM IR] on OTC derivatives,centralcounterpartiesandtraderepositories(MiFIR)I. INTRODUCTION1.TheCommission transmittedtheabovementionedproposalstoamendthecurrent MiFID to the Council on 20October 2011.Theobjectiveof this legislativepackageis, inter alia, to furthertheintegration, competitiveness, and efficiencyof EU financial marketsbyrespondingtothechallengescreatedbydevelopmentsin financialmarkets,and dealingwiththe weaknessesthe financial crisishasexposed.2.ThelegislativepackageamendingMiFID has twoparts:- ARegulationsetsout requirementsin relationtothedisclosure of tradetransparencydata to thepublic and transaction data tocompetentauthorities, removingbarriers to nondiscriminatory accessto clearingfacilities,themandatory tradingof derivativeson organisedvenues,specificsupervisoryactionsregardingfinancialinstrumentsandpositionsin derivatives.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  55. 55. P a g e | 55- ADirectiveamendsspecific requirementsregarding the provision ofinvestment services, thescope of exemptionsfrom the currentDirective,organisational and conduct of businessrequirementsforinvestment firms, organisationalrequirementsfor tradingvenues, theauthorisationand ongoing obligationsapplicabletoprovidersof dataservices, powersavailabletocompetent authorities, sanctions,and rulesapplicableto third-country firmsoperatingvia a branch.3.Intensivenegotiationshave been going on during the PL, DK, CY andIE Presidenciesaimingat an agreement on theCouncils generalapproach,whichwouldallowthePresidencytostart negotiationswiththeEuropean Parliament witha view toreachinga first readingagreement.TheEPECON Committeevoted onitsreportson26September2012,andtheEP positionwasfurther confirmed bythePlenaryon 26October 2012.4.During the discussions at the Working Party on Financial Services thePresidencies have tabled several overall compromise proposals and othertextsin order tomake progresson the file.II. STATE OF PLAY5.While significant progresshasbeen madetowardsachievingagreementon a Council general approach, during the latestmeeting of theWorkingPartyon Financial Services(Attachés) on 11April 2013,therewasnot yet aqualifiedmajority supporting an overall compromise in particular becauseof the key outstandingissue of accessto tradingvenuesand centralcounterparties(CCP) (MiFIR, Articles 28-30).6. Access(Articles 28-30MiFIR)Toavoid anydiscriminatorypracticesand toremovevariouscommercialbarriers that can be used to prevent competitionin the clearingoffinancial instruments,the Commission Proposal provided in theRegulation (MiFIR) that CCPs should accept to clear transactionsexecutedin different tradingvenues, to theextent that thosevenuescomplywiththe operational and technical requirementsbythe CCP.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  56. 56. P a g e | 56Accessshouldonlybedeniedif certainaccesscriteriaarenot met (Article28MiFIR).Trading venues should also be required to provide access including datafeeds on a transparent and non-discriminatory basis to CCPs that wish toclear transactionsexecuted on thetradingvenue (Article 29MiFIR).In addition, accesstolicencesof, and information relatingto, benchmarksthat areused to determinethe value of financial instrumentsshould beprovidedto CCPs and tradingvenues(Article 30MiFIR).Thenon-discriminatoryclearingaccessfor financial instrumentshasproved tobe a difficult issuethroughout thenegotiationson MiFIR, withdelegationsbeingsplit into twogroups.Onegroup isin favor of maintainingtheprovisionsofArticles28and29,asproposed by theCommission, for thereasonsmentionedabove, whereasthe other group isin favor of deletingtheseArticlesasthey believethat non-discriminatoryaccesswill lead to fragmentation atthetradinglevel and toreduction in liquidity.Furthermore,somedelegationshave doubtson the relationship betweenArticle 30 (nondiscriminatoryaccessand obligationto licencebenchmarks) and intellectual property rightswhereasother delegationsconsider that Article 30is necessaryasit tacklesthe issueof monopoliesandthusenhancescompetition.ThePresidencyhasproposed a compromisesolution in Articles 28-30ofMiFIR (doc. 7743/ 13REV 2), whichis basedon a non-discriminatoryaccesstoCCPs, tradingvenuesand licencebenchmarks, providingat thesametime necessarysafeguardsrelated toorderly functioningof themarketsand liquidityfragmentation.This solution is acceptable to several delegations, but thereare, however, a number of delegations which have outstandingconcerns, and to whom the deletion of Articles 28-30 would be thepreferred option.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  57. 57. P a g e | 577.In thesecircumstances,the Presidencyconsidersthat itscompromisesolution isthe onlyviableoption toaddressthis issue.However,the Presidencyacknowledgesthat there are still seriousconcerns.If theseconcernsarenot resolvedthePresidencysuggeststhat at thetimeof the agreement on the general approach, a statement asset out in theAnnex wouldbe enteredintothe minutesof Coreper.8.Apart from theabovementionedissuetherearecertain otherissuesthatrequirefurther work.ThePresidencyconsidersthat thisworkcan becompleted at WorkingParty level, if an agreement onArticles 28-30in MiFIR can beachievedatCoreper.III. CONCLUSION9. The Presidencythereforesuggeststhat thePermanent RepresentativesCommittee:-agreesonArticles28-30in MiFIR asset out in doc. 7743/13REV 2;-in theevent that agreement isnot reachedon articles28-30MiFIR, agreeson the content of thestatement set out in Annex, whichistobeentered intothe minutesof Coreper at thetimeof final agreementon thegeneral approach, and-invitestheWorkingPartyonFinancial Services(Attachés) tofinalisethethetext, and submit the general approach for agreement by Coreper in thevery near future .Statement by the CouncilThe Council notes the divergent positions of Member States on certainaspects of the Presidencys proposed general approach, in particular asregards toclearing accessprovisions(articles28-30).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  58. 58. P a g e | 58It invitesthePresidencytostart negotiationswiththeEuropeanParliament on the basisof this general approach, takingintoaccount theneed for further work totry toresolve outstandingissues.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  59. 59. P a g e | 59APRA releasessecondconsultation package for thesupervision of conglomerategroupsTheAustralian Prudential RegulationAuthority (APRA) hastodayreleasedfor consultation proposed risk management and capitaladequacyrequirementsfor the supervisionof conglomerategroups.Conglomerategroups, referredto asLevel 3 groups,are groupscomprisingAPRA-regulated institutionsthat perform material activitiesacrossmore thanoneAPRA-regulated industry and/ orin oneor morenon-APRA-regulated industry.Theconsultationpackagereleased todayincludesa response tosubmissionsreceived onAPRA‘s March2010discussionpaper on thesupervision of conglomerategroupsand a set of draft prudentialstandards.Thepackage, on risk management and capital adequacy, complementstheconsultation packagereleasedin December 2012on proposedrequirementsfor group governance and risk exposures.Theproposed Level 3 framework will assistAPRA toensure that itssupervision adequatelycapturesthe risksto whichAPRA-regulatedinstitutionswithin Level 3 groupsare exposed and which arenotadequatelycovered by existingprudential arrangementsfor stand-aloneentities(Level 1supervision) and singleindustry groups(Level 2supervision).APRA Chairman Dr John Laker said that theintroduction of a Level 3frameworkinAustralia is a significant progression ofAPRA‘s prudentialregime.‗Oneof thekey lessonsfrom theglobal financial crisis is theneed toInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  60. 60. P a g e | 60enhancesupervisoryregimes tobetter capture the risksfacingregulatedinstitutionsthat arepart of a widerconglomerategroup.‘‗By implementinggroup-widerequirementson governance, exposuremanagement, risk management and capital adequacy, APRA‘sproposedLevel 3 supervision frameworkwill underpin asafer financial system inAustralia,‘ Dr Laker said. ‗At this stage, potential Level 3 groupsareunlikelyto need additional capital to meet the proposedLevel 3requirements.‘Submissionson theproposed risk management and capital adequacyprudential standardsaredueby 5 July2013.Over thecourseof 2013,APRA will consult on a set of prudential practiceguides,reportingstandards, reportingforms and instructions,andconsequential amendmentsto other prudential standardsthat give effecttothe Level 3 framework.The Level 3prudential standards are expectedtotake effect from 1January 2014.Theresponsepaper and draft prudential standardscan be found on theAPRA websiteat:www.apra.gov.au/ CrossIndustry/ Consultations/ Pages/ Supervision-of-conglomerate-groups-2013.aspxTheAustralian Prudential RegulationAuthority(APRA) istheprudentialregulator of thefinancial servicesindustry. It overseesbanks, creditunions,buildingsocieties, general insuranceand reinsurancecompanies, life insurance, friendlysocieties, andmost membersof thesuperannuation industry. APRAis fundedlargely bytheindustries that itsupervises. It wasestablished on 1July1998. APRAcurrentlysupervisesinstitutionsholding$4.2trillion in assetsforalmost 23millionAustraliandepositors, policyholders and superannuation fund members.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  61. 61. P a g e | 61To all Chief Executive Officersof potential Level 3 groupsAPRA hastoday releasedthe second consultationpackageon thesupervision of conglomerategroups(Level 3 groups).This packageincludesa responsepaper totheMarch 2010discussionpaper and draft prudential standards, whichfocuson requirementsforgroup risk management and capital adequacy.This packagecomplementsa first consultationpackage, releasedinDecember 2012,regardingproposed requirementsfor group governanceand risk exposures.APRA hasalsoreleaseda consultation packageon harmonisingandenhancingcross-industryriskmanagement requirements,whichcontainsa new cross-industryrisk management prudential standard and anupdatedgovernancestandard.Thesestandardsare proposed to applytoall Level 1ADIs, generalinsurers,life companies, Level 2 groupsand Level 3 groups.Aseparate letter on this consultationpackagehasbeen issued to allaffected institutions.However,proposalsin therisk management prudential standard whichaffect Level 3 groupsare addressed aspart of thesupervisionofconglomerate groupsresponse paper.During the courseof developing theseproposals,APRA hashad anumber of positivediscussionswithpotential Level 3 groupsand havetaken intoconsideration many of the issuesraisedin thosediscussions.Consultationon theproposed risk management and capital adequacyprudential standardscloseson 5 July2013.Over thecourseof 2013,APRA will consult on a set of prudential practiceguides,reportingstandards, reportingforms and instructions,andInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  62. 62. P a g e | 62consequential amendmentsto other prudential standardsto give effect totheLevel 3 framework proposals.Theconsultationpackageis available on theAPRA websiteat:http:/ / www.apra.gov.au/ CrossIndustry/ Consultations/ Pages/Supervision-of-conglomerate-groups-2013.aspxTheLevel3prudentialstandardsandthecross-industryriskmanagementprudential standard are expected to take effect from 1January 2014.Queriesin relationtothe Level 3 project should be directedtoyourResponsibleSupervisoror the dedicated Level3Framework@apra.gov.auemail address.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  63. 63. P a g e | 63GovernorElizabethA. DukeAt the Housing PolicyExecutiveCouncil, Washington, D.C.AView from the Federal ReserveBoard: The Mortgage Market andHousing ConditionsSincejoiningthe Board in 2008amid acrisiscentered onmortgagelending, I havefocused much of my attentionon housingandmortgage markets,issuessurroundingforeclosures,and neighborhood stabilization.In Marchof this year, I laid out my thoughtson current conditionsin thehousing and mortgagemarketsin a speechto theMortgageBankersAssociation.Today I will summarize and update that information witha focusonmortgagecredit conditions.Before I proceed, I should note that the viewsI expressare my own andnot necessarily those of my colleagueson the Board of Governors or theFederal Open Market Committee.Asustained recoveryin thehousing market appearsto be under way.Houseprices,asmeasuredbyavarietyofnationalindexes,haverisen6to11percent sincethe beginningof 2012(figure 1).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  64. 64. P a g e | 64The recovery of house prices has been broad based geographically, with90 percent of local markets having experienced price gains over the yearendingin February.Also since the beginning of 2012, housing starts and permitshave risen bynearly 30 percent (figure 2), while new and existing home sales have alsoseen double-digit growthrates.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  65. 65. P a g e | 65Homebuilder sentiment hasimprovednotably, and real estate agentsreport stronger trafficof people shoppingfor homes(figure 3).In national surveys, householdsreport that low interestratesand housepricesmake it a good time to buy a home; they alsoappear more certainthat house pricegainswill continue(figure 4).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  66. 66. P a g e | 66International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  67. 67. P a g e | 67Despitetherecent gains,thelevel ofhousingmarket activityremainslow.Existinghome salesare currentlyat levelsin linewiththoseseen in thelate 1990s,while single-familystartsand permitsare at levelscommensuratewiththe early1990s.And applicationsfor home-purchasemortgages, asmeasuredby theMortgageBankersAssociation index, wereat a level in linewiththat ofthemid-1990s(figure 5).Thesubdued level of mortgage purchaseoriginationsis particularlystrikinggiven therecordlow mortgageratesthat haveprevailedin recentyears.Thedrop in originationshasbeen most pronounced amongborrowerswith lowercredit scores.For example, between2007and 2012,originationsof prime purchasemortgagesfell about 30 percent for borrowerswithcredit scoresgreaterInternational Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  68. 68. P a g e | 68than 780, comparedwith a drop of about 90percent for borrowerswithcredit scoresbetween620and 680(figure6).Originationsarevirtuallynonexistent for borrowerswith credit scoresbelow 620.Thedistribution of credit scoresin thesepurchaseoriginationdata tellsthesamestoryin a different way:The median credit score on these originationsrose from 730 in 2007 to770in 2013, whereas scores for mortgages at the 10th percentile rose from 640to690(figure 7).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  69. 69. P a g e | 69Many borrowerswhohave faced difficultyin obtaining primemortgageshaveturned to mortgagesinsured or guaranteed by the Federal HousingAdministration(FHA), theU.S.Department of VeteransAffairs (VA), ortheRural Housing Service(RHS).Data collectedunder the Home MortgageDisclosureAct indicatethattheshare of purchasemortgagesguaranteedor insured by theFHA, theVA, or theRHS rosefrom 5 percent in 2006tomore than 40percent in2011(figure 8).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  70. 70. P a g e | 70But here, too, loanoriginationsappear tohave contracted for borrowerswith low credit scores.Themedian credit score on FHApurchaseoriginationsincreasedfrom625in 2007to690in 2013,whilethe10thpercentile hasincreasedfrom 550to650(figure 9).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  71. 71. P a g e | 71Part of the contraction in loan originationsto householdswithlowercredit scoresmay reflect weakdemand among thesepotentialhomebuyers.Although wehave littledata on thispoint, it may be the casethat suchhouseholdssuffereddisproportionatelyfrom thesharp riseinunemployment duringtherecessionandthushavenot beenin afinancialpositionto purchasea home.There is evidencethat tight mortgage lendingconditionsmay alsobe afactorin thecontraction in originations.Data from lender ratequotessuggest that almost all lendershavebeenofferingquotes(through thedaily "ratesheets" providedtomortgagebrokers) on mortgageseligiblefor saletothegovernment-sponsoredenterprises(GSEs) toborrowerswithcredit scores of 750over the pasttwoyears.Mostlendershave been willingto offer quotestoborrowerswith creditscoresof 680aswell.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  72. 72. P a g e | 72Fewer than two-thirdsof lenders,though, arewillingto extend mortgageoffersto consumerswithcredit scores of 620(figure 10).And thisstatistic mayoverstate theavailability of credit toborrowerswithlowercredit scores:Therateson many of these offersmight be unattractive, and borrowerswhosecredit scoresindicateeligibilitymay not meet other aspectsof theunderwritingcriteria.Tight credit conditionsalsoappear tobepart of the story forFHA-insured loans.In theFederal Reserves October 2012Senior LoanOfficer Opinion Survey on Bank LendingPractices(SLOOS), one-half totwo-thirdsof respondentsindicatedthat they werelesslikelythan in 2006tooriginate an FHAloanto a borrowerwith a credit score of 580or 620(figure 11).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  73. 73. P a g e | 73Standardshave tighteneda bit further since: In theApril 2013SLOOS, about 30percent of lendersreported that theywerelesslikelythan a year agotooriginateFHAmortgagestoborrowerswithacreditscoreof 580or 620(figure 12).International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  74. 74. P a g e | 74TheApril SLOOS offerssome cluesabout whymortgagecredit issotight for borrowerswith lowercredit scores.Banks participatingin the survey identifieda familiar assortment offactorsasdamping their willingnessto extend any type of loan to theseborrowers:the riskthat lenderswill be required torepurchasedefaultedloansfrom theGSEs("putback" risk), the outlook for housepricesandeconomicactivity, capacityconstraints,the risk-adjustedopportunitycostof such loans,servicing costs,balancesheet or warehousingcapacity,guaranteefeeschargedbytheGSEs,borrowersabilitytoobtainprivatemortgageinsuranceor second liens,and investorappetiteforprivate-label mortgage securitizations.Respondentsappeared to put particular weight on GSE putbacks,theeconomicoutlook, and the risk-adjustedopportunitycost.In addition, several largebankscited capacityconstraintsand borrowersdifficultiesin obtainingprivatemortgage insuranceor second liensasatleast somewhat important factorsin restrainingtheir willingnesstoapprovesuch loans.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com
  75. 75. P a g e | 75Over time, some of thesefactorsshould exert lessof a drag on mortgagecredit availability. For example, asthe economic and housingmarketrecoverycontinues,lendersshould gain confidencethat mortgage loanswill perform well, and theyshould expand their lending accordingly.Capacityconstraintswill likely alsoease. Refinancingapplicationshaveexpanded much moreover thepast year and ahalf than lenders ability toprocessthese loans.For example, one measureof capacityconstraints--thenumber of realestatecredit employees--hasonlyedgedup over thisperiod (figure 13).When capacityconstraintsare binding, lendersmay prioritize theprocessingof easier-to-completeor more profitableloan applications.Indeed, preliminaryresearch by theBoards staff suggeststhat theincreasein the refinanceworkloadduring the past 18monthsappears tohavebeen associatedwitha 25to 35percent decreasein purchaseoriginationsamongborrowerswithcredit scoresbetween620and680anda 10 to 15percent decreaseamong borrowerswithcredit scoresbetween680and 710.International Association of Risk and Compliance Professionals (IARCP)www.risk-compliance-association.com