Five Years after Lehman s Collapse: Where are we going to?

Five Years after Lehman s Collapse: Where are we going to? Luis M. Linde Governor XCVII MEETING OF CENTRAL BANK GOVERNORS OF THE CENTER FOR LATIN AMERICAN MONETARY STUDIES São Paulo 28 April 2014

LEHMAN BROTHERS: Lehman was not one of the biggest failed banks 4500 4000 3500 3000 2500 2000 1500 1000 500 0 bln$ 3,744.5 1,750.3 1,359.0 1,302.2 1,049.9 896.3 RBS Lloyds HBOS ABN Amro MAIN FINANCIAL ENTITIES INTERVENED ASSET SIZE BEFORE INTERVENTION 639.4 AIG Dexia Lehman Brothers 399.0 309.7 229.8 227.4 Bear Sterans Washington Mutual Bankia Northern Rock but it was one of the biggest and more complex firms to be orderly liquidated by traditional channels 800 700 600 500 400 300 200 100 0 bln$ 691.1 Lehman Lehman Brothers (2008) MAIN M AINLIQUIDATIONS: OF LEHMAN FINANCIAL VERSUS ENTITIES OTHER BANKRUPTCIES ASSET ASSET SIZE SIZE 103.9 91.1 80.5 65.5 61.4 WorldCom (2002) General Motors (2009) CIT Group (2008) Enron (2001) Conseco (2002) 1

Lehman s liquidation revealed how demanding was to solve complex and interconnected financial firms VOLATILITY INDICES Something that exacerbated global uncertainty 350 300 250 January 2006 = 100 MOVE (bonds volatility) VIX (S&P 500 volatility) VSTOXX (Euro Stoxx volatility) 200 150 100 50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 and reduced cross border financial flows FINANCIAL FLOWS AFTER THE BANKRUPTCY OF LEHMAN BROTHERS Cross border bank claims 7,000 bln $ Total financial claims (excluding other investment) 6,000 5,000 4,000 3,000 2,000 1,000 0-1,000-2,000-3,000-4,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2

Public authorities reacted with all the available tools to avoid a financial collapse With conventional and unconventional monetary policies FED BALANCE SHEET COMPOSITION, ASSET SIDE bln. $ 5,000 Term auction credit (a) CB liquidity swaps Agencies MBS Treasuries Total liquidity facilities (b) CP funding faclity Rest of liquidity facilities Agencies' debt Total assets (c) at the risk of validating expectations that failed systemic banks will eventually be bailed out 4,000 3,000 2,000 1,000 0 20-feb-0827-oct-0804-jul-0911-mar-1016-nov-1024-jul-1130-mar-1205-dic-1212-ago-13 OFFICIAL INTEREST RATES 6.0 % US ECB Japan UK 5.0 4.0 3.0 2.0 1.0 0.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 3

NEW INTERNATIONAL ECONOMIC ORDER G-7 G-20 Reform of Bretton Woods IFIs New pillar of the International Economic Order International Monetary Fund Strengthened surveillance Quadrupling of resources New lending policy Governance World Bank Increased resources Enlarged lending policy Governance Regulation Financial Stability Board (FSB) (Sep. 2008- April 2009) Supervision 4

FSB. PRIORITY AREAS OF THE REGULATORY REFORM Assessment of vulnerabilities ( EWEs ) Information gathering (Data gaps, shadow banking monitoring) Building resilience of financial institutions Basel III SIFIs Project (Systemically Important Financial Institutions) FSB (in coordination with other International Committees and Organisations) Leadership and coordination of financial regulatory reform in response to the 2007-2008 crisis Priority Areas Ending Too-Big-To-Fail (TBTF) Shadow Banking OTC derivatives market reforms Monitoring of implementation of internationally agreed standards and recommendations Peer Reviews Other areas of the regulatory reform: Reform of compensation practices Enhancement and convergence of accounting standards Reducing reliance on CRA s ratings Macro-prudential supervisory frameworks and tools Underwriting practices for residential mortgages, etc. 5

FSB. ENDING TOO-BIG-TO-FAIL PROJECT TARGET: Reducing probability of failure of a G-SIFI Identification of G-SIFIs capital surcharges Annual publication of the list of G-SIBs (Global Systemically Important Banks) Capital surcharges, 5 buckets: 1%, 1,5%, 2%, 2,5% and a 5th empty bucket with a 3,5% surcharge (to avoid that firms become more systemic) Resolution TARGET: Reducing the impact in case of failure of a G-SIFI Key Attributes of Effective Resolution Regimes ( KA ) New international standard for the resolution of financial institutions Intensity and Effectiveness of Supervision TARGET: Reducing probability of failure of a G-SIFI Supervisory Independence and Resources Enhancing supervisory practices of systemic groups. 6

FSB ENDING TBTF RESOLUTION OF SYSTEMIC INSTITUTIONS Key Attributes of Effective Resolution Regimes (FSB, October 2011) Legislative Reforms bail-in Recovery and Resolution Plans ( RRP ) Resolution Strategies Resolvability Assessments ( RAP ) SPE Single Point of Entry MPE Multiple Point of Entry GLAC Gone-concern Loss Absorbing Capacity 7

STRUCTURAL REFORM PROPOSALS A comparison of selected structural reform proposals Volcker Liikanen Vickers Broad approach Institutional separation commercial banking and investment activities have to be separated Subsidiarisation Proprietary and highrisk trading activity in separate legal entities Ring-fencing Structural separation of activities via a ring fence for retail banks Alternative domestic initiatives Need for international coordination 7 bis

FIVE YEARS AFTER LEHMAN S COLLAPSE: WHERE ARE WE GOING TO? Regulatory and supervisory initiatives in response to the international financial crisis (in particular after Lehman failure) New institutions + significative reform of existing ones New rules, especially for internationally active banks A credible and effective global resolution regime for SIFIs Advances but still some key aspects under discussion Impact of regulatory and supervisory changes in financial intermediation Financial stability, financial complexity and financing of growth Perspectives for bank businesses Structural reforms 8

EURO AREA : CRISIS AND AUTHORITIES RESPONSE

THE EUROPEAN SOVEREIGN DEBT CRISIS - The Greek crisis expanded to Euro area countries that had accumulated macroeconomic imbalances and vulnerabilities. - Fragmentation of financial markets - Sovereign and banking risk link TEN YEARS SOVEREIGN SPREADS OVER GERMANY pb 1600 1400 1200 1000 800 600 400 200 0 2008 2009 2010 2011 2012 2013 2014 FRANCE ITALY SPAIN 4000 3500 3000 2500 2000 1500 1000 500 0 5 YEARS BANKS CDS 700 pb 600 500 400 300 200 100 0 2008 2009 2010 2011 2012 2013 2014 GERMANY FRANCE ITALY SPAIN 10

Institutional Framework Legal Framework BANKING UNION Single Supervisory Mechanism Single Resolution Mechanism Deposit Guarantee Scheme Council Regulation 1024/2013 (SSMR) ECB: macro and micro prudential tasks CRD IV- CRR EBA - Single Rule Book Banking Resolution Directive (BRRD) Agreement: December 2013 Approval: April 2014 (pending final revision) Deposit Guarantee Scheme Directive (DGS) Harmonization of Deposit Guarantee Schemes Agreement: February 2014 Approval: April 2014 (pending final revision) SSM A mechanism integrated by the ECB and the NCAs SRM Single Resolution Mechanism and National Resolution Authorities European System of Deposit Guarantee Schemes 11

SINGLE SUPERVISORY MECHANISM (MICRO PRUDENTIAL SUPERVISION) SSM = ECB supported by National Competent Authorities (NCAs) Perimeter: euro zone plus opt-in non euro countries Significant banks Size: Assets > 30 billion Importance: > 20% GDP Cross-border activities The three most significant credit institutions in each jurisdiction Governing Council Supervisory Board ECB General Directorates I, II, III & IV Micro prudential supervision Significant Banks ECB Direct supervision Joint Supervisory Teams Other Banks ECB indirect supervision NCAs Joint Supervisory Teams (JST) ECB Coordinator National Subcoordinators Supervisors 1 BCE by 3,3 NCAs Joint Supervisory Teams ECB staff NCA staff Significant Banks 130 banks, 85% euro assets 12

COMPREHENSIVE ASSESSMENT Two main elements: Asset Quality Review and Stress Test Objective twofold: improve transparency and recapitalize viable banks with inadequate solvency levels final objective: strengthen confidence in the soundness of European banks The Asset quality Review will examine the asset side of bank balance sheets as at 31 December 2013 The stress test is a forward-looking exercise, which analysis the ability of institutions to maintain adequate solvency levels in stressed scenarios The relevant thresholds already established: 8% CET1 in the baseline scenario ; 5.5% under the adverse scenario Publication of the results in late October, before the ECB takes over the supervision of significant institutions on 4 November 13

MACROPRUDENCIAL POLICY IN THE EU Microprudential policy was not enough, there is a need to address system-wide risks Risks across the banking sector: Size, interconnections, complexity, etc. Cyclical risks: Excessive credit growth, possibly concentrated (eg: real estate), excessive maturity mismatch, misaligned incentives, excessive leverage, etc. Identification of systemic risk sources Macroprudential instruments Dynamic provisions, countercyclical capital buffer, capital surchages for systemic institutions EU institutional framework ESRB: Macroprudential oversight of the financial system within the EU ECB: Share macroprudential powers with SSM national authorities National Authorities: Implement macroprudential policies at national level 14

SINGLE RESOLUTION MECHANISM (SRM) Geographical Scope: as the SSM Single Resolution Board (SRB): Plenary Board General Rules Executive Board: 5 members and the National Resolution Authority on an ad-hoc basis For a specific bank Single Resolution Fund (SRF) Industry contributions ranging from 55-60 billion National buckets Progressive mutualization from 40% in 2016 up to 100% in 2023 Decision process: as in the SSM SSM Significant banks and cross border entities Direct Resolution by the SRB Other entities National Authorities Resolution steps 1. Bail- in: minimum 8% assets 2. Single Resolution Funds 1 st National buckets 2 nd Other buckets (mutualization calendar) 3. Additional industry contributions, or national public backstop RULES Banking Resolution Directive BRDD INSTITUTION European Resolution Board FUNDING Single Resolution Fund RESOLUTION 15

THE FINANCIAL SYSTEM FIVE YEARS AFTER LEHMAN BROTHERS International Coordination: How much international coordination of financial regulation is needed? Are we making (un)even progress depending on the topic at stake? Are there any areas requiring further harmonization? Is the system becoming too complex? Banks versus other intermediaries and their role in financial intermediation: Implications for financial stability and economic growth. Is there a need for greater cooperation and harmonization on entities supervision and resolution? 16

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