As Prepared for Delivery on March
WASHINGTON - Chairman Johnson, Ranking Member Shelby, and members
of the committee, thank you for the opportunity to discuss our international
financial reform agenda.
In the wake of the financial
crisis, the United States responded swiftly and aggressively. We took forceful measures to stabilize
financial markets, including through transparent and groundbreaking stress
tests. Congress moved rapidly to enact
the Dodd-Frank Act – which provides the most significant set of financial
reforms in generations. And in parallel
we secured unprecedented commitments from our international partners in the
G-20 and the Financial Stability Board – the same commitments from the emerging
economies as from the advanced economies.
There is a vigorous debate over
the merits of moving slow or fast – of moving first or last. This is an important debate with direct
bearing on the pace and tone of the recovery, the safety and soundness of our
financial system, and the fairness of the international playing field. The United States moved fast and first to
repair and reform our financial system, and we believe that strategy is already
beginning to demonstrate its effectiveness.
Some argued that strengthening
the safety and soundness of our financial institutions should wait until after
the recovery is complete. I
disagree. A strong and stable financial
system is a precondition for a growing and competitive U.S. economy. It was important to take action while the
urgency of the crisis was still fresh in our memories. There are substantial lead times built into
many of these reforms, allowing markets time to adapt. Now is not the time to increase uncertainty
in the market by backtracking.
Making our Financial System Stronger, Safer, and More Transparent
U.S. supervisors responded early
and forcefully by compelling U.S. financial institutions to build capital,
reduce leverage, and strengthen liquidity buffers. Far from disadvantaging U.S. institutions and
harming credit, these early actions built greater resilience and helped to
safeguard credit flows in the face of elevated financial stress in the second
half of 2011.
Because we acted early and fast,
U.S. banks built larger and higher-quality capital buffers. Tier 1 common equity at large bank holding
companies increased by more than $400 billion to $960 billion from the first
quarter of 2009 through the fourth quarter of 2011, a more than 70 percent
increase. The ratio of Tier 1 common
equity to risk-weighted assets at these institutions has increased from 6
percent to over 10 percent during this period.
U.S. financial institutions have
strengthened their funding models: short-term wholesale financial debt has
decreased as a share of total financial institution assets from a peak of 29
percent in 2007 to 17 percent in the fourth quarter of 2011, and regulatory
filings show that short-term wholesale funding at the four largest bank holding
companies has decreased from a peak of 36 percent of total assets to 20 percent
over this period. Depository
institutions have built a more stable base of funding. Core deposits as a share of total liabilities
at FDIC-insured institutions increased from a low of 44 percent in 2008 to 64
percent in the fourth quarter of 2011.
Risks have diminished outside of
the banking sector as well. The size of
the U.S. shadow banking system has fallen substantially, with prime money
market funds shrinking by 32 percent and the tri-party repo market shrinking by
nearly 40 percent since their peaks in 2008.
And credit availability has
improved during this time, even as safety and soundness have materially
strengthened. Bank credit to U.S.
companies increased by annual rates of 11-12 percent in the third and fourth
quarters of 2011.
By contrast, Europe opted to move
more slowly on stress test disclosures and measures to build capital and
improve funding. As a result, many euro
area banks were less resilient in the face of shocks last year, putting
pressure on funding and credit and raising financial stress in a negative
spiral. Since that time, European
authorities have taken steps to strengthen the capital position of euro area
banks. These actions, and the critically
important actions taken by the European Central Bank to strengthen liquidity,
have helped to reduce financial stress.
Far from disadvantaging our
firms, the early actions to strengthen bank balance sheets and improve funding
put U.S. banks in a stronger position to withstand financial stress relative to
many of their international peers, while supporting credit flows to U.S.
households and businesses at a critical time for the recovery.
International Convergence on Financial Reform
Some argue that by moving first,
we have put the United States at a competitive disadvantage. To the contrary, by moving early, we have
been able to lead from a position of strength in setting the international
reform agenda and elevating the world's standards to our own. The alternative would have been to follow the
reform standards set by other countries or subject our firms to a divergent set
of standards. Of course, we will need to
be vigilant in addressing the inevitable inconsistencies and lags on
implementation. But this should not detract
from the remarkable degree of convergence we are seeing on a comprehensive
reform agenda spanning bank capital and liquidity, resolution, and
over-the-counter (OTC) derivatives markets for the first time. This common, comprehensive set of reform
commitments encompasses not only the established financial centers in advanced economies
but also up-and-coming financial centers in emerging markets. Moving first and ensuring that others enact
reforms consistent with our own are the best ways to reduce opportunities for
regulatory arbitrage and a race to the bottom, to prevent firms from exploiting
gaps in regulation, to provide a fair and level playing field for U.S. firms,
and to protect our economy from risks emanating beyond our shores.
Going into the crisis, too many
financial institutions had too much leverage, too little liquidity, and
inadequate loss absorbing capacity. This
led to a downward spiral in confidence among counterparties. Going forward, we have agreed to new global
capital standards that raise the quality and quantity of capital so that banks
can withstand losses of the magnitude seen in the crisis and reduce the risks
of financial system collapse as a result of financial excesses. We have also secured agreement
internationally to strengthen liquidity standards and limit leverage. We have identified the globally systemically
important banks, agreed to a capital surcharge for these institutions, and
developed a comprehensive set of enhanced prudential measures to address risks
from globally active financial institutions.
However, there is much more work
that needs to be done. We must remain
vigilant against attempts to soften the national application of new capital,
liquidity, and leverage rules. It is
essential for banks across the world to measure risk-weighted assets similarly,
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 for
Going into the crisis, few
understood the magnitude of aggregate derivatives exposures in the system
because derivatives such as credit default swaps (CDS) were traded over the
counter on a bilateral basis and without transparency. Going forward, we have agreed to stronger
international standards for the OTC derivatives markets, including requiring
greater transparency, moving their trading onto exchanges, and requiring them
to be centrally cleared.
Now we must ensure that national
authorities continue to coordinate closely to align implementation; our
frameworks for derivatives must be tightly aligned or differences could lead
firms to move activities to jurisdictions with lower standards, increasing
risks to the global financial system. We
must guard against fragmentation of the global payments infrastructure,
ensuring that global infrastructure is adequately safeguarded, and avoid
geographic mandates for clearing. It is
critical that others across the globe follow the U.S. lead and accelerate
timetables where needed.
We must also finalize work on a
global standard for posting collateral (or margin) on uncleared derivatives
transactions. To reinforce the push towards
central clearing and enhance safety and soundness, the charges associated with
uncleared derivative transactions must exceed those on cleared
transactions. Both the United States and
the European Commission are developing margin requirements for OTC derivatives
that are not centrally cleared, and the G-20 and the FSB have committed to
developing a global standard.
Going into the crisis, countries
lacked tools to resolve systemically important financial institutions,
effectively rendering them too big to fail.
Going forward, we have reached an important agreement that all major
financial jurisdictions should have the tools to resolve large cross-border
firms without the risk of severe disruption or taxpayer exposure to loss. The FSB is working actively to see that this
international commitment is implemented on a national level to ensure that in
addition to national resolution regimes, regulators and the major global banks
develop cross-border recovery and resolution plans by the end of 2012; develop
criteria to improve the “resolvability” of systemically important institutions;
and negotiate institution-specific cross-border resolution cooperation
resolution is a difficult issue given the diverse national laws and the
infeasibility of a single global bankruptcy regime. The U.K., Germany, and Canada have already
passed resolution legislation, and the European Commission is developing a
draft for the second quarter of 2012. We
are working to put in place cross border cooperation agreements; establish
cross border crisis management groups for the largest, most complex
institutions; and finalize recovery and resolution plans by the end of this
Going into the crisis,
supervisors and market participants did not have adequate visibility into the
buildup of concentrations of risky activities in the financial markets. Going forward, a global Legal Entity
Identifier (LEI) system will uniquely identify parties to financial transactions,
ensuring greater transparency and more efficient data collection across the
global financial system, and enabling better understanding and management of
systemic risk. Working with our
international counterparts and the financial industry, we must finalize the
global LEI framework and the reporting systems to support it by the G-20
Leaders Summit in June.
New laws and rules aimed at the
home market of any major financial center will inevitably impact other
jurisdictions, given the globalized nature of cross-border flows. In these circumstances, aligning the
substance and timing of reforms across jurisdictions will be critical. Regulators will have to sort out whose rules
apply, how, and where. We need to figure
out sensible ways to apply and enforce rules across major jurisdictions in
consistent ways. The greater the degree
of convergence around high quality standards, the greater the scope for
deferring to foreign jurisdictions that have regulatory regimes as strong as
that of the United States.
Regulators are grappling with common
issues pertaining to the structure of risk-taking in their national
markets. The Volcker rule, which limits
proprietary trading and hedge fund activities for banks, is a good example of
where the United States has moved ahead of others, continuing in a long
tradition of recognizing structural differences across countries, reflecting
national history and laws. The U.S.
federal depository insurance net – which has served our country well – was not
designed to be extended to the riskiest trading activities of U.S. banks. But even in this instance, while regulators
are sifting through the 16,000 comments that were submitted on the rule, other
jurisdictions are grappling with the same issues. In the U.K., the Vickers Commission proposed
rules to insulate core financial intermediation activities from riskier
business lines in order to promote financial stability. In the European Union,
Commissioner Barnier has assembled a commission to explore possible regulations
for proprietary trading.
With financial markets that are
more globally integrated than ever, we need financial reforms that are more
globally convergent than ever.
In today’s highly interconnected
global financial markets, the risk of regulatory arbitrage carries real
impact. It means the potential loss of
jobs if firms seek to move overseas where regulation is weaker. It means a race to the bottom for standards
and protections. And it may mean a
heightened risk of a future financial crisis if riskier activities migrate to
areas with less transparency and laxer supervision.
In cooperation with the
regulatory agencies represented here today, Treasury is intensely focused on
ensuring global convergence on regulation and resolution of large, complex
financial institutions and on regulation of derivatives markets – the three
areas with the greatest potential for discrepancies in national regulations to
create disproportionate dislocations in global markets that could negatively
impact our economy and our firms. This
is a necessary response to the crisis.
Since the outset of the crisis,
the G-20 and the FSB have played an increasingly critical and welcome role,
alongside the international standard setting bodies, in shaping the
international regulatory reform agenda and promoting sound regulation and more
resilient financial markets. Recognizing there will be discrepancies when it
comes to implementation at the national level, the Treasury and U.S. regulatory
agencies buttress our cooperation through the G-20 and the FSB with extensive bilateral
engagement. Each day, we talk with our
colleagues in Europe and conduct ongoing dialogues across the major financial
centers. This helps us get the details
right. Additionally, the FSB and the
standard-setting bodies have jointly developed an implementation monitoring
framework that will report annually on our collective progress to the FSB, the
G-20, and the public.
Undoubtedly, we will not attain
perfect alignment and we will not get everything right. Despite this, nothing could be more costly
than backtracking on reforms. We cannot
lose sight of the costs of the last crisis – millions of jobs and trillions of
dollars in lost wealth. Nor can we lose
sight of the causes – inadequate risk management, imprudent-risk taking, opaque
instruments whose risks were not understood or overseen, and failures by our
regulators. This is why it is necessary
to complete the work that is underway in the United States and internationally.
The system is stronger today and will continue to strengthen in the future as a
result of our efforts.