29 December 2017

BIS: François Villeroy de Galhau: Monitoring large and complex institutions

It is true that large global banks might look complex. The 2008 Great Financial Crisis showed how highly interconnected financial institutions that were exposed to overly complex derivative products could spread and amplify domestic shocks. Since then, the "too-big-to-fail" issue has been put high on the agenda of the Financial Stability Board and significant progress has been made in this regard. However, there is evidence that some global banks are growing bigger and perhaps becoming even more complex than before.

Complexity is not in itself a drawback. After all, the globalisation of trade might require a certain dose of complexity either due to the nature of the financial products required to hedge against traditional or newly emerging risks, or due to the organisational structures that result from cross-border activities. Similarly, one should not preclude the diversification benefits associated with large global financial institutions exposed to partially correlated domestic markets. The true question is how to strike the right balance between the diversification benefits that arise from multiple businesses financing the real economy and the potential weaknesses in risk management caused by this increased complexity.

A regulatory framework in Europe that penalises unnecessarily complex banking activities by imposing higher capital requirements, allowing for more intrusive and comprehensive supervision and fostering greater transparency was set up. The new resolution mechanism aims at extinguishing the implicit government guarantees, which provide an incentive for excessive risk taking and levels of complexity in order to gain "too-big-to-fail" status.

“But we still face important challenges ahead. I want to stress two of them. The Single Resolution Mechanism, the second pillar of the Banking Union, has just successfully passed its first real test this summer with the orderly resolution of Banco Popular. However, there is still room for improvement in the coordination between the numerous institutions and authorities involved in these procedures. It means that every participant must know and very clearly understand its role in the process to ensure an efficient resolution.

“Second, Europe still suffers from overcapacity and cross-border consolidation is needed. In the United States, the top five banks have a market share of more than 40% while this figure is barely 20% in Europe. Given the new regulatory and supervisory framework I described earlier, we believe that the Banking Union should be considered - according to the criteria set up by the BCSB - as a single geographic area. Furthermore, we are reaching the point in Europe where facilitating healthy and well-designed cross-border mergers could actually improve financial stability. It would make banks better able to diversify their risks, achieve economies of scale and become more efficient. And as we have strengthened the single supervision and resolution of significant institutions, we should not fear the "too-big-to-fail" issue. Cross-border consolidation would foster a more efficient allocation of savings towards productive investments in Europe and it would place European banks in a better position in terms of international competition.

“To conclude, interactions between policy makers, researchers and practitioners are very valuable and I am certain that this conference will contribute to fuelling these interactions. We strongly believe in the positive spillovers from the research function being closely intertwined with the supervisory and financial stability divisions. In particular, empirical evaluations and theoretical works on policy design - and we will see some of them presented today - are absolutely necessary in order to fine tune and reinforce the regulatory reforms that have been implemented not only in Europe but worldwide.”

Full speech

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