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12 March 2019

ECB's Lautenschläger: The evolution of banking regulation

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Sabine Lautenschläger, Member of the Executive Board of the ECB, speaks about the crucial challenges Basel III poses - getting the balance right between risk sensitivity and simplicity.

Sabine Lautenschläger says:

”I remember the often passionate discussion in the Basel Committee on Banking Supervision (BCBS) about balancing risk sensitivity and simplicity. Not all of us believed in risk sensitivity as a basis for capital requirements.

”So first of all, I am glad that we still have a risk-sensitive capital framework, although restricted by important backstops.

”I am convinced that risk sensitivity is the only way to give banks effective incentives. Bigger risks need to be accompanied by higher capital buffers. Lower risks need smaller capital buffers. If we were to de-link capital requirements from risks and, therefore, potential losses, we would have to deal with unhealthy consequences.

”Although I am convinced by the idea of making capital requirements more risk-sensitive, I acknowledge that estimating actual risk weights is very hard. Thus, it was very important to combine greater sensitivity with backstops. So, with Basel III we introduced the input and output floors, which will limit the influence of modelling choices. And we prohibited the most complex model choices for some specific asset classes.

”And then there is the leverage ratio, of course, which serves as an additional backstop to the risk-sensitive capital requirements.

”Overall, I think we managed to strike a balance by combining a risk-sensitive approach with solid backstops.

”But did we manage to keep the framework simple? Well, it is not actually simple; that much I admit. But we must remember that Basel III is targeted at a financial sector that is very complex. It is a grave mistake to believe that there are simple solutions to complex problems.

”Besides this general point, there are several issues which should and could be dealt with, or discussed at the BCBS. Work can be done to improve joint understanding of emerging risks in the banking sector, to exchange information on standards and best practices on new or increasingly relevant topics, and to work on a minimum convergence of supervisory practices. And if I am informed correctly, many of the topics I will mention can be found in the 2019 work programme of the BCBS:

  • First and foremost, the BCBS should monitor how the new Basel rules are implemented in national laws and ensure it has a thorough overview of how these are then translated into supervisory practices.
  • It should also foster an intensive exchange of information about the risks and vulnerabilities we see in today’s and, in particular, tomorrow’s macroeconomic environment. These discussions should also cover the approaches supervisors could use to analyse, assess and react to these upcoming risks via Pillar 2, or other instruments. After all, a US supervisor’s challenge today may be a European supervisor’s concern tomorrow. I believe that supervisors from around the world would benefit from sharing views and experiences. The one thing we have to keep in mind is this: good supervision is a positive-sum game – everyone wins.
  • The BCBS could and should be a hub for exchanging supervisory knowledge, tools and approaches regarding cyber risk.
  • And finally, the BCBS could be of great help for supervisors regarding operational, legal and reputational risks in banks which are linked to conduct risks or anti-money laundering. The same is true for green finance or climate-related risk. Here, too, a structured exchange of information about different tools and methods would help to strengthen supervision globally.”

Full speech

© ECB - European Central Bank

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