Improving the quality of banking supervision worldwide in the post-reform world
By Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank
Since the onset of the global financial crisis, the regulatory community have initiated a series of significant reforms. The Basel III framework constitutes a central component of the G20 regulatory reforms that have followed. The aim has been to develop a regulatory framework that increases the resilience of the banking system. In turn, this will reduce the probability and mitigate the impact of future financial crises, setting the stage for strong, sustainable and balanced growth.
The Basel framework comprises three Pillars. Pillar 1 sets minimum capital (and now liquidity) requirements. Pillar 2 is the supervisory review process. And Pillar 3 promotes market discipline through public disclosure. All three pillars have been strengthened significantly through a variety of measures.
With the reform agenda largely completed, it is tempting to think that the hard work is over. But, in fact, it is only beginning. First, we must ensure that the reforms are implemented by both authorities and banks as they were intended, which the Committee is doing through its Regulatory Consistency Assessment Programme. Second, we must continue to strengthen our oversight and supervision as banks incorporate the new regulatory requirements into their risk management frameworks. In this respect, banks and supervisors both have a role to play.
Pillar 1: Stronger minimum requirements for regulatory capital and liquidity
Basel III responds to the risk management and supervisory challenges observed during the crisis. The framework seeks to improve banks’ resilience to a range of shocks. It also provides supervisors with the necessary tools to address weaknesses identified in individual banks and oversee the health of the broader financial system.
The major components of the regulatory reforms focus on enhancing banks’ management of capital and liquidity risk. The Basel III capital standards introduced stronger minimum requirements for regulatory capital, by increasing the quantity, quality and risk coverage of capital standards. These measures are complemented by a simpler leverage ratio, which serves as a backstop to the risk-weighted measures.
While the Committee has long discussed liquidity risk, the sudden drying up of liquidity during the crisis brought greater impetus to establish globally harmonised standards. Basel III introduces, for the first time, two minimum standards to manage liquidity risk. In early 2014, we finalised the Liquidity Coverage Ratio and just published the final Net Stable Funding Ratio.
In addition to enhancing the resilience of individual banks, the Basel III framework incorporates broader macroprudential elements. The countercyclical capital buffer regime has been introduced to increase the resilience of banks to the build-up of system-wide risks. Higher loss absorbency requirements have been imposed on systemically important banks perceived to be too-big-to-fail. In addition, the Committee’s revised global framework for measuring and controlling large exposures helps address the negative externalities such banks create and the risks associated with their interconnectedness.
Pillar 2: Strengthening supervision
While much of the attention has been on minimum regulatory standards, the Committee has published important guidance to strengthen supervisory practices. In 2012, the Committee updated the Core Principles for Effective Banking Supervision. The revised Principles emphasise the need for greater supervisory intensity for systemically important banks. By applying a system-wide perspective, the Principles increase focus on effective crisis management and recovery and resolution measures, and place greater emphasis on corporate governance.
The Core Principles are complemented by a series of other initiatives to improve supervision. This includes guidance on identifying and dealing with weak banks; principles for sound stress testing practices and supervision; fundamental elements of a sound capital planning process; and internal audit practices.
Finally, the global community has heightened expectations for cross-border cooperation and information sharing. The Committee has highlighted this through our revised principles for supervisory colleges and ongoing efforts to foster dialogue among supervisors.
While standards and guidance are essential tools of supervision, we should bear in mind that effective supervision ultimately rests on the ability and willingness of supervises to intervene.
Pillar 3: Fostering market discipline
It is critical that these improvements in risk management and supervision are understandable and comparable to stakeholders. Thus, the Committee has placed great emphasis on disclosure and transparency, both from banks and from supervisors. This includes comprehensive, standardised disclosure requirements for all the major Basel III standards, along with a broader review of Pillar 3 disclosure requirements. Greater consistency and comparability in bank disclosures will enable investors to better assess bank risk and thereby strengthen market discipline.
The new minimum requirements for capital, liquidity and disclosure have raised the bar, requiring banks to take greater responsibility to safeguard financial stability. Supervisors, too, are stepping up their efforts to ensure implementation of the Basel III framework into domestic frameworks, and to more effectively – and more intrusively – supervise banks for which they are responsible. A sound and stable financial system is crucial; only strong banks can help the G20 achieve its promise by facilitating strong, sustainable economic growth.