G20 Foundation Publications Australia 2014 | Page 14

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