Wednesday, July 26, 2017

There is No Room for Complacency

French Central Banker Outlines Priorities to Complete Post-Crisis Reform

In a July 12, 2017 address before the Paris Europlace International Financial Forum, François Villeroy de Galhau, Governor of the Banque de France, outlined what he sees is necessary to complete the work of financial regulatory reform. Noting that resilience of the global financial system has significantly improved in eight years as a result of sweeping regulatory changes, de Galhau urged regulators and central bankers not to be complacent. There is work yet to finish on the new regulatory framework, and steps that must be taken to consolidate the achievements made thus far in making the global economy safer and more secure.

 

Basel III

 

First and foremost, de Galhau urged the finalization of Basel III “without further significantly increasing overall capital requirements across the banking sector, while promoting a level playing field.”  While this goal was reaffirmed by the G20 members in Hamburg at the beginning of July, work remains to be done on tricky issues like the “output floor” which would apply to banks using internal models. Mssr. de Galhou said he believes that agreement can and must be reached on a prudent but a reasonable level of the output floor.

 

"The objective of Basel III is to lay the foundations for a strong, balanced and risk-sensitive international regulation while reducing the undue variability of risk-weighted assets (RWAs). So we need a prudent but a reasonable level of the output floor, combined with strengthened supervision of banks’ internal models – and Europeans made sensible proposals to achieve this. But should the output floor be set at too high a level, the consequences in terms of the reduction of risk sensitivity and the increase in capital requirements would be unacceptable: for example, a 75% output floor would affect half of international banks. It would de facto result in creating a “Basel IV” framework based on the standardized approach. The output floor is to serve as a backstop, not as the primary driver of capital requirements: yes to Basel III, no to Basel IV.”

 

Shadow Banking

 

With Basel III standards widely accepted and implemented, the solvency of banks is no longer the main worry for the global financial markets. Rather, the liquidity of non-banks is now what keeps regulators awake at night. Though it played a role in the financial crisis, shadow banking remains an area of considerable risk to the global economy.

 

"Therefore the bulk of the regulatory efforts must now be focused on the shadow banking system, which has risen from USD 73 trillion of assets in 2007 to USD 92 trillion in 2015ii– i.e. 150% of total GDP – in the jurisdictions monitored by the Financial Stability Board. And those parts of shadow banking that may pose financial stability risks represent USD 34 trillion; two-thirds of which is composed of collective investment vehicles (CIVs) with features that make them susceptible to runs. It is thus of key importance that authorities develop and use system-wide liquidity stress-testing tools, in order to address the risks of a 'funds-run' in adverse market conditions. The FSB decided on this; it has to be implemented with a strong commitment by IOSCO and national regulators."

 

Central Counterparties

 

Mssr. de Galhou warned that while clearing obligation of OTC derivatives has fortunately reduced OTC transactions, as a result, central counterparties have also become more and more systemic and concentrated. This unanticipated consequence of post-crisis regulation needs to be addressed. The FSB has taken steps to address this risk by issuing guidance on a recovery and resolution framework, which is currently being transposed into EU legislation. But this is just a first step.

 

Backtracking

 

Taking a step back and reexamining post-crisis reform and their effects is healthy and necessary, Mssr. de Galhou said. 

 

"The second requirement is to carefully assess the impact of these new financial regulations. . . This is a key part of the credibility of global financial reforms. Ex-post evaluations will make it possible to assess whether G20 financial regulatory reforms have actually achieved their intended outcomes. Going forward, these evaluations are meant to provide a basis for the possible fine-tuning of post-crisis regulatory reforms, where relevant."

 

But de Galhou warned that backtracking by individual nations is perilous and raises the prospect of “competitive deregulation" and could jeopardize all the regulatory progress made to date.  

 

"Some adjustments to national regulations, applying for instance to locally-active entities, or the Volcker rule, may indeed be deemed appropriate and legitimate. But withdrawing from internationally-agreed minimum requirements which apply to globally-active entities – such as the FRTB or the NSFR standards, I want to insist on the Trading Book – would be completely different and a source of great concern for all. Any temptation of competitive deregulation would be a lose-lose game which would increase the risks of a new financial crisis and therefore weigh on economic growth. International cooperation on financial sector regulation is our common good, and, fortunately, the Hamburg G20 Summit reaffirmed it.”

 

The full text of François Villeroy de Galhau’s address is available via: http://www.bis.org/review/r170725g.pdf

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