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Basel III News, October 2012


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Basel III News, October 2012

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Basel III News, October 2012

  1. 1. 1 Basel iii Compliance Professionals Association (BiiiCPA) 1200 G Street NW Suite 800 Washington, DC 20005-6705 USA Tel: 202-449-9750 Web: www.basel-iii-association.comDear Member,There are some interesting job openingsand descriptions:Vice President - Bank Regulatory Policy /BaselManhattan, NY, Salary $120,000-$180,000 / yr., Full -Time“This individual will assist in interpreting and developing firm policy forU.S. and international banking regulations related to capital and andother regulatory reporting matters. They are seeking individuals withprior Basel II and III and bank capital regulations experience.”Finance and Risk Solution ArchitectLondon, Salary £80,000 - £115,000 + Bonus“We are currently looking for profiles with a consulting or businessstream background in the following areas for a new business practice inthe finance sector: we are looking for individuals with the followingbackground or experience: Risk Management in Capital or Liquidityrequirements, Financial Industry Regulatory Reporting such as FSA,Dodd Frank, Basel II/III & Industry Best Practice, reporting strategies& Global Transactions. Individuals will have a Business/TechnicalArchitectural Background ideally with some Business Analysis &Consulting background.”Business Analyst with Basel III Job“We are actively seeking a contractor to lead a team in documentation,design, and traceability of requirements in support of Basel IIIimplementation. This includes defining solutions to business/systems Basel iii Compliance Professionals Association (BiiiCPA)
  2. 2. 2problems and ensuring the integrity of delivery through customeracceptance and final disposition of solution for the Basel III project.This is a minimum 6-8 month project with strong possibility of extensionor conversion to full time” employment.”Very interesting job descriptions…… and very interesting salary.Dealing with financial systemic risk: thecontribution of macroprudential policiesPanel remarks by Jaime Caruana, GeneralManager of the Bank for InternationalSettlements, Central Bank of Turkey/G20Conference on "Financial systemic risk",IstanbulAbstractThere are important two-way interactionsbetween macroprudential policy and other areas of public policy.These interactions put a premium on cooperative institutionalframeworks that recognise the complementarities between policy actions.This means that, within a single jurisdiction, macroprudential authoritiesshould be independent and should focus primarily on mitigating systemicrisk while recognising that other policies will have an impact on the sameobjective.Cooperation between macroprudential policies across national bordersstarts from the high level set by various international regulatory standardsand is improving with the explicit macroprudential frameworks recentlyintroduced for countercyclical capital buffers and the higher lossabsorbency requirements for systemically important banks. Basel iii Compliance Professionals Association (BiiiCPA)
  3. 3. 3Greater cooperation, however, does not mean that we should disregardthat individual policies have specific objectives and that some hierarchyof action is necessary.Full speechLet me thank the Central Bank of the Republic of Turkey and the G20presidency of Mexico for having invited me to attend such an interestingconference addressing the topic of financial systemic risk.In my remarks today, I would like to explain how macroprudentialpolicies can greatly contribute to dealing with systemic risk and fosteringfinancial stability.I will highlight a few key issues that we should focus on in order to makethis effective.1. Trend towards strengthening the macroprudentialorientation of policyThe term "macroprudential" has gained currency in policy discussionsduring the past four years.Indeed, the recent financial crisis has given rise to a general trend towardsstrengthening the macroprudential orientation of policy in countries withvery diverse institutional frameworks and financial structures.This is very welcome: recent experience has taught us that we need to bemore focused on addressing system-wide risk, and this is precisely whatmacroprudential policy is all about.Macroprudential frameworks may be new, but mainly in the sense ofbecoming explicit.Many countries have been using prudential instruments to addresssystem-wide vulnerabilities without making reference to macroprudentialpolicies. Basel iii Compliance Professionals Association (BiiiCPA)
  4. 4. 4For example, variable ceilings for loan-to-value (LTV) ratios have beenused repeatedly in Hong Kong and other Asian economies to slow downfrothy mortgage lending and ensure that banks do not overexposethemselves to property risk.Nevertheless, the more recent introduction of formal structures brings tothe fore issues of definition, delineation of responsibilities andgovernance.In my remarks today, I would like to underscore a critical aspect ofmacroprudential policy and to offer a word of caution.The critical aspect I am referring to is the strong two-way interactionsbetween macroprudential policy and other areas of public policy.These interactions put a premium on cooperative institutionalframeworks that recognise the complementarities between policy actions,both within and across jurisdictions.This is a particularly important issue at the national level; but cooperativeframeworks are also essential at the international level, requiring bothsufficient information-sharing and reciprocity.The word of caution is that we should be mindful that individual policieshave specific primary objectives and that some hierarchy of action isnecessary.Let me explain.2. Macroprudential policy is not the only area of policy thatinfluences systemic riskMany other policies can affect the resilience of the financial system andits ability to provide valuable services to the economy.Quite apart from microprudential policy, the influence of monetary, fiscaland tax policies, of financial reporting standards and of legal frameworksis also very strong. Basel iii Compliance Professionals Association (BiiiCPA)
  5. 5. 5 For instance, prolonged periods of low policy rates affect leverage,encourage financial market participants to take on risks and may at timesfuel asset price bubbles. Conversely, instruments and actions aimed at mitigating and managingsystemic risk can have very important effects on the macroeconomy andthus impinge on the objective of other policies. For example, tightening capital requirements to protect banks from thebuild-up of systemic risk during a credit boom can also cool down creditexpansion and, by extension, aggregate demand. To be sure, a more stable, more resilient and less procyclical financialsystem will improve the effectiveness of monetary and other policies.So there are externalities in the interaction of different policies: there canbe positive complementarities when the policies are mutually reinforcing,but also negative spillovers when one policy weakens the effectiveness ofanother.Hence, there is a need for coordination.This is true both within a given jurisdiction and across borders.3. The need for coordination within a single jurisdictionLet me talk first about coordination within a single jurisdiction.The interactions between policies suggest a few principles for instrumentdesign and deployment.One such principle is that macroprudential policy instruments should bein the hands of an independent authority with the explicit objective ofmaintaining financial stability.This is important, for two reasons: the lack of precise measurement toquantify this objective, and policymakers inevitable reliance onjudgment in pursuing it. Basel iii Compliance Professionals Association (BiiiCPA)
  6. 6. 6Measurement presents a serious challenge for the design, governance andaccountability of macroprudential policy.There are no readily available and widely accepted metrics of systemicrisk to help calibrate instruments or gauge policy performance, even expost, with much precision.And it is notoriously difficult to answer the counterfactual question ofhow things would have evolved had an alternative action plan beenadopted.As a result, more than ever, policy needs to rely on a significant degree ofjudgment.One telling example relates to anticyclical policies.All anticyclical policies have to work with real-time information that isincomplete and imprecise.Decisions rely on judgment to interpret the multitude of inputs.This is not unique to macroprudential policy, but it is particularly evidentin this case: current technology provides far less in the way of robustquantitative models to guide macroprudential policy in addressing boththe time and the cross-sectional dimensions of systemic risk.As regards the time dimension, only recently have researchers beenattempting to be specific about what the financial cycle is and how tocharacterise it.A few features are worth mentioning: It is possible to identify a well defined financial cycle that is bestcharacterised by the co-movement of medium-term cycles in credit andproperty prices.Such financial cycles are longer and more severe than business cycles.The duration and amplitude of the financial cycle has increased since themid-1980s: financial cycles last, on average, around 16 years; but when Basel iii Compliance Professionals Association (BiiiCPA)
  7. 7. 7considering only cycles that peaked after 1998, the average duration isnearly 20 years, compared with 11 for previous ones. Peaks in the financial cycle are closely associated with systemic bankingcrises (henceforth "financial crises" for short).Finally, the financial cycle and the business cycle are differentphenomena, but they are related.Recessions associated with financial disruptions tend to be longer anddeeper.As regards the cross-sectional dimension of systemic risk, we are alsouncertain about how best to map the systemic importance of financialinstitutions onto their size, the extent and density of their links to others,and the uniqueness of their economic function.The need for judgment, combined with the need to resist powerfulpolitical economy pressures, puts a premium on operationalindependence.Pressures may be high because the future rewards of macroprudentialpolicy actions tend to be uncertain, difficult to quantify and distant in thefuture, whereas the costs are immediate and can be easily exaggerated.Operational independence is easier to achieve if the relevant authority hasa clear mandate.And it has to go hand in hand with accountability and clarity ofcommunication.Policymakers need to be transparent about how policy decisions relate totheir mandate and to their economic assessments.This helps anchor the publics expectations and the holding of theauthorities to account.From this perspective, it is key to ensure the adequate involvement of thecentral bank. Basel iii Compliance Professionals Association (BiiiCPA)
  8. 8. 8One may even argue that it is preferable for the central bank to be themacroprudential authority.A second principle is that the control over instruments should becommensurate with the objective of managing systemic risk.Not many tools are purely macroprudential.The vast majority are simply prudential tools tailored for use from amacroprudential perspective through adjustments to their design andcalibration.Capital requirements are a key tool but are not sufficient.They need to be complemented with other instruments and moreintrusive supervision.Given that we have to deal with human behaviour that is imperfectlyunderstood, combining instruments is more promising than relying on asingle one.Liquidity requirements and instruments such as loan-to-value ratios orlimits on exposures have all been used and proven effective.In addition, explicit resolution plans are also important: they address thesource of the problem, as they reduce the costs of (disorderly) failure.More generally, all tools are inadequate in the absence of effective and attimes intrusive supervision: the incentives for regulatory arbitrage aresimply too powerful.This means that there is a need for coordination in the use of variousinstruments, through both the sharing of information and thecommunication of assessments.Moreover, this should be supported by a framework that allocatesresponsibilities and accountability clearly. Basel iii Compliance Professionals Association (BiiiCPA)
  9. 9. 94. The international dimensionLet me now turn to the international dimension.As long as we have open financial systems, risks in one country can affectothers.Similarly, macroprudential policy can have spillovers across borders.To what extent does this call for formal coordination?Countries are developing their own policy frameworks to deal with thecross-sectional and the time dimensions of systemic risk.They are introducing arrangements to assess the banks that aresystemically important from a domestic perspective.They are also introducing policy measures linked to rough indicators ofbanks systemic significance.I would argue that, despite being the new kid on the block,macroprudential policy is one of the economic policy areas in whichinternational coordination has gone furthest.To be sure, we started from a very good basis, namely the existinginternational regulatory framework for markets and institutions.A number of independent international committees have proposed, andcountries around the globe have adopted, minimum prudential standardsfor banks and market infrastructures.And, importantly, more recently there have been concerted efforts topromote consistent implementation across jurisdictions.The Basel Committee on Banking Supervision has conducted significantwork in this area under the leadership of Stefan Ingves.For my part, I would simply like to highlight two examples ofcoordination in the macroprudential area: as regards its time dimension,the design of the countercyclical capital buffers; and, as regards the Basel iii Compliance Professionals Association (BiiiCPA)
  10. 10. 10cross-sectional dimension, the imposition of capital surcharges forsystemically important banks.The countercyclical buffer is intended to counterbalance the procyclicalbehaviour of banks by building up buffers in good times that can absorblosses in times of stress.It is a prudential instrument calibrated to achieve a macroprudentialobjective.Critically, the level of the buffer depends on the state of the financial cyclein a given jurisdiction.The framework allows for a large degree of judgment and tailoring tolocal circumstances - there is no one-size-fits-all solution.It also provides for international reciprocity: supervisors of foreign banksshould apply the same surcharge on these banks exposures as thesupervisor in the host jurisdiction demands of the local banks.This levels the playing field and addresses regulatory arbitrage. A similar degree of coordination applies to the treatment of systemicallyimportant banks.The Basel Committee and the Financial Stability Board have developed aframework to assess the banks that are globally systemically important(G-SIBs).By necessity, the assessment of capital surcharges and their application tothose banks comprise a joint decision at the international level, since therelevant system is global.Furthermore, the proposed framework to deal with the banks that aresystemically important from a domestic perspective (these are morenumerous than the G-SIBs) sets out principles that govern the interactionbetween the assessment and actions of a banks host supervisor and thoseof its home supervisor. Cooperation is built into the framework. Basel iii Compliance Professionals Association (BiiiCPA)
  11. 11. 11Macroprudential policy may be a recent addition to the toolbox ofpolicymakers, but it already embeds international cooperation.I believe that this approach to international cooperation is a good one.It fully recognises international spillovers while preserving national roomfor manoeuvre in applying agreed principles.Coordination is advanced through information-sharing, commonminimum standards and reciprocity.5. The hierarchy of actionLet me now close by offering a cautionary remark concerning theinteraction between macroprudential policy and other policies.As I noted earlier, macroprudential policy may have macroeconomiceffects.Attempts to mitigate the financial cycle are likely to influence thebusiness cycle.Prudential tools may affect credit and asset price dynamics and, byextension, aggregate demand.Because of that, it is essential to ensure that the hierarchy of policy toolsis clarified.Macroeconomic management should first rely on macroeconomic tools(monetary and fiscal policies) before asking for help frommacroprudential policy.Financial stability is already a large enough job for macroprudentialpolicy.It should remain focused on its main objective rather than trying tosmooth the business cycle. Basel iii Compliance Professionals Association (BiiiCPA)
  12. 12. 12The temptation to bend prudential tools away from their primaryobjective of financial stability to tackle shorter-term macroeconomicfluctuations can be quite strong.Given measurement uncertainties, the case for doing so is less compellingthan it appears.It is in situations like these that the independence and accountability ofmacroprudential frameworks are particularly valuable.Moreover, financial stability is too big a burden to rest exclusively onprudential and macroprudential policies; it needs the cooperation of otherpolicies: a more symmetrical monetary policy across the financial cycle,fiscal policies that create additional space in financial booms, etc.Finally, let me finish on a positive note.Despite our limited knowledge about the impact of macroprudentialpolicies, there is significant room for effective action - for at least threereasons:First, potential policy conflicts are usually exaggerated.It seems likely that, in most circumstances, macroprudential policy andmonetary policy will be complementary, tending to support each otherinstead of conflicting.It is important to realise that the financial cycles that matter for prudentialpolicy are of a much lower frequency than business cycles.This suggests that, most of the time, monetary policy should be able totreat macroprudential policy developments as a relatively slow-movingbackground.However, it also requires monetary policy to keep an eye ondevelopments over longer horizons in order to take into account theeffects of the gradual build-up and unwinding of financial imbalances.This longer horizon diffuses some of the possible tensions betweenmonetary policy and macroprudential decisions. Basel iii Compliance Professionals Association (BiiiCPA)
  13. 13. 13Second, there is already a growing body of research and experience thathas led to significant progress being made both conceptually andoperationally, for instance in the design and calibration ofmacroprudential tools.Third, some tools and indicators seem to produce reasonable results -certainly better than doing nothing.In particular, the credit gap indicator embedded in the Basel IIIcountercyclical capital buffer seems to provide good guidance for action.Simulations indicate that following this indicator would help to producemeaningful action (eg raising capital) at an early stage, before thebeginning of a financial crisis.For example, the United States and the United Kingdom would havestarted setting aside more capital in 1999, and the 2.5% buffers would havebeen completed by 2002 and 2006 respectively, ie well before the financialcrisis.Spain would have started even earlier, in 1997 (with the 2.5% buffercompleted in 1999).Of course, the indicator would not have worked so well in some othercountries.For instance, in the case of the Netherlands, it would have peaked tooearly compared to the evolution of the financial cycle; nonetheless,healthy buffers would have been built.Also, the credit gap indicator has proved to be noisy for some largeemerging market economies such as Brazil and Turkey.To be sure, this indicator can be supplemented with the informationcoming from the analysis of other indicators.These are just a few examples of the possibilities of one of theinstruments of macroprudential policies. Basel iii Compliance Professionals Association (BiiiCPA)
  14. 14. 14They illustrate the potential but also the need to continue to work on howthe macroprudential approach can be formalised and applied to differentinstitutional frameworks in a way that strengthens other policies andmitigates systemic risk. Basel iii Compliance Professionals Association (BiiiCPA)
  15. 15. 15Chairman Ben S. BernankeAt the "Challenges of the Global Financial System:Risks and Governance under Evolving Globalization,"A High-Level Seminar sponsored by Bank ofJapan-International Monetary Fund, Tokyo, JapanU.S. Monetary Policy and InternationalImplicationsThank you. It is a pleasure to be here. This morning I will first brieflyreview the U.S. and global economic outlook.I will then discuss the basic rationale underlying the Federal Reservesrecent policy decisions and place these actions in an internationalcontext.U.S. and Global Outlook The U.S. economy has faced significant headwinds, and, although theeconomy has been expanding since mid-2009, the pace of our recoveryhas been frustratingly slow.The headwinds include the effects of deleveraging by households, thestill-weak U.S. housing market, tight credit conditions in some sectors,spillovers from the situation in Europe, fiscal contraction at all levels ofgovernment, and concerns about the medium-term U.S. fiscal outlook.In this environment, households and businesses have been quite cautiousin increasing spending.Accordingly, the pace of economic growth has been insufficient tosupport significant improvement in the job market; indeed, theunemployment rate, at 7.8 percent, is well above what we judge to be itslong-run normal level. Basel iii Compliance Professionals Association (BiiiCPA)
  16. 16. 16With large and persistent margins of resource slack, U.S. inflation hasgenerally been subdued despite periodic fluctuations in commodityprices.Consumer price inflation is running somewhat below the FederalReserves 2 percent longer-run objective, and survey- and market-basedmeasures of longer-term inflation expectations have remained wellanchored.The global economic outlook also presents many challenges, as youknow.Fiscal and financial strains have pushed Europe back into recession.Japans economy is recovering from last years tragic earthquake andtsunami, and it continues to struggle with deflation and persistent weakdemand.And in the emerging market economies, the rapid snap-back from theglobal financial crisis has given way to slower growth in the face of weakexport demand from the advanced economies.The soft tone of global activity is yet another headwind for the U.S.economy.Looking ahead, economic projections of Federal Open MarketCommittee (FOMC) participants prepared for the CommitteesSeptember meeting called for the economic recovery to proceed at amoderate pace in coming quarters, with the unemployment rate decliningonly gradually.FOMC participants generally expected that inflation was likely to run ator below the Committees inflation goal of 2 percent over the next fewyears. Basel iii Compliance Professionals Association (BiiiCPA)
  17. 17. 17The Committee also judged that there were significant downside risks tothis outlook, importantly including the potential for an intensification ofstrains in Europe and an associated slowing in global growth.Federal Reserves Recent Policy ActionsAll of the Federal Reserves monetary policy decisions are guided by ourdual mandate to promote maximum employment and stable prices.With the disappointing progress in job markets and with inflationpressures remaining subdued, the FOMC has taken several importantsteps this year to provide additional policy accommodation.In January, the Committee noted that it anticipated that economicconditions were likely to warrant exceptionally low levels of the federalfunds rate at least through late 2014--a year and a half later than inprevious statements.In June, policymakers decided to continue through year-end the maturityextension program (MEP), under which the Federal Reserve purchaseslong-term Treasury securities and sells short-term ones to help depresslong-term yields. At its September meeting, with the data continuing to signal weak labormarkets and no signs of significant inflation pressures, the FOMCdecided to take several additional steps to provide policyaccommodation.It extended the period over which it expects to maintain exceptionally lowlevels of the federal funds rate from late 2014 to mid-2015.Moreover, the Committee clarified that it expects to maintain a highlyaccommodative stance of monetary policy for a considerable period afterthe economic recovery strengthens. Basel iii Compliance Professionals Association (BiiiCPA)
  18. 18. 18The FOMC coupled these changes in forward guidance with additionalasset purchases, announcing that it will purchase agencymortgage-backed securities (MBS) at a pace of $40 billion per month, ontop of the $45 billion in monthly purchases of long-term Treasurysecurities planned for the remainder of this year under the MEP.The FOMC also indicated that it would continue to purchase agencyMBS, undertake additional asset purchases, and employ other tools asappropriate until the outlook for the labor market improves substantiallyin a context of price stability.The open-ended nature of these new asset purchases, together with theirexplicit conditioning on improvements in labor market conditions, willprovide the Committee with flexibility in responding to economicdevelopments and instill greater public confidence that the FederalReserve will take the actions necessary to foster a stronger economicrecovery in a context of price stability.An easing in financial conditions and greater public confidence shouldhelp promote more rapid economic growth and faster job gains overcoming quarters.As I have said many times, however, monetary policy is not a panacea.Although we expect our policies to provide meaningful help to theeconomy, the most effective approach would combine a range ofeconomic policies and tackle longer-term fiscal and structural issues aswell as the near-term shortfall in aggregate demand.Moreover, we recognize that unconventional monetary policies comewith possible risks and costs; accordingly, the Federal Reserve hasgenerally employed a high hurdle for using these tools and carefullyweighs the costs and benefits of any proposed policy action.International Aspects of Federal Reserve Asset Purchases Basel iii Compliance Professionals Association (BiiiCPA)
  19. 19. 19 Although the monetary accommodation we are providing is playing acritical role in supporting the U.S. economy, concerns have been raisedabout the spillover effects of our policies on our trading partners.In particular, some critics have argued that the Feds asset purchases, andaccommodative monetary policy more generally, encourage capital flowsto emerging market economies.These capital flows are said to cause undesirable currency appreciation,too much liquidity leading to asset bubbles or inflation, or economicdisruptions as capital inflows quickly give way to outflows.I am sympathetic to the challenges faced by many economies in a worldof volatile international capital flows.And, to be sure, highly accommodative monetary policies in the UnitedStates, as well as in other advanced economies, shift interest ratedifferentials in favor of emerging markets and thus probably contribute toprivate capital flows to these markets.I would argue, though, that it is not at all clear that accommodativepolicies in advanced economies impose net costs on emerging marketeconomies, for several reasons. First, the linkage between advanced-economy monetary policies andinternational capital flows is looser than is sometimes asserted.Even in normal times, differences in growth prospects amongcountries--and the resulting differences in expected returns--are the mostimportant determinant of capital flows.The rebound in emerging market economies from the global financialcrisis, even as the advanced economies remained weak, provided stillgreater encouragement to these flows.Another important determinant of capital flows is the appetite for risk byglobal investors. Basel iii Compliance Professionals Association (BiiiCPA)
  20. 20. 20Over the past few years, swings in investor sentiment between "risk-on"and "risk-off," often in response to developments in Europe, have led tocorresponding swings in capital flows.All told, recent research, including studies by the International MonetaryFund, does not support the view that advanced-economy monetarypolicies are the dominant factor behind emerging market capital flows.Consistent with such findings, these flows have diminished in the pastcouple of years or so, even as monetary policies in advanced economieshave continued to ease and longer-term interest rates in those economieshave continued to decline.Second, the effects of capital inflows, whatever their cause, on emergingmarket economies are not predetermined, but instead depend greatly onthe choices made by policymakers in those economies.In some emerging markets, policymakers have chosen to systematicallyresist currency appreciation as a means of promoting exports anddomestic growth.However, the perceived benefits of currency management inevitablycome with costs, including reduced monetary independence and theconsequent susceptibility to imported inflation.In other words, the perceived advantages of undervaluation and theproblem of unwanted capital inflows must be understood as apackage--you cant have one without the other. Of course, an alternative strategy--one consistent with classicalprinciples of international adjustment--is to refrain from intervening inforeign exchange markets, thereby allowing the currency to rise andhelping insulate the financial system from external pressures. Basel iii Compliance Professionals Association (BiiiCPA)
  21. 21. 21Under a flexible exchange-rate regime, a fully independent monetarypolicy, together with fiscal policy as needed, would be available to helpcounteract any adverse effects of currency appreciation on growth.The resultant rebalancing from external to domestic demand would notonly preserve near-term growth in the emerging market economies whilesupporting recovery in the advanced economies, it would redound toeveryones benefit in the long run by putting the global economy on amore stable and sustainable path.Finally, any costs for emerging market economies of monetary easing inadvanced economies should be set against the very real benefits of thosepolicies.The slowing of growth in the emerging market economies this year inlarge part reflects their decelerating exports to the United States, Europe,and other advanced economies.Therefore, monetary easing that supports the recovery in the advancedeconomies should stimulate trade and boost growth in emerging marketeconomies as well.In principle, depreciation of the dollar and other advanced-economycurrencies could reduce (although not eliminate) the positive effect ontrade and growth in emerging markets.However, since mid-2008, in fact, before the intensification of thefinancial crisis triggered wide swings in the dollar, the real multilateralvalue of the dollar has changed little, and it has fallen just a bit against thecurrencies of the emerging market economies.Conclusion To conclude, the Federal Reserve is providing additional monetaryaccommodation to achieve its dual mandate of maximum employmentand price stability. Basel iii Compliance Professionals Association (BiiiCPA)
  22. 22. 22This policy not only helps strengthen the U.S. economic recovery, but byboosting U.S. spending and growth, it has the effect of helping supportthe global economy as well. Assessments of the international impact ofU.S. monetary policies should give appropriate weight to their beneficialeffects on global growth and stability. Basel iii Compliance Professionals Association (BiiiCPA)
  23. 23. 23The new UK Regulator:The Financial Conduct AuthorityThe Financial Conduct Authority (FCA)will be the new regulator whose vision it is to make markets work well soconsumers get a fair deal.It will be responsible forrequiring firms to put thewell-being of their customers atthe heart of how they run theirbusiness, promoting effectivecompetition and ensuring thatmarkets operate with integrity.The FCA will start work in 2013,when it will receive new powersfrom the Financial Services Billthat is currently going throughparliament.The Journey to the FCA sets outhow we will approach ourregulatory objectives, how weintend to achieve a fair deal infinancial services for consumersand where we are on thisjourney.Changes to authorisationsThe UK regulatory structure will be changing in 2013, when the FSA willsplit into two regulatory bodies the Financial Conduct Authority (FCA)and the Prudential Regulation Authority (PRA). Basel iii Compliance Professionals Association (BiiiCPA)
  24. 24. 24In April 2012, Supervision adopted the internal-twin peaks structure, andnow Authorisations are implementing a similar structure, withassessments carried out by both the Prudential Business Unit (PBU) andthe Conduct Business Unit (CBU).This change will only affect firms that will be dual regulated in future.The application submission process will not change and we will continueto seek to meet our statutory deadlines.What will change is how the application is processed internally.There will be a CBU case officer and a PBU supervisor responsible foreach application and they will coordinate to minimise duplication or theimpact on applicant firms and individuals.The final decision will need to be agreed by both the PBU and the CBU toensure a single FSA decision during transition to the new regulatorystructure.These changes will allow us to start to deliver, as far as possible, a modelthat will mirror the future authorisation procedures in the PRA and theFCA.What is happening to the FSA Handbook?At legal cutover, the FSA Handbook will be split between the FCA andthe PRA to form two new Handbooks, one for the PRA and one for theFCA.Most provisions in the FSA Handbook will be incorporated into thePRA’s Handbook, the FCA’s Handbook, or both, in line with each newregulator’s set of responsibilities and objectives.Users of the Handbook will be able to access the following online: Basel iii Compliance Professionals Association (BiiiCPA)
  25. 25. 25 1. The PRA Handbook, displaying provisions which apply to PRA-regulated firms 2. The FCA Handbook, displaying all provisions which apply to FCA-regulated firms; and 3. To support the transition, a central version which will show the provisions of both Handbooks, with clear labels indicating which regulator applies a provision to firms.The new Handbooks will reflect the new regulatory regime (for example,references to the FSA will be replaced with the appropriate regulator), andin some areas more substantive changes will be made to reflect theexistence of the two regulators, their roles and powers.(This is likely to include such aspects as the future processes forpermissions, passporting, controlled functions, threshold conditions andenforcement powers.)The more substantive changes will be consulted on before the PRA andthe FCA acquire their legal powers.Changes to the FSA Handbook as a result of EU legislation and FSApolicy initiatives will continue throughout this work.After acquiring their powers, the FCA and the PRA will amend their ownsuites of policy material as independent bodies in accordance with theprocesses laid down in the Financial Services Bill, including cooperationbetween them and external consultation.What does this mean for firms?This approach to the Handbooks for the FCA and the PRA has beenplanned to ensure a safe transition for firms and the new regulators as thenew regime is introduced.Firms will have a new regulator or regulators, and will consequently needto assess how the new Handbooks of these bodies will apply to them. Basel iii Compliance Professionals Association (BiiiCPA)
  26. 26. 26Dual regulated firms will need to look to both the PRA and the FCAHandbooks, and FCA regulated firms to the FCA Handbook.When will the changes be in the Handbook?We expect to publish the new Handbooks before legal cutover.This will allow firms and others time to adjust to the application of thenew Handbooks before the FCA and the PRA are fully operational.The new Handbooks will not be available in detail before this.Alongside the publication, we will publish material on how to interpretthe application of the Handbooks, where this is not dealt with in theHandbooks themselves.The FSA will continue to make changes to its Handbook in accordancewith the normal procedure, until the new bodies acquire their legalpowers.The FSA Handbook will remain in force until the FCA and PRA acquiretheir legal powers. Basel iii Compliance Professionals Association (BiiiCPA)
  27. 27. 27Launch of the Journey to the FCASpeech by Martin Wheatley - Managing Director,FSA, and CEO Designate, FCA at the Launch ofthe Journey to the FCA eventGood morning. I would like to thank the MinisterGreg Clark for joining us today, for his supportivewords – and for demonstrating the Government’scommitment to working alongside us to deliver better conduct regulation.I would also like to thank Thomson-Reuters for hosting this morning.Today is a big step forward on the road to becoming the new regulator,and I am glad that you are all here to join us as we launch the Journey tothe FCA.The FCA offers a huge opportunity for the regulator and firms to startafresh, and work in partnership to reset how we deal with conduct infinancial services.We see it as the role of the regulator to not only make the relevant marketswork well but also to help firms get back to putting their customers at theheart of how they do business.Regulation has a huge impact on the people and businesses that rely onfinancial services, and we should never forget this.We have approached the creation of the FCA in a thoughtful andconsidered way, as the document we are sharing with you today shows.We will regulate one of our most successful industries, central to thehealth of our economy and a provider of two million UK jobs.This makes our job an important one, and it will mean that we carry outour work in a way that is as open and accountable as possible.We spent the summer engaging with consumer organisations, and 500firms from all areas of financial services, as we developed our thinking onthe FCA. Basel iii Compliance Professionals Association (BiiiCPA)
  28. 28. 28This allowed us to gather useful feedback and we will continue this openworking in the FCA.We aim in the Journey to the FCA to demonstrate what our neworganisation will mean for the firms we regulate and the consumers weare here to help protect.I encourage you all to read it, and to give us your views.We are clear about the type of regulator we want to become, and we wantto work with all of our stakeholders to get there and deliver regulation thatworks better.You have not yet had a chance to read the document, so let me explain abit more about what the FCA is going to be about.The FCA has been set up to work with firms to ensure they put consumersat the heart of their business.Underlining this are three outcomes:1. Consumers get financial services and products that meet their needsfrom firms they can trust.2. Firms compete effectively with the interests of their customers and theintegrity of the market at the heart of how they run their business.3. Markets and financial systems are sound, stable and resilient withtransparent pricing information.Reforming regulation is not just good for consumers, it will also be goodfor firms. The industry’s standing has suffered as the mis-selling scandalsand other problems have taken their toll.This has damaged the reputation of firms across the industry, whetherdirectly involved or not. We need to work with you to put that right.While much of what we will do is new, we will also build on what hasworked well under the FSA. Basel iii Compliance Professionals Association (BiiiCPA)
  29. 29. 29We will keep up our policy of credible deterrence, pursuing enforcementcases to punish wrongdoing.And our markets regulation will continue to promote integrity and carryon the FSA’s fight against insider dealing, which has secured 20 criminalconvictions since 2009.We will continue to keep unauthorised firms from trying to takeadvantage of consumers.We will set high expectations for those firms that want to enter financialservices, while still allowing innovation and good ideas to flourish.And we will take forward a strong interest in the fair treatment ofcustomers – an agenda that has been around for many years, but is stillkey to the FCA.There will, however, be important changes, and our approach will bemore forward-looking, better informed, and we will have a greaterappetite to get things done.A new department will act as the radar of our new organisation –combining better research into what is happening in the market, andanalysis of the risks to our objectives.This will then feed into our policymaking and our supervision of firms.We want to really understand what is happening to your customers, thedeal they are getting and the issues they face.This will include getting a better understanding of why consumers act inthe way they do, so we can adapt our regulation to their commonbehavioural traits.Fewer firms will have regular direct contact with supervisors, as we shiftresources to allow us to deal more quickly and effectively with emergingissues, and run more cross-industry projects to get to the root cause ofproblems. Basel iii Compliance Professionals Association (BiiiCPA)
  30. 30. 30We will have new partners to work with and our relationship with the newPrudential Regulation Authority will be crucial, and driven by a culture ofcooperation.We will aim to bring our expertise to international debates, so that EUand international policymaking works for UK consumers and firms.All of this will be delivered by a new culture in the FCA. We willencourage our staff to be more confident in making bold, firm andpredictable decisions.To help us do our job, the Government intends to give the FCA new toolsto ensure that consumers get products that meet their needs.This builds on one of the key lessons from past problems, which is thatregulation is often more effective if it steps in early to pre-empt andprevent widespread harm.We will reflect this in our supervision work when we look at how firmsdesign and sell their products.But a key new power will mean that we can step in and ban the sale ofproducts that pose unacceptable risks to consumers for up to 12 months,without consulting first.We will also be able to ban misleading advertising.We will use these new tools in a measured way – and while we will actsooner, and more decisively, our approach will be based on a properunderstanding of the issues and a full consideration of the potentialsolutions.So whilst there may be times when we have to act rapidly, this is notsomething that firms should be afraid of.Firms selling the right products, in the right way, to the right consumershave little to fear.Our new approach will mean that we will take competition into account inall our work. Basel iii Compliance Professionals Association (BiiiCPA)
  31. 31. 31We will weigh up the impact on competition of new measures wepropose.We will also consider whether competition could lead to better resultsthan other action we could take.In our work here, and in other areas, I am very conscious that we have towork with firms.Making regulation work better for us is also about allowing firms room totry new ideas and develop their business.Promoting competition will play an important part in this.We are not here to stand in the way of progress that will be of benefit toconsumers.Our goals as the FCA are clear: we will work for an industry that is betterat serving the needs of its customers.I see this as an opportunity – not just for us but for the industry.We can do our job better if we work with you, and I am pleased that somany of the chief executives that I speak to are talking the same languageand have committed to rebuilding confidence and trust, and reconnectingwith their customers.It is great hearing about these good intentions, but the difficult bit for usall is to make sure this change actually happens.There are challenges and opportunities for both us the regulator, and youthe industry.It is a journey we have to walk together, as we put consumers back at theheart of what we do. Basel iii Compliance Professionals Association (BiiiCPA)
  32. 32. 32Andrew G Haldane: The Bank and thebanksSpeech by Mr Andrew G Haldane, ExecutiveDirector, Financial Stability, Bank of England,at Queen’s University, Belfast***The views expressed within are not necessarilythose of the Bank of England or the FinancialPolicy Committee.I would like to thank Bethany Blowers, Forrest Capie, John Keyworth,Victoria Kinahan, Emma Murphy, Varun Paul, Richard Roberts, and thestaff of the Bank’s archives for their comments and contributions.In the light of the financial crisis, there is much to explain.Doing so is not just important for reasons of accountability to the public.Explaining and understanding errors of the past is absolutely essential ifpolicymakers are to learn lessons for the future.To misquote someone none of you have ever heard of, those who forgetthe errors of the past are doomed to repeat them.During the course of its 318-year history, the Bank of England has hadplenty of crisis experience.And encouragingly, on my reading of history, there is evidence of ithaving learnt from this experience.In response, radical reform of the Bank’s policymaking framework hasbeen commonplace.There are few better examples than the radical reform of the Bank’stransparency and accountability practices over the past twenty-five years. Basel iii Compliance Professionals Association (BiiiCPA)
  33. 33. 33Those reforms are continuing to the present day.A wholly new framework for financial stability policy is being put in placein the UK, perhaps the most radical in the Bank’s history.I will discuss that framework later on.This framework can be seen as an evolutionary response to crisisexperience, not just this crisis but a great many previous ones.It is impossible to know if this framework will proof us against futurecrises.But in remembering those errors of the past, it gives us a fighting chanceof not repeating them.So I want to take you on an historical journey charting the Bank ofEngland’s role in financial crises and its response to them.Now, I know what you are thinking.The evolution of financial stability in the UK viewed through the lens ofthe Bank of England sounds deadly dull.So I am going at least to try to add a touch of colour to the events andpersonalities of the time.The very beginningLet’s start at the very beginning.The Bank of England was put on earth, way back in 1694, to do none ofthe things it does today – namely, preserving monetary and financialstability. Basel iii Compliance Professionals Association (BiiiCPA)
  34. 34. 34Instead, it was a confection of the then monarchs, William III and MaryII, to pay for their war debts.At the time the Bank was little more than a branch, with a mere twentystaff.Pretty early in its life, however, the Bank began to involve itself in thebusiness of banking.It began to grow its balance sheet by taking deposits from and extendingloans to other banks, typically by the practice of “discounting” bills ofexchange.The Bank also issued its own notes which, due to the implicit backing ofthe government, circulated as currency with the public.At this stage, the Bank was far from being the nationalised, policymakingbody we know today.Rather, the Bank was a quasi-private bank conducting its business forquasi commercial ends.Other banks at the time were engaged in similar commercial pursuits,including often issuing their own notes.Except, of course, they lacked the government as guarantor.This made for a competitive, and at times rather antagonistic,relationship between the Bank and the commercial banks.This strained relationship lasted for the whole of the 18th and a goodchunk of the 19th centuries.Was the Bank friend or foe, collaborator or competitor? Basel iii Compliance Professionals Association (BiiiCPA)
  35. 35. 35The commercial banks did not know. And the Bank – private in name butpublic in finances – was itself in a state of mild schizophrenia.These psychological flaws were exposed in the middle of the 19th century.By then, the Bank had been granted monopoly rights to issue currency.Quite literally, this cut the commercial banks out of a lucrativemoney-making scheme.This did little to ease competitive tensions between the Bank and thebanks.This tension bubbled over in the famous case of Overend and GurneyBank. In the early part of the 19th century, Overend had grown rapidly tobecome the largest discount house in London.If not too big to fail, it was certainly large enough to look after itself – asthe Bank found out in 1860.Two years earlier, the Bank had abolished the right of other banks tocome to it for cash by discounting bills.The banks took umbrage.With Overend and Gurney playing the role of shop steward, theycollectively withdrew £1.6 million from the Bank over three days in anattempt to bring the Bank, if not to its knees, then at least to its senses.Dark, anonymous messages were sent to the Bank, presumably not byTwitter, warning: “Overends can pull out every note you have”.In the event Overend eventually caved, returning to the Bank the notesthey had withdrawn apologetically – or at least semi-apologetically, as thenotes actually came back cut in half. Basel iii Compliance Professionals Association (BiiiCPA)
  36. 36. 36Six years later in 1866, when Overend and Gurney asked the Bank for anemergency loan of £400,000, the answer was “No”.The Bank won this battle, but was to lose decisively the war. Overend andGurney failed.The City shook. Panic took hold.The Bank was forced to lend £4 million – ten times the initial sum – tosupport other banks.There was a chorus of disapproval.The Bank’s role in crisis management would never be the same again.Supporting the financial systemCriticism of the Bank’s role in the Overend crisis came prominently fromWalter Bagehot, then-editor of The Economist and Bank-of-Englandbasher of his day.He lambasted the Bank’s acting “hesitatingly, reluctantly and withmisgiving”.Henry Gibbs, Governor of the Bank from 1875 to 1877, highlighted theOverend experience as “the Bank’s only real blunder”.Yet the Bank had also learned from this experience.It had discovered that its role could be neither commercial norcompetitive.Instead its role was as guardian of the financial system as a whole,protecting banks from what is today called systemic risk. Basel iii Compliance Professionals Association (BiiiCPA)
  37. 37. 37In Bagehot’s words, the Bank should act as last resort lender to solventinstitutions against good collateral at a penalty rate.It has done so ever since.The Bank did not have to wait long to put its new-found role into practice.On Saturday 8 November 1890 the Bank Governor of the day, WilliamLidderdale, summoned his Directors. This itself aroused suspicion.Bank directors were never seen at work at the weekend.They typically departed for the country around Friday lunchtime.(Let me tell you, things have changed for Bank of England Directorssince then.)What Lidderdale told his Directors was electric.There were serious liquidity problems at another big and famous bank,Baring Brothers and Company.But the Bank had not the faintest clue as to Barings’ true financialposition.To rectify that, Lidderdale ordered an accountant’s report on Barings tobe brought to him with immediate effect.And with that, he departed to London Zoo with his son.The accountant’s report showed a solvent but illiquid Barings.Back from the Zoo, Lidderdale began to construct a financial “lifeboat”for Barings, with a contribution from the Bank but also from thecommercial banks.This was the system acting in support of the system. Basel iii Compliance Professionals Association (BiiiCPA)
  38. 38. 38The lifeboat was launched and Barings was saved, in what has becomeknown as the “crisis that never became a drama”.The Bank’s lifeboat has since been re-launched on more than oneoccasion.A second financial lifeboat – different in detail, but identical in principle –was launched by the Bank of England in the early 1970s.Then, it was intended to save the small banks rather than the large.It, too, steadied some sinking ships.Third time, however, was not so lucky.On 24 February 1995, it was Barings Bank who were again knocking onthe Bank of England’s door for help.Bank Directors were again summoned on a Saturday.I myself was caught by a TV crew entering the Bank on that Saturdaymorning, arousing suspicion something was amiss.In fact, I had not been recalled to save the day.(I believe I was filmed wearing a tracksuit.)And I was as blissfully unaware of Barings’ problems as most of the rest ofthe world.(I was at the Bank completing a research paper on “A Structural VectorAutoregressive Model of the Monetary Transmission Mechanism”.)Life was easier then. Basel iii Compliance Professionals Association (BiiiCPA)
  39. 39. 39Nick Leeson, at the time a despised and corrupt rogue-trader, today amuch-admired reality- TV star and after-dinner speaker, had put a hugehole in the Barings boat.Over the weekend, then-Governor Eddie George tried hard to assemble alifeboat.All visits to London Zoo were cancelled.But the lifeboat failed and with it Barings.That Barings was allowed to fail, and did so without rupturing the system,is a key lesson for today, to which I will return later.So what does this tell us about how the Bank of England’s role hadevolved on entering the 20th century?The Bank now spoke and acted as steward of the financial system,marshalling its own and others’ financial resources to keep the financialsystem panic-free.The Bank was at the frontline of crisis management.But these episodes also contained lessons.When the first Barings crisis came, the Bank had been reactive andbackfoot.It had been blindsided by the risk to its own and the financial system’sbalance sheet.The Bank was finding its feet as a crisis-container.But in attitude and expertise, it was a world away from being an effectivecrisis-preventer. Basel iii Compliance Professionals Association (BiiiCPA)
  40. 40. 40Supporting the economyFast forward to the start of the First World War.William Lidderdale had been replaced as Bank Governor by WalterCunliffe.Cunliffe was not what would these days be called an equal opportunitiesemployer.The Bank’s staff rules were stifling and sexist – although were ahead oftheir time compared to other City firms.The Bank went 150 years without employing any women at all.When they did, it was to do the work of 15–18 year old boys, sorting andlisting returned notes.On getting married, women at the Bank were required to resign theirposition.The Bank was “Old Lady” by name but “Young Lady” by nature.Cunliffe’s greatest achievement was his contribution to solving thefinancial panic of 1914.On Friday 24 July, the City woke to the threat of war as Austria made anultimatum to Serbia.There was a worldwide scramble for the safety of cash.Mass-selling led to stock markets closing in Europe, then New York, thenAustralia.London was not exempt. By 31 July, the London Stock Exchange hadclosed for the first time in its near 150-year history. Basel iii Compliance Professionals Association (BiiiCPA)
  41. 41. 41Panic soon spread to the money markets, sucking liquidity and life out ofthe financial system.Unable to finance themselves, lending by the banks began to drain away,starving the economy of credit and causing it too to crater.This was truly a credit crunch.Cunliffe’s plan, hatched with the Treasury, was to lift the liquidity burdenon the banks by purchasing the IOUs they were holding from overseasborrowers which had become understandably illiquid on the outbreak ofwar.These bills were bought by the Bank and stored in its vaults, in whatbecame known as the “cold storage” scheme.By freeing the banks’ balance sheets in this way, the cold storage schemewas intended to stimulate credit.It was only a limited success, with the banks still fearful about makingnew loans because of the rising risk of default by overseas borrowers.In response, the government announced an extension to the scheme, withthe government effectively insuring the banks against the credit risk onthese assets too.It worked.Within a couple of months, money market conditions had stabilised andcredit was once more flowing.Cunliffe’s cold storage plan had averted a credit crisis.The cold storage scheme was a piece of clever financial engineering bythe Bank, designed to support credit and the wider economy. Basel iii Compliance Professionals Association (BiiiCPA)
  42. 42. 42In the past few years, with credit growth and the economy weak, the Bankhas been in the vanguard of creating new pieces of machinery to serve asimilar end.In 2008, the Bank introduced a Special Liquidity Scheme, or SLS, to helpfinance UK banks’ legacy asset portfolio.Over £180 billion of support was provided to the banks and has sincebeen repaid.The SLS bears more than a passing resemblance to the first phase of thecold storage scheme.In June this year, the Bank announced a second scheme, the Funding forLending Scheme, or FLS. It provides liquidity support to UK banks onterms which depend on their lending to the UK economy, thereby actingas a direct incentive to stimulate new lending.The FLS bears some resemblance to the second phase of cold storage.The SLS and FLS may be less famous than JLS, the London R&Bboy-band.But they are an important recognition of the Bank’s role in supportingcredit intermediation.That role began in the early part of the 20th century with schemes likecold storage.The Bank’s role had expanded beyond its own doorstep, on which thebanks stood, to the doorsteps of households and companies up and downthe country seeking credit. Basel iii Compliance Professionals Association (BiiiCPA)
  43. 43. 43Supporting financial infrastructureYet one thing at least had stayed the same: in 1914, the Bank had onlyacted when jolted into doing so by war.Its role was still as crisis-container rather than preventer.During the 1920s and 1930s, the Bank of England became MontaguNorman’s Bank.And Norman set about changing that.Norman was not Cunliffe’s greatest fan and the feeling was clearlymutual.“There goes that queer-looking fish with the ginger beard again”,Cunliffe is said to have observed about Norman.“Do you know who he is? I keep seeing him creep about this place like alost soul with nothing better to do.”Nor would Norman necessarily have ingratiated himself to today’s armyof Bank economists.“You are not here to tell us what to do, but to explain why we havedone it” is the way Norman rebuked the Bank’s Chief Economist of theday.Norman saw the Bank’s role in expansive terms, as provider not just ofemergency help but as builder of infrastructure and supporter of industry.The Bank became part of the post-war reconstruction effort.Having spent 200 years tending to its back garden, the Bank began toexplore pastures new. Basel iii Compliance Professionals Association (BiiiCPA)
  44. 44. 44To take one example, in 1928 the Lancashire cotton industry was on itsknees.These problems risked ricocheting back to the financial system, with atleast two of the big five UK banks up to their neck in cotton.A plan was conceived involving consolidating the industry into aLancashire Textile Corporation.This was to be financed with debt and shares issued and supported by –you’ve guessed it – the Bank of England.It was a bold and cunning plan. Unfortunately, it flopped.The share issue by the Corporation in 1931 was a resounding failure,leaving the underwriter with a large chunk of the shares.The Bank ended up having to support the market.It, too, found itself up to its neck in cotton.Undaunted, the stage had nonetheless been set for the Bank’s on-goinginvolvement in financial infrastructure.This came not a moment too soon. In the immediate post-war period,the UK faced pressing financial infrastructure problems – the so-called“Macmillan gaps”.These gaps referred the inability of small firms to finance themselves withlong-term loans.If these gaps sound strangely familiar, then they should.The post-war Bank set about closing these Macmillan gaps with gusto. Basel iii Compliance Professionals Association (BiiiCPA)
  45. 45. 45In 1945 it set up two new financing entities – the Finance Corporation forIndustry (FCI) and the Industrial and Commercial Finance Corporation(ICFC).These were financially supported by banks and institutional investors,providing a platform for the supply of longer term funding and venturecapital finance to small firms.In 1973, the two corporations combined to form Finance for Industry(FFI).During the early 1980s, the company was rebranded as Investors inIndustry, commonly known as 3i.In 1987, the entity went public as 3i Group.This was not a flop.Arguably, 3i and its predecessors were one of the largest feathers in theBank’s post-war cap, helping support generations of new businesses andstart-ups.And those MacMillan gaps?Regrettably, the crisis has re-opened them.Today, small firms are once more starved of finance, including many herein Northern Ireland.Once again, the quest is on for a new financial infrastructure to help closethese gaps.Through the 1980s and 1990s, there were further examples of the Bankstepping in to close structural financial gaps.When the UK’s high-value payment system started creaking in the early1980s, the Bank designed and built a new, bullet-proof system. Basel iii Compliance Professionals Association (BiiiCPA)
  46. 46. 46Given the Bank’s somewhat chequered record on gender diversity up tothat point, it was rather unfortunately named CHAPS.And indeed still is.In 1993, the Bank stepped-in to rescue a flagging project to upgrade thesecurities settlement process in the UK.The Bank designed and built a new, safety-first, system which againexists to this day.Fortunately, we did not call this one BLOKES, but rather thegender-neutral CREST.Most recently, in the light of the crisis, the Bank has been at the forefrontof the debate about re-organising the structure of banking, with aring-fence or firewall between the basic retail and investment bankingsides of the business.This structural approach is increasingly finding favour both in the UK(through the proposals of the Vickers Commission) and internationally(for example, through the Volcker proposals in the US and the recentLiikanen proposals in Europe).For the past half-century, the Bank’s structural agenda has become acentral feature.But at the time it marked a radical departure from the Bank’s past.Designing what are in effect financial public goods is a front-foot activity.The Bank had grown a new limb, augmenting its crisis-managementright arm with a crisis-prevention left arm. Basel iii Compliance Professionals Association (BiiiCPA)
  47. 47. 47Stitching it all togetherSo far, I have made no real mention of monetary policy.That is because, for much of its life up to the early 1970s, monetary controlat the Bank of England was pretty simple.It came care of fixing the exchange rate – first to gold under the GoldStandard and latterly in the post war period to the dollar.With the demise of the dollar standard in the early 1970s, however, theexchange rate anchor had been tossed overboard.At the Bank of England, as elsewhere, the search was on for a newnominal anchor.Into this vacuum stepped Andrew Duncan Crockett. Crockett joined theBank in 1966 as a graduate entrant, just before the break-up of the BrettonWoods dollar standard.He set to work on the biggest problem of the day, locating a new nominalanchor.In so doing, he began working alongside another young(ish) new Bankentrant, Charles Goodhart.The result was a joint paper published in the Bank’s Quarterly Bulletin inJune 1970.It was titled “The Importance of Money”.Re-reading it now, it was a prophetic piece of work.In the UK, it laid some of the analytical foundations for what, during thelate 1970s and 1980s, became monetarism. Basel iii Compliance Professionals Association (BiiiCPA)
  48. 48. 48More than that, the paper placed commercial bank money and credit atthe centre of the macro-economy.It could as well have been titled “The Importance of Credit” or indeed“The Importance of Banks”.After a successful spell at the IMF, Crockett returned to the Bank ofEngland in 1989.In 1994, he then became General Manager of the Bank for InternationalSettlements, the central banks’ central bank.In central bank circles, change was in the air. Monetary policy wasembarking on a path which targeted inflation and which, unlikemonetarism before it, downplayed money and credit.And the regulation of banks, long the preserve of central banks, was inmany countries being hived off to separate regulatory agencies.What happened next was truly extra-ordinary.Whether by coincidence or causality, the world experienced the largestbanking bubble in history.Between 1990 and 2007, global bank balance sheets rose by a factor four.On the eve of the crisis they had reached around $75 trillion, or almost 1.5times the annual output of the entire planet.At the Bank for International Settlements, Andrew Crockett saw troublebrewing.In 2000, he gave a speech calling for a “macro-prudential” approach toregulation. Basel iii Compliance Professionals Association (BiiiCPA)
  49. 49. 49Crockett argued that central banks needed to look at, and act on,developments across the whole financial system if systemic risk was to beheaded-off.Credit booms, the like of which was occurring for real at the time, sowedthe seeds of that systemic risk.The rest is of course history, as pre-crisis credit boom turned toshuddering bust.Or rather it would be history were it not for the fact that this crisis, whoseseeds were sown in the credit boom, is still with us.Output in the UK is still well below its 2007 level.The so-called Great Recession in the UK is already as severe as the GreatDepression of the 1930s.In response, the policy framework has, once more, been radicallyaugmented.Macroprudential policy is the next big thing.It is now widely acknowledged as the missing policy link during thepre-crisis period, the essential bridge between monetary policy andregulation.As I discuss below, this bridge is now being constructed through newframeworks in the UK and internationally.The Bank tomorrowSo where does all of this leave the Bank today and, indeed, tomorrow?In the light of the crisis, we are moving to a wholly new structure forfinancial policymaking in the UK. Basel iii Compliance Professionals Association (BiiiCPA)
  50. 50. 50In many important respects, this can be seen as building on the lessons ofhistory.To illustrate that, let me set out some of its main features.First, there is to be a radical shift in the organisation and approach tosupervising individual financial institutions.The UK will move to a so-called “twin-peaks” regime.That means in practice separating the safety and soundness aspects of theregulation (so-called prudential) from the consumer protection aspects(so-called conduct).The prudential part will from next year sit in the Bank of England in anew Prudential Regulatory Authority, or PRA.This is much more than deck-chair rearrangement.Accompanying this change will be a rootand-branch change in ourapproach to supervision.There will be a focus on the big risks – the Barings of yesteryear, the RBSof yesterday.Supervision will be front-foot, testing for stress before it strikes and visitsto the zoo need to be cancelled.It will be also tolerant of bank failure – Barings Mark 2 rather than Mark 1– so that market discipline can work its magic.Second, during the course of the crisis, there has been a radical, ifunderplayed, rethink of the Bank’s approach to supplying liquidity to thebanking system. Basel iii Compliance Professionals Association (BiiiCPA)
  51. 51. 51While not quite a change on the scale of the Overend and Gurney crisis,this allows banks to access the Bank’s facilities against a much widerrange of collateral.The Bank’s liquidity menu is now crystal clear, from which banks cannow themselves choose.Third, an entirely-new piece of policy machinery has been introduced –new not just for the UK, but internationally too.In the UK, this is called the Financial Policy Committee or FPC.It was put on earth to do macro-prudential policy, to act as the bridge, toprovide the missing link, to monitor the punchbowl before it is emptiedand before aspirin needs administering.A year on, the FPC is doing just that.Most recently the FPC has been navigating a particularly hazardouscourse.The financial system and economy are suffering the hangover from hell.The FPC’s task is to keep the system safe in the face of heightened risksof a relapse, while at the same time keeping the banks’ credit arteriesopen to support the economy.Both objectives are steeped in the Bank’s history – and both objectives areembodied in the FPC’s remit.The FPC has a remit, too, to strengthen the structural fabric of thefinancial system, including through improved financial infrastructure.That objective has a place deep in the Bank of England’s heart – fromLancashire cotton mills of the 1930s, to 3i of the post-war years, toCHAPs of the 1980s, to Vickers of the past few years. Basel iii Compliance Professionals Association (BiiiCPA)
  52. 52. 52Supporting and executing these new responsibilities will be a massivetask.First and foremost, it will require the Bank to have a rich and diverse setof skills.Historically at least, the Bank has been skills-rich but diversity-poor.But I am pleased to say that, too, has been changing for the better.This year’s graduate intake has close to a 50/50 gender split.One in seven of the intake is drawn from ethnic minorities.Only a fifth come from Oxford or Cambridge.The PRA’s arrival next year will broaden further the diversity of theBank’s skills and experience – legal, accountancy, banking, insurance.The Bank’s policy committees, meanwhile, bring diversity of experienceand expertise to the decision-making table, from academe and the privatesector.There has been a transformation, too, in the Bank’s approach to externalcommunications and transparency.Think back twenty years.Then, there were no quarterly Inflation Reports, no six-monthly FinancialStability Reports and certainly no press conferences to accompany both.Twenty years ago, there were no minutes of the deliberations of theBank’s policy committees (today, the MPC and FPC).Back then, press interviews were rare and scripted to within an inch oftheir life. Basel iii Compliance Professionals Association (BiiiCPA)
  53. 53. 53In the past year, Bank officials gave around 65 speeches and over 200press interviews.In Montagu Norman’s day, the combined total was one.The days of “keeping the Bank out of the press and the press out of theBank” are well and truly gone.Earlier this year, the Governor gave the Bank’s first live peacetime radioaddress to the nation for 73 years.The Bank Tweets, fortunately with rather less vigour than your averagePremiership footballer.Soon we will have, for the first time in history, published minutes of theBank’s Court of Directors.The Governor has appeared before the Treasury Committee on no lessthan 47 occasions since he took office.In 2011, a word search of “Mervyn King” in the press revealed more hitsthan “Kylie Minogue”.To my knowledge, this is the first time a sitting Bank of EnglandGovernor has toppled the Aussie pop princess in the media opinion polls.Given its new responsibilities, the Bank cannot fail to remain in thepublic’s eye in the period ahead.Transparency and accountability will remain the watchwords – andrightly so.ConclusionWhen pressed by the Macmillan Committee in 1930 to explain the Bank’sactions, Montagu Norman replied: “Reasons, Mr Chairman? I don’t havereasons, I have instincts”. Basel iii Compliance Professionals Association (BiiiCPA)
  54. 54. 54I suspect such an answer would work less well with today’s TreasuryCommittee, to say nothing of today’s media.All public policymakers have an obligation to explain.And all policymakers have an obligation to learn from past crises and pastmistakes.That is the only way credibility can be built: not the avoidance of crisesand mistakes, which is impossible, but the recognition by the public that,when they do happen, the crises are contained and the mistakes arehonest ones.The Bank of England is embarking on the latest chapter in its 318-yearhistory.We cannot avoid a crisis but, as with Barings in 1890, we can endeavour toprevent it becoming a drama.We will certainly be doing our best to prevent it becoming a tragedy likethat of the past few years.If nothing else, this new chapter will have learnt from, and will build on,the lessons of history.Thank you. Basel iii Compliance Professionals Association (BiiiCPA)
  55. 55. 55The Federal Reserve BoardTwo final rules with stress testingrequirements for certain bank holdingcompanies, state member banks, andsavings and loan holding companiesThe Federal Reserve Board on Tuesdaypublished two final rules with stress testing requirements for certain bankholding companies, state member banks, and savings and loan holdingcompanies.The final rules implement sections 165(i)(1) and (i)(2) of the Dodd-FrankWall Street Reform and Consumer Protection Act that require supervisoryand company-run stress tests.Nonbank financial companies designated by the Financial StabilityOversight Council will also be subject to certain stress testingrequirements contained in the rules."Implementation of the Dodd-Frank stress test requirement is animportant step in the Federal Reserves efforts to promote the health ofthe financial sector," Governor Daniel K. Tarullo said."Stress testing is a key tool to ensure that financial companies haveenough capital to weather a severe economic downturn without posing arisk to their communities, other financial institutions, or to the generaleconomy."The Federal Reserve will begin conducting supervisory stress tests underthe final rules this fall for the 19 bank holding companies that participatedin the 2009 Supervisory Capital Assessment Program and subsequentComprehensive Capital Analysis and Reviews. Basel iii Compliance Professionals Association (BiiiCPA)
  56. 56. 56The final rules also require these companies and their state-member banksubsidiaries to conduct their own Dodd-Frank company-run stress teststhis fall, with the results to be publicly disclosed in March 2013.In general, other companies subject to the Boards final rules forDodd-Frank stress testing will be required to comply with the final rulebeginning in October 2013.Companies with between $10 billion and $50 billion in total assets thatbegin conducting their first company-run stress test in in the fall of 2013will not have to publicly disclose the results of that first stress test.The Boards two final rules revise portions of the Federal Reserves noticeof proposed rulemaking to implement the enhanced prudential standardsand early remediation requirements established under the Dodd-FrankAct.The Board coordinated closely with the Office of the Comptroller of theCurrency and the Federal Deposit Insurance Corporation to ensure thatfinal stress testing rules issued by the agencies are consistent andcomparable.The Board also coordinated with the Federal Insurance Office as requiredby the Dodd-Frank Act.The Federal Reserve will release the scenarios for this years supervisoryand company-run stress tests no later than November 15, 2012.As required by the Dodd-Frank Act, the scenarios will describehypothetical baseline, adverse, and severely adverse conditions, withpaths for key macroeconomic and financial variables.To help firms prepare to estimate their losses and revenues under thescenarios, the Federal Reserve on Tuesday released historical data forvariables likely to be used in the scenarios. Basel iii Compliance Professionals Association (BiiiCPA)
  57. 57. 57A revised version of these historical data, reflecting the latest information,will be published along with the scenarios.Important PartsFEDERAL RESERVE SYSTEMAnnual Company-Run Stress Test Requirements for BankingOrganizations with Total Consolidated Assets over $10 Billion Other thanCovered CompaniesAGENCY: Board of Governors of the Federal Reserve System (Board).ACTION: Final rule.SUMMARY: The Dodd-Frank Wall Street Reform and ConsumerProtection Act (Dodd-Frank Act or Act) requires the Board to issueregulations that require financial companies with total consolidatedassets of more than $10 billion and for which the Board is the primaryfederal financial regulatory agency to conduct stress tests on an annualbasis.The Board is adopting this final rule to implement the company-runstress test requirements in section 165(i)(2) of the Dodd-Frank Actregarding company-run stress tests for bank holding companies with totalconsolidated assets greater than $10 billion but less than $50 billion andstate member banks and savings and loan holding companies with totalconsolidated assets greater than $10 billon.This final rule does not apply to any banking organization with totalconsolidated assets of less than $10 billion.Furthermore, implementation of the stress testing requirements for bankholding companies, savings and loan holding companies, and statemember banks with total consolidated assets of greater than $10 billionbut less than $50 billion is delayed until September 2013. Basel iii Compliance Professionals Association (BiiiCPA)
  58. 58. 58DATES: The rule is effective on November 15, 2012.BackgroundThe Board has long held the view that a banking organization, such as abank holding company or insured depository institution, should operatewith capital levels well above its minimum regulatory capital ratios andcommensurate with its risk profile.A banking organization should also have internal processes for assessingits capital adequacy that reflect a full understanding of its risks andensure that it holds capital commensurate with those risks.Moreover, a banking organization that is subject to the Board’s advancedapproaches risk-based capital requirements must satisfy specificrequirements relating to their internal capital adequacy processes in orderto use the advanced approaches to calculate its minimum risk-basedcapital requirements.Stress testing is one tool that helps both bank supervisors and a bankingorganization measure the sufficiency of capital available to support thebanking organization’s operations throughout periods of stress.The Board and the other federal banking agencies previously havehighlighted the use of stress testing as a means to better understand therange of a banking organization’s potential risk exposures.In particular, as part of its effort to stabilize the U.S. financial systemduring the recent financial crisis, the Board, along with other federalfinancial regulatory agencies and the Federal Reserve system, conductedstress tests of large, complex bank holding companies through theSupervisory Capital Assessment Program (SCAP). Basel iii Compliance Professionals Association (BiiiCPA)
  59. 59. 59The SCAP was a forward-looking exercise designed to estimate revenue,losses, and capital needs under an adverse economic and financial marketscenario.By looking at the broad capital needs of the financial system and thespecific needs of individual companies, these stress tests providedvaluable information to market participants, reduced uncertainty aboutthe financial condition of the participating bank holding companiesunder a scenario that was more adverse than that which was anticipatedto occur at the time, and had an overall stabilizing effect.Building on the SCAP and other supervisory work coming out of thecrisis, the Board initiated the annual Comprehensive Capital Analysis andReview (CCAR) in late 2010 to assess the capital adequacy and theinternal capital planning processes of large, complex bank holdingcompanies and to incorporate stress testing as part of the Board’s regularsupervisory program for assessing capital adequacy and capital planningpractices at large bank holding companies.The CCAR represents a substantial strengthening of previous approachesto assessing capital adequacy and promotes thorough and robustprocesses at large banking organizations for measuring capital needs andfor managing and allocating capital resources.The CCAR focuses on the risk measurement and management practicessupporting organizations’ capital adequacy assessments, including theirability to deliver credible inputs to their loss estimation techniques, aswell as the governance processes around capital planning practices.In the wake of the financial crisis, Congress enacted the Dodd-Frank Act,which requires the Board to issue regulations that require bank holdingcompanies with total consolidated assets of $50 billion or more (largebank holding companies) and nonbank financial companies that theFinancial Stability Oversight Committee has designated to be supervisedby the Board (together, covered companies) to conduct stress testssemi-annually, and requires other financial companies with total Basel iii Compliance Professionals Association (BiiiCPA)
  60. 60. 60consolidated assets of more than $10 billion and for which the Board is theprimary federal financial regulatory agency to conduct stress tests on anannual basis (company-run stress tests).The Act requires that the Board issue regulations that:(i) Define the term “stress test”(ii) Establish methodologies for the conduct of the company-run stresstests that provide for at least three different sets of conditions, includingbaseline, adverse, and severely adverse conditions(iii) Establish the form and content of the report that companies subjectto the regulation must submit to the Board(iv) Require companies to publish a summary of the results of therequired stress tests.On January 5, 2012, the Board invited public comment on a notice ofproposed rulemaking (proposal or NPR) that would implement theenhanced prudential standards required to be established under section165 of the Dodd-Frank Act and the early remediation requirementsestablished under Section 166 of the Act, including proposed rulesregarding company-run stress tests.The proposed rules would have required each bank holding company,state member bank, and savings and loan holding company with morethan $10 billion in total consolidated assets to conduct an annualcompany-run stress test using data as of September 30 of each year andthe three scenarios provided by the Board.In addition, each state member bank, bank holding company, andsavings and loan holding company would be required to disclose asummary of the results of its company-run stress tests within 90 days ofsubmitting the results to the Board. Basel iii Compliance Professionals Association (BiiiCPA)
  61. 61. 61The Dodd-Frank Act mandates that the OCC and the FDIC adopt rulesimplementing stress testing requirements for the depository institutionsthat they supervise, and the OCC and FDIC invited public comment onproposed rules in January of 2012.The Board is finalizing the stress testing frameworks in two separaterules.First, the Board is issuing this final rule, which implements thecompany-run stress testing requirements applicable to bank holdingcompanies with total consolidated assets greater than $10 billion but lessthan $50 billion and savings and loan holding companies and statemember banks with total consolidated assets greater than $10 billion.Second, the Board is concurrently issuing a final rule implementing thesupervisory and semi-annual company-run stress testing requirementsapplicable to large bank holding companies and nonbank financialcompanies supervised by the Board.Overview of CommentsThe Board received approximately 100 comments on its NPR onenhanced prudential standards and early remediation requirements.Approximately 40 of these comments pertained to the proposed stresstesting requirements.Commenters ranged from individual banking organizations to trade andindustry groups and public interest groups.In general, commenters expressed support for stress testing as a valuabletool for identifying and managing both microand macro-prudential risk.However, several commenters recommended changes to, or clarificationof, certain provisions of the proposed rule, including its timeline forimplementation, reporting requirements, and disclosure requirements. Basel iii Compliance Professionals Association (BiiiCPA)
  62. 62. 62Commenters also urged greater interagency coordination regarding stresstests.A. Delayed compliance dateCommenters suggested that companies with total consolidated assets lessthan $50 billion that have not previously been subject to stress-testingrequirements need more time to develop the systems and procedures tobe able to conduct company-run stress tests and to collect the informationthat the Board may require in connection with these tests.In response to these comments and to reduce burden on theseinstitutions, the final rule requires most bank holding companies, savingsand loan holding companies, and state member banks to conduct theirfirst stress test in the fall of 2013.In addition, the final rule requires bank holding companies, savings andloan holding companies, and state member banks with less than $50billion in total consolidated assets to begin publicly disclosing their stresstest results in 2015 with respect to the stress test conducted in the fall of2014.Banking organizations that become subject to the rule’s requirementsafter November 15, 2012 must comply with the requirements beginning inthe fall of the calendar year that follows the year the company meets theasset threshold, unless that time is extended by the Board in writing.For example, a company that becomes subject to the rule on March 31,2013 must conduct its first stress test in the fall of 2014 and report theresults in 2015.B. TailoringThe proposed rule would have applied consistent annual company-runstress test requirements, including the compliance date and the Basel iii Compliance Professionals Association (BiiiCPA)