As Prepared for Delivery
Thank you for this opportunity to speak with you today.
When I last had the privilege of addressing the IIB, it was the early summer of 2010. At that time, we were eagerly awaiting the passage of legislation reforming the U.S. financial regulatory architecture.
A lot has happened in the past 15 months. So I thought that today I would address some of the financial regulatory reform issues that the Group of 20 (G-20) financial leaders discussed in Washington these past days, as they prepare for the G-20 Cannes Summit in early November.
Before diving into the details, I’d like to explicitly recognize that – although we may disagree about the details of specific regulations – financial policy makers and the banking community share the same overarching goal. Our shared goal envisions a sustainable and vibrant environment for credit – credit that supports consumers, homeowners, and businesses, who in turn fuel our economic growth. Achieving this positive cycle on a durable, long-term basis is our challenge – which is why we need a financial reform agenda that safeguards financial stability and the global economy.
As a result of the lessons learned from the crisis, the leaders of the G-20 nations set out a robust financial regulatory reform agenda with the intent of reducing the likelihood and magnitude of future crises. The United States quickly went to work, crafting the most far-reaching and historic financial reform legislation in the United States since the Great Depression: The Dodd-Frank Wall Street Reform and Consumer Protection Act. In addition to protecting consumers and taxpayers, and strengthening our financial sector, Dodd-Frank put down an international marker, as the United States was one of the first nations to implement a domestic reform agenda that met, and in some cases exceeded, the G-20 commitments.
We recognize that the IIB has raised concerns about Dodd-Frank’s possible foreign implications. We welcome your input. The issues that you raise are being taken up by the financial regulatory agencies responsible for rule making. We are proud of our tradition of “notice and comment” rulemaking. During the regulatory rulemaking process, the input that consumers and business organizations such as the IIB provide can inform and improve the regulatory results. Collectively, we are implementing the Dodd-Frank statute in a manner that promotes both stable and innovative financial markets.
So now, a little more than one year after the passage of Dodd-Frank, let me highlight a few of our critical financial regulatory reform priorities: capital; OTC derivatives; large, interconnected firms; resolution; and a legal entity identifier (LEI).
1) First, the international focus on strengthening capital, liquidity and leverage requirements reflects the difference that these elements can make between the success or failure of firms, and the jobs and livelihoods that their lending supports. Capital, liquidity and leverage also make the difference between confidence or contagion in the markets, and between protection or exposure of taxpayer dollars.
In November 2010, the G-20 Leaders endorsed a new framework for bank capital, known as Basel III. This will help to ensure that banks hold significantly more capital, and that the capital will be of high quality and thus truly able to absorb losses of a magnitude associated with a major crisis – and without recourse to taxpayer support. Basel III will also help to ensure that the level and definition of capital will be uniform across borders.
Basel III also outlines new mandatory liquidity ratios, which are designed specifically to allow financial institutions to withstand significant balance-sheet losses in times of stress, while still being able to provide credit to households and business, and without exceptional government support. Basel III’s leverage ratio requires banks to hold a minimum level of capital against total assets. It is similar to the leverage ratio that has long been in force in the United States.
Full international convergence will be achieved only if supervisors in all major financial jurisdictions ensure that banks across the world measure risk-weighted assets similarly. This is essential to maintain a level playing field, and to ensure that markets and investors can be confident that the capital adequacy ratios stated by banks are consistent across borders. The United States is pursuing comparability by urging greater visibility into supervisors’ scrutiny of how banks measure risk-weighted assets. We are pleased that the Basel Committee has added this important work to its agenda.
Already, there is evidence of progress across the globe. For example, among the 50 largest global banks, tier one capital adequacy ratios have climbed from 8.1 percent in 2007 to 11.3 percent at the end of 2010, making the global financial system markedly more resilient. Since the end of 2008, the 19 largest financial institutions in the United States – the ones that were subjected to the early 2009 stress tests – have together increased common equity by more than $300 billion. And, European banks have raised $121 billion in capital since Europe’s June 2010 stress test exercise.
In wrapping up this topic, I will note that the timeline for Basel III includes a multi-year phase-in period, which allows a staged implementation that minimizes risks to economic recovery.
2)The second area that I will address is OTC derivatives – an area where international convergence is needed. In the run-up to the crisis, derivatives were traded over-the-counter on a bilateral basis. Because this market had so little transparency, few understood the magnitude of aggregate derivatives exposures in the system. Firms themselves, as well as their supervisors, had no basis to measure the risks of their derivatives exposure.
This lack of transparency hindered the identification of risk in the global financial system. To address this problem, the G-20 Leaders agreed that standardized derivatives should be cleared through central counterparties and, where appropriate, traded on exchanges or other electronic trading platforms. They also agreed that all trades should be reported to trade repositories. The OTC derivatives framework is an area in which small differences in rules can make a big difference. So a global approach to derivatives will help to prevent risks in derivatives from becoming concentrated in jurisdictions with less rigorous rules or the least amount of oversight or transparency. The United States is making significant progress in derivatives regulation and is on schedule to meet the G-20’s end-2012 deadline for implementing new rules.
At the international level, work is proceeding in a number of standard-setting and regulatory policy bodies, including IOSCO and the Financial Stability Board (FSB), to promote international convergence and develop supervisory cooperation arrangements. In addition, the United States is actively engaged with our counterparts in Europe and Asia to encourage them to adopt equally robust standards that live up to the G-20 commitments on the clearing, trading and reporting of swaps.
Recently, Secretary Geithner proposed the development of internationally-consistent standards for margins on un-cleared derivatives trades. We are pleased that the FSB and international standard-setting bodies have taken up work on this issue, and we expect that our G-20 partners will also support this effort.
3) A third vital issue is reducing the systemic risk from large, interconnected financial firms. Prior to the crisis, many large, interconnected firms held too little capital relative to their risk-weighted assets, posing risk to the global financial system and, in the end, necessitating significant government intervention when their balance sheets deteriorated rapidly.
To guard against a recurrence and to protect our taxpayers, Dodd-Frank created the Financial Stability Oversight Council (FSOC) to coordinate across financial regulatory and supervisory agencies, and instill joint accountability for the stability of the financial system. Dodd-Frank provides the FSOC with a leading role in designating the largest, most interconnected firms for heightened prudential supervision.
In a similar manner, at the international level, G-20 Leaders committed to developing additional capital requirements for Globally-Interconnected Systemically Important Financial Institutions, G-SIFIs. We are now at an advanced stage in identifying global systemically important banks (G-SIBs). Work is at earlier stages in identifying global systemically important insurers and other institutions.
The United States welcomes the FSB and the Basel Committee proposal for a capital surcharge for G-SIBs, and especially its focus on raising common equity. Common equity is the strongest defense against financial stress, and lower quality alternative instruments just cannot absorb losses as readily in a crisis.
It is equally important that the capital surcharge be well calibrated to balance the imperatives of the financial sector and of macroeconomic stability.
We look forward to the results of the FSB and Basel Committee consultations on their G-SIFI surcharge proposal.
4) The fourth topic that I will touch upon is resolution regimes. The recent financial crisis demonstrated the economic damage to our financial system and the global economy when large, complex financial institutions failed in a disorderly manner. The crisis exposed the fact that many countries lacked comprehensive national resolution tools and cross-border arrangements for winding down systemically important firms.
Dodd-Frank established a special robust resolution regime that provides federal regulators with strong authorities to resolve financial firms whose failure would have serious adverse effects on U.S. financial stability. These new authorities extend the resolution powers beyond traditional insolvency laws. They permit our federal regulators to wind down a firm in an orderly manner, and in a manner that takes account of the impact on U.S. financial stability.
But, when addressing firms that operate in multiple countries, the best national resolution regime in the world will not be sufficient if other countries do not have complementary authorities.
That is why the United States successfully urged the G-20 Leaders to endorse a set of principles for developing an effective cross-border resolution system. We recognize that achieving a truly international cross-border resolution regime is complex, and it is going to take time. We are currently working, through the FSB, on a three-pronged international framework. The first step is ensuring that regulators and G-SIFIs develop recovery and resolution plans that provide for advanced planning before a crisis. These are so-called “living wills.” The second step is developing criteria to improve the “resolvability” of G-SIFIs. And the third, and possibly most challenging, step is negotiating institution-specific, cross-border cooperation arrangements with foreign regulators.
The U.K. and Germany have already passed resolution legislation, and the European Commission is considering proposals. For our part, we will continue working to encourage other jurisdictions to adopt national resolution powers that will allow them to achieve orderly resolution.
5) The final topic that I want to touch upon briefly is LEI – legal entity identifiers. Secretary Geithner called for the establishment of one global system for uniquely identifying parties to financial transactions. A legal entity identifier system would be an efficient way to help regulators – and firms themselves – better understand, and ultimately reduce, systemic risk. Had such a system been in place during the financial crisis, policy makers and the private sector would have had a much better understanding of the true exposures and interconnectedness among and across financial systems.
We look forward to recommendations coming out of an FSB workshop on LEI that is being held later this week.
So, these are just some of the critical issues that we are addressing on the global financial regulatory front. We know that the steps we already have taken in the United States and globally have helped. Banks have more capital. Leverage has been reduced. But we also know that we need to do more. We must continue to pursue the highest standards if we want to secure our financial system against future crises, cultivate financial markets that efficiently allocate capital and support growth, and maintain the competitiveness of our markets and financial firms. Recent history has underscored that the risk is not in being too bold, too strong or too secure, but rather in being too lax and too vulnerable. Together with our partners in the G-20, the United States seeks to establish high standards that allow competition and innovation to thrive, while protecting consumers and taxpayers from future crises.