Guest lecture presented to masters degree classes at Trinity College Dublin. This presentation provides an overview of the importance of financial services to an economy. It outlines the objectives of central banks and how they manage a financial crisis. Some of the risks related to global financial stability are considered, as are some of the implications of emerging technologies in finance. In addition the presentation emphasises the critical importance of consumer protection and of fostering a consumer centric culture. Finally the criticality of strong leadership and values within the industry are discussed, and the need for consumers and businesses to be financially astute and to be aware and careful of herd mentality.

1. Trinity Business School
Trinity Business School
Leadership in
Financial Services
Guest lecture:
Paul Woods
March 7th 2018

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Introduction
• Background
v Head of Enterprise & Non-Financial Risk for Central Bank of Ireland
v Studied economics and computer science (distributed systems) at TCD
v Prior experience leading in corporate and startup
• Topics we’ll cover
v Central Banking
v Financial crises
v Emerging technology
v Financial stability
v Leadership and values: True North
• Inputs from great colleagues in Financial Stability and Monetary Policy
• The views do not formally represent the Central Bank, presentation given in personal capacity

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Ireland from the International Space Station,
sent to the author by Terry Virts, Commander and Astronaut
A bird’s eye view of CBI stakeholders

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The importance of financial institutions
• Intermediaries that perform critical role in any economy
v Banks: credit creation and maturity transformation (inherently risky)
v Insurance companies: pooling of risk, allowing efficient risk transfer and mitigation
v Other financial institutions act as important intermediaries between buyers and sellers
• Collectively financial institutions form a critical, potentially dangerous distributed system
v Distributed systems as useful as economics lens when assessing risks
v Anywhere great power is bestowed, responsible values based leadership is crucial
• History highlights laissez-faire approach to regulatory oversight doesn’t work
v Divergent incentives for micro institutions versus greater good for macro economy
• Regulation and supervision ensures conformity with acceptable codes of behaviour
v Authorisations, supervision, conduct, AML, credit register, enforcement, resolution ..

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Star Wars as an analogy to financial services
• Objective to maintain balance and ensure a stable financial system for all stakeholders
• System never designed with bad intent, but implicitly risky
v Stakeholders may not recognise or intend contributing to magnitude of collective risk
v Institutions have incentive to say, “there’s nothing to see here”, (book to market value)
v Collectively institutions can form an ‘economic Death Star’
v Financial risk models often only a weak abstraction
• Financial crises have disastrous impact
v > Inequality, recovery options constrained by segment
v Loss employment, homes, emigration tears apart families
• Each stakeholder in financial system bears huge responsibility
v System’s roots must be nourished with strong leadership values and regulatory oversight

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Risks confronting the system
Internal to a Central Bank
Micro prudential
risks
Macro prudential
risks

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The importance of price stability
• Primary objective of European System of Central Banks to maintain price stability
v Inflation is the rate at which general prices for goods and services rise
v High inflation causes a redistribution of wealth from lenders to borrowers
v Hyperinflation is an extraordinary high rate of inflation
v Deflation – incentive to postpone purchases, economy slows, cost of debt servicing rises
• Price stability a legal objective of central banks
v Often the target is set at 2%

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Price stability
Source:
Washington Post,
January 2018
Venezuela launched
world’s first sovereign
cryptocurrency – Petro,
backed by gold and oil,
but probability of
success considered low

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Financial stability and crises
Short-term
Decline in asset prices (property,
stocks), increase in unemployment
Banking sector losses and negative
market sentiment
Higher Government debt
Legacy issues
Muted credit growth, private and
public indebtedness
Weak banks and investor caution
Long-term growth prospects
• Typical short and longer term impact of financial crises

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• Boom/bust cycles in
property
• Leverage and “this time is
different”
• Globalisation and
interconnected economies
Real Economy
• Increase in size and
complexity
• Inadequate risk
management
• Financial innovation and
interconnectedness
Banking Sector
• Reliance on market
discipline rather than
intensive oversight
• Inadequate models
• Overly expansionary
economic policies
Economic and
Regulatory Policy
What causes a banking crisis?

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Macroprudential Policy
Policy Objective Type of tool
Monetary policy Price stability Broad-based tool
Microprudential
policy
Stability of individual
institutions
Targeted at specific institutions
Macroprudential
policy
Financial stability Range of instruments which
can be targeted at source of risk
• Policies that aim to reduce the possibility of a systemic crisis occurring
v Tools impacting how much banks can lend: loan-to-value, loan-to-income ratios
v Loan to income 3.5 times cap
v 20% value of new mortgage loans may exceed cap for first time buyers
v 10% value of new mortgage loans may exceed cap for second or subsequent buyers
v Tools increasing bank resilience: Capital, sector specific buffers, sector specific limits

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Financial crisis
• Like watching a very slow motion crash simulation impacting all consumers and
businesses
• But real people impacted, and coordinated response can have significant time lag
• Lesson: Importance of addressing risks ex ante, common good of macroprudential policy

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Banking crises: historical perspective
Region or Group Share of years in banking crisis since
1800 (or independence) to 2008
Number of banking crises
Africa 12.5 1.7
Asia 11.2 3.6
Europe 6.3 5.9
Latin America 4.4 3.6
Argentina, Brazil, and
Mexico
9.2 9.0
North America 11.2 10.5
Oceania 4.8 2.0
Advanced economies 7.2 7.2
Emerging economies 8.3 2.8
Source:
Reinhart & Rogoff, 2009, ”This Time Is Different”, p.154.

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Banking crises: recent responses
Source: Laeven & Valencia, 2012, IMF Working Paper WP/12/163 p. 6

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Irish Crisis
• Peak-to-trough fall (2007-2012): -50%
• Peak no. of negative equity mortgages (2012):314,000
Housing Market
• Total losses (2009-2013): -€67bn
• Peak non-performing loan ratio (2013Q4):27%
• State investment in Irish banks (as at 2012): €63bn
Banking Sector
• Rise in unemployment rate (2007-2012): 10.4pp
• Total fall in real GDP (2008-2010):-8.3%
Irish Economy

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Irish Crisis: Mistakes were made
All stakeholders must ensure mistakes never repeated
Our small team supervised Ireland’s most systemic
commercial banks with exposures a multiple of the
country’s GDP!!!
• By all stakeholders
v Governance and risk management within commercial banks disastrously weak
v Group think, internal bank procedures often overridden, especially credit risk controls
v Banking supervision significantly under resourced, focus on process rather than outcomes
v Weak monitoring of macro risks domestically / globally
v Misaligned incentives vs. standards – rating agencies
v Information asymmetries on toxic assets

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How does a central bank affect an economy?
Economy in
recession
Lower interest rates,
stimulus
Cost of borrowing falls
Firms and consumers
borrow more
Firms hire more workers
Economic growth
Upward pressure on prices
• Process buys time but does not substitute for longer term sound fiscal leadership
v Non-standard measures not typically designed to be used over medium to long term

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Monetary policy transmission channels
Banks’ and money market interest rates
Expectations of future interest rate & inflation/price developments
Asset prices & exchange rate
Supply of bank loans/credit
Savings and investment decisions
Aggregate demand and prices

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ECB main refinancing rate
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
%
Main Refinancing Rate
Further reductions constrained

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Low yield environment changes behaviour

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ECB main refinancing rate
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
%
Main Refinancing Rate
Further reductions constrained

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ECB balance sheet
• Quantitative easing
v Non-standard monetary policy also has bounds and implications for risk landscape
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
€bn

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Bond spreads within Eurozone
“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro.
And believe me, it will be enough.” Mario Draghi, 2012
0
2
4
6
8
10
12
14
%
Italian Spread Spanish Spread Irish Spread Greek Spread

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Great Financial Crisis
500
1000
1500
2000
2500
3000
S&P 500

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Future risks to global financial stability
Brexit
Societal
Long-term macro implications of
Brexit unclear, broader impact to
global stability
Ageing populations, inequality
(access to resources & education)
large scale involuntary migration
Interstate conflict
Territorial disputes, military
conflict, use of weapons mass
destruction, fiscal cost of securing
borders
Technology related
Financial institutions become tech
companies. Potential for systemic
cyber attack. Emerging risks – AI,
P2P, DLT, > HST flash crashes …
Political
Global power shifts, rise in
populism, trade wars …
Terrorism
Radical extremism and ability to
disrupt society through large scale
terrorist atrocities, ‘dog and flea’
economics – increasing burden
Global Warming
Disproportionate impact certain
economies, segments, and
institutions. Potential wholesale
reassessment, stranded assets
Macroeconomic
Fiscal crises, asset bubbles, energy
price shocks, derivative ‘black
holes’ …, disruptive tax change
Other
Natural disasters, pandemic,
extreme space weather event …

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Fintech
Source:
Washington Post,
February 2018

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Artificial Intelligence
• AI applied when a machine mimics “cognitive” functions - learning and problem solving
v Initial work in 1954-59, programming a computer to win in draughts
v AI focused on specific non-complex computation; production rules
v 90s, Moore’s law, same approach extended to complex problems: 1997 - Big Blue Vs
Kasparov, (design patterns, truncation based on heuristics, brute force computation)
v Around 2010, advances in statistical analysis of large volumes of data: Machine learning
v Move to Neural networks supporting ‘Deep Learning’ – automating causal links
Insight
Neurons in brain 10^11
Average N-N connections 10^4
Human neuron speed (sec) 10^-3
Machine processing speed (sec)* 10^-10
* Dependent on processor
Parallel processing of nodes key for both humans and machines
Machine processor progress speed >> human brain evolution

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Artificial Intelligence – financial markets
• Lower barriers to entry
v Increased exploitation by smaller players in emerging Fintech sector
v New data capture and analysis architecture versus legacy systems with overlay
• Diversification of technology players
v Inevitable that technology companies will increasingly enter financial services market
• Operational efficiencies
v Rapid analysis of data to identify market anomalies, potential flow to algorithmic trading
v Efficiency gains for transactions – such as underwriting & fraud detection (& false declines)
• Financial stability & regulatory issues
v New and unexpected forms of interconnection, new systemically important players
v Importance of considering data privacy, conduct risk, and cyber security

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Information & cyber security
• Ongoing review of perimeter defences crucial
v Includes technology controls and training to protect against social engineering
v Monitoring and recovery planning also essential

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A Central Bank must synchronise like an orchestra
• Understand how micro and macro risks interlink
v Evaluate right mix of tools, ensure tools well ‘tuned’, optimize timing of intervention
v Smooth handoffs, such as transfer of cases from Financial Supervision to Resolution
v Oversight becomes more complex with big data, shadow banking, Fintech …

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Consumer Protection & Culture

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• Financial institutions play a critical role in any economy
v Incentives diverge, regulatory oversight must be embedded into system roots
• Central Bank has broad portfolio of tools
v Each must overlap in a phalanx formation to prevent gaps
v Monetary Policy, macroprudential, microprudental, resolution ..
• Responsible and accountable leadership is crucial
v Embedding risk management, strong governance, board / mgt. diversity
v Deep onus of care to protect consumers; customers, not chess pawns
v Monitor and address technology evolution and emerging risks
• You are all nodes in the financial system
v Avoid the herd, learn financial skills, maintain your resilience
Safeguarding stability, protecting consumers

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Supervision &
Enforcement
Consumer
Protection
Regulatory Policy
Development
Payments, settlements
& currency
Economic advice
& Statistics
Financial
Stability
Price
Stability
Recovery
& Resolution
A Central Bank
trusted by the public,
respected by its peers
Central Bank’s role

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Maybe you can contribute?
www.centralbank.ie/careers