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Proposed Rulemakings for an Integrated Regulatory Capital
Framework, Questions and Answers, June 7, 2012
Question 1: What does the
package of proposed rulemakings contain and why is it divided
into three parts?
package contains three notices
of proposed rulemaking (NPRs)
that, taken together, would restructure the Board’s current
regulatory capital rules into a harmonized, comprehensive
framework, and would revise the capital requirements to
make them consistent with the Basel
III capital standards
established by the Basel Committee on Banking Supervision (BCBS)
and certain provisions of the
Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act).
proposals are published in
separate NPRs to reflect the distinct objectives of each
proposal, to allow interested
parties to better understand the various aspects of the overall
capital framework, including
which aspects of the rule would apply to which banking
organizations, and to help
interested parties better focus their comments on areas of
The BCBS quantitative
requirements and the BCBS capital surcharge for global
systemically important banks are
of this rulemaking.
The Basel III NPR
1. The first NPR,
Regulatory Capital Rules: Regulatory Capital, Implementation of
Basel III, Minimum Regulatory Capital Ratios, Capital Adequacy,
Transition Provisions, and Prompt Corrective Action (Basel III
NPR), is primarily focused on
proposed reforms that would improve the overall quality and
quantity of banking organizations’ capital.
would revise the Board’s risk-based and leverage capital
requirements, consistent with the Dodd-Frank Act and with
agreements reached by the BCBS in Basel III:
A Global Regulatory Framework for
More Resilient Banks and Banking Systems (Basel III).
proposal includes transition provisions designed to provide
sufficient time for banking organizations to meet the new
capital standards while supporting lending to the economy.
The Standardized Approach
2. The second NPR,
Regulatory Capital Rules:
Standardized Approach for Risk-weighted Assets; Market
Discipline and Disclosure Requirements (Standardized Approach
NPR), would revise and
harmonize the Board’s rules for calculating risk-weighted assets
to enhance their risk sensitivity and address weaknesses
identified over recent years.
It would incorporate
aspects of the BCBS’s Basel II standardized framework in the
International Convergence of Capital
Measurement and Capital Standards: A Revised Framework (Basel
II), Basel III, and
alternatives to credit ratings for the treatment of certain
exposures, consistent with the Dodd-Frank Act.
The Advanced Approaches and Market
3. The third
NPR, Regulatory Capital Rules:
Advanced Approaches Risk-based Capital Rule; Market Risk Capital
Rule (Advanced Approaches and Market Risk NPR),
would revise the advanced approaches
risk-based capital rule (in a manner consistent with the
Dodd-Frank Act) and
incorporate certain aspects of Basel III
that the Board would apply only to advanced approaches banking
organizations (generally, the largest, most complex banking
This NPR would also codify the Board’s
market risk capital rule and, in combination with the other
components described above, would apply consolidated capital
requirements to savings and loan holding companies (SLHCs).
Question 2: Which banking
organizations are covered by the proposed rulemakings?
The Basel III NPR and the Standardized Approach NPR would
apply to state member banks, bank holding companies domiciled in
the United States not subject to the Board’s Small Bank Holding
Company Policy Statement (generally, bank holding companies with
less than $500 million in
consolidated assets), and SLHCs domiciled in the United States.
Consistent with Section 171
of the Dodd- Frank Act, the proposed rulemakings would apply to
all SLHCs regardless of asset size.
Approaches and Market Risk NPR would generally apply to banking
organizations meeting specified thresholds.
the advanced approaches risk based capital rule applies to those
banking organizations with consolidated total assets of
at least $250 billion or consolidated
total on-balance sheet foreign exposures of at least $10 billion
(excluding insurance underwriting assets) and their depository
market risk capital rule generally applies to those banking
organizations with aggregate trading assets and trading
liabilities equal to at least 10 percent of quarter-end total
assets or $1 billion.
Question 3: How are these proposed rulemakings related to the
NPRs are consistent with statutory requirements in the
For example, pursuant to section 171 of
the Act, the NPRs would establish minimum riskbased and leverage
capital requirements for SLHCs, phase out certain capital
instruments over a three-year period, and establish new minimum
generally applicable capital requirements.
pursuant to section 939A of the act, the NPRs remove references
to, or requirements of reliance on, credit ratings in the
Board’s capital rules and replace them with alternative
standards of creditworthiness.
Question 4: What are the main changes
to the minimum capital requirements?
The proposal includes a new common equity tier 1 minimum
capital requirement of 4.5 percent of risk-weighted assets and a
common equity tier 1 capital conservation buffer of 2.5 percent
of risk-weighted assets.
The proposal also increases the
minimum tier 1 capital requirement from 4 to 6 percent of
minimum total riskbased capital
requirement would remain unchanged at 8 percent.
The proposal introduces a supplementary leverage ratio that
incorporates a broader set of exposures in the denominator
measure of the ratio for banking organizations subject to the
advanced approaches capital rule.
leverage ratio is based on the international leverage ratio in
What are the main changes related to the definition of capital
instruments issued by banking organizations would be subject to
a set of strict eligibility criteria that would prohibit, for
example, the inclusion in tier 1 capital of instruments that are
not perpetual or that permit the accumulation of unpaid
dividends or interest.
Trust preferred securities,
for example, would be excluded
from tier 1 capital, consistent with both Basel III and the
the Basel III NPR, banking organizations would be subject to
generally stricter regulatory capital deductions (the majority
of which would be taken from common equity tier 1 capital).
For example, deductions related to mortgage servicing
assets, deferred tax assets, and certain investments in the
capital of unconsolidated financial institutions would generally
be more stringent than those under the current rules.
Question 6: What is the capital
conservation buffer and how would it work?
In order to avoid limitations on capital distributions
(including dividend payments, discretionary payments on tier 1
instruments, and share buybacks) and certain discretionary bonus
payments, under the proposal banking organizations would need to
hold a specific amount of common equity tier 1 capital in excess
of their minimum riskbased capital ratios.
phased-in buffer amount would be equal to 2.5 percent of
Question 7: Will the new capital requirements and capital
conservation buffer be imposed immediately or will there be a
Basel III NPR contains transition provisions designed to give
ample time to adjust to the new capital requirements, consistent
with the agreement in Basel.
The new minimum regulatory
capital ratios and changes to the calculation of riskweighted
assets would be fully implemented January 1, 2015.
capital conservation buffer framework would phase-in between
2016 and 2018, with full implementation January 1, 2019.
Question 8: What is common equity
tier 1 capital and why are you proposing a new common equity
tier 1 requirement?
Common equity tier 1 capital is a new regulatory capital
component that is predominantly made up of retained earnings and
common stock instruments (that comply with a series of strict
eligibility criteria), net of treasury stock, and net of a
series of regulatory capital deductions and adjustments.
Common equity tier 1 capital may also include limited
amounts of common stock issued by consolidated subsidiaries to
third parties (minority interest).
equity tier 1 capital is the highest quality form of regulatory
capital because of its superior ability to absorb losses in
times of market and economic stress.
Question 9: What are the main
elements of the Standardized Approach NPR?
It would increase the risk
sensitivity of the Board’s general risk-based capital
requirements for determining risk-weighted assets (that is, the
calculation of the denominator of a banking organization’s
risk-based capital ratios) by proposing revised methodologies
for determining risk-weighted assets for:
Residential mortgage exposures
by applying a more risk-sensitive treatment that would
risk-weight an exposure based on certain loan characteristics
and its loan-tovalue ratio;
Certain commercial real estate credit
facilities that finance the
acquisition, development, or construction of real property by
assigning a higher risk weight;
Exposures that are more than 90 days
past due or on nonaccrual
(excluding sovereign and residential mortgage exposures) by
assigning a higher risk weight; and
Exposures to foreign sovereigns,
foreign banks, and foreign public sector entities
by basing the risk weight for each exposure type on the country
risk classification of the sovereign entity.
would also replace the use of credit ratings for securitization
exposures with a formula-based approach.
the NPR would provide greater recognition of collateral and
However, for most exposures, no changes are
being proposed in the NPR.
the treatment of exposures to the
U.S. government, government-sponsored entities, U.S. states and
municipalities, most corporations, and most consumer loans would
would introduce disclosure requirements that would apply to
banking organizations domiciled in the United States with $50
billion or more in total assets, including disclosures related
to regulatory capital.
The changes in the Standardized
Approach NPR are proposed to take effect January 1, 2015.
Banking organizations may choose to comply with the proposed
requirements prior to that date.
Question 10: What are the primary
objectives of the Advanced Approaches and Market Risk NPR?
It would revise the advanced approaches risk-based capital
rule in a manner consistent with the Dodd-Frank Act by removing
references to credit ratings from the securitization framework,
requiring an enhanced set of quantitative and qualitative
disclosures (especially in regard to definition of capital and
securitization exposures), implement a higher counterparty
credit risk capital requirement to account for credit valuation
adjustments, and propose capital requirements for cleared
transactions with central counterparties.
The NPR would
incorporate the market risk capital rules into the integrated
regulatory capital framework and propose its application to
savings and loan holding companies that meet the trading
11: How will the Prompt Corrective Action (PCA) framework change
as a result of the proposed rulemakings?
Under the proposal, the capital thresholds for the different
PCA categories would be updated to reflect the proposed changes
to the definition of capital and the regulatory capital minimum
Likewise, the proposal would augment the PCA capital categories
by incorporating a common equity tier 1 capital measure.
In addition, the proposal would include in the PCA framework
the proposed supplementary leverage ratio for advanced
approaches banking organizations.
Note that the new PCA
framework would take effect
starting on January 1, 2015,
consistent with the full transition of the minimum capital
requirements and the Standardized Approach for the calculation
of risk weighted assets.
2011 - Capital and
Speech by Governor Daniel K. Tarullo,
Board of Governors of the Federal Reserve System, before the
Committee on Financial Services, U.S. House of Representatives,
The financial stability
benefits of the Basel III
reforms will be realized only if they are implemented rigorously and
consistently across jurisdictions.
acceptable standards into national legislation or regulations is
only the first step in effective implementation.
critical step is
ensuring that these standards are, in
practice, rigorously enforced
by national supervisors and observed by firms across all the Basel
In the United States, the Federal Reserve, FDIC, and Office of the
Comptroller of the Currency (collectively, the banking agencies) are
working to update and enhance risk-based capital standards, and
introduce liquidity standards through a series of rulemakings.
These rulemakings will be used to align U.S. capital and liquidity
regulations with Basel III.
In accordance with the
internationally agreed-upon implementation timeframes, the banking
agencies plan to issue a notice of proposed rulemaking in 2011 and a
final rule in 2012 that would implement the Basel III reforms.
We expect that other jurisdictions will be adopting regulations or,
where necessary, legislation in a similar timeframe.
Basel Committee will review progress and identify any potential
inconsistencies with the terms of Basel III.
incorporation of Basel agreements into national law is a fairly
straightforward exercise, though no less important for that. It is
also a familiar exercise in the Basel Committee.
regard, the international leverage ratio the Basel Committee has
adopted and is currently monitoring serves as an important backstop
to risk-based ratios that rely extensively on banks' models.
It is notable that analysts that follow significant global financial
institutions use a leverage ratio to gain insights into the
credibility of banks' average risk-weighted assets.
Federal Reserve Board is fully committed to ensuring a robust
leverage ratio remains in place for internationally active
Despite extensive sharing of information on
supervisory practices, the Basel Committee has, over the years,
found it difficult to achieve what I have characterized as the
second critical step in the implementation of international capital
accords--that is, rigorous and consistent application of those rules
by supervisors and firms across countries, as reflected in reported
capital levels and amounts of risk-weighted assets of individual
An international process for monitoring
implementation on a bank-by-bank basis has become increasingly
necessary as capital standards have relied to a greater extent on
internal market-risk or credit-risk models, the parameters and
operation of which are not transparent.
This tendency has
combined with the relatively opaque nature of bank balance sheets to
complicate external efforts to assess how banks are meeting their
One area that has deservedly received
attention of late is the potential for differences in the
calculation of risk-weighted assets across banks, both currently and
prospectively under the Basel III standards.
market participants have focused on differences in measured risk
Analysts have pointed out that large U.S. banks
generally have markedly higher average risk weights, ratios of
risk-weighted assets to total assets, and ratios of common equity to
total assets, adjusted for differences in accounting, than some of
their foreign competitors.
These large disparities cannot
be easily explained away through differences in risk profiles, which
are largely similar within the business lines of competing banks.
Indeed, with regard to capital for trading activities,
where a commonly disclosed measure of risk is one-day value-at-risk
(VaR) U.S. trading banks appear to hold multiples of the capital
non-U.S. trading banks hold per unit of VaR. Precisely because of
the opacity of bank balance sheets and their internal risk models,
we do not yet fully understand the reasons for these disparities.
Some observers have suggested that U.S. stringency in
application of the rules and standards may be a factor.
Gaining insight into these differences and taking action to more
closely align capital requirements for similar risk exposures across
countries will take concerted work within the Basel Committee.
The Basel Committee leadership has acknowledged that failing to
implement Basel III in a globally consistent manner could lead to a
competitive race to the bottom and increase risks to the global
The Committee must take action to avoid
this outcome, specifically through the Committee's Standards
Implementation Group (SIG).
The SIG is initiating this year
a peer review process, through which teams of experts will assess
the extent to which countries have implemented Basel Committee
While these reviews will focus initially on
standards other than capital, such as stress testing, the process
should nevertheless provide insight into how approaches and outcomes
related to the implementation of Basel III can be meaningfully
monitored and compared.
The SIG has already begun sharing
information on the status of Basel III implementation by member
countries and is in the early stages of planning comparative work on
risk-weighted assets across jurisdictions and banks to promote
As the Basel Committee moves
into this next phase, we will urge the Committee to take a
comprehensive approach to monitoring processes that includes three
First, the Committee should begin work as soon as
possible to develop mechanisms to implement effective cross-country
Second, this process should go beyond
traditional stocktaking exercises to include a careful assessment of
the methodologies national regulators use to determine the
appropriateness and acceptability of bank practices.
Third--and here is where the real work will lie--the Committee must
develop a mechanism to validate the actual risk-weighted assets
calculated by individual banks under international capital
There are several possibilities for conducting
this work. One that has been discussed in the Basel Committee would
be to use tools such as benchmarks and test portfolios, in order to
provide an accurate, quantifiable comparison of standards
implementation across jurisdictions.
far-reaching option would be to use validation teams working under
the auspices of the Basel Committee itself to verify the
methodologies used at individual banks to ensure their compliance
with international standards.
They could use expertise
gained through horizontal reviews of institutions to make
assessments of individual banks in different jurisdictions.
A less far-reaching variant of this option would entail national
supervisors collaboratively participating in examinations of
As a result of these monitoring and
validation processes, outliers (i.e., banks whose risk weights for
comparable assets differ materially from those of other banks) could
be identified so that national supervisors might perform more
in-depth analyses of their banks' processes and outcomes.
This would lead to a greater understanding of the disparity in
results for certain institutions or jurisdictions based on their
assumptions, data, or risk profiles.
There can be
legitimate reasons that banks may have different risk estimates for
Where disparities are identified,
however, national supervisors of outlier banks should be called upon
to explain the results to their fellow supervisors, as well as steps
they are taking to address situations in which differences may arise
from systematic underestimation of risk or manipulation of capital
ratios to achieve desired outcomes.
Any of these options
would require the Basel Committee, international supervisors, and
banking organizations to work together to address confidentiality
concerns, as well as other jurisdictional issues. Some options will
surely prove more feasible than others.
While we do not
prejudge which will prove to be most effective, we do maintain that
something of this sort is necessary in order to assure that the
benefits for financial stability promised by international capital
standards are in fact being realized, as well as to prevent some
banks from enjoying competitive advantage through lax application of
At the same time, any of these options will
give banking supervisors from the countries represented on the Basel
Committee an opportunity to work together to address the many issues
of implementation, interpretation, and evasion that will surely
arise under Basel III.
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Bank holding companies should consult with
Federal Reserve staff before taking any actions that could
result in a diminished capital base, including actions such as
increasing dividends, implementing common stock repurchase
programs, or redeeming or repurchasing capital instruments more
broadly (planned capital actions).
capital plan submitted in response to this request should:
Reflect management’s plans for addressing proposed revisions to
the regulatory capital framework agreed by the Basel Committee
on Banking Supervision (Basel III).
BHCs should provide a transition plan that
includes pro forma estimates of regulatory capital ratios
consistent with the recently proposed Basel III regulatory
framework over the phase-in period, with supporting detail
around actions and assumptions to be taken over the entire
period necessary for the BHC to meet the fully phased in 7% tier
1 common equity target; and
in Anticipation of Basel III:
The Federal Reserve will evaluate whether
the proposed capital action(s) are appropriate in light of
management’s plans to address the proposed Basel III reform
The Federal banking agencies have begun
the process for adopting the Basel III framework agreed to by
the Basel Committee.
In line with this effort, the
Federal Reserve expects that BHCs will
demonstrate with great assurance that they could achieve the
ratios required by the Basel III framework,
inclusive of any proposed dividend increases or other capital
distributions, as those ratios come into effect in the United
Accordingly, as part of its comprehensive
capital plan submission, management should provide a transition
plan that includes pro forma estimates under the baseline
scenario of the BHC’s regulatory capital ratios in the recently
proposed Basel III regulatory framework, with due regard to the
possibility that earnings or losses may be less favorable than
As stated in the
September 2010 Group of Governors and
Heads of Supervision agreements, under the Basel III proposal
BHCs that meet the minimum ratio requirement during the
transition period but remain below the 7% tier 1 common equity
target (minimum plus conservation buffer) would be expected to
maintain prudent earnings retention policies with a view to
meeting the conservation buffer as soon as reasonably possible.
In considering a proposed capital
action, the Federal Reserve will also take into account the
nature of the proposed capital action, such as whether a
proposed redemption of regulatory capital instruments is funded
by the issuance of instruments of equal or better quality in
terms of loss-absorption capacity, or whether common share
repurchases are designed to offset increases in share count
related to employee share-based compensation awards.
Moreover, notwithstanding the factors
described above, the Federal Reserve may determine that a BHC’s
proposed capital actions are inappropriate in view of
supervisory concerns such as unresolved risk management issues.
The Federal Reserve will contact each BHC
when the supervisory review of its comprehensive capital plan
has been completed. Plans containing the elements specified
above that are submitted by the first week of a calendar quarter
will generally receive a supervisory response no later than 10
days prior to quarter end.
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September 22, 2010 - Treasury Secretary Timothy F. Geithner,
Written Testimony, House Financial Services Committee
"Basel III proposals, must be fully implemented through national
regulations by the end of 2012.
The United States is committed to meeting these deadlines."
"Chairman Frank, Ranking Member Bachus, and members of the
Financial Services Committee, thank you for the opportunity to
testify before you today about
international regulatory issues relevant to the implementation
of the Dodd-Frank Act, particularly reform of global capital
Last week the Federal Reserve, the OCC, and the FDIC
reached agreement with their principal foreign counterparts to
substantially increase the levels of capital that major banks
will be required to hold.
As a result of this agreement, banks will have to hold
substantially more capital.
The new standards are designed to ensure that major banks hold
enough capital to withstand losses as large as what we saw in
the depths of this recession and still have the ability to
operate without turning to the taxpayer for extraordinary help.
This agreement will make our financial system more stable
and more resilient.
By forcing financial institutions to hold more capital, we will
both constrain excessive risk-taking and strengthen banks'
abilities to absorb losses.
This agreement is designed to allow banks to meet these more
stringent standards gradually over time, so that they can
continue to perform their essential function of providing credit
to households and businesses.
These standards will help
establish a more level playing field around the world.
By moving quickly to recapitalize our financial system, we have
been in a strong position to insist on tough standards abroad.
The Importance of Capital and Liquidity
Excess leverage, a term that describes the amount of
risk firms take relative to the financial reserves they hold
against those risks, has played a central role in virtually all
Capital requirements determine the amount of losses firms can
absorb and the magnitude of the risks they can take without
They help the market provide discipline by forcing shareholders
who enjoy profits in good times to be exposed to losses in bad
Capital requirements are the financial equivalent of having
speed limits on our highways, antilock brakes and airbags in our
cars, and strong building codes in communities prone to
Failures in our system of capital requirements were
major contributors to the severity of this crisis.
Where we had capital requirements, they were too low and they
were not supplemented with complementary liquidity requirements.
Furthermore, there were no systematic capital requirements in
the rapidly emerging
"shadow banking" system.
Finally, capital standards were not applied consistently around
the world. Banks in many parts of the world were allowed to
operate with low levels of capital relative to the risks they
At last year's Pittsburgh Summit, the
G-20 Leaders, led by the Obama
Administration, called for financial institutions to raise the
quality and quantity of capital, strengthen liquidity standards
and implement rules to limit leverage.
Strengthening capital requirements for major financial
institutions was also an important objective in the legislative
debate on reforming U.S. financial regulation.
Dodd-Frank Act and the Basel process
are designed to ensure that major financial institutions are
subject to rigorous and consistent capital requirements.
agreement just reached in Basel is an important step towards
realizing that goal and fulfilling the G-20's call, and it will
be presented to G-20 Leaders at their November Summit in Seoul.
The New Standards
The work of the Basel Committee over the last year,
culminating in the
agreement announced last week,
will significantly tighten the system of global capital
requirements in a number of important ways.
the amount of capital that banks will be required to hold
relative to risks they take will increase substantially.
Under the new agreement major banks will be subject to
two tiers of capital requirements.
All firms will need to hold a substantial minimum level of
Further, they will be required to hold an
added buffer of capital above the minimum.
If a firm suffers losses that force it to eat into that buffer,
it will have to take active steps, such as
reducing dividends or limiting share repurchases, to restore the
The buffer is important because it will force banks to move more
quickly to strengthen their balance sheets as the risk of
potential losses increases.
Capital requirements are set
relative to a bank's assets, which are
weighted to reflect the riskiness of those assets.
That is, capital requirements are defined as a ratio of
"risk-weighted assets" (RWA).
The level of the new minimum and buffer – 4.5 percent and 2.5
percent of banks' RWA, respectively – have been set to ensure
that major banks hold enough capital so they can withstand
losses similar to what we saw in the depths of this recession
and still have the ability to operate without turning to the
taxpayer for extraordinary help.
Second, banks will be required to
hold more capital against more risky products and activities,
including derivatives, which caused substantial financial damage
during the crisis.
These assets and exposures are held predominantly by the very
this aspect of the Basel reforms will generate large increases
in capital requirements for risky
activities typically undertaken by the biggest banks, but is
likely to have only a modest impact on smaller banks.
the Basel agreements will improve the
quality of capital that banks hold.
In contrast to the current rules, which allow a wide range of
forms of capital, the new requirements are set in terms of high
quality common equity, tightly defined to mean capital that will
truly absorb first losses when firms get into trouble.
Taken together, the new Basel agreements impose a very
substantial increase in capital requirements on banks around the
The change in the ratios alone represents
more than a three-fold increase in high quality capital required
in the system.
Before the recent crisis, banks were implicitly required to hold
common equity equal to 2 percent of their risk weighted assets.
Now banks will effectively be required to hold tangible common
equity equal to 7 percent – the 4.5 percent minimum plus the 2.5
percent buffer – of their risk-weighted assets.
In addition, both the new more restrictive definition of what is
allowed to count as capital and the more stringent assessment of
the risks associated with derivatives, trading-related assets,
and exposures to other financial firms will effectively raise
capital requirements even further.
these additional effects will fall most heavily on the largest,
most inter-connected banks.
In addition to new capital requirements, the Basel
Committee has agreed to impose new global standards for
During the recent crisis banks were poorly prepared for the
funding pressures that occurred, and this was a major factor
that intensified stress throughout the financial system.
The new liquidity standards are designed to ensure that firms
can withstand a severe shock in liquidity without deepening a
crisis by, for example, selling assets in a panic, cutting
credit lines indiscriminately, or turning to central banks for
excessive liquidity support.
Basel Committee also agreed that banks should be subject to a
U.S.-style cap on leverage as a
backstop for the more complex risk-weighted capital
The new internationally applied leverage ratio requirement
will, for the first time, include firms' off balance sheet
commitments and exposures.
Finally, the recent agreement, by providing a
more constrained definition of capital
and by expanding to include new international standards on
liquidity and aggregate leverage, provides a framework for more
rigorous and consistent global capital standards.
cannot know with certainty how the economy and the financial
system will evolve, but these heightened capital requirements,
along with other important reforms, should substantially reduce
the likelihood that we will soon repeat the sort of severe
financial crisis that we have just lived through.
requirements are going up substantially.
But if we were to raise them too fast we could hurt economic
To limit that possibility, the agreement gives banks a
meaningful transition period to meet the new standards.
The new capital requirements will not become effective until the
beginning of 2013, and banks will not have to meet the full
minimum common equity capital requirement of 4.5 percent of
risk-weighted assets until the beginning of 2015.
The buffer will be phased in between 2016 and 2019.
In addition, the definition of capital becomes progressively
more stringent between 2013 and 2018.
It is important to note that because we moved so quickly
with the bank stress tests in early 2009 that forced banks to
raise more common equity, the U.S. financial system is in a very
strong position internationally to adapt to the new global
For the most part, banks should be able to meet these new
requirements through future earnings, which will help protect
the recovery currently underway.
The Road Ahead
The agreement that has just been reached is a major
milestone in the process of reforming global capital standards.
But we still have more work to do.
requirements are a new part of the Basel system. We will need to
make sure that they are calibrated correctly before they are
It is also essential that
the Basel agreements are implemented by national authorities in
a way that generates a `level playing field' in our increasingly
integrated global financial system.
We will engage our foreign
counterparts to look for ways to ensure that that these
agreements are implemented in a transparent and consistent way
by supervisors in different countries.
We will also continue to explore innovative ways, such
as the use of
counter-cyclical buffers and
contingent capital, to expand the capacity for the system to
absorb unexpected losses without amplifying shocks to the
The new capital standards have to be implemented
at the national level.
The agreement that was just reached, and other so-called Basel
must be fully implemented through national regulations by the
end of 2012.
The United States is committed to meeting these deadlines.
the agreement reached in Basel last week, working with the
Dodd-Frank Act, will significantly lower the probability and
severity of future financial crises,
and it will help protect taxpayers by limiting excessive
risk-taking by financial institutions.
The Basel agreement is the result of thoughtful and diligent
work by the men and women of key regulatory and supervisory
agencies here and around the world. We owe them our thanks. "
Treasury Assistant Secretary for Financial Institutions Michael
S. Barr, Remarks at the Chicago Club on Next Steps on
Financial Reform: Implementing the Dodd-Frank Act to End Too
Big To Failst month,
President Obama signed into law a comprehensive set of reforms
to our financial system that will lay a firm foundation for
growth and prosperity in the years ahead.
Last week in
Charlotte, I focused on getting the balance right on consumer
protection while fostering innovation and growth.
Today I want to focus on the task of ending "too- big-to-fail."
Dodd-Frank reforms will help to make sure that risks taken by
banks do not threaten the health of the economy as a whole.
These reforms require the largest financial firms to build up
their capital and liquidity buffers, constrain their relative
size, and place restrictions on their riskiest financial
These reforms bring transparency to the shadow banking system
and fully regulate our derivatives markets.
And these reforms create a mechanism for the government to shut
down failing financial firms without putting taxpayers at risk.
The import of the Act is clear: in the future, no financial firm
will be "too big to fail."
For much of the last century,
the American financial system was the envy of the
world--surpassing other major developed economies in innovation
and productivity growth.
It provided investors and consumers with the strongest
Its regulatory checks and balances helped create a remarkably
long period of relative economic stability. And the financial
system was consistently better at directing investment towards
the companies and industries where the returns would be the
But over time those great strengths of our
financial system were undermined. The careful mix of protections
we created eventually eroded.
Huge amounts of risk moved outside the banking system to where
it was easier to increase leverage. In the period leading up to
the recent crisis, we saw the significant growth of large,
highly leveraged, and substantially interconnected financial
These firms benefited from the perception that they were
"too-big-to-fail"-- a presumption that they would receive
government assistance in the event of failure.
This was an advantage for them in the marketplace.
Creditors and investors believed that large firms could grow
larger, take on more leverage, engage in riskier activity – and
avoid paying the consequences should those risks turn bad.
It was a classic problem of moral hazard.
adverse effects of "too-big-to-fail" are numerous.
Such a presumption reduces market discipline and encourages
excessive risk-taking by firms.
It provides an artificial incentive for firms to grow. It
creates an unlevel playing field with smaller firms.
And as we've recently seen, the government had no effective
tools to respond to the distress of major non-bank financial
firms, whose failures had devastating effects that rippled
throughout the economy.
Without meaningful reform, the
government's actions in the recent financial crisis, while
necessary to prevent the implosion of our financial system,
would have likely magnified the market's expectations of
government support in times of severe economic stress.
Any continuation of this presumption would have been a serious
threat to financial stability and free and fair markets. That is
why we had to enact reform, and that is why we must move quickly
to demonstrate credibly that, with the passage of the Dodd-Frank
Act, the conditions that once gave rise to this presumption have
been permanently ended.
The new resolution authority, and
the constraints on other emergency authorities, have critically
undercut any reasonable presumption that a major financial firm
can fail without significant pain being inflicted on its
shareholders, creditors and management.
We will--once and for all--fully end the market's perception of
"too-big-to-fail" firms, when we build a system that is capable
of absorbing the failure of the next AIG or Lehman Brothers; a
system that constrains risk-taking by major financial firms,
strengthens the basic shock absorbers and transparency in the
financial system, and provides the government with credible
tools to manage effectively the failure of major financial firms
while at the same time safeguarding the broader economy.
On the foundation provided by the Dodd-Frank Act, we must
now build that system--with speed and diligence--and restore the
American economy as the world's most reliable engine for
economic growth and innovation.
Monitoring and Mitigating Systemic Risk
In the recent crisis, a key enabler of the
"too-big-to-fail" presumption was the inability to sufficiently
monitor emerging concentrations of risk throughout the financial
system. Regulators cannot constrain risk if they cannot see it.
To address these risks, the Dodd-Frank reforms focus on
three major tasks:
1) providing an effective system for monitoring and responding
to systemic risks or threats to financial stability as they
2) creating a single point of accountability for tougher and
more consistent supervision of the largest and most
interconnected institutions; and
3) tailoring the system of regulation to cover the full range of
risks and actors in the financial system, so that risks can no
longer build up without oversight or ability to monitor.
these reforms create accountability and provide new authority to
identify and manage systemic risk in a way that we could not do
The Act establishes the
Financial Stability Oversight Council,
with clear responsibility for examining emerging threats to our
financial system regardless of where they come from.
The Council is chaired by the Secretary of the Treasury and its
membership includes the heads of the financial regulatory
The Council has a critical role in the management of systemic
risk: to designate firms for heightened supervision by the
Federal Reserve and to make recommendations to the Fed and other
federal financial regulators concerning the establishment of
heightened prudential standards.
The Act also establishes
Office of Financial Research (OFR) within the Treasury
– to support the Council through the collection and analysis of
data concerning risk in the financial system.
The OFR will be able to gather critical financial information
not available elsewhere – looking across the whole financial
system, and providing insight to the Council and its member
agencies, Congress, and the public.
these reforms provide for clear, accountable, strong and
consolidated supervision and regulation by the Federal Reserve
of any financial firm whose combination of size, leverage, and
interconnectedness could pose a threat to financial stability if
the reforms will shine sunlight on the
shadow worlds of derivatives and the parallel banking system,
which played such major roles in almost pushing us into a second
The recent crisis has clearly demonstrated that risks to
the system can emerge from all corners of the financial markets
and from any of our financial institutions.
That's why these reforms bring over-the-counter derivatives
markets into a comprehensive and rigorous regulatory framework;
provide for consistent and tough regulatory oversight for
critical clearing, payment, and settlement systems; strengthen
the regulation of markets for securitization; and require the
registration of all hedge funds and other private pools of
capital over a minimum threshold in size.
In the lead-up
to the recent crisis, we needed a system that let regulators see
risks as they emerged across the financial system. The reforms
we've enacted achieve that aim.
Basic Reform of Capital, Supervision, and Resolution Authority
To fully end "too-big-to-fail" we need to make our financial
system safer for failure.
We cannot rely on the hope of perfect foresight--whether by
regulators, or by managers of firms, private sector gatekeepers,
or other market participants.
Financial activity involves risk, and no one will be able to
identify all risks or prevent all future crises.
However, robust capital, leverage, and liquidity requirements
can prevent the build-up of risk, ex ante, and insulate the
system from unexpected shock events, ex post. Imposing higher
prudential standards on the largest, most interconnected firms
will require them to internalize the risks they impose on the
system by virtue of their size and complexity.
The largest and most interconnected firms cause more damage to
the system when they fail, so they need to hold more capital
against risk. That is based on a principle of fairness and also
of economic efficiency. It internalizes their costs of failure
and provides incentives for firms to limit their size and reduce
Internationally, we are working to raise capital requirements
so that financial firms can withstand future crises as severe as
the one we have just gone through, and do so without government
Basel III negotiations, we are pushing hard to set minimum
capital ratios at a level that will represent a significant
increase in firms' requirements.
These new requirements include the creation of a capital
conservation buffer above the minimums, which if breached will
restrict firms' ability to pay dividends or buy back stock. Such
restrictions will help shore up a firm's capital base before it
reaches a point of no return.
Not only are we
raising the ratios, but just as importantly, we are raising the
standards on the quality of capital that underlie them.
new capital requirements will focus on common equity, excluding
other liabilities that did not act as a buffer to absorb losses
in the crisis.
There will be strict limits on minority interests, as well as on
the aggregate contribution of investments in other financial
institutions, mortgage servicing rights and deferred tax assets.
In addition to increasing the quality of the capital that
firms hold, we are
increasing the capital required for banks' riskiest activities,
such as their trading positions and their counterparty credit
Capital calculations for trading
exposures will now have to be based on stressed market
conditions, and the charges for securitization exposures will be
derivatives and secured lending transactions, firms will now
also be subject to a capital charge for losses associated with a
deterioration in the credit worthiness of their counterparties.
Basel III we will also be introducing a new, internationally
applied, leverage ratio requirement that, for the first time,
includes firms' off balance sheet commitments and exposures.
The combination of these changes – higher capital
ratios, new capital requirements, tougher and more extensive
measurement standards – will help ensure that firms have
sufficient capital to weather the next crisis.
addition to new capital requirements, we will be instituting
explicit quantitative liquidity requirements for the first time,
to ensure that financial firms are better prepared for liquidity
Under the new rules, firms will have to
hold enough highly liquid assets to meet potential net cash
outflows over a 30 day stress scenario.
Through the Basel Committee we are also working on developing a
liquidity requirement that will require a minimum amount of
stable funding over a one year time period, relative to a firm's
assets, commitments and obligations.
These liquidity requirements will be crucial in helping to
mitigate severe strains like those that we saw on the financial
sector at the time of the collapse of Bear Stearns and Lehman
Brothers during 2008.
together, these heightened standards will provide positive
incentives for major financial firms to reduce their size,
leverage, complexity, and interconnectedness.
financial crisis has shown that a narrow supervisory focus on
the safety and soundness of individual firms can result in a
failure to detect and thwart emerging threats to financial
stability that may cut across many institutions or have other
Under these reforms, federal financial regulators will have the
responsibility to supervise our major financial firms in a
manner that is designed to protect overall financial stability.
The federal financial regulators will engage in a searching
review of the bank and nonbank subsidiaries of our major
Regulators must supplement existing
approaches to supervision with
mandatory "stress tests," credit exposure reporting, and "living
wills," so that they can adequately assess the potential impact
of the activities and risk exposures of these firms on each
other, on critical markets, and on the broader financial system.
When, despite reforms,
a major financial firm fails, the government simply must have
the necessary tools to wind-down a failing financial firm
without exposing taxpayers to losses and without pushing the
economy to collapse.
While we have long had a tested and effective system for
resolving failed banks, there was no effective legal mechanism
to resolve a large non-bank financial institution or bank
The Dodd-Frank Act fills this gap in our legal framework by
providing a emergency tool modeled on our existing system under
the Federal Deposit Insurance Act--a tool that replaces the
untenable choice between taxpayer bailouts and market chaos.
Resolution authority is a linchpin of ending
financial system and this crisis have been
global in scope.
So our solutions have been and must continue to be global.
International reforms must support our efforts at home,
including strengthening the capital and liquidity frameworks;
improving oversight of global financial markets; coordinating
supervision of internationally active firms; and enhancing
crisis management tools.
We have not waited for the international community to act before
building a new foundation in the Dodd-Frank Act, and we will not
accept an international race to the bottom on regulatory
Path Forward on Implementing Financial Reform
These reforms will help us restore market discipline to a
financial system distorted by the moral hazard associated with
"too-big-to-fail." And that process is already underway.
Let me give you a brief introduction to the steps taking
place over the next several months.
We are already hard
at work. The agencies involved in implementing financial reform
are in the process of establishing timelines for moving forward
on the scores of studies, regulations, and other regulatory
actions required by the Dodd-Frank Act. In some critical areas,
the agencies are already drafting proposed rules for public
In September, when the
Financial Stability Oversight Council
first meets, we will establish an integrated road map for the
first stages of reform and put that in the public domain.
We are going to move quickly to begin shaping reforms of the
derivatives market. In this process, we will work with the Fed,
the SEC and the CFTC to develop specific quantitative targets
and timelines for moving the standardized part of the
over-the-counter derivatives business onto central clearing
And we must accelerate the international effort to put in place
common global standards for transparency, oversight, and the
prevention of manipulation and abuse of these critically
We're going to stand-up the
Office of Financial Research,
which in the coming months will work closely with regulators and
market participants to assess the financial data reporting needs
and challenges for better monitoring of firm-specific and
systemic risk, to streamline current regulatory data reporting
requirements imposed on financial firms, to improve data sharing
among regulators, and to enhance the utility of existing data
As I mentioned, we are now finalizing an
international agreement that will require financial firms to
hold both more and higher quality capital than they did before
Those are some of the key areas
regarding prudential reforms where we –
the Treasury, the financial regulators – will be focused in the
I'd also like to briefly highlight our work on consumer
We are moving quickly to give consumers
simpler disclosures, so that they can make better choices,
borrow more responsibly, and compare costs.
in place of the two separate, inconsistent and
overly-complicated federal mortgage disclosure forms that
borrowers receive today, there should be one clear, simple,
In addition, we will be inviting
public comment on new national underwriting standards for
mortgages, so that we can begin to shape the reforms of the
And we are working quickly to get the
CFPB up and running, to consolidate rule-making, supervision,
and enforcement responsibilities that today are split,
inefficiently and ineffectively, among seven different
On all fronts, we are committed to
moving with speed, with transparency, and with a commitment to
ensuring that our financial system remains the most competitive
financial system in the world.
But reform is a shared
responsibility. And so to those in the financial industry, I
encourage you not to wait on Washington before embracing change.
As we work together to rebuild our financial system, responsible
private sector leadership is every bit as important as
responsible regulation and supervision.
reforms represent a comprehensive, coordinated response to the
moral hazard challenge posed by our largest, most interconnected
financial institutions: strong, accountable supervision; the
imposition of higher standards, both to deter excessive risk and
to force firms to better protect themselves against failure; a
strong, resilient, well-regulated financial system that can
better absorb failure; and a strong resolution authority to
enable the government to wind down major financial firms in a
financial crisis in an orderly manner that protects financial
These reforms fully protect taxpayers, and by contrast, enable
shareholders and creditors to take their losses when failure
As we go about the task of implementing these
reforms, we will be criticized by some for going too far and by
some for not going far enough. This distinction is stuck in a
debate that presumes that regulation--and efficient and
innovative markets--are at odds.
In fact, the opposite
is true. Markets rely on faith and on trust. Markets require
transparency. The discipline of the market requires clear rules.
The President's reforms lay a new foundation for financial
regulation that will once again help to make our markets vital
and strong. And for all our sakes and that of our economy, we
must implement the Dodd-Frank Act and thereby fully end
"too-big-to-fail" once and for all.
Statement by Daniel K. Tarullo, Member, Board of Governors of
the Federal Reserve System, before the Subcommittee on Security
and International Trade and Finance Committee on Banking,
Housing, and Urban Affairs. United States Senate, July 20, 2010
Chairman Bayh, Ranking Member Corker, and other members of
the Committee, I appreciate the opportunity to testify today on
developments in international regulatory reform and
U.S. government priorities for international regulatory
When you held a
hearing on this topic in the fall, I gave an overview of the
Federal Reserve’s role in international cooperative
activities and reviewed some pertinent recent developments.
In my testimony today, I will begin by enumerating
that should inform U.S. participation in international
regulatory and supervisory activities.
Then I will turn to some
of the issues you identified in your invitation letter as being
of interest to the Subcommittee in this hearing:
Reserve’s role in the international financial reform
efforts--including our work on the Basel III reforms,
cross-border crisis management and resolution, and incentive
compensation--and a preliminary assessment of the likely effect
of the Dodd-Frank Act of 2010 on international financial
Finally, I will close with a few thoughts on the future
role of the Financial Stability Board (FSB) and other
international regulatory bodies as we move from the design of
financial regulatory reforms to implementation of the new
Goals for International Cooperation in Financial
Regulation and Supervision
Before discussing some of the very
important initiatives that are under way, I think it
important to specify what I believe should be the U.S. goals for
international cooperative efforts.
First, to increase the
stability of our financial system through adoption of strong,
common regulatory standards for large financial firms and
important financial markets.
As events of the past few years
have shown, financial stresses can quickly spread across
Global financial stability is a critical
prevent major competitive imbalances
between U.S. and foreign financial institutions.
A core set
of good common standards will reduce opportunities for
cross-border regulatory arbitrage,
even as it
promotes financial stability.
This goal is particularly
noteworthy as the United States tightens its domestic
to make supervision of
internationally active financial institutions more effective
through a clear understanding of home and host country
responsibilities and adequate flows of information and
beyond the supervision of individual
institutions, to exchange information and analysis in an
effort to identify potential sources of financial instability
and to take action to help mitigate the buildup of risks in
international financial markets, particularly those potentially
posing systemic risks.
Embracing these goals does not, of
course, answer the often complex questions raised in specific
initiatives, such as the degree to which rules should be
standardized and the degree to which national variation or
discretion is warranted in pursuing shared regulatory ends.
I do think it is useful to keep all of these goals in mind as
we pursue our international agenda.
Our task as U.S.
regulators is to work to ensure that, together, the various
international financial organizations produce reforms and
practices that are consistent with U.S. interests and legal
The Federal Reserve’s Role in International
Financial Reform Efforts
As a central bank with significant
supervisory responsibilities, the
Federal Reserve actively
participates in both
(1) central-bank-focused groups that
monitor developments in global financial markets and promote
sound and efficient payment systems and
(2) supervisory forums,
such as the Basel Committee on Banking Supervision (Basel
Committee), which promotes high global standards for banking
supervision and regulation.
actively participate in the
FSB, which is coordinating many of the initiatives
undertaken in response to the financial crisis and is
directly communicating with the Group of Twenty (G-20).
contributions to these groups take advantage of the synergies
between our central banking functions and our supervisory
Our contributions combine our economic
research, knowledge of financial markets, and regulatory policy
Interestingly, in the wake of the financial
crisis, we see some other countries, notably the
back toward a more significant involvement of the
central bank in supervision, presumably for these same
The Basel Committee is working toward
new global standards for minimum bank capital levels and a
new liquidity requirement--a project that has become known as
This undertaking is central to the first and
second goals for international cooperation that I noted
The Basel Committee aims to complete this task by the
November G-20 leaders meeting in Seoul.
The Federal Reserve
has devoted considerable resources to this important global
initiative, and we note that international bank supervisors
continued to make progress at the Basel Committee meeting
We agree with the yardstick set forth last month
by the G-20 leaders in Toronto--that minimum capital
requirements should “enable banks to withstand--without
extraordinary government support--stresses of a magnitude
associated with the recent financial crisis.”
Our view is
that large institutions should be sufficiently capitalized so
that they could sustain the losses associated with a
problem and remain sufficiently capitalized to continue
functioning effectively as financial intermediaries.
this standard will require a considerable
strengthening of existing requirements, both with respect to the
amount of capital held and to the quality of that capital.
to the former, it is particularly important that the risk
weightings associated with traded instruments be substantially
As to the latter, the crisis confirmed what many
of us have long believed--that
common equity is by far the best
measure of a firm’s loss absorption capacity.
During the crisis,
regulators, counterparties, and market analysts all looked to
levels of common equity as the key measure of a firm’s
durability in the face of extraordinary financial stress.
have conducted extensive analysis to inform our judgments on
the specific rules needed to implement this standard.
respect, the stress tests we conducted last year as part of
the Supervisory Capital Assessment Program have been very
useful in assessing the amount of capital needed to survive a
financial crisis without unusual government support.
the Basel Committee published its proposals in a number of
the Federal Reserve and the other
U.S. federal banking agencies have been working together for
a Basel III framework that produces a strong set of globally
consistent capital and liquidity requirements that will
promote financial stability and a level playing field for
internationally active banks.
We have assessed how various
proposals would, or would not, achieve that aim.
We have also
considered carefully how to structure the transition to the new
requirements so as to minimize their effect on the economy as a
whole and to allow adequate time for firms to adjust their
Although adopting a robust, common set of
capital and liquidity rules for internationally active banks
is critical, it is neither practical nor desirable to negotiate
all details of financial regulation internationally.
important that the United States preserves the flexibility to
adopt prudential regulations that work best within the U.S.
financial and legal systems.
Within a common set of
agreed-upon global standards, each jurisdiction will want to
tailor some of its rules and supervisory practice to national
conditions and preferences.
Along these lines, there have
been recent discussions within the FSB on the possibility of
among member countries to examine
how each member is using its own mix of instruments to
achieve particular safety and soundness ends.
Committee has a number of initiatives and work programs related
to capital requirements that go beyond the package of
measures that we expect to be completed by the fall.
efforts include, among others, ideas for
buffers, contingent capital, and development of a metric for
capital charges tied to systemic risk.
Each of these ideas has
considerable conceptual appeal, but some of the difficulties
encountered in translating the ideas into practical rules
mean that work on them is likely to continue into next year.
Cross-Border Crisis Management and Resolution
capital and liquidity requirements,
improved resolution regimes
for both banks and systemically important nonbank
companies are a critical element of the domestic and
international agenda to contain systemic risk.
the FSB is seeking to enhance cross-border cooperation both
in making advanced preparations for handling severe stress at
specific firms and in dealing with financial crises when they
The FSB is developing concrete policy recommendations
for the G-20 Summit in November.
Specifically, the FSB is
working to identify common principles and key attributes for
effective national resolution regimes, including a menu of
resolution tools for authorities to draw upon in light of the
varying circumstances that may be associated with distress at a
Among these are restructuring and wind-down
measures for firms that will be closed down, such as
arrangements for providing temporary funding or the ability to
establish a bridge bank to take over essential
There is also considerable interest at the FSB in
developing a resolution tool that could facilitate a
restructuring of a firm’s own capital and liquidity that
would allow it to continue operating as a going concern.
Specifically, the FSB is exploring whether there could be a
viable mechanism for converting debt into equity through
terms set out in the debt instruments.
Another aspect of the
FSB’s work focuses on
four technical areas
that may affect
crossborder recovery or resolution:
(1) practices for booking
trades in one legal entity and then transferring the market
or credit risk of the trade to a different location or legal
(2) the use of intra-group guarantees and related
(3) the critical nature of global
payments operations, such as cash payments or securities
(4) the adequacy of a firm’s management
information systems and service level agreements.
The FSB is
exploring ways to mitigate challenges related to these four
Firm-specific crisis management working groups
composed of home and host supervisory authorities are working
to identify specific issues and barriers to coordinated action
that may arise in handling severe stress at identified firms.
This process should culminate in recovery plans--developed by
the individual firms--that outline options for an institution to
recover from a severe distress without extraordinary official
sector actions, and resolution plans--developed by the
official sector--intended to identify options that would result
in an orderly wind-down.
we have formed
crisis management groups to cover the key internationally
active U.S. banking organizations.
In addition to the Federal
Reserve, the groups include representatives from the Office
of the Comptroller of the Currency, Federal Deposit Insurance
Corporation, Securities and Exchange Commission, and relevant
foreign supervisors and central banks.
The firms are
each internally identifying and assessing their options and
strategies to lower risk in the event of stress, including
selling portfolios or business lines, restructuring
liabilities and implementing contingency funding plans.
objective is to ensure that each firm has a concrete and
viable plan to reduce riskiness, ensure the continuity of
critical financial services, preserve liquidity, and make up
cash flow shortages under severely adverse conditions.
are individually working with their own crisis management group
to isolate key impediments to recovery and are focusing on
work that should be undertaken in the near term to enhance
These plans will have to be dynamic to ensure
they remain relevant and appropriate in light of changing
business and economic conditions.
Despite the progress that
is being made through the FSB work and domestic efforts,
comprehensive solutions to cross-border crisis management
difficulties will not be easy to achieve.
cross-jurisdictional synchronization of resolution options and
recovery processes would be a meaningful step in the right
At least for the foreseeable future, a focus on
regulatory coordination and supervisory cooperation and planning
before a large firm’s failure becomes a real possibility is
likely to yield the greatest benefit.
In the last two years,
compensation has been a regular topic of
discussion at meetings of international regulatory groups,
culminating in the FSB’s agreement last year on principles to
guide incentive compensation.
The principles specify that
compensation practices at major financial institutions
properly account for risk, that boards of directors and risk
managers at such firms should ensure they do so, that
supervisors should provide effective oversight, and that
firms’ disclosures should be sufficient to inform stakeholders
about compensation and risk.
In addition to
these principles, a number of specific projects are in progress
or have recently been completed by international regulatory
FSB conducted a peer review of G-20
nations’ progress toward implementing the principles, which
found that progress is being made but more work is needed.
include work by the Basel Committee, expected
by end-2010, on practices that would improve the soundness of
risk-taking incentives, and a proposal for disclosure of
compensation information under Pillar 3 of Basel 2.
views of national supervisory authorities have in many respects
converged on such matters as the sources and effects of
incentive problems and some methods for better aligning the
risk-taking incentives of employees at major financial
institutions with the interests of shareholders and the
financial system, different nations have taken different
approaches in implementing the FSB principles.
adopted an approach that
requires large financial organizations
to establish and maintain internal governance and management
systems to implement principles for assuring that incentive
compensation arrangements are risk-appropriate.
principles, and the process by which we proposed that they be
implemented, were issued by the Federal Reserve for public
comment in October.
final supervisory guidance, which was
jointly issued with the other banking agencies, was released
We chose a
principles-based approach because of
the substantial variation in the actual incentives and risks
associated with the thousands of executives and other
employees within and among banking organizations.
continues to be that a uniform or
formulaic approach to all such employees would be neither
compensating employees nor effective in preventing excessively
risky activity, particularly among non-executives such as
this month the European Parliament
approved a directive that has the potential to lead to a
number of formula-based restrictions on employee compensation at
financial services firms operating in the European Union (EU).
This approach is consonant with views expressed by some EU
members to the effect that formula setting--for example, putting
a floor on the portion of an employee’s salary that must be
deferred--is the surest way to produce
changes in bank
However, many of the details are left to be set by the
European Commission, the Committee of European Bank
Supervisors, and other entities.
While both approaches have
merit, we believe the option we have chosen is likely to be
more successful in promoting risk-appropriate compensation
As already noted, we fear that a formula-based
approach applicable to all covered employees may spawn efforts
to circumvent the rules through creative new compensation
practices, whereas our requirement that the banks internalize
sound principles for incentive compensation and apply them to
all such arrangements places a continuing responsibility on
the firms themselves.
considerable oversight is
needed to ensure that a principles-based approach is implemented
We have already conducted an extensive horizontal
review of compensation practices at 25 large U.S. financial
holding companies and have sent detailed assessments to each
firm commenting on their proposals for implementing the
It may well be that over time the two approaches
will converge somewhat.
For example, we may determine on the
basis of experience with many firms that there are certain best
practices that should at least presumptively be applicable to
certain classes of employees.
the EU may find that
more attention to internalization of the principles and
customization of appropriate practices is necessary,
particularly as applied to non-executive employees.
to continue information sharing and discussions through the FSB
and the Basel Committee.
For now, though, there is indeed a
difference in approach, one that illustrates the point I made
earlier that there need not be complete harmonization in all
prudential regulation and supervision, even where there is
agreement on basic goals.
Effect of the Dodd-Frank Act
course, concurrent with the efforts of the Federal Reserve and
other U.S. agencies to advance the goals of international
regulatory reform, the U.S. Congress has debated and passed
the Dodd-Frank Act, creating a comprehensive package of domestic
Many elements of the Dodd-Frank Act
closely with the efforts of the G-20 leaders, the FSB, and
the Basel Committee.
For example, the act
provides the federal
government with the authority to subject all financial firms
that present outsized systemic risks--regardless of whether
they own an insured depository institution--to a common
framework of supervision and regulation by the Federal
In addition, the act creates a special resolution
regime that gives the government the capacity to unwind or
break apart major non-bank financial firms in an orderly
fashion with less collateral damage to the system.
act strengthens the resiliency of the financial market
infrastructure by mandating increased central clearing and
transparency for over-the-counter derivative transactions and
stronger prudential regulation of bank and nonbank
The act also provides for the
of advisers to hedge funds and other private investment
funds, improved regulation of credit rating agencies, and
more-consistent oversight of systemically important financial
At the same time, there are
aspects of the Dodd-Frank Act that are unlikely to become
part of the international financial regulatory framework.
example, the act generally prohibits U.S. banking firms (and
the U.S. operations of foreign banking firms) from engaging in
proprietary trading and from investing in or sponsoring private
The act also prohibits U.S. depository
institutions from entering into certain types of derivatives
In the United States, activity restrictions
have long been a part of the bank regulatory regime, serving
to constrain risk-taking by banking firms, prevent the spread of
the market distortions caused by the federal bank safety net
to other parts of the economy, and mitigate potential
conflicts of interest generated by the combination of banking
and certain other businesses within a single firm.
countries follow a universal banking model and are unlikely to
adopt the sorts of activity restrictions contained in the
Similarly, the Dodd-Frank Act expands the existing 10
percent deposit cap in U.S. law by preventing the Federal
Reserve from approving a material acquisition by a financial
firm if the resulting firm would have liabilities that exceed
10 percent of the total liabilities of the broader U.S.
Other countries with more concentrated banking
systems are unlikely to impose this type of concentration
limit on financial firms in their jurisdiction.
all elements of financial reform can be designed on a national
level in a way that is perfectly consistent across countries.
The characteristics of each country’s financial system
differ, sometimes significantly.
Our challenge is to
right balance between achieving global consistency on the
core reforms necessary to protect financial stability and
provide a workably level playing field, and at the same time
providing the flexibility necessary to supplement the common
standards with elements tailored to national financial systems,
legal structures, and policy preferences.
Current and Future Focus of International Regulatory Groups
As my testimony makes clear, the international regulatory groups
remain focused on responding to the crisis.
The FSB is
pursuing financial reform and working with the relevant
standard-setting bodies to ensure that detailed proposals are
developed in a timely manner.
In some cases, the importance
of the issues and the drive to respond quickly to the crisis
have led to a proliferation of international working groups
whose mandates may overlap.
While this reaction is natural in
the wake of a crisis, we will need to rationalize the activities
of these groups as our focus shifts from policy development
So, too, we will need to ensure that the
relatively new members of these groups are fully and effectively
integrated into their activities, including in leadership
It is also important that we not lose sight of the
third and fourth goals I suggested for our international
much of the effort in the
international groups has recently been focused on negotiating
rules and principles to reform financial regulation, it would
be unfortunate going forward if negotiations were to become the
dominant mode of international financial cooperation.
would not want to crowd out the other valuable aspects of
international regulatory cooperation, including sharing
supervisory perspectives on internationally active financial
institutions and analyzing latent risks to financial stability.
The FSB itself has a valuable role to play by bringing together
the international standard setting bodies and key national
authorities responsible for financial stability in the G-20
Its role might usefully be conceived as
roughly paralleling the role to be played by the Financial
Stability Oversight Council in the United States under the
The FSB can facilitate discussion and
analysis of emerging risks to financial stability that cut
across sectors or across the jurisdiction of more than one
Because it consists of senior officials
from finance ministries, regulatory agencies, and central banks,
it is well positioned not only to identify cross-cutting
risks or regulatory gaps, but also to take action to address
Finally, I believe that it will be important
for standard-setting bodies such as the Basel Committee to
enhance monitoring of the implementation of the sometimes
complex agreements reached internationally.
Where it is
difficult for market analysts and other outside observers to
determine if, for example, Basel III capital rules are being
vigorously implemented and enforced, the international
standard setters must themselves develop appropriate monitoring
These mechanisms must go beyond examining whether
international standards have been duly incorporated into
domestic law to consider whether financial institutions are
complying with those standards.
Thank you for again giving
me the opportunity to share our thoughts on the evolving
issues in international financial cooperation. I would be
pleased to answer any questions you may have.
The Group of Governors and Heads of
Supervision announces higher global minimum capital standards
At its 12 September 2010 meeting, the
Group of Governors and Heads of Supervision, the oversight body
of the Basel Committee on Banking Supervision,
announced a substantial strengthening of
existing capital requirements and fully endorsed the agreements
26 July 2010.
capital reforms, together with the introduction of a global
liquidity standard, deliver on the core of the global financial
reform agenda and will be presented to the Seoul G20 Leaders
summit in November.
The Committee’s package of reforms
will increase the minimum common equity requirement from 2% to
In addition, banks will be required to hold a
capital conservation buffer of 2.5% to withstand future periods
of stress bringing the total common equity requirements to 7%.
This reinforces the stronger definition of capital
agreed by Governors and Heads of Supervision in July and the
higher capital requirements for trading, derivative and
securitisation activities to be introduced at the end of 2011.
Increased capital requirements
Under the agreements
reached, the minimum requirement for common equity, the highest
form of loss absorbing capital, will be raised from the current
2% level, before the application of regulatory adjustments, to
4.5% after the application of stricter adjustments.
This will be phased in by 1 January 2015.
The Tier 1
capital requirement, which includes common equity and other
qualifying financial instruments based on stricter criteria,
will increase from 4% to 6% over the same period.
Group of Governors and Heads of Supervision also agreed that the
capital conservation buffer above the regulatory minimum
requirement be calibrated at 2.5% and be met with common equity,
after the application of deductions.
The purpose of the
conservation buffer is to ensure that banks maintain a buffer of
capital that can be used to absorb losses during periods of
financial and economic stress.
While banks are allowed
to draw on the buffer during such periods of stress, the closer
their regulatory capital ratios approach the minimum
requirement, the greater the constraints on earnings
This framework will reinforce the
objective of sound supervision and bank governance and address
the collective action problem that has prevented some banks from
curtailing distributions such as discretionary bonuses and high
dividends, even in the face of deteriorating capital positions.
A countercyclical buffer within a range of 0% – 2.5% of
common equity or other fully loss absorbing capital will be
implemented according to national circumstances.
purpose of the countercyclical buffer is to achieve the broader
macroprudential goal of protecting the banking sector from
periods of excess aggregate credit growth.
given country, this buffer will only be in effect when there is
excess credit growth that is resulting in a system wide build up
The countercyclical buffer, when in effect,
would be introduced as an extension of the conservation buffer
These capital requirements are supplemented by a
non-risk-based leverage ratio that will serve as a backstop to
the risk-based measures described above.
Governors and Heads of Supervision agreed to test a minimum Tier
1 leverage ratio of 3% during the parallel run period.
Based on the results of the parallel run period, any final
adjustments would be carried out in the first half of 2017 with
a view to migrating to a Pillar 1 treatment on 1 January 2018
based on appropriate review and calibration.
important banks should have loss absorbing capacity beyond the
standards announced today and work continues on this issue in
the Financial Stability Board and relevant Basel Committee work
The Basel Committee and the FSB are developing
a well integrated approach to systemically important financial
institutions which could include combinations of capital
surcharges, contingent capital and bail-in debt.
addition, work is continuing to strengthen resolution regimes.
The Basel Committee also recently issued a consultative
document Proposal to ensure the loss absorbency of regulatory
capital at the point of non-viability.
Heads of Supervision endorse the aim to strengthen the loss
absorbency of non-common Tier 1 and Tier 2 capital instruments.
Since the onset of the
crisis, banks have already undertaken substantial efforts to
raise their capital levels.
results of the Committee’s comprehensive quantitative impact
study show that as of the end of 2009, large banks will need, in
the aggregate, a significant amount of additional capital to
meet these new requirements.
Smaller banks, which are
particularly important for lending to the SME sector, for the
most part already meet these higher standards.
Governors and Heads of Supervision also agreed on transitional
arrangements for implementing the new standards.
will help ensure that the banking sector can meet the higher
capital standards through reasonable earnings retention and
capital raising, while still supporting lending to the economy.
The transitional arrangements include:
National implementation by member countries will begin on 1
Member countries must translate the rules
into national laws and regulations before this date.
of 1 January 2013, banks will be required to meet the following
new minimum requirements in relation to risk-weighted assets
– 3.5% common equity/RWAs;
– 4.5% Tier 1
– 8.0% total capital/RWAs.
minimum common equity and Tier 1 requirements will be phased in
between 1 January 2013 and 1 January 2015.
On 1 January
2013, the minimum common equity requirement will rise from the
current 2% level to 3.5%.
The Tier 1 capital
requirement will rise from 4% to 4.5%.
On 1 January
2014, banks will have to meet a 4% minimum common equity
requirement and a Tier 1 requirement of 5.5%.
January 2015, banks will have to meet the 4.5% common equity and
the 6% Tier 1 requirements.
The total capital
requirement remains at the existing level of 8.0% and so does
not need to be phased in.
The difference between the
total capital requirement of 8.0% and the Tier 1 requirement can
be met with Tier 2 and higher forms of capital.
regulatory adjustments (ie deductions and prudential filters),
including amounts above the aggregate 15% limit for investments
in financial institutions, mortgage servicing rights, and
deferred tax assets from timing differences, would be fully
deducted from common equity by 1 January 2018.
particular, the regulatory adjustments will begin at 20% of the
required deductions from common equity on 1 January 2014, 40% on
1 January 2015, 60% on 1 January 2016, 80% on 1 January 2017,
and reach 100% on 1 January 2018.
transition period, the remainder not deducted from common equity
will continue to be subject to existing national treatments.
4. The capital conservation buffer will be phased in
between 1 January 2016 and year end 2018 becoming fully
effective on 1 January 2019.
It will begin at 0.625% of
RWAs on 1 January 2016 and increase each subsequent year by an
additional 0.625 percentage points, to reach its final level of
2.5% of RWAs on 1 January 2019.
experience excessive credit growth should consider accelerating
the build up of the capital conservation buffer and the
National authorities have the
discretion to impose shorter transition periods and should do so
5. Banks that already meet the
minimum ratio requirement during the transition period but
remain below the 7% common equity target (minimum plus
conservation buffer) should maintain prudent earnings retention
policies with a view to meeting the conservation buffer as soon
as reasonably possible.
6. Existing public sector
capital injections will be grandfathered until 1 January 2018.
Capital instruments that no longer qualify as
non-common equity Tier 1 capital or Tier 2 capital will be
phased out over a 10 year horizon beginning 1 January 2013.
Fixing the base at the nominal amount of such instruments
outstanding on 1 January 2013, their recognition will be capped
at 90% from 1 January 2013, with the cap reducing by 10
percentage points in each subsequent year.
instruments with an incentive to be redeemed will be phased out
at their effective maturity date.
7. Capital instruments
that do not meet the criteria for inclusion in common equity
Tier 1 will be excluded from common equity Tier 1 as of 1
However, instruments meeting the
following three conditions will be phased out over the same
horizon described in the previous bullet point:
they are issued by a non-joint stock company;
are treated as equity under the prevailing accounting standards;
(3) they receive unlimited recognition as part of
Tier 1 capital under current national banking law.
Only those instruments issued before the date of this press
release should qualify for the above transition arrangements.
Phase-in arrangements for the leverage ratio were announced
in the 26 July 2010 press release of the Group of Governors and
Heads of Supervision.
That is, the supervisory
monitoring period will commence 1 January 2011; the parallel run
period will commence 1 January 2013 and run until 1 January
2017; and disclosure of the leverage ratio and its components
will start 1 January 2015.
Based on the results of the
parallel run period, any final adjustments will be carried out
in the first half of 2017 with a view to migrating to a Pillar 1
treatment on 1 January 2018 based on appropriate review and
After an observation period beginning in
2011, the liquidity coverage ratio (LCR) will be introduced on 1
January 2015. The revised net stable funding ratio (NSFR) will
move to a minimum standard by 1 January 2018.
Committee will put in place rigorous reporting processes to
monitor the ratios during the transition period and will
continue to review the implications of these standards for
financial markets, credit extension and economic growth,
addressing unintended consequences as necessary.
Basel Committee on Banking Supervision provides a forum for
regular cooperation on banking supervisory matters. It seeks to
promote and strengthen supervisory and risk management practices
The Committee comprises representatives from
Argentina, Australia, Belgium, Brazil, Canada, China, France,
Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea,
Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia,
Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the
United Kingdom and the United States.
The Group of
Central Bank Governors and Heads of Supervision is the governing
body of the Basel Committee and is comprised of central bank
governors and (non-central bank) heads of supervision from
member countries. The Committee’s Secretariat is based at the
Bank for International Settlements in Basel, Switzerland.
G20 - Meeting of Finance Ministers and Central Bank Governors,
Busan, Republic of Korea
June 5, 2010
"We, the G20 Finance Ministers and Central Bank Governors, met
at a critical juncture to firmly secure the global recovery and
address the economic challenges and risks.
Building on progress to date, we affirmed our commitment to
intensify our efforts and to accelerate financial repair and
Committed to reach agreement expeditiously on stronger capital
and liquidity standards as the core of our reform agenda and in
that regard fully support the work
of the Basel Committee on Banking Supervision and call on them
to propose internationally agreed rules to improve both the
quantity and quality of bank capital and to discourage excessive
leverage and risk taking by the November 2010 Seoul Summit.
It is critical that our banking regulators develop capital and
liquidity rules of sufficient rigor to allow our financial firms
to withstand future downturns in the global financial system.
As we agreed, these rules will be
phased in as financial conditions improve and economic recovery
is assured, with the aim of implementation by end-2012.
We welcome the progress on the quantitative and macroeconomic
impact studies which will inform the calibration and phasing in,
We are committed to move together in a transparent and
coordinated way on national implementation of the agreed rules.
Implementation of these new rules should be complemented by
G20 at the
London Summit in April 2009
DECLARATION ON STRENGTHENING THE FINANCIAL
SYSTEM – LONDON, 2 APRIL 2009
"We, the Leaders of the G20, have taken, and will continue to
take, action to strengthen regulation and supervision in line
with the commitments we made in Washington to reform the
regulation of the financial sector."
countries should progressively adopt the Basel II capital
framework; and the BCBS and national authorities should develop
and agree by 2010 a global framework for promoting stronger
liquidity buffers at financial institutions, including
cross-border institutions. "
G20 at the Pittsburgh Summit in September
PROGRESS REPORT ON THE ACTIONS TO PROMOTE
FINANCIAL REGULATORY REFORM ISSUED BY THE U.S. CHAIR OF THE
PITTSBURGH G-20 SUMMIT – 25 SEPTEMBER 2009
"We are committed to
action at the national and international level to
raise standards together so that our national authorities
implement global standards consistently in a way that ensures a
level playing field and avoids fragmentation of markets,
protectionism, and regulatory arbitrage."
Progress is being made
in the two major international initiatives
now underway on bank resolution frameworks, namely the
Cross-Border Bank Resolution Group (CBRG) of the
Basel Committee on Banking Supervision
(BCBS) and the initiative by the
IMF and the World Bank on the legal, institutional and
regulatory framework for national bank insolvency regimes.
the CBRG published for consultation a report, which includes
recommendations for authorities on effective crisis management
and resolution processes for large cross-border institutions. "
" The Group of Central Bank Governors and Heads of
Supervision, the oversight body of the BCBS, reached agreement
in September to introduce a framework for countercyclical
capital buffers above the minimum requirement.
will include capital conservation measures such as constraints
on capital distributions.
Committee will review an appropriate set of indicators, such as
earnings and credit-based variables, as a way to condition the
build up and release of capital buffers.
The BCBS is
also actively engaged with accounting standard setters to
promote more forward-looking provisions based on expected
The IASB is
working to enhance its provisioning standards and guidance on an
accelerated basis, including by considering a proposed
impairment standard based on an expected loss (called an
“expected cash flow”) approach to loan loss provisioning for
issuance in October 2009.
published initial proposals on its website in June to seek input
regarding the feasibility of this expected loss approach before
it issues an exposure draft in October 2009.
the BCBS continues to work on
approaches to address any excessive cyclicality of minimum
The BCBS will issue concrete proposals
on these measures by end-2009.
It will carry
out an impact assessment at the beginning of 2010, with
calibration of the new requirements to be completed by end-2010.
Appropriate implementation standards will be developed to ensure
a phase-in of these new measures that does not impede the
recovery of the real economy. "
" We commit to developing by
end-2010 internationally agreed rules to improve both the
quantity and quality of bank capital and to discourage excessive
leverage and these rules will be phased in as financial
conditions improve and economic recovery is assured, with the
aim of implementation by end-2012.
implementation of higher level and better quality capital
requirements, counter-cyclical capital buffers, higher capital
requirements for risky products and off balance sheet
activities, and as elements of the
Basel II capital framework, together with strengthened liquidity
risk requirements and forward-looking provisioning, will reduce
incentives for banks to take excessive risks and create a
financial system better prepared to withstand adverse shocks.
We welcome the
key measures recently agreed by the oversight body of Basel
Committee on Banking Supervision to strengthen the supervision
and regulation of the banking sector.
The BCBS should review minimum levels of
capital and develop recommendations in 2010.
to deal with impaired assets and to encourage the raising of
additional capital must continue, where needed.
We commit to
conduct robust, transparent stress tests as needed.
We call on
banks to retain a greater proportion of current profits to build
capital, where needed, to support lending. "
" The BCBS
has stated that the level of capital in the banking system, both
the minimum capital requirement and the buffers above it, will
be raised relative to pre-crisis levels to improve resilience to
future episodes of stress.
This will be
done through a combination of measures such as strengthening the
risk coverage of the Basel II capital framework, improving the
quality of capital, and raising the overall minimum requirement.
The BCBS will
carry out an impact assessment at the beginning of 2010 and
calibrate the new requirements by end-2010. Appropriate
implementation standards will be developed to ensure a phase-in
that does not impede the recovery of the real economy. "
Regulatory Arbitrage and Basel iii
Deutsche Bank is concerned about
the regulatory arbitrage possibilities. Andrew Procter, the
bank’s head of government and regulatory affairs,
has expressed concern that the United
States may not adopt Basel III.
“The United States
continues to influence the Basel process but, in effect, treats
the guidelines as optional” .
“Deutsche Bank believes that no other
Basel committee members should move ahead with implementation
until there is a clear timetable from the U.S.” Andrew
Our view is that Basel III
will be implemented in the United States.
We are not sure. Perhaps, after the end of
2012. It is true that the United States delayed Basel II, and we
consider that something similar is likely under Basel III. But,
Basel III is going to be implemented in the United States.
A report from Rabobank’s Economic Research
Department argues that proposed capital and liquidity
requirements for internationally operating banks will have a
major impact on the banking sector, could
restrict the credit supply and hamper economic growth.
Under the Basel III requirements,
banks will have to hold more and higher quality liquid assets as
a buffer for the short-term. They will also have to
finance these assets with more stable and
long-term funding. The Rabobank economists claim that the
will affect the
traditional role of the banks, that is transforming customer’s
savings into loans.
Improving Financial Regulation
Report of the Financial Stability Board to G20 Leaders
25 September 2009
1. Since the London Summit, the Financial Stability
Board (FSB) and its members have advanced a major
program of financial reforms based on clear principles
and timetables for implementation that are designed to
ensure that a crisis on this
scale never happens again.
2. Much has already been achieved, and much is
underway that when implemented will result in a very
different financial system than the one that brought
us this crisis.
However, policy development is
not completed, and detailed implementation of the full
set of needed reforms will take time and perseverance.
3. In a globally integrated market economy, where
concerns about a level playing field and protectionist
pressures are real, it is vital that G20 Leaders
strongly support the international policy development
underway and signal their determination to implement
fully and consistently the reforms at national levels.
4. In recent months, expectations have taken hold in
some parts of the private financial sector that the
financial and regulatory system will remain little
changed from its pre-crisis contours.
These expectations – that business will be able to go
on just as before – need to be dispelled.
5. Our objective is to create a
more disciplined and less procyclical financial system
that better supports balanced sustainable economic
This system will
leverage to increase to the extent that it did.
Nor will we allow
risks to be taken where profits accrue to individual
actors but ultimate losses are borne by governments
the wider public.
6. To these ends, our program
includes substantially higher requirements for the
quantity and quality of capital and liquidity at
It also includes
accounting standards and compensation regimes that
improve transparency and limit incentives to excessive
We will constrain risks in trading-related activity by
improving market infrastructure and by significantly
raising capital charges for trading books.
7. Our reform plans set reasonable implementation
windows to avoid aggravating the present crisis.
While the financial system will continue to face
challenges for some time, the faster our financial
systems and economies recover, the faster we should
implement finalised reforms.
8. This crisis has highlighted the moral hazard risks
posed by institutions that have become too big to fail
or that, by their interconnected nature, are too
complex to resolve.
We need to address the
deeper-seated challenges that these institutions pose.
We are committed to developing the solutions to these
problems over the next twelve months.
9. In recent quarters, many
financial institutions have returned to profitability.
These profits owe much to the
extraordinary official measures taken to stabilise the
system, many of which remain in place.
It is imperative that these profits be retained in
financial institutions to rebuild capital necessary to
support lending, allow official support measures to be
removed and prepare institutions to meet future higher
10. The international supervisory and regulatory
community is agreed that restricting dividend
payments, share buybacks and compensation rates are
appropriate means to these ends.
11. The support of G20 Leaders
will be vital for the major decisions that will need
to be made in these important areas, and we ask that
you support us in these endeavours.
Achievements to date
12. Bolstering the resilience of the international
financial system is a broad project encompassing a
considerable number of related measures.
progress has been made on the many measures
recommended in the Financial Stability Forum (FSF)’s
April 2008 and 2009 Reports, the G20 Washington Action
Plan and the London Summit Statement, especially at
the level of international policy development.
Significant actions have been
taken since the London Summit:
• The shortcomings in the Basel capital framework that
generated incentives for off-balance sheet
securitisation activity have been removed;
• The weaknesses in accounting practices and national
standards that generated similar incentives for
off-balance sheet activities have been addressed.
New standards have been set out that enhance the
consolidation of special purpose vehicles and the
transparency of banks’ relationships with such
• The risks that banks assume in their trading
activities have been brought under better control.
Substantially higher capital
requirements against risks in banks’ trading
activities have been issued;
• Strong new risk management standards for financial
institutions have been issued and are being
implemented, covering bank governance, the management
of liquidity risk, underwriting and concentration
risks, stress testing, valuation practices and
exposures to off-balance sheet activities;
• Banks’ disclosures of their on- and off-balance
sheet risk exposures have been materially improved.
New disclosure standards for banks have been issued
covering valuation and liquidity risk, securitisation
and off-balance sheet activities;
• The FSB Principles for Sound
Compensation Practices have been
integrated into the Basel
capital framework, and international guidance
is under development to reinforce their
• Central counterparties have been introduced to clear
credit default swaps, reducing the systemic risks from
standardisation in this market have been increased and
dealers have reduced their cross exposures through
• Stronger oversight regimes for credit rating
agencies have been developed.
New legislation creating
oversight regimes has been approved in Japan and is
close to final approval in the EU; in the US,
amendments to the existing oversight regime have been
proposed or already made;
• Internationally agreed principles for the oversight
of hedge funds have been issued, and national and
regional legislation has been or is in the process of
being introduced to implement them;
• Good practices for due diligence by asset managers
when investing in structured finance products have
been issued, which will reduce their reliance on
credit rating agencies;
• Abusive short selling has been
addressed. Internationally agreed principles have been
issued to counteract the abusive use of short selling
while maintaining the benefits of short selling for
the functioning of the markets, and their
implementation will be monitored;
• Supervisory coordination and cooperation in the
oversight of the most important global financial firms
have improved. Supervisory colleges have now been
established for all the large complex financial groups
that the FSB has identified as needing colleges;
• Strengthened arrangements for system-wide oversight
have been developed in many jurisdictions, bringing
together the relevant authorities to better assess
risks to financial stability and identify mitigating
• Firm-by-firm contingency planning is underway to
implement the FSB Principles for Cross-border
Cooperation on Crisis Management.
Relevant authorities will hold contingency planning
meetings for major cross-border banks within the first
half of 2010 and assess the barriers to coordinated
action that may arise in handling severe stress at
• Depositors will be protected in a more consistent
way around the world.
Core Principles for Effective Deposit Insurance
Systems have been developed and an assessment
methodology is under preparation.
Critical work underway
13. Beyond the areas above, a large body of critical
work is underway to take forward other parts of the
London Summit Statement. In some areas, policy
development is reaching a phase in which difficult
decisions will need to be made.
Strengthening the global capital framework
14. The Basel Committee on Banking Supervision is
working urgently to build stronger buffers into the
financial system, covering capital, liquidity and
provisioning, that will raise defenses and constrain
the procyclical build-up of leverage in the system.
15. New rules will be set out by
end-2009, calibrated in 2010 and phased in as
financial conditions improve and economic recovery is
Government capital injections will be grandfathered.
Banks should be retaining profits now to prepare to
meet these future additional capital requirements.
Restricting dividends, share buybacks and compensation
rates is a necessary part of that process.
16. The new rules will require a clear step up in the
amount and quality of capital that the system as a
whole will need to carry, so that banks holding the
minimum required capital levels will be clearly viable
in a crisis and confidence in the system as a whole
will be maintained.
17. To these ends, the Basel II capital framework is
We are agreed that:
• the level and quality of minimum capital
requirements will increase substantially over time;
• capital requirements will
so that financial
institutions will be required to build capital buffers
above the minimum requirements during good times that
can be drawn down during more difficult periods;
• significantly higher capital requirements for risks
in banks’ trading books will be implemented, with
average capital requirements for the largest banks’
trading books at least doubling by end-2010;
• the quality, consistency and transparency of the
Tier 1 capital base will be raised.
The predominant form of Tier 1
capital must be common shares and retained earnings.
Appropriate principles will be developed for non-joint
stock companies to ensure they hold comparable levels
of high quality Tier 1 capital.
Moreover, deductions and prudential filters will be
harmonised internationally and generally applied at
the level of common equity or its equivalent in the
case of non-joint stock companies;
• the definition of capital will
be harmonised across jurisdictions and all components
of the capital base will be fully disclosed so as to
allow comparisons across institutions to be easily
• a leverage ratio will be introduced as a supplement
to the Basel II risk-based framework with a view to
migrating to a Pillar 1 treatment based on appropriate
review and calibration.
To ensure comparability, the details of the leverage
ratio will be harmonised internationally, fully
adjusting for differences in accounting.
18. We will also examine the use of “contingent
capital” and comparable instruments as a potentially
cost-efficient tool to meet a portion of the capital
buffer in a form that acts as debt during normal times
but converts to loss-absorbing capital during
financial stress, thus acting as a shock-absorber for
the capital position.
19. We will also assess the need for a capital
surcharge to mitigate the risk of systemic banks.
Making global liquidity more robust
20. The crisis vividly demonstrated that adequate
liquidity is a prerequisite for financial stability.
The drying up of liquidity at the level of financial
institutions, countries and ultimately the global
system caused the seizing up of credit provision and
of financial flows.
Cross-border flows are often the
most vulnerable during financial crisis, and emerging
markets can face damaging volatility in foreign
exchange and liquidity flows.
21. Just as strong capital is a necessary condition
for banking system soundness, so too is a strong
Many banks that
had adequate capital levels still experienced
difficulties during the crisis because they did not
manage their liquidity in a prudent manner.
The lesson is that banks’ resilience to system-wide
liquidity shocks – affecting both market and funding
liquidity – must be significantly increased and their
management of this risk strengthened.
22. To this end, we are substantially raising the bar
for global liquidity risk regulation:
• The Basel Committee will issue
by the end of 2009 a new minimum global liquidity
This new regulatory framework
introduces a liquidity coverage ratio that can be
applied in a cross-border setting.
It establishes a harmonised framework to ensure that
global banks have sufficient high-quality liquid
assets to withstand a stressed funding scenario
specified by supervisors.
• The Basel Committee will also formulate a structural
ratio to address liquidity mismatches and promote a
strong funding profile over longer-term horizons.
• This new standard complements the supervisory
guidance for banks’ liquidity risk management
practices, the implementation of which is being
assessed in supervisory reviews.
23. Shortages of cross-border liquidity caused
problems at the national level for many countries.
Ex ante measures to reduce the risk of instability are
needed, as well as ex post mechanisms to provide a
coordinated official response if shortages arise:
• Regulators and supervisors in
emerging markets will enhance their supervision of
banks’ operations in foreign currency funding markets.
• The Committee on the Global Financial System will
investigate policy options to reduce system-wide
cross-border liquidity risk, including through
strengthening the infrastructure of the foreign
exchange swaps market and other aspects of funding
• National and regional authorities and the
international financial institutions will use the
results of this investigation to review together the
scope for improved cooperation over liquidity
provision when liquidity shortages arise.
Reducing the moral hazard posed by systemically
24. Notwithstanding the actions above to strengthen
capital and liquidity,
additional steps are needed to reduce the moral hazard
risks and economic damage associated with institutions
that are “too big to fail” (or, more accurately, too
big and too complex to fail).
25. Action in this area is essential to contain the
costs to governments and economies of future crises.
We will develop
over the next 12 months measures that can be taken to
reduce the systemic risks these
Possible measures include
specific additional capital, liquidity and other
prudential requirements as well as other measures to
reduce the complexity of group structures and, where
appropriate, encourage stand-alone subsidiaries.
More intense and internationally coordinated
regulation and supervision of firms presenting greater
risks can help to reduce the probability of their
26. For all major cross-border firms we will require
the development of specific contingency plans that aim
at preserving the firm as a going concern, promoting
the resiliency of key functions and facilitating rapid
resolution or wind-down, should that prove necessary.
The Basel Committee’s
consultation document on cross border bank resolution
proposes specific actions to achieve an effective,
rapid and orderly wind-down of large cross-border
27. We will assess the implications of different
responses for systemic cross-border institutions with
different group structures, and the impact of these
different measures for the stability and efficiency of
cross-border capital flows.
We ask you to support us in this important future
Strengthening accounting standards
In April 2009, the G20
Leaders stated that standard setters should “make
significant progress towards a single set of high
quality global accounting standards.”
There is significant progress in this area and nearly
all FSB member jurisdictions have programmes underway
to converge with or adopt the standards of the
International Accounting Standards Board (IASB) by
29. In addition, the G20 Leaders
welcomed the FSF’s procyclicality recommendations
relating to accounting and called on “accounting
standard setters to work urgently with supervisors and
regulators to improve standards on valuation and
provisioning and achieve a single set of high-quality
global accounting standards.”
Important steps have been taken to improve existing
standards and to enhance dialogue with prudential
But in some
instances, achieving improved valuation and
provisioning standards alongside the goal of
convergence need further attention by standard
30. At present, the IASB and the US Financial
Accounting Standards Board (FASB) are considering a
variety of approaches which could possibly lead to
divergences between IASB and FASB standards with
• improving and simplifying financial instruments
accounting, where FASB is considering an approach that
is based on fair value measurement for most financial
instruments, which would be proposed by early 2010,
while the IASB has proposed a mixed model of
historical cost and fair value, to be available for
use in 2009 year-end financial statements;
• provisioning and impairment, where the IASB plans to
propose a standard using an expected loss or expected
cash flow approach to loan loss provisioning in
October 2009, which would generally recognise credit
losses earlier and mitigate procyclicality,1 whereas
the FASB continues to consider changes toimpairment
recognition, including an approach based on fair value
with plans to issue its proposal by early 2010;
• off-balance sheet standards,
where the IASB’s proposal on derecognition, which is
now subject to consultation, would require repurchase
agreements to be treated as sales and forward
contracts in certain situations (thus leading to
off-balance sheet treatment), instead of as financing
transactions on the balance sheet as under current
IASB and FASB standards.
31. Moreover, continuing differences in accounting
requirements of the IASB and FASB for
netting/offsetting of assets and liabilities also
result in significant differences in banks’ total
assets, posing problems for framing an international
32. Therefore, additional work in the areas above is
urgently needed in order to meet the important
objectives of convergence, transparency and the
mitigation of procyclicality, as standard setters
continue their efforts to improve the quality of their
standards and reduce the complexity of their standards
on financial instruments.
33. We strongly encourage the IASB and FASB to agree
on improved converged standards that will:
• incorporate a broader range of available credit
information than existing provisioning requirements,
so as to recognise credit losses in loan portfolios at
an earlier stage as part of an effort to mitigate procyclicality.
We are particularly supportive of continued work on
impairment standards based on an expected loss model;
• simplify and improve the
accounting principles for financial instruments and
particularly supportive of continued work in a manner
that does not expand the use of fair value in relation
to the lending activities (involving loans and
investments in debt instruments) of financial
34. While respecting the independence of accounting
standard setters, the FSB is urging renewed efforts by
the IASB and FASB to achieve these objectives, working
with supervisors, regulators and other constituents.
The Basel Committee has issued for consideration by
accounting standard setters principles for the
revision of accounting standards for financial
instruments, agreed by all G20 banking supervisors,
that address issues related to provisioning, fair
value measurement and related disclosures.
35. We welcome the IASB’s recent initiatives with
respect to provisioning and its enhanced technical
dialogue with prudential supervisors and other
stakeholders, and encourage the IASB to continue its
dialogue with stakeholders as it moves forward.
We request G20 Leaders to support the call for action
set forth in this section.
Improving compensation practices
36. National regulatory and supervisory initiatives
are being taken to implement the FSB Principles for
Sound Compensation Practices.
call for wide ranging private and official sector
action to ensure that governance of compensation is
effective; that financial firms align their
compensation practices with prudent risk taking; and
that compensation policies are subject to
effective supervisory oversight and engagement by
37. Given competitiveness
concerns, speedy and determined coordinated action in
all major financial centres is needed to achieve
effective global implementation of the Principles.
We must ensure that the Principles are rigorously and
consistently implemented and applied to significant
financial institutions and especially large,
systemically relevant firms across the financial
38. To this end, we have set out in a separate report2
to the Summit specific implementation standards for
the Principles, focusing on areas in which especially
rapid progress is needed.
• independent and effective
board oversight of compensation policies and
• linkages of the total variable compensation pool to
the overall performance of the firm and the need
to maintain a sound capital base;
• compensation structure and risk alignment, including
deferral, vesting and clawback arrangements;
• limitations on guaranteed bonuses;
• enhanced public disclosure and transparency of
• enhanced supervisory oversight of compensation,
including sanctions if necessary.
39. The Basel Committee, the International Association
of Insurance Supervisors (IAIS) and the International
Organization of Securities Commissions (IOSCO) will
undertake measures to support implementation.
40. We will undertake a FSB thematic peer review of
actions taken by national authorities to implement our
Principles and implementation standards.
We will assess whether these actions have had their
intended effect and propose additional measures as
This review will
be completed in March 2010.
41. These actions are in addition to our call for
banks to conserve capital by limiting bonus payments
today and so be in a better position to meet future
additional capital requirements.
Expanding oversight of the financial system
42. In addition to strengthening the buffers in the
banking system, work is progressing to ensure that,
throughout the broader financial system, all
systemically important activity is subjected to
appropriate oversight and regulation.
• Regarding hedge funds,
regulators are working, including through IOSCO, to
set out for consideration by legislatures a consistent
framework for oversight and regulation of hedge funds
and/or hedge fund managers, including requirements for
mandatory registration, ongoing regulation, provision
of information for systemic risk purposes, disclosure
and exchange of information between regulators.
coordinating their respective work in order to ensure
the best possible consistency with regard to
implementation of hedge fund regulation in different
By March 2010, IOSCO will report on the level of
implementation in these areas and on proposed industry
• On credit rating agencies,
regulators are working, including through IOSCO, to
evaluate whether national and regional regulatory
initiatives are consistent with the IOSCO Principles
and Code of Conduct Fundamentals and to identify
whether divergences between initiatives might cause
conflicting compliance obligations for credit rating
work together towards appropriate, globally compatible
solutions as early as possible in 2010.
• Regarding the perimeter of regulation more
generally, supervisors and regulators working through
the Joint Forum will identify by end-2009 other key
areas where the perimeter needs to be expanded.
• By the November 2009 meeting of G20 Finance
Ministers and Central Bank Governors, the
International Monetary Fund (IMF), Bank for
International Settlements and FSB will have developed
preliminary guidance for national authorities to
assess the systemic importance of financial
institutions, markets or instruments.
43. To guard against regulatory arbitrage, it is
imperative that initiatives to expand the perimeter of
regulation are effectively and consistently
implemented across key jurisdictions.
The FSB will benchmark the regulations implemented in
these jurisdictions to assess whether they are well
aligned with each other.
Strengthening the robustness of the OTC derivatives
44. Global regulatory efforts to reduce systemic risks
in the over-the-counter (OTC) derivatives market have
intensified since the London Summit.
Given the global nature of the market, international
standards must be established and consistently applied
to address these risks, and regulators must coordinate
45. To these ends, the official sector will:
• strengthen capital requirements to reflect the risks
of OTC derivatives and further incentivise the move to
central counterparties and, where appropriate,
The Basel Committee will issue
new standards by mid-2010 to take full account of
counterparty credit risks, the benefits of centrally
cleared contracts and collateralisation.
Regulators need to ensure that equivalent rules are
applied outside the banking sector;
• strengthen standards for central counterparties by
mid-2010 to address the issues specific to clearing
OTC derivatives, and develop international
recommendations for OTC derivatives trade
repositories, working through the Committee on Payment
and Settlement Systems and IOSCO;
• coordinate efforts to oversee and apply
international standards to OTC derivatives central
counterparties and trade repositories. We strongly
support the ongoing work of the OTC Derivatives
Regulators’ Forum to develop international cooperative
oversight frameworks by end-2009, including for
sharing information among regulators and developing
common expectations for data reporting; and
• identify legal or other impediments to implementing
the OTC derivatives market reforms, which regulators
or legislative authorities will then take action to
46. The private sector needs to meet its commitments
to supervisors to expand central clearing of OTC
derivatives trades; improve risk management for trades
that are not cleared, meet increasingly stringent
targets for operational improvements and report data
on their performance to their regulators; and report
all non-cleared trades to regulated trade
If they do not meet these and future commitments,
supervisors will develop alternative approaches to
ensure the improvements are made.
Re-launching securitisation on a sound basis
47. The revival of securitisation markets is needed in
many countries to support the provision of credit to
the real economy.
initiatives are underway to standardise terms and
structures, reduce complexity and enhance
transparency, the official sector must provide the
framework that ensures discipline in the
securitisation market as it revives.
48. To this end, during 2010, supervisors and
• implement the measures decided
by the Basel Committee to strengthen the capital
treatment of securitisation and establish clear rules
for banks’ management and disclosure, including:
o higher risk weights for securitisations and
o requirements on banks to conduct more rigorous due
diligence of externally rated securitisations, with
higher capital requirements imposed where this does
not take place;
o tighter prudential guidance for bank management of
off-balance sheet exposures arising from
securitisation vehicles; and
o improved disclosures of securitisation exposures in
the trading book, sponsorship of off-balance sheet
vehicles, re-securitisation exposures, valuation
assumptions and pipeline risks;
• implement IOSCO’s proposals to
strengthen practices in securitisation markets,
o reviewing the due diligence practices and associated
disclosures of participants in the securitisation
o better informing and protecting investors by
requiring greater disclosure by issuers, including
initial and ongoing information about underlying asset
o reviewing and, as appropriate, strengthening
investor suitability requirements;
o considering what enhancements are needed to
regulatory powers to allow authorities to implement
the recommendations in a manner promoting
international coordination of regulation;
• examine other ways to align
incentives of issuers with investors, including
considering requirements on issuers of securitisations
to retain a part of the economic exposure of the
• encourage greater use of the contractual form used
in covered bonds, which tie issuers to the instruments
by obliging them to act as the de facto guarantor in
the event of underperformance by the underlying
assets, provided that depositors are not
• support implementation of industry initiatives to
standardise terms and structures, reduce complexity
and enhance transparency and, as securitisation
markets restart, adjust measures as appropriate.
Adherence to international standards
49. The FSB will put in place by the end of 2009 a
framework to strengthen adherence to international
regulatory and prudential standards. The framework,
which will build upon IMF and World Bank assessments,
is envisaged to provide comprehensive and updated
FSB member countries have agreed to lead by example in
disclosing their degree of
The FSB will report on the development of this
framework at the November 2009 meeting of G20 Finance
Ministers and Central Bank Governors.
50. We will apply this framework to identify
non-cooperative jurisdictions with reference to
cooperation, information exchange and other prudential
standards, focusing on jurisdictions of concern due to
weaknesses in compliance and systemic importance.
The FSB will work as quickly as possible to develop:
• a global compliance “snapshot”
for the relevant standards building on Financial
Sector Assessment Program (FSAP) assessments where
available and other relevant information, by November
• criteria for identifying jurisdictions of concern by
• procedures for an evaluation process to build on and
complement FSAP assessments, to be launched by
February 2010 at the latest; and
• a toolbox of measures to promote adherence and
cooperation among jurisdictions, by February 2010 at
51. Within this framework, we are also developing a
system of peer reviews among FSB members, based among
other evidence on the findings of IMF and World Bank
assessments, and will report on their outcome.
These will comprise both single-country and thematic
reviews to assess our implementation of international
financial standards and of policies agreed in the FSB
and determine whether additional steps are needed to
reach the intended results.
will be developed in parallel. Actual reviews will
start by end-2009 with the thematic peer review on the
implementation of the FSB compensation principles.
The need for perseverance and consistent national
52. While reforms are well underway, as we detail in a
separate report, they are far from complete.
Effective work to strengthen the global financial
system requires policies that are well designed and
will be robust over the long run.
This necessarily takes time.
It is important, therefore, that Leaders send a strong
message that they are determined to see these reforms
Where international policy development is ongoing, we
need Leaders’ continued support; where such policy
work has concluded, we need Leaders’ commitment to
consistent national implementation.
Achieving our objectives of
a well regulated open financial system requires the
maintenance of a level playing field.
Delivering this is
one of the reasons why the FSB exists.
However, the speed with which jurisdictions develop
and change financial regulation differs, and
consistency in what comes into place should not be
taken for granted.
While the FSB can
develop coherent policy proposals, only national
authorities can assure implementation that is
is consistent across borders.
Given the commitment we have all made to coherent
approaches as we improve the regulation of the system,
we must strive to overcome differences in our final
We will continue
to take actions to ensure achievement of this end.
54. To maintain ongoing attention to this issue and
foster the pace and consistency of implementation, we
will launch a project to compare national
implementation measures and identify cross-country
differences and any need for policy actions to address
55. As our economies recover, it
is crucial that national momentum for significant
reforms be maintained.
The FSB will
continue to work to ensure that the goals remain
ambitious, that clear targets are set to move us
forward towards those goals, and that their importance
is not lost even if markets seem to be calmer for the
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