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International Association of Risk and Compliance
Professionals (IARCP)
1200 G Street NW Suite 800 Washington, DC 20005-6705 USA
Tel: 202-449-9750 www.risk-compliance-association.com
Top 10 risk and compliance management related news stories
and world events that (for better or for worse) shaped the
week's agenda, and what is next
What can you do if the audit documentation is not
exactly what you want to disclose to investors and other
parties? There is an easy answer: Change the audit
documentation. Changing the company is definitely
more expensive and takes more time too!
Yes, I know (and they all know) that improperly altering
audit documentation is inconsistent with an auditor's
professional duty to act with integrity and as a gatekeeper.
Today we learn that the enforcement staff of the Public Company
Accounting Oversight Board (Board, PCAOB) has uncovered evidence
(again...) that registered firms and associated persons have improperly
deleted, added to, or altered audit documentation in connection with Board
inspections, and then presented the altered documents to PCAOB
inspectors without informing the inspectors of the alterations.
Wait: These are the problems we had before the Sarbanes-Oxley Act!
The PCAOB continues: In certain instances, evidence indicates that
documents were created shortly in advance of, or during, an inspection,
backdated, and then made available to PCAOB inspectors without any
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disclosure of when they were actually created.
These recent instances involve both domestic firms and non-U.S. firms,
including members of global networks.
To reduce the risk of improper alteration of audit documentation in
connection with a PCAOB inspection, it is important for registered firms to
take actions to assure that:
(1) work papers are properly archived;
(2) work papers, once archived, are not improperly altered; and
(3) the documentation provided to PCAOB inspectors for an audit
is the originally-archived documentation for that audit.
The Board may institute disciplinary proceedings and impose sanctions
against firms and their associated persons for non-cooperation with an
investigation, including non-cooperation involving improperly altering
audit documentation.
Wait! We may find an excuse for these registered firms and associated
persons, that have improperly deleted, added to, or altered audit
documentation. Perhaps they follow the advice of Giacomo Casanova, who
has said: “I have always loved truth so passionately that I have often
resorted to lying as a way of introducing it into the minds which were
ignorant of its charms.” I rest my case.
Friedrich Nietzsche has said: “I'm not upset that you lied to me, I'm upset
that from now on I can't believe you.” He has also said: “The visionary lies
to himself, the liar only to others.” As he has never said anything about the
PCAOB, we have to read more at Number 7 below.
The Sarbanes-Oxley Act of 2002, which created the PCAOB, required that
auditors of U.S. public companies be subject to external and independent
oversight for the first time in history. Previously, the profession was
self-regulated.
The five members of the PCAOB Board, including the Chairman, are
appointed to staggered five-year terms by the Securities and Exchange
Commission (SEC), after consultation with the Chairman of the Board of
Governors of the Federal Reserve System and the Secretary of the Treasury.
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The SEC has oversight authority over the PCAOB, including the approval of
the Board's rules, standards, and budget.
The Sarbanes-Oxley Act, as amended by the Dodd-Frank Act, established
funding for PCAOB activities, primarily through the annual accounting
support fees assessed on public companies based on their relative average,
monthly market capitalization and on brokers and dealers based on their
relative average, quarterly tentative net capital.
Welcome to the Top 10 list.
Best Regards,
George Lekatis
President of the IARCP
General Manager, Compliance LLC
1200 G Street NW Suite 800,
Washington DC 20005, USA
Tel: (202) 449-9750
Email: [email protected]
Web: www.risk-compliance-association.com
HQ: 1220 N. Market Street Suite 804,
Wilmington DE 19801, USA
Tel: (302) 342-8828
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The national and local economic outlook - an
update
William C Dudley, President and Chief Executive
Officer of the Federal Reserve Bank of New York, at the
University of Bridgeport, Bridgeport, Connecticut
“Despite the swings we have seen in financial markets
over the past few months and the recent divergences across different
economic and financial market indicators, recent developments have not
led me to make a fundamental change in my outlook for the U.S. economy.
I continue to expect that the economy will expand over the course of this
year at a pace slightly above its long-term trend - sufficient to push the
unemployment rate down a bit further and to more fully utilize the nation's
labor resources.
On inflation, although recent data have been somewhat firmer, it still
appears that inflation for this year will fall short of our 2 percent objective
for the personal consumption expenditure (PCE) deflator.”
The theory and practice of supervision
Remarks by Mr Kevin Stiroh, Executive Vice President
of the Financial Institution Supervision Group of the
Federal Reserve Bank of New York, at the SIFMA
Internal Auditors Society Education Luncheon,
Harvard Club, New York City
“I'd like to cover three topics today related to the theory and practice of
supervision.
First, what is supervision?
Second, why is it necessary?
Third, what are some of the emerging issues in the execution of
supervision?”
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A possible way out from the "New Normal":
Rebalancing fiscal-monetary policies by picking
"Low-Hanging Fruits" to engineer more
confidence
Remarks by Mr Luiz Awazu Pereira da Silva, Deputy
General Manager of the BIS, at the Eurofi High Level
Seminar 2016, Amsterdam
“My main assumption is that the process of triggering the real sector
"animal spirits" or "confidence" has been much more complex than we
thought it would be.
On the one hand, price incentives might not be enough to fully restore
credit multipliers and might have created distortions.
Hence, going further into NIRP with unknown results might produce more
uncertainty that could itself undermine policy effectiveness.
But on the other hand, "productivity-enhancing" stimulus directed to the
real sector is needed in conjunction with structural reforms.”
EIOPA consults on methodology
to derive ultimate forward rate
under Solvency II
The European Insurance and Occupational Pensions Authority (EIOPA)
published a Consultation Paper on the methodology to derive the ultimate
forward rate (UFR) and its implementation.
According to the Solvency II legislative framework the ultimate forward
rate shall be stable over time and shall only change as a result of changes in
long-term expectations.
The methodology to derive the ultimate forward rate shall be clearly
specified and be determined in a transparent, prudent, reliable and
objective manner that is consistent over time.
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Issues for the Academic Community
to Consider
Steven B. Harris, Board Member
Annual Meeting, Washington DC
“Welcome to the 2016 PCAOB Academic Conference. We appreciate your
participation in this year's forum and your role in educating future
accountants and auditors.
You play an essential role in upholding the integrity of financial statements
and promoting investor protection.”
“As many of you know from our previous sessions, I chair the PCAOB's
Investor Advisory Group and was the chair of the International Forum of
Independent Audit Regulators' Investor and Other Stakeholders Working
Group until last April.”
Interest rate risk in the banking book
April 2016
The Basel Committee on Banking Supervision has
today issued standards for Interest Rate Risk in the
Banking Book (IRRBB).
The standards revise the Committee's 2004 Principles
for the management and supervision of interest rate risk, which set out
supervisory expectations for banks' identification, measurement,
monitoring and control of IRRBB as well as its supervision.
The standards reflect changes in market and supervisory practices since the
Principles were first published in 2004, which is particularly pertinent in
light of the current exceptionally low interest rates in many jurisdictions.
The revised standards, which were published for consultation in June 2015,
are expected to be implemented by 2018.
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PCAOB Publishes Staff Audit Practice
Alert on Improper Alteration of Audit
Documents
Staff of the Public Company Accounting
Oversight Board published a Staff Audit Practice Alert reflecting PCAOB
staff concerns about auditors improperly altering audit documentation in
connection with a PCAOB inspection or investigation.
In the past several years, the Board has sanctioned firms and individuals for
improperly deleting, adding, or altering documentation in connection with
an inspection or investigation.
The sanctions in those cases have included revoking firms' registrations and
barring individuals from auditing for registered firms.
PCAOB staff has recently seen evidence that such misconduct is continuing
to occur.
Raghuram Rajan: Words matter but so does
intent
Dr Raghuram Rajan, Governor of the Reserve Bank
of India, at the 12th National Institute of Bank
Management (NIBM) Convocation, Pune
Congratulations to the graduating class, to their
professors, and to their proud parents, siblings and
friends.
If you are typical, you are happy to be leaving university and embarking on
a new journey, sad to be leaving familiar settings behind, and worried
whether you will measure up to the challenges of wherever you are going for
work or higher studies. You are also concerned about whether you have
taken, or will take, the right next step.
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Apple Ends Support for QuickTime for Windows; New
Vulnerabilities Announced
According to Trend Micro, Apple will no longer be providing security
updates for QuickTime for Windows, leaving this software vulnerable to
exploitation. All software products have a lifecycle. Apple will no longer be
providing security updates for QuickTime for Windows.
The Zero Day Initiative has issued advisories for two vulnerabilities found
in QuickTime for Windows. Computer systems running unsupported
software are exposed to elevated cybersecurity dangers, such as increased
risks of malicious attacks or electronic data loss. Exploitation of QuickTime
for Windows vulnerabilities could allow remote attackers to take control of
affected systems.
Financial stability in Europe and how to
improve it
Speech by Mr Yannis Stournaras, Governor of the
Bank of Greece, at the Croatian National Bank
"Financial stability and policy intervention by
Central Banks in Europe - where do we stand and
what challenges lie ahead", Zagreb
inancial stability is a critical condition for achieving
our common goals of prosperity and sustainable growth.
Yet, the financial landscape on which both regulators and market
participants operate, has been rapidly changing; it is very different today
from what it was only ten years ago, and it will be very different ten years
from now.
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The national and local economic outlook - an
update
William C Dudley, President and Chief Executive Officer
of the Federal Reserve Bank of New York, at the
University of Bridgeport, Bridgeport, Connecticut
Jaison Abel, Jason Bram, Tony Davis, Richard Deitz,
Jonathan McCarthy and Joseph Tracy assisted in preparing these remarks.
Good morning. I am very pleased to be in Bridgeport and to speak with you
today. I would like to give a special thanks to the University of Bridgeport
for their part in making this event possible.
My visit today is part of our ongoing efforts at the Federal Reserve Bank of
New York to better understand the regional economy. We plan trips like
this so that we can meet with a diverse array of stakeholders in the region to
gain insights and perspectives on the local economy.
These trips also allow us to hear from Main Street about the major issues
and concerns affecting people and businesses in the area. Fairfield County
is our first destination in 2016, and this is the second time we have visited
the area in the past three years.
I am looking forward to meeting with a number of different groups today.
After starting our day here at the University of Bridgeport, we will meet
with an organization called The WorkPlace to hear about some of the
nationally-recognized programs they have successfully developed to help
the long-term unemployed find jobs. Long-term unemployment is a
significant problem in the broader economy, and something that I will
discuss in more detail later in my remarks.
Next, we will take a tour of the American Job Center, an organization that
provides workforce assistance to job seekers in conjunction with local
businesses. Later we will attend, a roundtable lunch with members of the
Bridgeport Regional Business Community.
And, finally, we will meet with leadership from the Housing Development
Fund, New Horizons and NeighborWorks America to hear about the state
of affordable housing and community development in Fairfield County.
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These trips are valuable to us, and represent one of the many ways in which
the New York Fed engages with people and businesses in our region.
Another one of our efforts in this vein is our Small Business Credit Survey the latest version of which was released last month.
This survey - which includes responses from across 26 states - helps us
understand the challenges facing small businesses in the region, focusing
on financing needs and impediments to obtaining credit.
We partnered with multiple organizations throughout Connecticut to
produce this survey - some of which are right here in Bridgeport - and
received responses from nearly 200 small business owners from around the
state. I'd like to personally thank those who participated in the survey.
The remainder of my remarks will focus on recent developments in the
national and local economy. As always, what I have to say today reflects my
own views and not necessarily those of the Federal Open Market Committee
(FOMC) or the Federal Reserve System.
U.S. economic outlook
Despite the swings we have seen in financial markets over the past few
months and the recent divergences across different economic and financial
market indicators, recent developments have not led me to make a
fundamental change in my outlook for the U.S. economy.
I continue to expect that the economy will expand over the course of this
year at a pace slightly above its long-term trend - sufficient to push the
unemployment rate down a bit further and to more fully utilize the nation's
labor resources.
On inflation, although recent data have been somewhat firmer, it still
appears that inflation for this year will fall short of our 2 percent objective
for the personal consumption expenditure (PCE) deflator.
However, I anticipate an eventual return to our objective as the transitory
factors that have held down inflation dissipate over time.
In assessing the current state of the U.S. economy, recent news has
generated divergent signals. Several sectors have been showing signs of
softness.
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Real consumer spending growth appears to have moderated somewhat
from the relatively robust pace of the second half of 2015.
Both new and existing home sales have flattened since the middle of last
year.
Finally, indicators of real business investment spending point to continued
softness.
In contrast, manufacturing production - which had been a particular weak
spot of the U.S. economy in 2015 - rose in the first two months of this year.
Recent survey data, including our own Empire State Manufacturing Survey,
indicate further improvement in conditions for the manufacturing sector in
March.
Through it all, the U.S. labor market has remained healthy.
Payroll employment increased an average of about 229,000 per month over
the course of 2015, and the gains in the first quarter of this year were nearly
as high.
Even though the unemployment rate ticked up in March to 5 percent, the
amount of slack in the labor market still appears to be diminishing.
Both the share of the population that is employed and the labor force
participation rate have risen a bit over the past several months, with the
employment-to-population ratio now at its highest level since the end of the
recession.
However, measures of aggregate wage growth have remained quite
subdued, which suggests there is still some slack in the labor market.
An important question is how to reconcile these cross-currents.
I continue to anticipate that consumption and housing activity will expand
at a moderate pace this year.
Continued job and wage gains, combined with still-low energy prices,
should sustain real disposable income growth and support consumer
spending.
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The housing market should remain on a solid trajectory, supported by
rising employment and low mortgage rates. In contrast to previous years,
fiscal policy should also provide a moderate stimulus this year.
I believe that these positive factors will be sufficient to offset weakness in
other areas, such as net exports and fixed business investment that will
continue to be adversely impacted by the still-strong dollar, weak foreign
growth, and low energy and commodity prices.
Putting this all together, I expect real GDP growth of about 2 percent in
2016, slightly below the average pace of growth in this expansion, but a bit
above my estimate of the potential growth of the U.S. economy.
If this materializes, then we should see some further reduction in the
unemployment rate to around 4¾ percent - my estimate of the rate that I
view as consistent with stable inflation over the long term.
Turning to the outlook for inflation, on a year-over-year basis, both
headline and core inflation have recently risen above the low levels that
prevailed through most of 2015.
Nevertheless, inflation still remains below the Federal Reserve's 2 percent
objective.
As the FOMC noted in its March statement, this continued low inflation is
partly due to declines in energy prices and non-energy import prices.
Although energy prices have stopped falling and the dollar has stopped
appreciating, earlier movements in these factors still appear to be weighing
on inflation.
A concern with this long period of low inflation is that it has the potential to
reduce inflation expectations, which, in turn, would tend to continue to
hold down inflation.
As past experience shows, it is difficult to push inflation back up to the
central bank's objective if inflation expectations fall meaningfully below
that objective.
Japan's experience is cautionary in this regard.
Recent evidence on inflation expectations suggests some firming, but there
is still cause for concern.
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Although both measures of longer-term inflation compensation based on
nominal and inflation-indexed Treasury securities as well as some survey
measures of inflation expectations have risen modestly since mid-February,
the levels of many of these measures remain quite low.
Now, as I have noted, the low level of market-based inflation compensation
probably reflects factors besides inflation expectations, in particular lower
term premiums.
Still, it would be prudent to consider the possibility that longer-term
inflation expectations of market participants may have declined somewhat.
Even after a rise in its most recent reading, the median of the three-year
inflation expectations from the New York Fed's Survey of Consumer
Expectations remains near its lowest reading over its short history.
Renewed declines in survey measures would be worrisome. However, at
this point, my conclusion is that inflation expectations have not become
unanchored.
In sum, I anticipate that the combination of decreasing resource slack and
anchored longer-term inflation expectations will help push inflation up to
our 2 percent objective over the medium term.
The recent rise in inflation and in measures of inflation expectations have
increased my confidence around this outlook compared to earlier in the
year, but it is still possible that the return of inflation to our objective could
take longer than I anticipate.
The forecast that I have just described is my best assessment of how the
U.S. economy will evolve this year.
As always, there is uncertainty and risk relative to this forecast, which also
needs to be taken into consideration in assessing the implications of the
outlook for monetary policy.
I see the uncertainties around my forecast to be somewhat greater than
usual.
This assessment reflects the divergent economic signals I highlighted
earlier.
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In addition, the factors behind the financial turbulence we saw earlier this
year do not yet appear to be resolved fully.
Although the downside risks have diminished since earlier in the year, I still
judge the balance of risks to my inflation and growth outlooks to be tilted
slightly to the downside.
The low levels of energy and commodity prices may signal more persistent
disinflationary pressures than I currently anticipate, while renewed
tightening of financial market conditions could have a greater negative
impact on the U.S. economy.
Also, there is significant uncertainty about economic growth prospects
abroad and how this will affect the U.S. economic outlook.
I continue to monitor global economic and financial market developments
closely to assess their implications for the outlook.
Given my outlook and risk assessment, I judge that a cautious and gradual
approach to policy normalization is appropriate.
Moreover, caution is also called for because of our limited ability to reduce
the policy rate to respond to adverse developments, recognizing that we
could also use forward guidance and balance sheet policies to provide
additional accommodation if that proved warranted.
Of course, the trajectory of short-term interest rates and the timing of
future monetary policy adjustments will continue to be informed by the
incoming data - both economic and financial - and how that data influences
the outlook.
The problem of long-term unemployment
Before turning to the outlook for the local economy, I would like to spend a
few minutes talking about the problem of long-term unemployment.
The Great Recession was very severe, resulting in a large decline in output
and damage to the labor market.
From peak to trough, non-farm payroll employment declined by 8.7
million.
The unemployment rate peaked at 10 percent.
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At the same time, the average duration of unemployment increased
significantly.
The number of individuals classified as long-term unemployed - that is,
those who were unemployed for at least 27 weeks - peaked in December
2010 at 6.4 million, an increase of 5.3 million from the cyclical low in May
2007.
Long-term unemployment as a fraction of total unemployment increased
from 16.7 percent to 44.8 percent.
The hardships of prolonged unemployment touched many families around
the country and this is tragic.
The very accommodative monetary policy that we implemented in response
was aimed at helping to heal the labor market and promote price stability.
Slowly, the economy began to respond and to recover.
In October 2014, the FOMC announced the end of its latest asset purchase
program citing that "there has been substantial improvement in the outlook
for the labor market since the inception of its current asset purchase
program."
In March 2015, the FOMC set out conditions for the decision to begin to
normalize monetary policy, stating "The Committee anticipates that it will
be appropriate to raise the target range for the federal funds rate when it
has seen further improvement in the labor market and is reasonably
confident that inflation will move back to its 2 percent objective over the
medium term."
The FOMC judged at its December 2015 meeting that those conditions had
been met.
The improvement that we have seen in the labor market is very welcome. It
took until May 2014 for the labor market to recover the jobs lost in the
recession, but now there are 5.3 million jobs beyond the prior cyclical peak.
The unemployment rate has declined to 5.0 percent. With this
improvement, the number of long-term unemployed has been reduced to
2.2 million.
Despite these gains, it is important to emphasize that more needs to be
done to improve the labor market. The current number of long-term
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unemployed is still higher than the prior cyclical peak in June 2003, and is
more than a million above the prior cyclical low in October 2006.
Further progress on transitioning these unemployed workers back into jobs
requires sustained effort on many fronts. Essential to this effort are
programs such as the Platform to Employment developed by The
WorkPlace.
I am looking forward to my visit there later today to hear more about this
program.
The Platform to Employment program has been replicated in nearly 20
communities across the country from Newark to San Diego. Helping the
long-term unemployed regain employment needs to be a priority for all of
us.
The ongoing challenge in reducing the number of long-term unemployed is
also a reminder of the importance of financial stability and sustainable
economic growth.
Recessions can quickly undo years' worth of hard-earned progress in the
labor market.
Making the financial system and the economy more resilient so we can
avoid such deep downturns in the future is a responsibility that I take very
seriously.
Local economic outlook
Turning now to the region, while Fairfield County's economy has recovered
from the Great Recession, its job growth has lagged behind both New York
City and the nation.
Only recently has employment approached its pre-recession levels, and it is
still well shy of where it was back in 2000.
Other barometers of the Fairfield County economy, such as home prices,
also indicate a slow recovery from the recession.
There are still a sizable number of properties that are either in foreclosure
or up for foreclosure sale, which has weighed down the local housing
market.
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Yet, Fairfield County has not been the only place in the metro region to see
a sluggish recovery - notably, both northern New Jersey and the
Mid-Hudson Valley have yet to see employment return to their
pre-recession peaks.
This picture is in contrast with New York City's economic performance,
which has been exceptionally strong throughout this expansion, and has
been a driver of growth for the whole tri-state region.
Why is New York City seeing so much stronger job growth than Fairfield
County?
After all, it wasn't so long ago that Stamford was attracting finance-sector
jobs away from Manhattan.
The answer lies in a mix of cyclical and secular trends. On the cyclical side,
while finance employment has been sluggish in both New York City and
Fairfield County, New York City is benefiting from strong employment
gains in technology, construction, retailing and advertising - sectors that
are not contributing to the same degree in Fairfield County. In addition,
Stamford has had to deal with the relocations of UBS and RBS, while
Fairfield faces the prospective relocation of GE.
One potential long-term trend that is likely affecting the region is a renewed
urbanization: that is, a gradual but broad-based shift of preferences to
urban living, especially for younger generations.
Throughout the second half of the 20th century, we saw a steady and
widespread migration from cities to suburbs.
More recently, this suburbanization trend seems to have halted; and there
are signs that cities, especially major cities, have been gaining relative to
their suburbs.
It's too early to say if this is the start of a secular trend, and the implications
for Fairfield County are unclear.
However, Stamford and Bridgeport stand to benefit from a shift in
preferences toward more urban living, given their high population densities
and strong transit links to New York City.
Even now, while Fairfield County may have lagged in job growth,
population growth has remained quite sturdy - not only across the county,
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but here in Bridgeport as well. In fact, Bridgeport's population has grown
by about 6 percent since 2000 - its first sustained increase since the 1940s while Stamford's has grown by almost 10 percent.
Fairfield County can leverage its proximity to the New York City job market.
While most residents of Fairfield County rely on job opportunities locally,
many residents commute to jobs in Manhattan.
So the strength in New York City's economy should be of significant help to
Fairfield County.
Over the past year, New York City's economy has, on average, added more
than twice as many jobs each month as the total expected job losses from
the relocations of GE, UBS and RBS.
While a majority of these jobs may not have been in high-paying-industry
sectors, some of them were - especially in technology-related industries.
So, as long as New York City keeps adding jobs at such a brisk pace,
Fairfield County will benefit.
In addition, research indicates that a strong central city is critical for the
well-being of its suburbs, meaning that a healthy and growing New York
City economy is critically important to Fairfield County.
What else can the region do to foster economic growth going forward? It
certainly helps for cities like Bridgeport and Stamford to be attractive
locations for businesses to locate and grow.
It is also important to focus on quality of life issues that make people want
to live here - like good schools and low crime, and also amenities ranging
from nice parks to good restaurants.
Bridgeport has clearly been making progress in this regard, both along the
waterfront at Steelpointe Harbor and along Main Street.
With New York City's large and booming economy nearby, and Metro North
providing a convenient mass transit link, anything that makes people more
inclined to live here - and perhaps even set up shop here - is bound to boost
the local economy.
And finally, one of the most important ingredients for a healthy urban
economy is a well-trained and motivated work force.
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It cannot be overstated how important it is to help provide residents with
the skills and tools they need to be productive and successful, so that they
can realize their full potential.
College graduates finding good jobs
I would like to close with a message for the students in attendance today,
especially those of you who will be graduating soon. If you started college
four or five years ago, you may have heard about the difficult time that
graduates have had finding good jobs, perhaps even making you wonder
about the value of obtaining a college degree.
Indeed, in the years following the Great Recession, unemployment and
underemployment among recent college graduates reached highs not seen
in decades. So, it wouldn't be surprising if many of you are concerned about
your ability to find a good job after graduation.
I want to make two points that should temper these concerns.
First, it is not unusual for college graduates to take some time to find the
right job when they transition from school to the working world.
In good economic times, as well as in bad times, there is often an
adjustment period as newly-minted graduates search for a job that best fits
their skills and interests.
Second, as the job market has continued to strengthen through the
expansion, it has gotten easier for those graduating from college to find a
good job.
While job opportunities for those with a college degree were flat between
2011 and early 2014, demand for college graduates has been on the rise for
about two years now.
As a result, for the first time during this recovery, both unemployment and
underemployment among recent college graduates has generally been
falling.
This means that, not only has it become easier to find a job upon
graduation, but more college graduates are taking jobs that better utilize
their degrees.
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In addition, starting salaries for recent college graduates have been
increasing for the past couple of years, reflecting the growing demand for
their skills in a tighter job market.
To conclude, while there are economic challenges facing both the nation
and the region, I am optimistic that we will continue to make progress on
both fronts over the next few years.
Achieving our dual mandate of maximum sustainable employment and
price stability will help those who will graduate soon to achieve their own
aspirations.
Thank you for your kind attention. I would be happy to take some
questions.
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The theory and practice of supervision
Remarks by Mr Kevin Stiroh, Executive Vice President
of the Financial Institution Supervision Group of the
Federal Reserve Bank of New York, at the SIFMA
Internal Auditors Society Education Luncheon,
Harvard Club, New York City
Introduction
Good afternoon. I'm Kevin Stiroh, the head of the Supervision Group at the
Federal Reserve Bank of New York. I'd like to thank SIFMA for the
opportunity to speak today about the theory and practice of supervision.
By way of background, I took over my current role in October of 2015, after
spending time in the New York Fed's Research, Markets and Integrated
Policy Analysis Groups, as well as earlier positions within Supervision.
I am an economist by training and I spent much of my career studying the
performance and function of financial institutions in the U.S., the critical
role of bank capital, and the potential link with financial stability.
I'd like to cover three topics today related to the theory and practice of
supervision.
First, what is supervision?
Second, why is it necessary?
Third, what are some of the emerging issues in the execution of
supervision?
Before beginning, let me emphasize that my comments today are my own
and do not necessarily represent those of the Federal Reserve Bank of New
York or the Federal Reserve System.
What is supervision?
The Federal Reserve has many responsibilities, most closely linked to the
execution of U.S. monetary policy and the regulation and supervision of the
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U.S. financial system. In fact, the official title of the Federal Reserve Act
includes the phrase "to establish a more effective supervision of banking in
the United States," so supervision has been a core responsibility of the
Federal Reserve from the beginning.
But what does "a more effective supervision of banking" mean?
At the highest level, the Federal Reserve's mission for supervision and
regulation is to promote a safe, sound, and stable banking and financial
system that supports the growth and stability of the U.S. economy and a fair
and transparent consumer financial services market.
That's a lot, so it is useful to drill down a little; I can do that by describing
what we do on an ongoing basis at the Federal Reserve Bank of New York.
At the New York Fed, we operate under delegated authority to supervise the
financial institutions in the Second Federal Reserve District, which
encompasses New York, parts of New Jersey and Connecticut, the
Commonwealth of Puerto Rico, and the U.S. Virgin Islands.
This area includes enormous diversity in institutions from state member
banks with total assets of less than $100 million operating in a local
community to bank holding companies with trillions of dollars of assets
operating on a global scale.
Our staff assesses the safety and soundness of domestic banking
institutions and operations of foreign banking organizations in the district
through onsite evaluations and offsite financial analysis and surveillance.
One of our fundamental responsibilities is to ensure that each institution
has in place the appropriate risk identification and risk management
processes that are necessary for prudent banking.
We also analyze issues and industry developments to identify emerging
risks and to contribute to the development of domestic and international
supervisory policy.
I'll return to a discussion of emerging risks later in my talk.
The Supervision Group at the New York Fed works with our colleagues
around the Federal Reserve System to develop and implement the System's
supervisory programs.
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This includes working through governance structures like the Large
Institution Supervision Coordinating Committee (LISCC) that oversees
supervision for the largest, most systemically important institutions in the
U.S.
We are also involved in similar System-wide committees for other types of
institutions such as community banks, regional banks, foreign banks, and
other large banking institutions, as well as consumer protection.
I'll speak mostly today about our supervisory responsibilities for the largest
firms, but will note that we recently hosted a conference at the New York
Fed focusing on the role of community banks.
For the largest firms, we actively participate in System-wide horizontal
examinations such as the Comprehensive Capital Analysis and Review, or
CCAR, which is the annual process for evaluating capital adequacy of the
largest firms that began last week.
We are actively involved in other horizontal programs such as the
Comprehensive Liquidity Analysis and Review (CLAR), and the Supervisory
Assessment of Recovery and Resolution Preparedness (SRP).
CLAR is the Federal Reserve's annual, horizontal, forward-looking program
to evaluate the liquidity position and liquidity risk management practices of
LISCC firms. SRP is the Federal Reserve's annual horizontal review of the
LISCC firms' options to support recovery and progress in removing
impediments to orderly resolution.
These three programs form the foundation for the horizontal aspects of the
System's supervisory program for the largest firms.
The Supervision Group at the New York Fed plays a strong role in
developing and executing these initiatives.
In parallel to the horizontal work for the largest firms, the Federal Reserve
has a dedicated supervisory team for each of the largest firms.
These teams execute supervisory strategies for each firm that align with
Federal Reserve System priorities.
Through the execution of firm-specific supervision, these dedicated
supervisory teams play a critical role in helping to achieve these objectives.
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Given the location of the headquarters of many of the largest firms in New
York, the Supervision Group at the New York Fed plays a central role within
the Federal Reserve System in the execution of supervisory activities
through the dedicated supervisory teams.
To conclude this section, I'll note that my colleagues in the Research Group
at the New York Fed recently hosted a conference entitled "Supervising
Large Complex Financial Institutions: Defining Objectives and Measuring
Effectiveness."
This conference brought together academic economists, policymakers and
senior supervisors to talk about the goals and objectives of supervision and
different approaches to assessing supervisory success and effectiveness.
While this conference focused on the largest institutions, the main themes
apply more broadly to the objectives of supervision.
One important theme of the conference was the conceptual distinction
between regulation and supervision. Both are designed to help the Fed
achieve its objectives and they are mutually reinforcing, complementary
efforts.
Broadly speaking, regulation involves writing the rules that govern what
financial institutions can and cannot do.
Supervision focuses on monitoring, oversight and enforcing compliance
with law, and supervisory expectations for firms' governance, internal
processes and controls, and financial condition.
Why is supervision necessary?
I think it is useful to take a step back and talk about what motivates the
need for public sector intervention in the form of ongoing supervision.
Why doesn't the market provide sufficient discipline on financial
intermediaries as is presumed for some other industries?
In the language of an economist, what are the frictions that lead to a market
failure so that financial institutions, left to their own incentives and choices,
won't necessarily make optimal choices from a societal perspective?
I'll talk about two types of market frictions that create the need for public
sector intervention.
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The first is asymmetric information - the difference in what the borrower
knows about an investment opportunity and what the lender or funder of
that investment knows.
The second is externalities - the ability of one firm's decisions or actions to
affect other unrelated market participants. Both of these forces can drive a
wedge between private and socially - desired outcomes and motivate the
need for public sector intervention.
Conceptually, either supervision or regulation can help solve these
problems and their relative efficacy depends, in part, on the type of
information being assessed or the problem being solved.
1.Asymmetric Information
There is considerable academic research describing how asymmetric
information can create a special role for financial intermediaries.
The basic issue is that lending requires the production of private
information about things like the probability of a successful investment
outcome, but this can be difficult to convey to third parties who might be
providing the funding.
This creates a role for a financial institution to bridge the gap between
borrowers and savers.
Moreover, these information asymmetries create the scope for two
problems endemic to credit markets: adverse selection where the riskiest
borrowers are the most likely to seek credit and moral hazard where
borrowers pursue riskier behavior after credit has been extended because
their own funds are not invested.
In both cases, mitigation requires costly screening and monitoring, which
creates a role for a specialized financial intermediary.
Asymmetric information also creates issues on the liability side of a bank's
balance sheet.
The banks' creditors - depositors or providers of funding - don't have as
much information about the health of the institution as insiders do.
This asymmetry makes banks opaque and inherently fragile, which can
subject them to runs.
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This type of "run risk" has been largely mitigated, at least in the case of
retail depositors, by deposit insurance, access to lender of last resort
facilities, and other elements of the bank safety net.
Importantly, however, a broad safety net weakens market discipline of
banks and can create incentives for excessive risk-taking.
This contributes to the need for risk-sensitive regulation and supervision.
Regulations can control risk-taking through a variety of means such as
setting minimum requirements for capital and liquidity positions, while
supervision can identify and constrain activities that are not well-captured
through regulation but still affect a firm's risk management, governance
and control infrastructure.
One common objective is to counter the incentive for excessive risk-taking
by intermediaries.
2.Externalities
A second and distinct type of market failure that creates a need for public
sector intervention stems from the externalities that the failure of a large,
systemically important bank failure can have on the rest of the financial
sector or the economy as whole.
For example, the financial crisis vividly demonstrated how the distress of a
large financial firm can destabilize broader financial markets and impact
other financial firms.
These effects can be seen through direct linkages via counterparty
exposures.
They can also be seen through less direct linkages such as
confidence-related behaviors that are manifest in higher haircuts and
margins or reluctance to do business with certain firms or types of firms,
uncertainty about the true health of a firm, or the impact of fire sales on the
valuation of a broad class of assets held by a broad range of investors.
The fact that these costs are external to a given financial firm can lead to
excess risk-taking.
The realization of these externalities during the financial crisis has had a
profound impact on the Federal Reserve's approach to supervision.
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Most specifically, they provided the practical experience to support the
conceptual case for tightened prudential requirements for the largest, most
systemically important institutions.
This focus is seen in the mandate from the Dodd-Frank Act for the Federal
Reserve to implement enhanced prudential standards, including higher
capital standards, to mitigate the risks posed to financial stability by
systemically important financial institutions.
For example, both the Basel Committee for Banking Supervision and the
Federal Reserve System have identified factors that contribute to a financial
firm's systemic importance through these types of externalities.
These mechanisms are proxied for by observable metrics such as the size of
the balance sheet, interconnectedness between firms, complexity of the
business, cross-jurisdictional activity, short-term wholesale funding, and
substitutability of certain activities.
These metrics then determine the capital surcharge for systemically
important banks as outlined in the Federal Reserve rule and white paper
from July 2015.
More generally, these types of differences across firms provide one of the
conceptual underpinnings for differentiating supervisory expectations for
different types of financial institutions.
This concept - often referred to as "tailoring" - has long been part of the
supervisory approach, and has received considerable attention recently.
It is reflected in our organizational structure as seen in things like the
LISCC and in application of supervisory guidance across different types of
firms.
As a specific example, the Federal Reserve issued two Supervisory and
Regulation letters in December of 2015 that consolidate previously-issued
guidance on capital planning and more clearly differentiate supervisory
expectations between financial institutions with more complex operations
and those with less complex operations.
This tailoring of guidance applies to capital planning expectations related to
governance, risk management, internal controls, capital policy, scenario
design and projection methods.
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This guidance further clarifies how capital planning expectations are
moderated for firms that pose more limited risk to financial stability.
Key issues
I've discussed some of the conceptual underpinning of supervision and I'll
now turn to some of the practical implications and issues that I'm thinking
about.
We continue to strive to provide clarity and transparency on our
supervisory expectations and concerns.
This can be seen through a variety of mechanisms, including public
discussion and private communications with supervised firms.
I've mentioned some of the most useful sources of information such as
Supervision and Regulation letters that provide public guidance on specific
topics to supervised firms, rules and white papers that outline and
implement the underlying conceptual thinking on key issues such as the
surcharge for systemically important banks or the expectations around
CCAR, and public speeches by policymakers.
Of course, we engage regularly in private communications with supervised
firms.
This is both to provide feedback on a firm's progress relative to supervisory
expectations and to gain information about the developments in the
financial industry and the efficacy or our supervisory programs.
We do this on a regular and continuous basis through both formal and
informal channels, and this is a key part of the supervisory program for
firms of all sizes.
I also want to highlight three specific developments that are relevant for us
as we execute our supervisory responsibilities.
I expect these topics - cybersecurity, fintech and reputational risk - will be
familiar and I'll provide a supervisory perspective on each.
1.Cybersecurity
The Federal Reserve, in its supervisory role, collaborates with the Federal
Financial Institutions Examination Council (FFIEC) to coordinate work on
enhancing cybersecurity supervisory programs.
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We are also interested in working with the industry on a coordinated
approach for cybersecurity to strengthen the resiliency of the financial
services sector against cyberattacks.
Internally, the Federal Reserve has organized a supervisory program on
cybersecurity that consists of subject matter experts from across the
Federal Reserve System.
Work is underway to enhance the analysis of IT examination data in
conjunction with threat information to enhance risk-focused reviews
during examinations.
Through our discovery work with financial institutions, we have found that
the state of cybersecurity readiness varies across firms.
Supervisors are seeking to develop common principles to address
cybersecurity issues and will work with other agencies to ensure that firms
are dedicating resources and taking the appropriate actions to defend the
operations that are critical to the financial services sector against cyber
threats.
This is particularly true for those risks that could be channeled through
interconnected organizations and that could potentially have an impact on
other firms and more broadly across the sector.
2.Fintech
The financial sector, like the broader U.S. economy and society, is becoming
increasingly digital and there is considerable discussion of "fintech" defined simply as the intersection between financial services and new
technologies.
A recent industry study, for example, reports that investment in fintech
companies grew from $1.8 billion in 2010 to $19 billion in 2015.
It is unclear, however, whether fintech will enhance or fundamentally
disrupt the financial service and payments industries, or perhaps it is some
combination of both.
In any of these cases, however, supervisors will have a keen interest in
monitoring the impact on the business models and risks of financial
institutions and the way financial intermediation is done.
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We observe financial firms engaging in a variety of ways with fintech
companies.
This can be through the development of in-house projects such as setting
up innovation labs or encouraging developers to code on open application
program interfaces (APIs).
This can also be through collaboration with industry consortiums to come
up with unified industry standards that enhance operability and enable
future technological advancements, or it can be through partnering with or
investing directly in fintech companies.
Some of the interesting questions for supervision revolve around things
like: what new benefits might these new technologies bring?
Will they enhance existing processes or bring about entirely new solutions
to existing financial sector problems?
Will they create risk, mitigate risk, or simply reallocate existing risks?
How should the current supervisory framework evolve to incorporate these
types of developments?
The New York Fed is assessing the implications of fintech developments
through participation in a wide range of Federal Reserve System,
interagency, and international efforts.
In addition, we meet regularly with supervised firms, fintech companies,
and industry groups to follow these developments. Our supervisory
program will continue to evolve with the underlying technologies.
3.Reputation risk
Over the past few years, the New York Fed has been challenging the
financial industry to consider the many factors that have contributed to
recent, widespread misconduct and the perceived lack of trust in the
financial sector.
The various forms of misconduct impose direct costs such as fines, legal
fees in investigating allegations and defending lawsuits, and internal
monitoring costs that should matter to firms.
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In this view, a principal benefit to a financial firm of having a strong culture
that builds trustworthiness is the avoidance of the bad behavior that can
carry significant monetary costs and can inflict destructive damage to the
organization's reputation. Firms should have every incentive to manage and
internalize those potential costs.
More broadly, there may be additional adverse effects on other firms or the
financial sector as a whole if there is a widespread lack of trust in financial
services.
Similarly, my colleague Michael Strine has argued that the financial
industry exists, in part, to enhance the public good and thus faces a higher
degree of social responsibility due to its role in supporting the broader
economy.
Both of these effects suggest a role for the public sector in facilitating
appropriate behavior and conduct in the financial services industry.
Supervision can contribute to this through support for the development of
effective internal governance regimes, prudent risk management policies,
and strong compliance and control structures, all within a framework of
effective oversight from the Board of Directors.
Conclusion
To conclude, I've spoken today about the conceptual rationale for public
sector intervention through supervision and some practical issues related to
how we execute on our supervisory responsibilities at the Federal Reserve
Bank of New York.
Our goal is to promote a safe, sound, and stable banking and financial
system that supports the growth and stability of the U.S. economy, and we
will continue to strive to meet these responsibilities.
Thank you very much for your attention this afternoon. I'd be happy to take
some questions.
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A possible way out from the "New Normal":
Rebalancing fiscal-monetary policies by picking
"Low-Hanging Fruits" to engineer more
confidence
Remarks by Mr Luiz Awazu Pereira da Silva, Deputy
General Manager of the BIS, at the Eurofi High Level
Seminar 2016, Amsterdam
There is a broad agreement that monetary policy (MP) is not sufficient to
fundamentally change growth prospects under the "New Normal" in most
advanced economies (AEs).
Conversely there is a heated debate as to whether unconventional monetary
policy (UMP) is still effective using Negative Interest Rate Policy (NIRP),
especially in Europe and Japan.
Moreover, without fully endorsing any of the explanations, many
economists are wondering: why has the response to policies been so muted?
Is it because of "debt deleveraging"? Or is it because of a fundamental shift
such as the "secular stagnation" hypothesis?
The answer is not easy, but perhaps one can try to propose an explanation
and a possible alternative policy framework.
In these personal remarks, I will discuss one such possible alternative, a
"way out" with all due respect to all.
My main assumption is that the process of triggering the real sector "animal
spirits" or "confidence" has been much more complex than we thought it
would be.
On the one hand, price incentives might not be enough to fully restore
credit multipliers and might have created distortions.
Hence, going further into NIRP with unknown results might produce more
uncertainty that could itself undermine policy effectiveness.
But on the other hand, "productivity-enhancing" stimulus directed to the
real sector is needed in conjunction with structural reforms.
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The issue is how to achieve that with a rebalancing of policies that removes
the excessive burden placed on MP. This rebalancing should be pro-growth
without creating complacency and "free-riding".
So, here I will try to:
-
explain the muted response to policy, looking at the uncertainty and
market scepticism, including doubts about NIRP;
-
acknowledge that, despite the analytical reasons that might justify
continuing UMP, there are also risks to financial stability that call for
complementary policies; and hence
-
propose a possible gradual "way out" with a rebalancing of our
fiscal-monetary policy mix. My hope is that more confidence could be
engineered and market expectations re-anchored if we use a pragmatic
and more balanced policy framework.
1. Why is there increasing market anxiety about monetary policy
effectiveness?
In my view, uncertainty is increasing market anxiety. It is about where the
global economy is heading, it is about how the ongoing US business cycle
with normalisation of its MP can be reconciled with developments in other
systemic economies, and it is about policy divergence.
Uncertainty arises in part because of significant dispersion in growth
projections both in major AEs and in many emerging market economies
(EMEs).
Data seem finally to confirm the ongoing growth momentum in the US, but
it is coming perhaps as the usual US business cycle reaches its peak.
More worrisome, US growth does not seem to be supported by Europe or
Japan as much as hoped for despite the fact that both are using very
accommodative monetary policy (eg quantitative easing (QE) in Europe,
quantitative and qualitative easing (QQE) in Japan) and now entering into
NIRP.
All this is playing out against the backdrop of a much anticipated growth
regime rotation in China (whose real and financial consequences we do not
fully know, even as we hope for the best), stress (albeit somehow
idiosyncratic) in major systemic EMEs (eg Brazil, Russia and South Africa
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with the notable exception of India) and commodity price-led downturns in
other related important economies (eg Canada, Saudi Arabia and the
Middle East).
To compound this picture, you could add odd events such as the Brexit
debate, potential political crises in parts of Europe, severe geopolitical
tensions (from Ukraine to Syria, Iraq and parts of North Africa and
Nigeria), the unpredictable effect of the migrant crisis on the European
political economy and, last but not least, the unresolved issue of (now)
global confrontation with terrorist groups.
But there is also uncertainty over the policy front vis-à-vis the Global
Financial Crisis (GFC).
After having implemented and maintained unprecedented monetary
stimuli for years with undeniable initial success, we might be facing
decreasing returns from these bold interventions over time.
In particular, NIRP has been implemented over and above many already
exceptional and unprecedented policies after the zero lower bound (ZLB)
was reached (eg asset purchase programmes as a form of QE and forward
guidance).
Academics and practitioners are debating whether the recourse to NIRP
might have produced a rather unintended market reaction.
Publicly expressed views from the private sector suggest that, instead of
incentivising financial agents to provide more credit and positively
influencing expectations and consumption demand, NIRP, if it persists for
a long time, might have actually prompted more worries about financial
stability, tilting market sentiment towards a risk-off mindset resulting from
NIRP's possible undesirable consequences for the profitability of banks,
pension funds and insurance companies.
Regarding the profits of banks, the concern is not necessarily profits per se,
but the returns on lending activities, the impact on resilience and the
uncertainty in the business models that NIRP might bring (eg distortions in
the allocation of credit). In addition, the long-term effects on the behaviour
of savers and financial institutions are difficult to foresee.
Of course, there needs to be a more complete empirical investigation to
better document and understand these consequences.
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Some evidence, for example, suggests that volatility in early 2016 is an
illustration that markets are now possibly viewing the current valuation of
assets as not supported by the foreseeable growth outcomes and future
productivity prospects.
Overall, anxiety appears to be increasing somewhat on both data and policy
fronts and prompting more market criticism. Even if many would claim
that UMP has worked as intended in the US, the assessment vis-à-vis NIRP
is more complex in Japan and Europe.
On this front, evidence is obviously limited (the typical lag on economic
activity is at least 12 months).
At best, one should say that we don't yet know which is higher, costs or
benefits. And even those that are very optimistic about the effectiveness of
NIRP do recognise that it won't do the trick on its own: policymakers have
to operate on other fronts.
2. Are there reasons that continue to justify UMP? Benefits and
risks.
Despite the analytical justifications that can support using NIRP, as stated
above, the real problem is "persistence" of ultra-low or negative rates for a
long period of time that create distortions.
If low rates or NIRP are only transitory, they might represent much less of a
problem. In addition, we also know that UMP instruments are less effective
when they are used in isolation.
They have been helpful in preventing the financial meltdown, but their
effects on "prices" are now showing decreasing marginal returns. And in the
end, the negative side effects could more than offset the positive ones if not
accompanied by other policies.
In the presence of uncertainty, UMP "price incentives / interventions" can
buy time but do not solve the problems if not accompanied by more active
policies to foster growth and aggregate demand via "quantities", as I will
explain shortly.
There are many documented disagreements among economists, including
this one: theoretically, ultra-low interest rates are justified by the
fundamentals of the "New Normal".
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Real interest rates might be and need to remain very low because the GFC
has deeply affected our growth potential and/or we are entering a long
period of "secular stagnation".
So there are both structural and cyclical analytical reasons that justify
current policies. Under this reasoning, monetary policy has affected the real
interest rate, but it is not necessarily UMP that has pushed interest rates too
low, the new fundamentals have. The new neutral interest rate could be
much lower than before the GFC.
Among other types of disagreements are the following:
(i) whether or not to alter the composition of the asset purchase
programmes (QE), ie consider buying riskier assets to lower spreads
instead of acquiring mostly risk-free assets that lower yields;
(ii) whether or not to communicate the acceptance of an asymmetric policy
response to inflation (ie tolerating higher-than-target inflation readings
after inflation has hovered at much lower levels); and
(iii) whether or not to use capital flow management policies to address the
spillover effect on EMEs of unusually massive capital inflows.
There might also be practical justifications for maintaining ultra-low
interest rates and even NIRP. In order to get out of this prolonged period of
low growth due in part to the GFC, the alternative would be the much
heralded and needed structural reforms in factor markets to increase
efficiency and enhance productivity.
But as we all know, these reforms are dependent on local political economy
conditions and will (as they should) entail a social debate and hence take
some time.
Therefore, the view goes, MP still is and will remain "the only game in
town" because of the absence of a practical alternative. And thus, pursuing
NIRP seems to be the only practical option that is left.
The conclusion here seems discouraging. In theory, there could be a case for
UMP at ZLB or even NIRP.
But the way these policies are now perceived by markets (eg perhaps with a
mixture of "addiction" and "scepticism") might not be helping to fully
restore confidence.
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The theoretical and practical arguments listed above are generating
competing and yet plausible narratives about future growth that are simply
too distant from each other to be capable of reassuring the private sector
and make it invest and consume.
And ironically, using extreme versions of an already unconventional MP
can be perceived as tantamount to sending the economy back to "intensive
care", which is not a good sign.
Therefore, despite the very significant effort by central banks to use
unprecedented price incentives to revive credit and hence real economy
growth, they have produced more limited outcomes than markets thought
they would.
So if nine years into the GFC price incentives are not fully working, how can
we bring back growth and productivity?
3. Rebalancing our policy mix by investing in total factor
productivity (TFP), "low-hanging fruits" projects.
Markets themselves are now voicing a growing recognition for the need to
rebalance policies, making more use of the public sector balance sheet and
less of monetary policy.
But rebalancing policy instruments is easier said than done.
One needs to be careful about naive and/or "populist" approaches: some
countries (usually those that want to apply fiscal stimulus) do not have
enough fiscal space or have exhausted it; others (usually those that do not
want to apply it) do have fiscal space but without the "political economy
space" to activate it.
So the rebalancing needs to be pro-growth, be accompanied by structural
reforms, and avoid complacency and "free-riding".
Above all, it should be a matter of careful analysis and not "one size fits all".
AEs and especially EMEs have spent decades trying precisely to build the
set of institutions that would prevent the accommodation of excessive
aggregate demand through the use of debt, inflation, taxation and other
beggar-thy-neighbour policies that rely on some form of fiddling with the
exchange rate, the tax structure, the capital account regime, banking
regulations, etc.
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In many EMEs, this policy direction has already gone too far nine years into
the GFC, and stabilising debt and reducing risk premia is the main task at
present.
At the same time, going back to a more direct fiscal or parafiscal impulse
using the government's balance sheet should not mean forgetting old
lessons of prudence.
As has been extensively documented in the literature about macroeconomic
populism and painfully felt in real life policy experiments, excessive usage
of government resources has always led to crises.
The GFC has shown that macro and credit populism is an equal opportunity
menace for emerging and advanced economies alike, because somehow
politicians tend always to think that "this time is different".
Rebalancing needs to combine reforms in some countries that need to be
implemented with determination to trigger goodwill perhaps in countries
where there is fiscal space.
Then, all together, there could be a reassessment and a clear
communication of how reforms plus a rebalancing of monetary and fiscal
policy stimulus would help achieve a more pro-growth policy mix.
So what can be done? No sensible economist anywhere is today advocating
a naive and simplistic approach involving the use of unproductive ("digging
and filling holes") short-term fiscal policies.
But we can continue - as some policymakers have already proposed and
somehow done - reflecting on a rebalancing of fiscal-monetary policies that
call more on profitable investments that improve medium- to long-term
TFP; use a sustainable financing framework; and link these investments
with structural reforms that might have a short-term cost but can also be
absorbed in the medium to long term by producing higher growth.
In a nutshell, the suggestion here implies identifying and investing in
"low-hanging fruits" projects for a more prolonged, clearly defined period
of time (five to six years) and making more extensive use not only of
existing government plans but also of the multilateral public sector balance
sheet.
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We could be more positive about investment in the short run if the overall
policy package has a good narrative. In particular, as part of the reforms,
there is a need to remove impediments to the reallocation of resources.
Profitable investment in "low-hanging fruits" projects. This is a convenient
expression for investments that have high potential TFP returns and low
"screening costs" and that increase potential GDP.
There is a need for more public investment and infrastructure in several
countries (but not in all). Public investment is typically one of the victims of
financial crises, but let's also be careful. We are also observing, in several
countries, a secular trend of rising fiscal transfers and declining public
investment.
The former may be crowding out the latter. In several cases, the transfers
are biased towards the old, also intensifying the intergenerational conflict.
If we control that problem, what might be our "low-hanging fruits"?
It is certainly not the task of the monetary authorities or central banks to
identify profitable investment projects. However, intuitively, one could
point to a combination of physical infrastructure with projects to enhance
human capital, for example in regions where there is skilled-youth
unemployment.
Sustainable financing framework for these projects. Taking the example of
an imperfect fiscal union such as the euro zone, constructing automatic
stabilisers and fiscal transfer and investment mechanisms that ensure
efficiency and fairness will take time.
Local fiscal space might be very limited in countries that are in greater need
of investment and/or where youth or general unemployment are high.
Some of these countries might also have less institutional capacity to spend
the money effectively.
There may be, in other words, a significant governance deficiency that goes
hand in hand with high debt, lack of investment, high transfers and lack of
efficiency.
However, while recognising the governance-efficiency issue, there might
also be other ways to mobilise and adequately screen resources for
investment through multilateral and/or national development financial
institutions that foster public investment together with private capital
through public-private partnerships.
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Structural reforms typically have a short-term cost but they can be
sustainable if we follow the route described above.
It should be acknowledged upfront that the problems of financing
TFP-enhancing projects and undertaking structural reforms are
intertwined and run deeper than economics: they are about institutions and
the political economy of our societies.
So, structural reforms need to be undertaken in a broad sense (beyond
simply factor - labour and product - markets).
They need to involve the fiscal system, redistribution of income and the
sensible reform of institutions. Such reforms are paramount if governments
are to adopt "long-term planning horizons", instead of persisting with their
current quite myopic choices, dependent as they usually are on electoral
cycles.
That is necessary for them if they are to acquire the capacity to absorb the
risk of projects whose fruits take a long time to ripen.
Moreover, some of these structural reforms also have an important
signalling effect for others. They can show the determination that is needed
to unlock the goodwill of those that are sceptical, for good reasons, about
engaging in financing even TFP-enhancing projects.
Will investment ignite growth? Here we are arguing for a policy sequence in
which investment comes first, generating confidence and growth. The latter
would then lower resistance to structural reforms.
But engaging also in structural reforms is paramount to show
determination and change perceptions of complacency and "free-riding".
Moreover, if there are severe structural impediments to growth, then even
TFP-enhancing investment may generate only a very limited short-term
effect on demand. Removing these impediments would be a precondition
for making the investment profitable, a "Catch 22" dilemma for our
"low-hanging fruits" projects.
Some structural reforms have a low or zero negative short-run aggregate
economic impact (eg reforming the judicial system in some countries
and/or removing red tape) but are necessary, albeit highly difficult, from a
political economy perspective.
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Investing more money in professional training and education could bring
some TFP, but it won't work unless those areas, through reforms, are made
more competitive and efficient.
Therefore, there could be a fundamental time-inconsistency argument, and
those concerns should be clearly in any sensible economist's mind.
However, and conversely, the "do nothing" solution is a guarantee of failure
too. And the time-inconsistency argument can also be reversed:
undertaking any structural reform is also difficult because of the absence of
any clear future growth perspective in the current gloomy context.
Reforms have more chances of succeeding in an environment of positive
sum games than of zero sum games.
It is not easy. Some countries need to carry out more structural reforms
upfront to trigger a positive spin-off that will enable more financing of
TFP-enhancing investments.
High-level policy dialogue is more than ever necessary to escape from
"corner" solution policies and rebalance instruments.
But perhaps showing that policies combining investment with reforms can
ignite some growth momentum is part of, and should lead to, more
sustainable socioeconomic equilibria that could allow some constructive
talk of reform.
That, in turn, should help address some of our entrenched and widespread
disputes about current and intergenerational resource allocation, our
societies' "social contracts".
Thank you. I hope that these personal thoughts can help us think of our
current challenges in a constructive and mutually beneficial way.
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EIOPA consults on methodology
to derive ultimate forward rate
under Solvency II
The European Insurance and Occupational Pensions Authority (EIOPA)
published a Consultation Paper on the methodology to derive the ultimate
forward rate (UFR) and its implementation.
According to the Solvency II legislative framework the ultimate forward
rate shall be stable over time and shall only change as a result of changes in
long-term expectations.
The methodology to derive the ultimate forward rate shall be clearly
specified and be determined in a transparent, prudent, reliable and
objective manner that is consistent over time.
Furthermore, the ultimate forward rate shall take account of expectations
of the long-term real interest rate and of expected inflation.
The main objective of Solvency II is the protection of policyholders. To
achieve that objective, the UFR needs to be chosen appropriately.
The proposed UFR methodology strives for a balance between the stability
of the UFR and the need to adjust the UFR in case of change in long-term
expectations about interest rates and inflation.
EIOPA invites stakeholders and interested parties to provide feedback on
the proposal for the UFR methodology and its implementation (section 2).
The consultation paper also explains the underlying rationale of EIOPA's
proposal (section 3) and analyses the impact of changing the UFR on the
risk-free interest rates, the time value of money and on the present value of
insurance cash-flows (section 4).
The consultation period will end on 18 July 2016.
Please note that comments submitted after the deadline or not submitted in
the provided template cannot be processed.
EIOPA plans to decide on the outcome of the review in September 2016.
The currently used UFRs will not be changed until at least the end of 2016.
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What is the ultimate forward rate?
Under Solvency II, the assessment of the financial situation of insurance
and reinsurance undertakings is based on harmonised principles and
methodologies for the valuation of their assets and liabilities. In particular,
the risk-free interest rates to be used for the discounting of insurance and
reinsurance liabilities are set out in implementing acts. For that purpose,
EIOPA is required to derive and publish risk-free interest rates on a regular
basis.
Accordingly, EIOPA has been publishing on a monthly basis risk-free
interest rates for 33 currencies since February 2015.
The risk-free interest rates are derived from prices of financial instruments
that are traded in deep, liquid and transparent markets. The financial
instruments are interest rate swaps and, where swaps are not available,
government bonds.
As insurance liabilities can have durations of several decades, in particular
in life and health insurance, risk-free interest rates for long durations are
required.
The durations of financial instruments traded in deep, liquid and
transparent markets are limited.
Depending on the currency, the highest duration (last liquid point) is
between 10 and 50 years, for the euro for example it is 20 years.
The risk-free interest rates for maturities beyond the last liquid point are
derived by means of extrapolation.
According to Article 77a of the Solvency II Directive, the risk-free interest
rates should be extrapolated towards an ultimate forward rate (UFR).
EIOPA is currently applying a UFR of 4.2% for most currencies, including
for the euro.
For the Swiss franc and the Japanese yen a UFR of 3.2% and for the
Brazilian real, the Indian rupee, the Mexican peso, the Turkish lira and the
South African rand a UFR of 5.2% is used.
The consultation paper and the template for comments can be viewed at:
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https://eiopa.europa.eu/Publications/Consultations/RFR%20CP%20on%
20methodology%20to%20derive%20the%20UFR%20%28after%20BoS%2
9.pdf
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Issues for the Academic Community
to Consider
Steven B. Harris, Board Member
Annual Meeting, Washington DC
Welcome to the 2016 PCAOB Academic Conference. We appreciate your
participation in this year's forum and your role in educating future
accountants and auditors.
You play an essential role in upholding the integrity of financial statements
and promoting investor protection.
Before I continue, I should mention that the views I express are my own
and do not necessarily reflect the views of the Board or the PCAOB.
Today I will touch on three topics: auditing and financial matters on the
minds of investors, the evolving role of technology in audits, and the future
and relevancy of the audit.
I hope that what you hear at this conference will benefit your current and
future research.
Investors' Concerns
As many of you know from our previous sessions, I chair the PCAOB's
Investor Advisory Group and was the chair of the International Forum of
Independent Audit Regulators' Investor and Other Stakeholders Working
Group until last April.
These positions have afforded me an opportunity to hear directly from
investors about some of the topics that are on their mind. They include, in
no particular order:
1. Auditor Independence – It is only because investors perceive that the
auditor's report is issued by an objective third party that they rely on it.
If the auditor is not considered independent, the audit report and the audit
do not provide value to investors.
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Investors are concerned that firms, while expanding their consulting and
advisory practices, are not diligently monitoring the provision of prohibited
services by themselves and their affiliates, or have the necessary policies
and procedures in place to do so.
Their concerns are based on frequently reported independence violations.
For example, in the past two years, all of the Global Network Firms or their
affiliates have either settled enforcement actions related to independence
violations or resigned from a client because they provided prohibited
non-audit services. Further, investors note that companies continue to
engage auditors even when that auditor provided prohibited services.
In addition, investors question if independence requirements need to be
updated to reflect changes in industry practices. For example, some
question the provision of tax structuring and consulting in light of recent
press stories.
2. Audit Reform Recommendations – Investors are also interested in
learning about the status of the recommendations put forth by the U.S.
Treasury's Advisory Committee on the Auditing Profession (ACAP) in its
2008 report, which included improving the auditor's report, developing
audit quality indicators, requiring independent members on the firms'
boards, and for firms to provide audited financial statements, to name a
few.
They believe that it is time for a review of the Board's actions in relation to
those recommendations.
There is also interest in comparing the audit reform efforts currently
underway in Europe to what is happening here in the United States.
Noting that European regulators have taken action on certain issues, such
as expanding the auditor's report, firm governance, and retendering, some
are asking why the U.S. is not leading efforts in these areas.
3. Expanded Auditor's Report – Investors continue to express support for
the Board's current project on expanding the auditor's report. The auditor's
report is no longer viewed as providing as much meaningful information as
it should. Aware that auditors communicate important matters to the audit
committee, some believe such information should also be communicated
directly to investors, the actual clients of the auditor.
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4. Audit Quality Indicators – Investors also support the Board's continued
effort to understand and refine audit quality indicators.
The Concept Release published last July explored the subject in detail.
The AAA's comment letter was wide-ranging and made a number of
suggestions.
I am curious about how, at this point, you would define "audit quality" to
test AQIs, how the link between audit quality and particular groups of AQIs
should be measured, and what sampling or other methods should be used
to track how AQIs are being employed.
5. Role of auditors with respect to information outside of the financial
statement – Investors rely not only on the information contained in the
financial statements but also what is presented outside of the financial
statements, such as non-GAAP measures, sustainability information, and
XBRL data.
Some are concerned that non-GAAP measures presented by management
reflect different results than the audited financial information.
As noted in a February Wall Street Journal article, actual GAAP earnings
were 25% less than what was reported by companies in non-GAAP
measures.
SEC Chair Mary Jo White has also addressed this matter recently.
Some investors wonder if the auditor should examine and provide some
level of assurance on non-GAAP measures, as well as sustainability and
XBRL data.
Additional topics of investor concern include an update on the Board's
project on going concern, continued examination of the firms' business
model and the expansion of consulting and advisory services on audit
quality, the role of the audit committee in overseeing the company's audit,
financial reporting and investor protection, and the auditor's
responsibilities as it relates to fraud.
As you can see, some of these concerns are new and others are not. What
this tells me, though, is that we still have much work to do. I encourage you
to examine these issues.
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Evolving Role of Technology in Audits
The role of technology in audits is not new. For several decades auditors
have been using computer assisted auditing techniques. The technology
that is used today, however, has evolved and its impact on audits is still
unknown but will undoubtedly be profound.
Firms large and small are interested in using technology to make their
audits efficient and more comprehensive.
They assert that such technological tools allow them to automate certain
time-consuming tasks, review nearly all of a client's transactions, and better
identify risky areas. Using data analytics software, auditors derive insight
from large amounts of data to identify potential signs of fraud and to add
value in key audit areas, such as risk assessment and analytical procedures.
Firms are making significant investments in developing technologies
in-house or through creative strategic partnerships with analytics service
providers. Today, accounting firms routinely join forces with technology
firms to incorporate emerging technologies into their audit methodologies.
For example, on March 8, 2016, both KPMG and Deloitte announced
alliances with different technology companies that will enable them to
employ cognitive capabilities to analyze large volumes of structured and
unstructured data related to a company's financial information and
documents.
In December 2015, Ernst & Young announced a strategic alliance to use
SAS' advanced analytics platform.
While these technological tools may present certain benefits for audit, they
also pose some challenges, including:
-
Data Integrity issues – Auditors need to ensure that they have access to
all of the client's available data. Incomplete or low quality data may
provide misleading insights to the auditor.
-
Data Security – Security of client information becomes a key
consideration for firms as they gain access to their client's databases.
How the auditor protects such data and what, if any, liability does the
auditor bear for cyberattacks on its systems are open matters.
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As I noted at this conference last year, audit firms have also altered their
hiring practices as a result of their expanded use of technology.
Expectations of new auditors are changing with the increased investment
by firms in new technologies, especially big data analytics.
A big four CEO recently said "[b]eyond the core technical accounting and
audit skills, the ability to work with large volumes of data is becoming
critical."
A number of the largest firms also assert that technology will allow them to
detect industry trends and enhance their predictive analysis.
How such trends and predictive analyses are used to benefit investor
protection remains to be seen.
The PCAOB and other entities are exploring data analytics to better
understand its effects on the audit process.
It is important that you study the impact of technology on audit quality and
bring your findings to our attention.
The Future and Relevancy of Audits
Lastly, I would like to leave you with some thoughts about the future and
relevancy of audits. Following the recent financial crisis, many asked
"Where were the auditors?"
I have heard from the profession and others that predicting economic
failures of the nature involved in the 2007-2008 financial crisis is not
within the scope of an audit.
Whether I agree with that response or not, I can't help but wonder why
weren't investors given a warning from the auditors about the potential for
failures within the financial industry?
With an economic upheaval of that magnitude, how could auditors not have
had some insight into the level of risks that were being taken and the
pending failures of some of those companies?
As James Turley, former Global CEO of Ernst & Young, said in a 2012
interview, "[w]hen almost every set of financial statements are correct, yet
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the world experiences the biggest financial surprise in decades, something
is wrong."
So it strikes me that maybe the question should be "Why weren't the
auditors there?"
What is it about auditors' existing responsibilities that precluded them from
sounding an alarm about the potential for trouble in the housing market
and the financial industry?
Would the outcome have been different if the auditors – as a profession –
had been in a position to alert regulators and investors about the now
notorious explosion of subprime mortgages and the exposure of the
financial industry to these products?
I am not expecting auditors to identify bubbles but I do believe that their
training and work provides them with a unique understanding of business
and market risks within a given sector.
In other words, is it time to rethink the role of auditors in our capital
markets?
If, for example, the auditing profession as a whole is involved with certain
industries and financial institutions, what role should they play in helping
regulators and investors better understand the risks these organizations are
taking?
In short, considering the auditors' skills, knowledge and the fact that they
are ubiquitous, should the audit profession play a more macro role?
Expanding the role of the auditor is not a new concept. John C. "Sandy"
Burton, the Chief Accountant of the Securities and Exchange Commission
from 1972-1979, discussed this concept in an opinion piece published 36
years ago when he said "Accountants…could [make] a significant
contribution in developing measurement approaches and in analyzing and
presenting data regarding aggregate effects."
He went on to say that "We must … get across the idea that accountants are
not primarily record keepers and checkers, but measurers of economic and
social phenomena whose measurements can significantly influence… our
society."
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And, he argued that "the accountant's task should not be confined to
auditing corporate books, but should include forecasts, judgments on the
corporation's financial controls and evaluations of management."
In the 36 years since the New York Times published Mr. Burton's opinion
piece we have witnessed failures such as the savings and loan crisis, the
financial scandals of Enron, WorldCom, Tyco and others that led to the
Sarbanes-Oxley Act of 2002 and the worst financial crisis and economic
slump since the Great Depression.
Mr. Burton concluded in his opinion piece that "If a narrow audit focus
prevails, the profession runs the danger of being defined out of economic
utility and remaining only a regulatory parasite."
Mr. Turley echoed these sentiments in 2012 when he said "The most
important issue facing our profession is the relevancy of our audit service
product and making sure that we communicate with stakeholders in ways
that are of importance to them."
As educators of accounting students, I would encourage you to consider,
and would welcome your thoughts on how we should go about keeping the
audit relevant and how to prepare our next generation of auditors for the
future that awaits them.
Conclusion
Thank you again for coming today. I look forward to hearing more of your
views on actions that the PCAOB should undertake as we continue to work
toward protecting investors by improving audit quality.
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International Association of Risk and Compliance Professionals (IARCP)
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Interest rate risk in the banking book
April 2016
The Basel Committee on Banking Supervision has
today issued standards for Interest Rate Risk in the
Banking Book (IRRBB).
The standards revise the Committee's 2004 Principles
for the management and supervision of interest rate risk, which set out
supervisory expectations for banks' identification, measurement,
monitoring and control of IRRBB as well as its supervision.
The key enhancements to the 2004 Principles include:
-
More extensive guidance on the expectations for a bank's IRRBB
management process in areas such as the development of interest rate
shock scenarios, as well as key behavioural and modelling assumptions
to be considered by banks in their measurement of IRRBB;
-
Enhanced disclosure requirements to promote greater consistency,
transparency and comparability in the measurement and management
of IRRBB. This includes quantitative disclosure requirements based on
common interest rate shock scenarios;
-
An updated standardised framework, which supervisors could mandate
their banks to follow or banks could choose to adopt; and
-
A stricter threshold for identifying outlier banks, which is has been
reduced from 20% of a bank's total capital to 15% of a bank's Tier 1
capital.
The standards reflect changes in market and supervisory practices since the
Principles were first published in 2004, which is particularly pertinent in
light of the current exceptionally low interest rates in many jurisdictions.
The revised standards, which were published for consultation in June 2015,
are expected to be implemented by 2018.
The Basel Committee wishes to thank all those who contributed time and
effort to express their views during the consultation process.
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IRRBB refers to the current or prospective risk to the bank’s capital and
earnings arising from adverse movements in interest rates that affect the
bank’s banking book positions.
When interest rates change, the present value and timing of future cash
flows change.
This in turn changes the underlying value of a bank’s assets, liabilities and
off-balance sheet items and hence its economic value.
Changes in interest rates also affect a bank’s earnings by altering interest
rate-sensitive income and expenses, affecting its net interest income (NII).
Excessive IRRBB can pose a significant threat to a bank’s current capital
base and/or future earnings if not managed appropriately.
Definition of IRRBB
Three main sub-types of IRRBB are defined for the purposes of these
Principles:
(a) Gap risk arises from the term structure of banking book instruments,
and describes the risk arising from the timing of instruments’ rate changes.
The extent of gap risk depends on whether changes to the term structure of
interest rates occur consistently across the yield curve (parallel risk) or
differentially by period (non-parallel risk).
(b) Basis risk describes the impact of relative changes in interest rates for
financial instruments that have similar tenors but are priced using different
interest rate indices.
(c) Option risk arises from option derivative positions or from optional
elements embedded in a bank’s assets, liabilities and/or off-balance sheet
items, where the bank or its customer can alter the level and timing of their
cash flows.
Option risk can be further characterised into automatic option risk and
behavioural option risk.
All three sub-types of IRRBB potentially change the price/value or
earnings/costs of interest ratesensitive assets, liabilities and/or off-balance
sheet items in a way, or at a time, that can adversely affect a bank’s financial
condition.
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To read more:
http://www.bis.org/bcbs/publ/d368.pdf
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PCAOB Publishes Staff Audit Practice
Alert on Improper Alteration of Audit
Documents
Staff of the Public Company Accounting
Oversight Board published a Staff Audit
Practice Alertreflecting PCAOB staff concerns about auditors improperly
altering audit documentation in connection with a PCAOB inspection or
investigation.
To read it:
http://pcaobus.org/Standards/QandA/SAPA-14-improper-alteration-audit
-documentation.pdf
In the past several years, the Board has sanctioned firms and individuals for
improperly deleting, adding, or altering documentation in connection with
an inspection or investigation.
The sanctions in those cases have included revoking firms' registrations and
barring individuals from auditing for registered firms.
PCAOB staff has recently seen evidence that such misconduct is continuing
to occur.
"Improper alteration of audit documentation not only frustrates the Board's
mission, but also undermines the public's trust that auditors are actually
serving their gatekeeper function," said Claudius B. Modesti, the Director of
the Division of Enforcement and Investigations.
"We take matters involving this type of misconduct extremely seriously,
and auditors should be aware of the significant enforcement consequences
that can follow such behavior."
Recently, PCAOB enforcement staff has uncovered evidence of additional
instances of similar misconduct, including evidence that registered firms
and associated persons have improperly deleted, added to, or altered audit
documentation in connection with Board inspections, and then made the
altered documents available to PCAOB inspectors without informing the
inspectors of the alterations.
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In certain instances, evidence indicates that documents were created
shortly in advance of, or during, an inspection, backdated, and then made
available to PCAOB inspectors without any disclosure of when they were
actually created.
These recent instances involve both domestic firms and non-U.S. firms,
including members of global networks.
"PCAOB standards provide specific requirements for auditors to follow if
they have legitimate reasons for making changes to audit documentation
after the audit has been completed," said Martin F. Baumann, the PCAOB's
Chief Auditor and Director of Professional Standards. "Auditors must
follow those requirements for any changes made."
PCAOB staff urges registered firms or individuals that become aware of any
improper alteration of audit documentation to report that information to
the Board.
They can do so by directly contacting staff in the Division of Registration
and Inspections or the Division of Enforcement and Investigations, or by
contacting the PCAOB Tip and Referral Center. Individuals can also report
improper alteration of audit documentation to the Securities and Exchange
Commission.
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Raghuram Rajan: Words matter but so does
intent
Dr Raghuram Rajan, Governor of the Reserve Bank
of India, at the 12th National Institute of Bank
Management (NIBM) Convocation, Pune
Congratulations to the graduating class, to their
professors, and to their proud parents, siblings and
friends.
If you are typical, you are happy to be leaving university and embarking on
a new journey, sad to be leaving familiar settings behind, and worried
whether you will measure up to the challenges of wherever you are going for
work or higher studies. You are also concerned about whether you have
taken, or will take, the right next step.
This is all perfectly normal. Given that you have been trained well at NIBM,
the answer to the question of whether you will measure up is almost surely
"Yes!"
As to whether you have taken the right next step, the answer is less
comforting - you will never know. My task is to leave you with some last
thoughts as you graduate.
As I reflected on what I should speak on, I thought I would speak on a
recent experience that offers what the Americans call "a teachable
moment".
And then I want to give you some career advice, for what it is worth.
To get to the experience, start first with where India is. India is the fastest
growing large country in the world, though with manufacturing capacity
utilization low at 70% and agricultural growth slow following two bad
monsoons, our potential is undoubtedly higher.
Growth, however, is just one measure of performance. The level of per
capita GDP is also important.
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We are still one of the poorest large countries in the world on a per capita
basis, and have a long way to go before we reasonably address the concerns
of each one of our citizens.
We are often compared with China. But the Chinese economy, which was
smaller than ours in the 1960s, is now five times our size at market
exchange rates.
The average Chinese citizen is over four times richer than the average
Indian.
The sobering thought is we have a long way to go before we can claim we
have arrived.
As a central banker who has to be pragmatic, I cannot get euphoric if India
is the fastest growing large economy.
Our current growth certainly reflects the hard work of the government and
the people of the country, but we have to repeat this performance for the
next 20 years before we can give every Indian a decent livelihood.
This is not to disparage what has, and is, been done.
The central and state governments have been creating a platform for strong
and sustainable growth, and I am confident the payoffs are on their way,
but until we have stayed on this path for some time, I remain cautious.
We must remember that our international reputation is of a country with
great promise, which has under-delivered in the past.
This is why we are still the poorest country on a per capita basis among the
BRICS.
We need to change perceptions by delivering steadily on our promise for a
long time - by implementing, implementing, and implementing.
We cannot get carried away by our current superiority in growth, for as
soon as we believe in our own superiority and start distributing future
wealth as if we already have it, we stop doing all that is required to continue
growing.
This movie has played too many times in India's past for us to not know
how it ends.
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So in speaking to a foreign journalist the other day, who asked what it felt
like to be the bright spot in the world economy, I used the phrase "Andhon
mein kana raja" or "In the Land of the Blind, the one-eyed man is king".
The proverb has a long multinational history.
The Dutch philosopher, Erasmus, used it in Latin when he wrote "In
regione caecorum rex est luscus", but he probably was inspired by earlier
work.
My intent was to signal that our outperformance was accentuated because
world growth was weak, but we in India were still hungry for more growth.
I then explained that we were not yet at our potential, though we were at a
cusp of a substantial pick-up in growth given all the reforms that were
underway.
In our news-hungry country, however, our domestic papers headlined the
phrase I used.
To be fair, they also offered the surrounding context, but few read beyond
the headline.
So the interview became moderately controversial, with the implication
that I was denigrating our success rather than emphasizing the need to do
more.
More generally, every word or phrase a public figure speaks is intensely
wrung for meaning.
When words are hung to dry out of context, as in a newspaper headline, it
then becomes fair game for anyone who want to fill in meaning to create
mischief.
Worst, of course, are words or proverbs that have common usage
elsewhere, because those can be most easily and deliberately
misinterpreted.
If we are to have a reasonable public dialogue, everyone should read words
in their context, not stripped of it.
That may be a forlorn hope!
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I do, however, want to apologize to a section of the population that I did
hurt, the blind.
After all, the proverb suggests that a one-eyed man is better than a blind
one.
A moment's thought suggests this is not true. For the blind can develop
capabilities that more than make up for their disability.
Indeed, the sheer willpower and hunger to succeed of the disabled can help
them become over-achievers in a seeing man's world.
Moreover, because their other faculties such as touch, smell, and hearing,
are more finely honed, the blind may add new perspectives and new variety
to our world, making it richer and more vibrant.
So I am indeed sorry for implying the blind were otherwise than capable.
But this leads to an important question. How much of our language is
tinged with meaning that is liable to misinterpretation? How forgiving
should we be of a bad choice of words when the intent is clearly different?
Let me give you two examples. Gandhiji used to say "An eye for an eye will
only make the whole world go blind".
Clearly, what is implied is that the whole world going blind is not a
desirable state of affairs.
One might take umbrage since it suggests blindness is an inferior state to
that of being able to see, and the saying could be seen as discriminatory.
Yet Gandhiji's focus was on the absurdity of a policy of revenge, not on
blindness, and his intent was not to disparage the blind.
My second example comes from a faculty meeting I once attended where a
male professor used the phrase "As a rule of thumb" to make his point.
A female history professor became visibly agitated and angry.
She explained that "the rule of thumb" referred historically to the maximum
width of the stick with which a man could beat his wife without breaking the
law.
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She was angry the male professor used the phrase so lightly, seemingly
condoning domestic violence.
He, of course, had no clue of the historical origins of the phrase, and
apologized profusely. Clearly, his ignorance suggested he had no intent to
offend, yet the female professor was offended.
There are two important issues here. First, if we spend all our time
watching our words and using inoffensive language or hedging everything
with caveats, we will be dull and will not be able to communicate because
no one will listen.
For instance, "An eye for an eye will only make the world go blind" could be
replaced by "Revenge reduces collective welfare". The latter is short,
inoffensive, and pithy, but meaningless for most listeners. Alternatively, we
could say "The taking of any body part for another will temporarily reduce
the collective capabilities of the population thus affected, until they develop
the faculties that will allow them to compensate for the missing body parts."
This restatement is more correct than the original, but lacks zing and
therefore the ability to persuade.
At the same time, not paying attention to words or phrases that give offense
risks perpetuating debilitating stereotypes that prevent advancement.
When referring to bankers, scientists, engineers, or surgeons in the
abstract, we often refer to them as "he" thus perpetuating the unfortunate
stereotype that these are not jobs for women.
Clearly, in doing so we ignore the increasing presence, and even
dominance, of women in these fields. What should we do to remedy
matters?
I think we all have work to do to improve public dialogue. Speakers have to
be more careful with words and not be gratuitously offensive.
At the same time, listeners should not look for insults everywhere, and
should place words in context so as to understand intent.
In other words, for effective communication and debate, rather than the
angry exchanges that we see on some TV shows, we need both respect and
tolerance.
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The greatest danger of all is that we do not communicate or debate, for then
we will allow distorted stereotypes to flourish unchallenged, and
divisiveness to increase.
In a country like ours, conceived and flourishing in diversity, that will truly
be a disaster.
Enough food for thought. But here is my promised career advice; Most of us
are ambitious and have career goals in mind. We think we will be happy if
we are successful - become CEO of a major multinational corporation; win
the Nobel prize; become a mega movie star, and so on.
And to achieve these goals we sometimes take jobs we dislike for we think
the pain will be worth the eventual gain.
When we reason like this, I believe we have causality backwards.
You are rarely happy simply because you are successful, but you are much
more likely to be successful if you are happy, doing work you enjoy.
Indeed, there are careful studies suggesting this.
So when you choose what to do, don't focus on the end point. Instead, focus
on whether you like the work itself.
Not only will you be more likely to reach your goal, even if you don't arrive
at that end point, you will have had a joyful life.
Advice over, congratulations to all of you, and I hope you enjoy a
well-deserved break. Good luck and thank you.
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Apple Ends Support for QuickTime for Windows; New
Vulnerabilities Announced
Systems Affected
Microsoft Windows with Apple QuickTime installed
Overview
According to Trend Micro, Apple will no longer be providing security
updates for QuickTime for Windows, leaving this software vulnerable to
exploitation.
Description
All software products have a lifecycle. Apple will no longer be providing
security updates for QuickTime for Windows.
The Zero Day Initiative has issued advisories for two vulnerabilities found
in QuickTime for Windows.
Impact
Computer systems running unsupported software are exposed to elevated
cybersecurity dangers, such as increased risks of malicious attacks or
electronic data loss. Exploitation of QuickTime for Windows vulnerabilities
could allow remote attackers to take control of affected systems.
Solution
Computers running QuickTime for Windows will continue to work after
support ends. However, using unsupported software may increase the risks
from viruses and other security threats. Potential negative consequences
include loss of confidentiality, integrity, or availability of data, as well as
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damage to system resources or business assets. The only mitigation
available is to uninstall QuickTime for Windows. Users can find
instructions for uninstalling QuickTime for Windows on the Apple
Uninstall QuickTime (link is external) page.
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Financial stability in Europe and how to
improve it
Speech by Mr Yannis Stournaras, Governor of the
Bank of Greece, at the Croatian National Bank
"Financial stability and policy intervention by
Central Banks in Europe - where do we stand and
what challenges lie ahead", Zagreb
Before I begin my presentation, please allow me to
dedicate the following remarks to the late Vassiliki Zakka, who was an
exceptional colleague at the Bank of Greece and a dear friend. Before
passing away unexpectedly several weeks ago, Vasso had contributed to the
drafting of this speech. She will be badly missed.
Ladies and gentlemen,
It is a great pleasure to be in Zagreb today and to have the opportunity to
share with you some thoughts on financial stability in Europe and, in
particular, how to improve it.
Financial stability is a critical condition for achieving our common goals of
prosperity and sustainable growth.
Yet, the financial landscape on which both regulators and market
participants operate, has been rapidly changing; it is very different today
from what it was only ten years ago, and it will be very different ten years
from now.
I will begin by describing the present landscape on which efforts to
strengthen financial stability have been taking place. Then, I will briefly
discuss some developments in the EU regulatory framework relevant to the
financial system and its stability.
In particular, we can identify a new role for central banks in this framework
that stems from mandates that have been revised to include the
safeguarding of financial stability.
I conclude by outlining the challenges ahead and I provide some thoughts
on the way forward.
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A. The setting - a broader context
Beginning with the initial efforts to forge closer European integration in the
early950s, the European Union has faced a series of challenges that have, at
times, tested both the coherence and the stability of the union.
The responses to these challenges have shown that the EU is built on solid
ground as the bonds among Member States have become stronger over
time.
To cite two notable examples: the breakdown of the Bretton Woods System
in the early970s led to the creation of the European Monetary System - or
EMS - in the late970s; the breakdown of the EMS in the early990s led to the
creation of the euro in 1999.
Developments since the eruption of the 2007-08 international financial
crisis have further strengthened the bonds among EU members. That crisis
raised issues related to "too-big-to-fail", "too-big-to-save", and
"too-complex-to-resolve".
The Basel Committee on Banking Supervision, following the G20
agreement in 2008, took-on the task of comprehensively strengthening
international bank-regulatory standards.
Its updated report, presented to G20 Leaders last November, noted that
substantial progress has been made towards finalizing post-crisis reforms
and that the regulatory-reform agenda for global banks has almost been
completed.
Further clarification of these elements will provide regulatory certainty,
supporting the banking sector's ability to make long-term sustainable
business plans.
The euro-area financial crisis, which originated in 2009-10, provided
another - more serious - challenge to the stability of the European Union.
More recently, with the recovery in the euro area still fragile, a slowdown in
growth in the Emerging Market Economies, along with a rise in geopolitical
tensions, which have led to an unprecedented refugee crisis, and concerns
about a Brexit, have led to an increase in uncertainty.
Finally, different approaches among member states regarding banking
union, and the slow progress in establishing a single European deposit
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insurance scheme, have been hindering further progress in securing the
financial system architecture needed to enhance stability.
A salient characteristic since the onset of the euro-area crisis is that shares
of European banks have been trading at a discount to tangible book value,
while those of the largest US banks have traded at a premium to book value.
This situation cannot be explained by differences in capital-adequacy ratios
since capital ratios for euro-area banks have risen from about 8 percent in
2008 to about 14 percent today (Cœuré, 2016).
On the contrary, these differences are indicative of a European banking
sector undergoing a transformation that demands a comprehensive and
radical adjustment of the core business model of operation.
The first two months of 2016 saw a sharp deterioration in market
sentiment, related to not only a weakening of global economic activity, but
also other concerns:
-
First, the threat of low nominal growth, generating not only high NPL
ratios but also lower and flatter yield curves with potentially negative
effects on banks' profitability.
-
Second, concerns about the effectiveness of monetary policy, with some
market analysts believing that central banks may be running out of
ammunition. I can assure you that they are not. The monetary-policy
decisions by the ECB Governing Council two weeks ago provide clear
confirmation of this fact.
-
Third, regulatory uncertainty about the suite of capital and bail-in
requirements - the Supervisory Review and Examination Process
(SREP), the Minimum Requirements for Own Funds and Eligible
Liabilities (MREL), the Total Loss Absorption Capacity (TLAC), and
EBA guidance on the minimum distributable amount (MDA).
Uncertainty as to the actual effects that can be expected from the newly
introduced BRRD instruments seems to have played a role.
-
Fourth, negative feedback loops between equity and debt markets,
amplified by low secondary market liquidity.
B. The EU response
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The responses of the European Union to the weaknesses to the financial
stability landscape that emerged have been effective, despite the initial lack
of crisis mechanisms and the unfavorable and challenging environment - an
environment in which fires were often being simultaneously fought on a
number of fronts.
Initially, the response came in the form of monetary policy and a significant
easing of the monetary policy stance.
Indeed, in October 2008, six major central banks, including the ECB,
executed a coordinated and simultaneous cut in interest rates.
Additionally, at that time the euro-area countries set out an action plan of
coordinated measures to restore confidence and improve financing
conditions in the economy.
These measures included the granting of government guarantees on bank
debt issuance and the recapitalization of banks.
With the eruption of the euro area financial crisis in 2010, and during
subsequent periods when the monetary transmission mechanism was
dysfunctional, the ECB increasingly implemented nonstandard monetary
tools.
Additionally, to provide financial assistance to countries under stress, in
June 2010 Europe created the EFSF, which was replaced by the ESM in
October 2012.
Perhaps the greatest challenge - and surprise - posed by the euro-area crisis
was in the area of financial integration and banking.
At the inception of the euro, it was widely-expected that the single currency
would spur integration across previously-fragmented European financial
markets.
Economists believed that this integration would be stabilizing: portfolio
diversification and access to credit markets were expected to encourage
risk-sharing while making national demand less dependent on national
income - that is, portfolio diversification was expected to encourage
consumption smoothing.
And for the euro's first ten years, that scenario unfolded very much as
expected.
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Then came a major surprise.
The euro-area crisis revealed that countries within a monetary union can
become subject to balance-of-payments crises - a possibility that had been
almost completely overlooked by the architects of the euro.
Moreover, once a crisis erupted - whether in the sovereign sector or the
banking sector - a central feature of the crisis was the negative feedback
loops between banking fragility and sovereign weakness.
One factor contributing to those feedback loops was the following.
Although the largest banks in the euro area and the United States are of
roughly the same size in terms of euro-area GDP and U.S. GDP,
respectively, the largest euro area banks represent a much larger share of
any individual national economy in the euro area compared with the
situation of U.S. banks.
This circumstance implies that the fiscal consequences of euro-area bank
failures could be large enough to bring state-solvency into question.
Moreover, the fact that bank regulation and supervision prior to the crisis
were mostly national was seen as having contributed to the crisis and as
having impeded its effective resolution.
Consequently, a key lesson of that crisis has been that a monetary union is
not viable in the absence of a banking union.
In response to these developments, in 2012 European leaders initiated the
creation of the Banking Union - which is an integral part of a genuine
Economic and Financial Union in Europe.
The three pillars of the Banking Union are: the Single Supervisory
Mechanism, the Single Resolution Mechanism and the still-to-be
completed common deposit guarantee system.
As of January 1st 2016, the Banking Recovery and Resolution Directive
(BRRD), which sets common EU rules for failing banks, entered into full
force.
The BRRD aims, inter alia, to end the policy of bailing-out failing banks by
introducing bail-in tools to ensure that losses are borne by creditors,
including senior unsecured creditors.
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The BRRD, especially its bail-in tool, has been criticized - perhaps with
some justification.
However, the argument sometimes made, namely, that the activation of the
BRRD has been a primary cause of the recent deterioration in market
sentiment, including the large losses in European bank stocks, is
far-fetched.
The provisions of the BRRD have been widely known since 2014.
What analysts, perhaps, failed to realize is that the new and stricter rules
introduced with the BRRD will affect the volatility of the prices of banks'
shares should concerns be raised about the banks' profitability, solvency
and, most importantly, their viability.
That said, we must keep in mind that the BRRD is a new and untested
framework for failing banks, and it is not particularly suited to addressing a
systemic crisis.
As it will be revised by June 2018, we will have to closely monitor its
implementation and identify any areas where adjustments and fine-tuning
will be needed.
While we may need tools for failing banks, our primary aim as supervisors
is the prevention of bank failure, in order to foster financial stability and
ensure that depositors remain protected.
As John Vickers (2016) recently highlighted "Orderly bank failure is better
than disorderly failure, but it's best not to fail in the first place-Regulatorsare adding usefully to the supply of fire extinguishers.
With more fire extinguishers the average damage from a fire is materially
reduced. But that is no good reason to economise on fire prevention".
C. Central Banks and macro-prudential policy
Now let me turn to the issue of crisis prevention.
The challenges facing EU financial sectors in recent years have significantly
increased the responsibilities of central banks in the area of crisis
prevention.
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Mandates have been amended to explicitly refer to financial stability typically defined as avoiding rapid credit growth combined with increases
in asset prices beyond those justified by the economic fundamentals - as a
core central bank task.
The toolbox for providing financial stability has been expanded to include
macro-prudential policy tools and enhanced micro-prudential policy tools
for both the national authorities and the SSM.
Examples of macro-prudential tools include: a countercyclical capital
buffer, a systemic risk buffer and the other systemically important
institutions buffer along with measures to control, inter alia, leverage,
liquidity and large exposures.
In the past, it was not thought to be necessary to separate monetary policy
from the task of providing financial stability.
It was thought that price stability in the market for goods and services
would be sufficient to ensure financial stability in the market for assets.
The experience since the early-2000s has dispelled such beliefs.
That experience has shown that the business cycle and the financial cycle
are not necessarily synchronized; long periods of disconnect between the
two cycles can materialize.
In particular, the financial cycle tends to have larger amplitude and lower
frequency than the normal business cycle.
Macro-prudential policy bridges the gap between the micro-prudential
supervision of individual banks and monetary policy.
Its objectives are, first, to enhance the resilience of financial institutions
and the entire financial system, and, second, to smooth the financial cycle.
In this regard, macro-prudential policy allows monetary policy to focus on
maintaining price stability so that real economic activity can flourish, while
micro-prudential supervision focuses on individual institutions.
In this way, macro-prudential policy enhances the institutional separation
that is one of the principles of the architecture of the euro area.
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Indeed, I believe that a strong case can be made that, had macroprudential
tools been available ten years ago, we may not have had a euro-area crisis.
Ten years ago macroprudential tools to limit the excess borrowing that was
taking place in the soon-to-be crisis countries were either not used or were
too weak to dampen credit growth sufficiently in those countries.
That said, the usefulness of coordinating policies should not be forgotten whether that be coordination of specific policies across different countries
(as happened in the wake of the failure of Lehman Brothers with the
simultaneous cuts in policy rates) or coordination of policies within one
jurisdiction.
Respect for the independence of the various authorities involved in
securing financial stability should not imply separation and a lack of
coordination.
Thus, I strongly agree with Danielle Nouy that "micro-prudential
supervision needs to be complemented by a macro-prudential perspective".
It is imperative, however, that the macro-prudential toolbox be further
enhanced with innovative tools beyond those focused on capital
requirements.
Cyclical systemic risk can arise not only as a result of excessive credit
expansion (an issue that can be addressed with the countercyclical capital
buffer) but also because of inadequate channeling of credit that keeps the
real economy under-financed for extended periods.
A lesson drawn from the crisis is that we have focused on rather narrow
areas of financial activity.
Nowadays, it is important that we focus on the risks that might be missed at
the micro level, that is the interlinkages between and among sectors, and
thus explore how the financial system can influence, and be influenced, by
the wider economy.
In the euro-area, there is evidence of limited financing of the real economy,
with the consequence that euro-area investment has not recovered to
pre-2008 levels despite ECB policies directly aimed at increasing the
lending of the banking sector.
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D. Developments in the EU financial regulatory framework and
further steps ahead
Apart from the elements of Banking Union and the BRRD, a number of
other important regulatory initiatives have been taken, covering not only
the banking sector, but also insurance, financial markets and
infrastructures.
Many initiatives are on-going and further steps are required for their
completion.
If macroprudential policy is to effectively curb the financial cycle, it is
essential to have tools that deal with the credit-real estate relationship.
There are two ways to deal with this relationship.
The first is by imposing restrictions on credit institutions - that is, through
capital-based measures.
The second way in which the credit cycle can be moderated is by limiting
leverage by households and non-financial corporations.
With regard to the banking sector, the Capital Requirements Regulation
(CRR) and Directive (CRD IV) play a prominent role in setting the
prudential standards for credit institutions and investment firms in the EU.
Implementation is ongoing and expected to be completed by 2019.
From January 2016, the countercyclical capital buffer (CCB), the systemic
risk buffer (SRB) and the other systemically important institutions (OSII)
buffer have been operational.
Given the need to diversify the available tools beyond regulations based on
capital, tools based on liquidity, leverage and funding sources are also being
introduced.
With regard to the borrower's side, instruments such as the loan-to-value
(LTV), loan-to-income (LTI) and debt-service-to-income (DSTI) limits are
considered to be among the most effective macroprudential instruments in
curtailing excessive credit growth.
In order to effectively moderate the financial cycle, a time-varying
dimension is crucial in the design of the various ratios.
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For example, the loan-to-value ratio should be lowered during the
expansionary phase of a financial cycle and it should be raised during the
contractionary phase.
Otherwise, there is a risk of pro-cyclicality since leverage constraints
decrease as asset prices rise.
Regulatory initiatives for financial markets and infrastructures and the
implementation of the European Market Infrastructure Regulation (EMIR)
include macro-prudential intervention tools (such as an enhanced and
cooperative oversight framework for central counterparties).
Thus indicators that will contribute to better monitoring the extent to
which the system is assuming more risks, as well as tools which can
contribute to maintaining financial stability are being developed.
E. Challenges ahead and the way forward
Challenges, of course, remain. I will highlight seven of these challenges.
1. The first challenge is the completion of the Banking Union. Questions
surrounding the financial capacity of the Single Resolution Fund (SRF),
both in the short and in the long run, have to be addressed. The size of the
SRF has been criticized for being insufficient and its governance structure
has been criticized as being overly complex.
If a sound backstop is not in place, there will be pressure for stress tests to
become softer, which would be a detriment to financial stability.
The ESM could become an effective backstop to the SRF, safeguarding
financial stability in the Banking Union.
Another issue that requires further reflection concerns the implications of
implementing a single vs. a multiple point of entry in developing resolution
plans.
With respect to deposit insurance, aside from the Deposit Guarantee
Scheme Directive (DGSD), the transposition of which is still pending in
some Member States, the proposed European Deposit Insurance Scheme
(EDIS) is of paramount importance.
Deposit insurance at the supranational level will contribute significantly to
financial stability by providing a back-up when national schemes do not
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have the capacity to handle large shocks. Such insurance will be a decisive
step towards breaking the diabolical link between banks and sovereign and,
along with a sound backstop to the SRF, safeguarding stability across the
Banking Union.
It is also important to keep communicating with the markets.
Thus, we have to provide consistent communication on regulatory
initiatives and macroprudential policies to reduce regulatory uncertainty.
It is necessary to revise the legislation and EBA Guideline regarding the
definition of the Minimum Distributable Amount (MDA) to bring it into
line with other countries.
We need to harmonize the Minimum Requirements for Own Funds and
Eligible Liabilities (MREL) and the Total Loss Absorption Capacity (TLAC),
for example, by using the same definition of eligible liabilities for both tools
and adjusting the relative thresholds.
Close cooperation between the SSM and the SRB will be needed.
One first area where this cooperation could be beneficial is at the level of
the MREL.
Finally, we need to promote strategies for banking sector restructuring
while having a comprehensive strategy to tackle NPLs.
This is particularly important for banks with high NPL ratios.
2. A second challenge ahead relates to the issue of the increased burden of
complying with the new regulatory framework and assessing its cumulative
impact.
I am not referring to additional capital adequacy requirements.
In the pursuit of making banks more robust, liquid, responsible and
transparent, huge progress to regulate their operation and supervision has
been achieved.
However, there has been no estimate of the cumulative impact of these
regulations.
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I welcome and look forward to the report on the impact of capital
requirements on the economy; however, the impact of other regulations
should also be examined.
We need to keep in mind the principle of proportionality.
As new regulation accumulates, we know that it can come with costs as well
as with benefits. Policymakers need to be watchful that, in attempting to
limit externalities, they do not inadvertently create new externalities.
The financial sector ultimately exists to serve the real economy.
It is very likely that there are trade-offs between ensuring financial stability
and imposing such a burden on the financial sector that it ceases to be able
to do its job, namely to intermediate between surplus and deficit units in
any economy in order to encourage long-term investment and growth.
Thus we have to develop methods to judge the appropriateness of
indicators and tools. Since many of the regulations have been applied over
the last few years, that is, in a period of acute financial stress, I expect that
in the coming years there will be a need to reassess those regulations and
perhaps conduct some fine-tuning.
Similar arguments apply to the national options and discretion in the new
regulatory framework.
3. Closely related to the previous challenge is the degree to which regulatory
developments should be front-loaded.
The regulations themselves often have long phase-in periods such that new
versions of the regulations are developed before the previous versions have
been fully implemented.
Supervisors have tended to compensate for the long phase-in periods by
front-loading all prudential requirements, a situation that sometimes can
be considered excessively harsh.
Of course the long phase-in periods are often a reaction to the expected
impact of the regulation on bank behaviour and, in particular, on the
lending to the real economy. Some middle road has to be found.
4. A fourth challenge is the need to reduce reliance on models. Recently
conducted stress-tests at the EU level followed a "single-model-fits-all"
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methodology, which left very little room for idiosyncratic and specific
national characteristics.
Moreover, according to some analysts, there is a risk that stress tests are
becoming less effective as a supervisory tool. Instead, they may increasingly
be seen as having been undertaken in order to calm the markets.
Ideally, stress tests should be implemented in benign times in accordance
with an old wisdom attributed to John F. Kennedy, that "the time to repair
the roof is when the sun is shining".
In crisis times, there is the risk that crucial inputs such as macroeconomic
variables are under or over-estimated and that adverse scenarios become
unrealistic - either too benign or too severe.
In consequence, there are ambiguous outcomes that are difficult to
interpret.
Additionally, the potential pro-cyclical effects of stress tests should be
explored.
More appropriately, stress tests should not only place emphasis on
solvency, but they should explore the impact of the assumed shock on bank
liquidity, the implications of applying the bail-in tool, the funds needed to
meet any demand on deposit guarantee funds, etc.
We should focus on harmonizing processes, while models should be
enriched with constrained judgement as is standard practice in
macroeconomic forecasting.
5. Fifth, there is a need to widen the scope of regulation. A crucial challenge
ahead is related to recent disintermediation and the development of
"shadow" banking as an alternative means of financial intermediation.
The CRR/CRDIV legal framework covers mainly the banking sector, yet
financial activity and the financing of the euro-area economy have
increasingly shifted to non-banks.
The need for macroprudential regulation of certain financial activities
becomes clear if we consider that banks and non-banks are closely tied
through market-based intermediation activities.
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These include a broad array of services related to securitization
transactions, securities financing transactions, repos, collateral
management and derivatives.
The consequences of poorly-monitored risks in this area are unknown and
the risk of a new crisis could be lurking, while spill-over effects are difficult
to assess.
Moreover, the more that policymakers are effective in using
macroprudential tools to constrain excessive credit growth in the banking
sector, the more likely it becomes that there will be excessive adjustments
in the non-bank sector through leakages.
Fortunately, "shadow banking" is high on the agenda of the relevant fora
and there is a clear need to extend the regulatory toolkit.
At this point I would like to mention also the Capital Markets Union.
The Capital Markets Union aims at connecting saving more effectively to
investment by funding projects in a transparent and ordered way. In this
way, it could contribute to growth by providing alternatives to traditional
bank intermediation for savers and investors.
In pursuit of growth, Europe needs a financial system that is able to meet
the financing needs of all economic entities (businesses and households) at
different stages in their development.
6. A sixth challenge is one that the SSM has identified as a top priority for
its supervisory action plan for 2016 - namely, banks' business model and
profitability.
In particular, low profitability in a low (even negative) interest rate
landscape is a key challenge that banks need to address.
Moreover, European banks have to address the problem of radical
restructuring which has been delayed in many cases.
This observation, accompanied by frequent top management changes,
stands in contrast to strategy implementation in the US.
It is even more complicated now with the deterioration in market sentiment
and the weaker-than-expected economic outlook.
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Part of the challenge in addressing a new business model relates to the
increasing stock of Non-Performing Exposures (NPEs) and their
management.
These exposures are acting as a significant impediment to banks'
reorienting their business model as well as, more broadly, to growth and
financial stability, particularly in the countries of the European South.
It should be highlighted, however, that we are in a good position to deal
with this challenging issue as, thanks to the Comprehensive Assessment
and the Asset Quality Review, we are aware of the full picture and
important knowledge has been acquired for both monitoring and managing
troubled assets.
At the Bank of Greece, our research on the issue of NPLs indicates that they
are overwhelmingly driven by recession.
Thus, additional capital requirements cannot always provide a remedy.
Indeed, in some cases such a remedy is likely to prove sub-optimal.
Instead, at my Bank we have concluded that active private sector loan
restructuring, the improvement in the insolvency framework, more efficient
judicial systems and the involvement of loan servicers and private equity
funds with experience in restructuring sectors of the economy are crucial
components of an overall strategy of dealing with NPLs.
7. A seventh challenge, the role of the central bank as a lender of last resort
to the banking system, needs to be addressed on the basis of principles that
are consistent with our mandate of preserving financial stability.
The principle developed by Thornton and Bagehot is well-known. Central
banks should lend freely to solvent but illiquid banks against good collateral
at a high rate of interest.
How is this tried and tested principle to be made operational in today's
environment with much larger bank balance sheets and fewer liquid assets?
In the past, government bonds were automatically considered good
collateral.
Today, central banks accept a wider pool of collateral. By what criteria
should collateral be judged?
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We know that liquidity problems can become solvency problems if liquidity
is denied or not provided generously enough.
Thus the seemingly simple principle developed by Thornton and Bagehot
can be open to various interpretations. There is a need, I think, to revisit the
question.
Mervyn King's pawnbroker concept (2016) provides some new ideas on the
issue.
The ultimate aim in meeting these challenges is to make finance in Europe
more resilient and to enhance and safeguard financial stability.
The role of supervisors of the financial system is to enhance harmonization
while respecting proportionality.
They should safeguard a level-playing field among all participants and
protect depositors while striking the right balance between "strictness" and
"fairness".
Their mandate is to set clear boundaries within which financial
intermediation can prosper while financial stability is maintained.
F. Concluding remarks
The financial sector is facing challenges on many fronts. Banks are no
exception. Jonathan Hill (2015, 2016) recently spoke about "a brave new
world for banks" and the need of a revolution in which banks are reformed
and restructured with respect to both their business models and
governance. Supervisors will also have to adapt to this revolution.
Despite the progress made in the past few years, with Banking Union as the
flagship of the reform effort, more progress is needed as Economic and
Monetary Union (EMU) remains incomplete.
Divergence across the euro area is significant and the crisis of recent years
has further highlighted existing shortcomings and important differences
that need to be bridged.
With respect to the financial system, we should seek an approach that
promotes proportionality, transparency and competitiveness.
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Regulatory consistency, coherence and certainty are crucial to investors'
decision-making process.
While financial stability is a necessary condition for prosperity in the euro
area, it is not a sufficient condition.
To this end, Europe should build upon other proposals outlined in the Five
Presidents' Report (2015).
As argued in that report, EMU will not be complete until the appropriate
mechanisms to share fiscal sovereignty are in place. Monetary unions have
to develop mechanisms for risk sharing.
Mark Carney (2015) recently highlighted the stylized fact that, whatever
happens to asset prices, debt endures.
Reducing debt levels is difficult and he notes that it is unlikely that high
debt in one sector or region can be reduced without at least temporarily
increasing it in another. Fiscal integration can help in this respect.
Allow me to remind you of Keynes's view about the Bretton Woods System it needed, he believed, to provide mechanisms to promote symmetric
adjustment within the fixed exchange rate area so that there would not be a
bias towards deficient demand across the system.
A more-fiscally-integrated monetary union would help address the
problems of asymmetric adjustment and the deflationary bias of our
monetary union.
Financial stability is a prerequisite for sustainable growth; it is also a fact,
however, that financial stability on a sustainable basis cannot be achieved
without economic growth.
Failure to maintain sustainable growth has been the biggest threat to the
long-term stability of the EU since the onset of the 2007 crisis.
An appropriate balance between managing risk and enabling investment
needs to be struck.
In this connection, it is crucial that the regulatory framework does not
impede, but provides a suitable environment, for sustainable growth.
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Ladies and gentlemen, ultimately, a sustainable recovery will need to be
underpinned by higher investment.
Yet, in the euro area we presently face a significant investment gap.
The financial system and its stability have a crucial role to play in closing
this gap.
Central bankers and supervisory authorities bear an enormous
responsibility in shaping a system that can deliver prosperity to the citizens
of Europe.
We have made important progress in securing the financial stability needed
to deliver such prosperity, but we have not yet completed the job.
As the ancient Greek mathematician, Archimedes, once said, "Give me a
place to stand and I will move the earth, but first I need a place to stand, a
foundation." The completion of our financial-stability edifice will provide
the necessary foundation for the citizens of Europe.
Thank you for attention.
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