Carney on unfinished Basel business

Basel III must be completed urgently and then implemented faithfully, Mark Carney, Chair of the Financial Stability Board, has said ahead of the G20 Leaders meeting in Hamburg this weekend.

Before the summit, Carney, Governor of the Bank of England, highlighted the G20's achievements, explaining that having fixed the fault lines that caused the global financial crisis, the banking system is now safer, simpler and fairer.

“Having put major post-crisis reforms in place, banks are considerably stronger, more liquid and more focused," he said.

However, he argued that the financial system is evolving, and the G20 will continue to scan the horizon for new and emerging risks to financial stability before these threats get out of hand.

These risks include fintech, along with the decline in correspondent banking relationships, climate-related disclosure rules and shadow banking.

“At present, we have not identified other new systemic risks from shadow banking that would warrant additional regulatory action at the global level," said Carney.

“However, since shadow banking evolves over time, authorities should continue to monitor vigilantly and address promptly emerging financial stability risks."

Further work

In the speech, Carney counted among the Board’s successes moves to eliminate the toxic parts of shadow banking and said what is left of that activity is resilient market-based finance.

The FSB chair said progress had been made to reform the over-the-counter derivatives markets and that a "complex and dangerous web of exposures" has been replaced with a more transparent and robust system.

Carney also called for improvements to the trading data that covers OTC markets.

And, while underlying causes of misconduct are being addressed by bolstering individual responsibility accountability and better aligning incentives and reward, more needs to be done.

Crucially, Carney is urging the global regulators to sign off on Basel III – specifically on the restrictions that will stop the big banks from understating risks when using internal models. 

Agreement looks to be close on the so-called output floor sitting at 75 per cent. In other words, the banks’ measurements of asset risk using internal models can’t drop below 75 percent of the result yielded by standardised model.

Keen to compromise

A deal is more likely to be struck now that the US has softened its stance on the floor and Europe seems willing to compromise.

This shifting mood was highlighted recently when Sabine Lautenschläger, a European Central Bank executive board member, told a London conference that it is time to “finalise and implement banking reforms that have now been under way for almost a decade”.

In a bid to bridge the gap between the US skepticism of banks’ internal models, and Europe’s insistence that internal models are fine, Lautenschläger said risk sensitivity should be central to calculating capital requirements.

But she agreed that internal models have become very complex. "And that makes them prone to error or even manipulation."

Consequently, the ECB has launched a review of internal models in a bid to harmonise the supervisory treatment of these models and ensure a level playing field. The central bank also wants to ensure that the results of internal models are conservative and driven by actual risks, and not by modelling choices.

“This will strengthen trust in banks' calculation of risk and, ultimately, in the adequacy of capital buffers."

According to KPMG’s risk partner, Michael Cunningham, these are strong words especially for an executive board member.

“Given that an arms war broke out over capital models when the US accused Europe of manipulating their models, Lautenschläge speech is very conciliatory which is creating the fervent hope that a deal can be reached between US and European regulators."

Upcoming Events
RFi Group Webinar: The Surge of BNPL in Asia.
Singapore, Riverview, Singapore
See all upcoming events
Subscribe to receive insights delivered straight to your inbox
Latest news, unbiased expert analysis and insights across banking and finance