19 September 2013

Bundesbank/Dombret: Five years after Lehman

"We should see the financial system as what it is: a service provider for the real economy. Subscribing to this notion of finance will probably be the most important step toward financial stability."

Dombret gave a brief overview of the lessons that had been learnt from the past, and highlighted measures taken to translate those lessons into a better regulatory framework.

Regulators have to ensure that new financial instruments do not pose systemic risks, which means addressing the problems of distorted incentives and the lack of transparency with regard to securitisation. On both accounts, we have made good progress.

Looking at the incentive structures within banks: the problem of inadequate compensation schemes is addressed by the Financial Stability Board principles for sound compensation practices.

Raising banks' resilience

The good news is that, today, banks are much better capitalised than they were five years ago. And this is in line with the new international regulatory standards. Basel III requires banks to hold more and better capital. This raises bank’s capacity to absorb losses and makes them more resilient against sudden shocks.

The concept of risk-weighted assets is being maintained – and rightly so. Despite all criticism, risk weights set proper incentives for prudent risk management – and these should not be foregone. However, risk weights assigned to different asset classes need to be reassessed. I doubt that the zero risk weight for government bonds is adequate.

But, during the crisis, it was not only inadequate capital buffers that posed a problem. Many banks also had inadequate liquidity buffers. And now, five years later, we have, for the first time ever, decided on an international standard on liquidity.

But, still, individual banks getting into trouble was just the first step toward the brink.  If a too-big-to-fail bank runs into difficulties, the government will have to step in to prevent a systemic crisis. This entails an unhealthy asymmetry to the detriment of the taxpayer. This asymmetry in turn provides distorted incentives for banks. So the next step must be to ensure that even large and interconnected banks can fail without causing a systemic crisis. Toward this end, a new international standard on recovery and resolution of systemically important banks has been developed.

In general, transparency will be further enhanced by a new tool that is currently under development: the legal entity identifier, LEI for short. This tool will allow the risk management of banks to aggregate and assess total exposure to individual counterparties much more easily.

One of the main outstanding issues is that there is still no international capital standard for insurers. However, initial steps have been taken in this regard. And taking a more medium-term perspective, a comprehensive supervisory and regulatory framework for internationally active insurers will be developed, including a quantitative capital standard.

And there are other areas of bank-like business ("shadow banks") that are still outside the perimeter of banking regulation. It is a place where systemic risks can emerge because of unregulated liquidity and maturity transformation, because of the build-up of leverage, and because of pro-cyclicality. Just two weeks ago, the Financial Stability Board provided the G20 summit with new recommendations on how to address these risks.

Since Lehman failed, we have chosen the right way, but we have not yet reached our destination: a stable financial system that serves the real economy. And to achieve that objective in due time, we have to move at a faster pace. What we need is a change of culture. The times of "greed is good" should have long been gone. 

Full speech

© Deutsche Bundesbank