Good morning everyone. Can I ask you to take your seats so that we can start and Welcome to the second day on the ECB forum on the future of international monetary and financial architecture yesterday's contributions We were very interesting and led to a lively debate as much in the rooms here as outside and I trust that you all Appreciated the time you had in the afternoon to further your conversations. It certainly didn't look like much of free time But rather fruitful time So today we're shifting the focus to the regulatory perspective and I trust this will be just as inspiring as yesterday Before I give the floor to Benoit Coré and as I for those who hadn't heard it yesterday We had to make a change due to Zabine falling in I would just like to quickly remind everyone of the rules on media Everything here is on the record and can be reported upon life Everything that is on the sidelines is off the record And also a last plea you all know the games of numbers We do need your voting on the posters to have a good representative view and you have time until 11 30 to do so today I Now hand over to Benoit Coré who will chair session number two financial regulatory challenges Over to you Benoit. Thank you Christine. Good morning to all of you. I'm not Sabine a lot and slager as you've seen which Is certainly bad for For the certainly for the the substantial quality of this panel because you you won't have the supervisory Angle into that discussion or you will have it from the path from the speakers but not from the ECB since I'm sitting clearly on the other side of the ECB which is the monetary policy side Nevertheless the monetary policy side of the ECB has an interest in sound regulation And That's why we I'm looking forward to hearing from the speakers. This is a session on global financial regulatory challenges will have two presentations the first presentation by Darrell focusing on regulation and second presentation by Stein on financial structures Darrell will be commented by Charles and Stein will be commented by Hume the What I would expect from the discussion is not only a The speakers shedding light on what are the most efficient structures In particular in the eurozone, which is which is our focus here, but also in other places What what's good for financial stability, but also I would I would Plea not to lose sight of the of the cross-border perspective. That is the whole the theme of the conference is about global Coordination global consistency, so it's it's very important that this session can also address cross-border consistency level playing field In particular when it comes to the what has been achieved on the regulatory side So what has been what has been consistent what has not been consistent and what can be improved And also in the light of the discussions. We're having with the industry also Have to have some sense of the of the of the timeline and horizon that is how far have we advanced in this Regulatory reform process how we close From reaching the steady state or not at all But that's that's a message that the industry is very eager to listen How how how much remains to be done? Do we need we need new waves of regulation? Are we close to the end? There are industry industry talks of Basel 4, which we don't like so we say there is no Basel 4 but there are fears in the industry that there would be a Basel 4 and What's really as a value of that discussion is to to bring answers that are not based on partial equilibrium Special interest thinking which is unfortunately the way most of the discussion has been structured in different places But really to bring these a general equilibrium and welfare social welfare Perspective that's very much what we what we want to hear from you. So now a dial with a due delay Thank you Benoit. Good morning, everyone Baldea It's great to see so many familiar faces and meet so many new friends. I want to get started right away on this Very interesting and challenging assignment that the European Central Bank gave to me Which is to give you an assessment or at least my assessment of? progress It with financial regulation since the crisis as you know in 2009 and in Pittsburgh the G20 The G20 met and set out a very ambitious program of reform I've broken it into five areas The first four on financial stability are verbatim from the financial stability boards progress reports They monitor Progress on each of these basic core elements. They call them of financial stability improvements across the G20. I Recommend a report. So these are making financial institutions more resilient Ending too big to fail making derivatives markets safer and Transforming shadow banking Now there is no financial efficiency board But if there were one it would have listed the fifth core element of the G20 Reform which is improving trade competition now clearly in the short time that we have together this morning I'm not going to go through all of these I'm just going to pick a few salient areas where there has been a lot of progress and A few areas where improvements could be made or more progress could be made and so if you're thinking in In terms of where are we maybe half done? I won't use sports analogies First on I'm going to focus on is making financial institutions more resilient. I'll do that briefly Then if we have it looks like we'll have time I'll talk a little bit about making derivatives markets safer and then a little bit about improving trade competition Which is an area in which I do a lot of research lately So making financial institutions more resilient Let me just give you one example of the really excellent progress that has been made through the Basel 3 program I'll pick Europe on this chart from the European Banking Authority You can see in red the fraction of banks whose core equity tier one Capital ratios are below 9% those are essentially disappeared And the good news is the green those are the banks whose CET one ratios are above 12% are now the norm Now this is not to say that the work is all done Because of the events of last Thursday and Friday. I decided to take a quick peek at the largest European banks based on market capitalization and The numbers there are not good Some of the very largest European banks have market capitalization to book ratios of on the order of 25% one particularly large bank in Europe has Market capitalization, which is only 1% of its assets and I have the feeling that this is not so much about the solvency of these banks as their balance sheets stand today, but the Rather the prospects for profitability going forward. And as you know one of these Can turn into the other over time. So There's a lot more work to be done in this area But let me dive ahead the and discuss the trade-off between resiliency improvements and the impact on Market efficiency and capital markets because capital markets are facilitated by bank dealers and This trade-off in my view is well worth it. We've got a lot more resiliency the amount of market liquidity that we've lost is correspondingly Not that big so it's a good trade-off, but that doesn't mean that there's no trade-off And I want to focus a little bit on what the trade-off might be and I'm even going to grant the Modigliani-Miller theorem as a given and look at another conceptual foundation for where market efficiency might be impaired due to a different part of Finance theory, which is called dead overhang. This is a a concept introduced by Stuart Myers of MIT in 1977 So imagine if you will the balance sheet of a major dealer bank I'm going to focus on market value now not book values We have assets debt and equity of some initial market value and now I'm going to conduct two experiments one purely abstract and One realistic the abstract one will be this one the bank is considering purchasing some new market-making assets and Hypothetically again, this is only abstract it will fund the new the purchase by issuing new equity So this is a very onerous for some reason the capital requirement is so high that it's all new equity So one for one new equity The right-hand side is the new balance sheet and If you either remember your corporate finance one-on-one or you have extremely good eyesight You should be able to detect that the blue block the market value of debt Is now at least a bit higher. Why well because the same creditors are backed by more assets The new equity was one-to-one with the new assets. The only way this can add up Is if the old equity shareholders have lost some money They've made a value transfer to the creditors and I'm going to help you here by drawing in the lines So you can see this tiny sliver of value transfer Now let's explore incentives Why would the legacy shareholders of this bank conduct this transaction?  With a bit-ass spread profit that's wide enough to overcome this value transfer And that's the proposition that we're looking at I think Especially in the area of safe asset intermediation. So now I'm going to conduct the realistic experiment of safe asset intermediation Here's the experiment we're going to talk about Repo intermediation this is when a large bank Supplies liquidity to the securities market by taking in treasury securities or bunts. Let's say a German bunts Collateralizing a cash Provision now this is an extremely safe Transaction the cash provided is more than collateralized by bunts which By all accounts are very safe instruments There should be no economic No significant at least economic increase and risk to the creditors However Under the new rule called the leverage ratio or particularly for the largest banks called the supplementary leverage ratio Any addition to the balance sheet of assets must be accompanied by a uniform additional amount of equity It's three percent for the largest European banks five percent for the dealers of the US banks Again regardless of the risk now if you need to Add a lot of equity for an essentially risk-free trade that means again The creditors of this bank will be very happy their debts are now safer And the only way this adds up is if the equity shareholders give up some value They will be willing to do this only if the bid-ask spread in the repo market is big enough to Overcome this debt overhang value transfer There's a very simple model in the back of my paper that explains why the widening of the bid-ask spread for this requirement is Twice the leverage ratio times the credit spread of The bank which in Europe is now between 150 and 180 for the largest banks that went up about 40 basis points in the last few days So how much is that well? It's much less than the banks have claimed they're multiplying the capital ratio by the return on equity Which is a huge number and that's a ridiculous claim, but it's still for the repo market a big enough impact on the incentive to intermediate the repo market that it's killing at least in the US the liquidity of the Government securities repo market here is the increase in the bid-ask spread in the US Government securities repo market since the imposition of the supplementary leverage ratio It's true traditionally in both the US and Europe. It's been under five basis points three to four basis points and Now in the United States and it's an excess of 15 to 16 basis points Doesn't seem like much, but with a bid-ask spread of a few basis points This has basically caused the largest banks not to want to do this trade unless it's subsidized by some other trade You can see from these data provided by Antoine Martin of the Federal Reserve Bank of New York That the provision of liquidity by the largest bank dealers to the non bank dealers Has shrunk dramatically the amount of cash provided in this market is down about 75 percent since the implement implementation of the SLR in the US in Europe Iqma, which is the private market association that has been complaining Significantly about the European situation in this regard Has data which I got from the ECB Showing only a minor Reduction in the total amount of repo done in Europe and I think that's due to some Differences between the US and Europe and also the fact as I mentioned that the SLR in Europe is less than in the US You can read my paper to get more details So now I'm going to go from this area of resiliency and talk a little bit about Making derivatives markets safer and then trade competition So making derivatives markets safer the flagship regulation of this area in the G20 is central clearing and It has been very successful. This is a big improvement in the safety and soundness of the derivatives markets Roughly two-thirds of US swaps are now centrally cleared Europe is beginning to centrally clear by requirement This month in the interest rate swap market Europe has been in the whole area of derivatives markets and trade competition Moving more slowly than the United States and that's partly because Europe has been too slow and the US has been too fast In the sense of extraterritoriality One of the areas of concern in this area is that now we've created these central counterparties Will they be safe and my report goes into that in detail? I hope it will come up during the discussion. Benoit is one of the experts. I recommend his speech at the ESRB Two weeks ago showing progress in this area, but the progress is far from complete Especially in the United States where failure resolution is not even at least in public on the agenda That is administrative failure resolution Another big improvement in the derivatives markets is that the imposition of those new resiliency requirements of capital and margin is forcing down the outstanding amounts of derivatives exposures in the market This is a private sector initiative. That's in response. This is not itself a quantity-based reduction By regulation, this is the incentives provided by capital regulation and margin requirements on getting the dealers to push down the outstanding amounts of derivatives without a loss in number of transactions or not much of the loss so the Amount of risk relative to the amount of trading is well down and it continues to go down For reasons described in my in my paper Now I'm going to get to my last topic which is trade competition and the main Initiative G20 initiative in this area is focused on the bond and swap markets over the counter markets and The idea is to reduce the inefficiencies associated with an oligopolistic and opaque inefficient bilateral dealer Intermediated market And this and this schematic the blue dots are the buy side firms the hedge funds the corporations the pension funds insurance companies The green dots are the major dealers. They take requests for trade from the blue dots and They intermediate those and they lay off the risks in the inter dealer market. This is very inefficient Because of the local monopoly power that a dealer has When a client faces the dealer and because there's not much price transparency of at least there wasn't pre-crisis The reforms are in two areas number one push the trading onto central venues like this one a central limit order book market Or other venues that I'll talk about in a moment The second initiative is post-trade price transparency So that when you can see the going price in the market, you're in a better position as a buy side firm To shop around to turn down a trade bid or offer You'll be able to compete you'll be able to create more competition for your trade request Now the market hasn't really gone very far in the direction illustrated here of a central limit order book market rather What it's been doing in both the US and Europe is to go to market trading platforms Sometimes called market trading facilities or seps swap execution facilities for bonds and swaps Where the customer sends a request for quote? To a small subset of dealers who provide bids and offers and now at least the customer can take the better of the two in this diagram Remember the customer is not doing all to all trade the customer cannot be a Provider of liquidity it can only be a requester for liquidity which lowers market efficiency The problem and the main problem other than the fact that this is not a central limit order book market is that we have extreme fragmentation fragmentation trade is divided across different trading platforms Part of this is that there is no incentive for the dealers to combine their trading platforms because that would only introduce More competition, which doesn't benefit the dealers and partly it's due to the lack of harmonization of regulation between the United States and Europe and This is probably not where to get into that there there has been some progress made But basically the regulations are not so far encouraging more trade on the same platforms and with the events of Brexit This could become even worse since London is the Currently at least at least for the time being currently the most important trading center for bonds and swaps and That implies probably probably greater fragmentation. I mentioned central clearing there could be greater fragmentation in that area as well President Olaan yesterday Suggested that central clearing of eurozone Swaps should take place in Europe in the eurozone in New York New European Union, and I think that's a natural outcome Although there will be some costs Just to give you an idea of how much benefit there is to create more trade competition on the same platform I refer you to some work by Terry Hendershott and Anant Madhavan Who controlling for other factors estimates the trading costs of a buy-side firm for buying corporate bonds or selling corporate bonds? on a trading flat for platform in Which the buy-side firm is able to generate? N quotes where n can vary and the point of this diagram is that the cost To the buy-side firm of execution Goes down dramatically as the number of quote providers goes up Now this is no shock to anyone in the room because we all took economics You know that if you have an auction among more bidders That the seller in the auction the initiator of the auction is going to get a better price no shock at all but yet we're dealing with fragmentation and It's going to be hard to eliminate it the buy-side hasn't coordinated itself to demand this kind of Consolidation of trading platforms and that needs to happen. I expect it will happen The private sector is good at this. It will just take a while for the buy-side firms to initiate this So what we've ended up with in? effect in Response to this last major Regulatory initiative for better trade competition is what's known as a two-tiered market meaning fragmentation in which The ultimate investors are obtaining a small number of quotes on the periphery of the market and the dealers are Providing those quotes. There's no all-to-all trade Except among the dealers themselves who of course are smart enough to know that they get Better execution and faster more liquid execution if they themselves have all-to-all trading on their own central limit order books And you might ask well what prevents the buy-side firms from simply applying For membership on these all-to-all platforms in the middle of this market nothing in law Prevents that however. There are some institutional impediments to it, which I describe in my paper and Maybe that will come up in the Q&A So just to sum up I've given you only a very high level view in several areas of progress With financial regulation. It's been a major Reform project, but there is a lot more to do I have some very specific criticisms in my report of how we have ended up In a number of areas. I'm not going to detail those now. This is not hard to give an overarching Catalog when the issues are piece-by-piece one issue I would point you towards is foreign exchange derivatives We don't have safer derivatives markets in that area that deserves attention the too big to fail failure resolution project is a wonderful Project it's well on its way, but in the position of someone who actually needs to press the button on Failure resolution for a very large complicated bank. I explain in my report why that's not yet ready for deployment And Charles actually has a paper on this Maybe he'll have the time to bring that up during his discussion. There's a number of other areas that I cover in my report But for now, I'm just going to thank you for the opportunity to speak with you And I look forward to hearing what the rest of this But the rest of this panel has to say thank you Dearly beloved brethren, let me start by leading you in prayer Lord forgive us because we have done those things we ought not to have done And we have not done those things that we ought to have done and life is full of sins of commission and omission now Darrell has mostly focused on the sins of commission things that have been done in trying to Improve and reform regulation and that have turned out to be somewhat difficult Or not entirely going to plan Now on the whole I agree with his assessments and in certain areas particularly derivatives and money markets Darrell is really the world-leading academic expert and I sit at his feet and try and learn from him And I very little to say either about Darrell's presentation Or his paper with one exception which I shall come to later so what I want to talk about today is rather the the sins of omission in other words what has not been done what has not been attempted by the authorities outside of the four core elements that Darrell has talked about in his paper Now the first of these is housing finance Now in his executive summary Darrell states and I quote the biggest underlying source of risk to the financial systems were poorly monitored and excessive residential finance and Stein class and his Paper coming up ads and I quote a big item here is the amount and form of housing finance given Besides its large role in booms and busts given its limited productive impact and as many Including John Muir bar in the audience and me and and Sufi and the recent NBR working paper have noted It is a collapse of housing prices that cause first-order real distress in financially driven downturns So the former mountain regulation of housing finance is a big issue What has been done? Directly to tame the boom and bust cycle of credit financed real estate My answer would be not much at all. There's been some sporadic, but not comprehensive Increase in the allocation of macro prudential powers to some but not all central banks But I rather doubt whether they will be applied strongly enough to work effectively It's not only brain-hard caution if you don't know exactly what you're doing and you haven't tried this out before you tend to do It very gently It's rather that I don't think it will be Undertaken sufficiently aggressive Governor Mark Carney speaks with pride about having managed to achieve a multiplication of the size of the tier one core equity ratio in UK banks of about 10 times and He claims That this hasn't had very much effect on total bank lending to the private sector Now compare that with the kind of Conticyclical Increase in capital ratios that are considered under the sort of macro prudential arrangement for dealing with housing prices It's a fraction of small fraction of the amount of increase in courtier equity And this is going to be introduced at a time When the housing market is booming and people expect housing prices to go on up Is it likely under these circumstances that it will have very much effect on the provision by banks of housing finance? Now I've lived through three financial crises in the UK 73 or 74 the fringe bank crisis the ERM crisis in 91 92 and now the great financial crisis in 2008 9 all of these were effectively centered on real estate residential and commercial You will have noted that they are 17 years apart Undertaking the standard econometric Assumption that the future will be exactly like the past I can therefore With considerable confidence guarantee that you can pencil in the next financial crisis in 2025 Not quite yet certain about the month, but perhaps within shortly. I'll be able to tell you that as well now It's not as if there was No suggestions about to improve how to improve housing finance I'm for example We could try to move much more towards the Danish covered bond system Miyaan and Sufi have suggested the shared the shared responsibility mortgage But rather than attempting to improve the structure of finance of particularly housing finance it still remains privileged as For example in the net stable funding ratio and again, let me quote in this Unencumbered residential mortgages with the residual maturity of one year or more and with a risk weight of less than or equal to 35% Under the standardized approach get a required stable funding ratio of 65% Considerably less than other loans certainly of other loans of the same kind of maturity For another indication of total inertia in this field I Recognize that there has really been no advance at all in trying to reform and decide what to deal with Fannie and Freddie in the United States If we've got to give a date or a turning point To the moment that shifted us from a relatively stable to a relatively unstable system of housing finance It is I would propose The time when there was a switch from a system of mortgage finance provided by a group dedicated financial specialists and mutual and Conservative institutions like the building societies and the SNL's Financed almost entirely by sticky personal deposits to mortgage finance provided by limited liability Profit maximizing banks and shadow banks finance not only at the margin But to a very large extent by informed Uninsured very short-term wholesale deposits ready to flee at a moment's notice We haven't done very much to deal with that And that brings me to my second point which is the unwillingness of the regulatory authorities To intervene in matters of governance and remuneration It's been a matter of surprise to me always That the regulators have been prepared to deal at some considerable detail with capital ratios liquidity ratios Risk modeling risk management procedures, etc. Etc. But Refrain from interfering in those matters such as governance and remuneration that much more fundamentally Influence personal incentives and therefore business decisions Oceans of ink have been spilt on Examining and deploring the incentive and moral hazard effect of deposit insurance Whereas much less attention has been paid to the much more powerful and similar implications of limited liability especially on those in a position to influence a bank's decision and in situations with the debt Overhang that Darrell talked about in his presentation Now that bail-innable creditors face a risk of being switched Into the position of being equity holders willy-nilly and not at a time or an occasion of their own choosing Should they not also be given a much larger say and vote on the direction of the banks management? My own worry is that the proposed system of bank bail-in May not survive a widespread systemic crisis Because of its a likely adverse effects on financial markets generally of which events earlier this year in January gave us really something of a foretaste in My view bailout has been the best and simplest the most effective method of stopping a financial disaster And hence the best possible use as tarp was of taxpayer money But that's now prevented by a political and social and public backlash But did the politicians and public really want their financial and banking system to be closed and shuttered? Was the fury directed not so much at the salvation of the banks But rather at the rescue of the bankers Perhaps what we should respire to is a return of All the cities to a condition of partnership where the executive decision-makers the partners have in effect Unlimited or much greater liability than is provided by limited liability So that if a bank has to be bailed out the partners should pay up All or at least a great proportion of that what they have Clawback has been a step in the right direction But only a pretty small step where the distance yet to travel is much greater so can I leave you with a Thought that the main problems of financial stability lie in governance and incentives Rather than in the details of capital and liquidity of requirements not that I object at the ladder But I don't think that they're dealing with the if you like the fundamental problems But before I finally sit down may I just comment on one aspect of Darrell's masterful paper Now he notes quating the Bank of England's Financial Policy Committee That the leverage ratio is meant as a backstop for the risk-weighted asset capital requirement Because regulatory risk may not vary sufficiently with the true riskiness of assets and that's of course true But I think that the case for applying a leverage ratio as a main element goes much further than that As Charlie Calamirus and others have shown The leverage ratio was a reasonable predictor of failure in the GFC where the risk asset ratio was simply not Moreover the basic leverage ratio is in some respect and in principle simple Whereas the risk asset ratio is complex and subject to politically inspired capture and Not leased by the housing industry Now while it is certainly the case as Darrell argues that the leverage ratio Discriminate against low-profit high asset activities with certain adverse consequences For the liquidity of some key money markets including the US GCF repo ratio a Repo market I would not want to respond to that Concern by reinserting some risk weightings into the leverage ratio by the back door Where the leverage ratio? Calculation is in any case anything, but simple lies in its allowance for netting offsetting positions And as Darrell shows quite rightly the reason why all this is low risk is because it's effectively With the positions are effectively hedged by offsetting positions So of Darrell's various proposals for dealing with this issue My own preference would be very much for a much more liberal and constructive approach To netting allowances in this and similar markets rather than for Introducing some form of risk weighting into the otherwise relatively simple Liberate ratio approach. Thank you very much. Thank you Charles We now move to financial structures and Stein will present his views Well, thank you very much for inviting me to be here and to present I should start however with the disclaimer that what I'm going to present are not the views necessarily of the Federal Reserve Board So the topic given to me is regulation and structural change in financial systems Which is a big topic and it's not an easy one to analyze. We have seen many changes in financial systems over the past few decades Some of them due to cyclical factors the global financial crisis some of them due to regulations So in my paper I try to this distinct the more right the more longer term trends The way I do that looking at the demand side. What do we see in change in terms of the economy? What do we see on the supply side in terms of financial service provision? The intra financial system changes I also want to look at regulatory trends that have been going on for a longer period of time They've been driving some of these changes and all of those of course is endogenous. So it's very hard to tease out cause and effect The objective I have is to look at was the optimal financial system a decade from now a very tough challenge and Trying to improve both on growth and financial stability objectives. I think we realize that we want both obviously I'm not going to give you categorical very clear Regulatory actions. It's going to be more in the form of guideposts as to what we may need to do and where we need to focus on So lens of analysis as I said is financial structure So I'm going to spend a little bit time on what they are and how we can define them But also more importantly, what does it mean for growth and financial stability? I'm going to do a little bit of a reference to the G to for your area Japan, UK and US in terms of what the structures are there and then they're going to talk about the empirical findings that we have focusing a little bit on the complementarity between financial services because I think that's where we've seen much kind of new Emphasis technology has given us much of that Complementarity, but it has come by the cost of volatility in person locality and that's really the core of my paper is trying to say How can we balance that? Beneficial complementarity with the volatility that may come along with it So that's where I'm going to end up discussing regulatory trends and as to where we may need to go forward Some terms of the analytics of financial structure that many distinctions one can make I mean the banks versus markets is obviously the one that we're most familiar with The different ways in which risks is being allocated information is being shared relationships versus heart transaction based Lending and we know that very well and it's an important distinction But we cannot make other distinction as well I mean is the system involved in payments or credit or insurance is the system giving loans to the corporate sector or to the Government or to the housing and or is the system getting financing from retail also the possible So there are many distinctions I'm not even talking about kind of the industrial organization of a financial system in terms of concentration number of players foreign domestic ownership So obviously a lot of areas to discuss. I'm only going to pick out a few Particularly the bank versus market based All of this of course in the context that financial structure matters with other in the first best We have many frictions. We have enforcement information issues with a host of reasons why financial structure may make a difference for both growth and for Stability is kind of the corporate finance question of what do you need a mix of depth and equity? Yes, we do because we have certain financial frictions The focus however in the research has been largely been on the demand side I would say in terms of what the impact is of these structures on growth and the like it's been less on the supply side And I think a lot of what we've seen in the last decade has come from the supply side This technology driven complementarities have increased in the financial system. That's one of the reasons why we've seen more problems in recent years Now just a quick review. What do we know about the bank versus market-based distinction? We do know as income rises that banks become less important the chart in the right shows Advanced countries have a lot smaller share of banks in blue as a total share of financial assets compared to merger markets and Developing countries and we also know that over time the Complementaries and the supply side have probably been increasing. We've been one of the reasons why we've seen more market finance in most of the countries Although there are exceptions and even among the G4 We know very well that within the G4 and in the chart on the left show should the US Being a lot less bank-based compared to the Euro area in Japan and the UK And it's really striking difference that we still although we're very similar levels of development We see these large differences No one could argue within the Euro area We really have to look at the financial centers because they provide services among for the whole group But even if you do it on a weighted basis, we still see the Euro area and the EU much more bank-based and the US Part of the complementarity is not always for the better has been shadow banking that had been grown before the crisis been interrupted Both in absolute terms a share of GDP and relative to banking In the G4, but it's been on the rise again and again. It's a complementarity. That's increasingly important to take into account Allocation of lending. I'm not going to speak much about it. It's an important difference even among the G4 So we know us has much less corporate credit and more housing Although the crisis has brought it down a little bit and as Charles has said the impact of finance in terms of where it goes Obviously, it's quite different between the different forms of Credit, but I'm not going to speak too much about that time I do want to say about the overall effect on growth I think that's the really the emphasis that we would want to keep in mind particularly in the Euro area where we have had low growth For some time now and what is the distinction here for example between banks and markets in terms of growth impact Initially the view was that there's no difference as long as you have good property rights whether your banks versus markets All of it works. I think we've come back from that and saying listen depending on the level of development the level of your income You might want to prefer a certain mix of banks versus markets with a mixed shifting towards markets as your income level rises Because that's at the margin give you a greater impact in terms of growth Again, I'm gonna skip over the destination of the financing in terms of stability The view I think has been for a long time diversity more market-based is a better buffer a better less crisis Prone system but also system that recovers faster from a crisis So we want the diversity as much as possible We don't want to in the perverse way in the sense of the shadow banking that way But we do want that diversity in many ways this pair of wheel as long as we can keep the prosyclic ality Managed to some degree and again. I'm not going to talk about finance in terms of the level of development I think we know now that we don't want too large a financial system because then there are declining returns And maybe even negative returns beyond a certain level of debt I'm going to give you a little bit of a few empirical charts on this topic So if you look at the left you see bank credit on the right you see stock market credit This is organized on the horizontal axis by a percentile quantiles of income levels So the richest countries on the right which have in green the highest level of bank and highest level of stock market development Obviously, and then the blue line gives you the marginal impact of a level of an extra dollar of bank or stock market development For a given level of income So if you're in the lowest bucket you see that in terms of bank development You get a higher return from that bank development in terms of growth But it diminishes over time if you get more richer the Mars return from the bank development is less Conversely in the stock market is the opposite as you get richer You get more growth benefits out of a marginal return of a stock market development Obviously, there are lots of analogies and causalities people have controlled for those but with all the caveats It seems to be a fact that is an important one to keep in mind them. So the growth story I think is a fairly straightforward one the complementarity part of it is a little bit more Complicated in the sense that if we see complementarities we like them to see the growth To be higher if stock markets are more developed and in addition to that banks are more developed because then we have a complementarity On the growth side that it used to be there before 1999 That's the chart on the left side where you see the increase as you move up in the scale of bank and stock market development At the same time that complementarity seemed to have disappeared after 1999 So although I keep mentioning the complementary on the supply side We haven't seen the growth impact as much of those complementarities Partly because we I think we had some perverse Complementaries between banks and markets is a shadow banking and nevertheless we do want these Complementaries because a lot of economies of scope. There's a lot of funding reasons why banks need capital markets But also on the securitization side. So we do want this mix to be there. We wanted to be in a productive way Lastly on the stability side, I think by now the record is very clear and obvious that market-based Systems are much more stable, but also have a better recovery record and a less prone to large and deep recessions The charts here shows you both for credit crunches and for equity bus that coincide with Recessions along their last in number of quarters on the left side and how deep they are in terms of the cumulative losses And the one thing that stands out from this chart that on the whole there's not much of a difference But the cumulative loss of a recession in a bank-based system That combines with the credit crunch is much much higher as a cumulative loss of 16 percent Whereas the equity bust in a market-based system not worse It's still actually the case that in bank-based systems even equity busts are worse So from a diversity point of view you do want to have a much more Balanced system a much more market-based system a lot of it comes from the housing as we mentioned and Charles is a reiterate as well So we need to keep that particularly in mind But it comes with this somewhat increased volatility And that is an issue that a market-based system is something to be careful for them The chart here shows you the degree to which leverage growth and asset growth correlates So in some sense it's asking the question if you have a shock to capital for whatever reason an asset price increase or a decrease What does it mean for the banks asset growth leverage? growth Translating in terms of new lending in terms of more intermediation And you see that in banks that are in market-based economies have a twice as high Assistive twice higher response rate to a shock to capital than banks that are in bank-based systems So there's a little bit more proscyclicality in terms of those environments and to buy Zedrian and you and Shin have really emphasized it for US but it's a it's a pattern that comes across all market-based systems So there's a trade-off here that you may have some short-run volatility proscyclicality Introduced and more generally I think with more market-based we have more fragmentation We have more diversity so we could expect more both asset price volatility more peak pricing more Short shorter horizons that come along with some risks. So there are concerns So how are we going to basically balance those concerns about volatility proscyclicality with a desire for more market-based? for growth and other reasons We do want less bank-based We do want to less of course too big to fail all the all the issues that there already has mentioned But we also want a little bit more innovative financing more market-based at the same time with fewer Perverse links and the question is the transition Can we go from a largely bank-based system in Europe and other countries towards a more market-based oriented system? Do the regulatory trends support that and I think on the whole yes to some degree But I think we have to adapt and adjust Let's take a step back and ask what the regulatory trends have been over a longer period of time. This is a Story that you know all very well. We have less structural regulations in terms of restrictions on banks operations Let's say an entry or on branching. We have less conduct regulations We have replaced it with more capital-based market-based disclosure At the same time, however, we still had a large safety net So we have been balancing the the rules away from structure and conduct towards a more capital-based self regulatory discipline based regulation That has worked to some degree. We had a big financial crisis So we shouldn't be saying that it has worked perfectly We will and we have come back now to some degree in reversing some of those regulatory trends Both on the structural side as well as in the conduct side. I'm not gonna review these issues They're in their old paper. I've talked about it as well. I think basically we're still doing that within limits We still haven't tested many of these issues where in the early days in terms of reform agenda So but what points where are we we still an early overall? I would say But there are a lot of things that I want to come back to that We still have to revisit in the context of moving also towards more market-based finance So what are these the starting point for? Revisiting regulation, but I think in many ways This really comes down to very fundamental issues in terms of let's say the legal system the property rights the overall approach Towards markets and of course here Common law civil law issues come to play. I'm just picking out here one comparison I think that is important to keep in mind if you look at the elasticity of bank development To credit the rights. That's the chart on the left Then you have four quartiles and you ask if you move from the lowest to the highest quartile was increasing in bank development You double the bank development So you the worst credit the right and the best one if you ask the stock market you do the same thing you triple The level of stock market development It's a very simplistic way to say property rights are going to be key to developing those equity market based Ones and that's a really fundamental issue of course outside the regulatory sphere But you have to keep it in mind many other factors here They all mentioned some I think taxation is obviously important But it's also important to keep in mind the big political economy that favors banks at in many many countries So is there then a role for regulation? I think so. Yes I'm gonna talk about five issues A set of issues. I think they're increasingly already being addressed the first one for sure This is really about shadow banking. How do we Avoid perverse links between banks and shadow banking I call it reducing the puts from the banking system towards the shadow banking system. It's in the FSB agenda Including in that I would say reducing the regulatory and legal privileges for volatile financing the safe harbor issues It's in their own papers as well. And there's some role for structural limits as in the Vulcan Ville Cana and Vickers rule Agendas on the way. I won't spend much time on it Second is regulating within the non-bank systems It's not just reducing the links the perversed links between banks and shadow banks But we also have to regulate within the bankings the non banking system And here we can do it in a direct way And an indirect way the indirect way is has been done in security market financing make it more costly Who banks to extend financing to the more risky forms of the non-banks financing? And that will give some less proscict locality less risk. We could also do it in a direct way minimum haircuts We can do through them Earlier redemption fees and gates the many ways in which we can adopt a little bit more through the cycle approach in This area and I think a lot of the things are on the way as well I would add to that That we need much better data in this this segment of the market We need to know much more and I think we can actually do much much better in terms of disclosing issues The margins we still don't know necessarily. We still don't know the exposure on a good level third area is To approach these whole non-bank markets in a little bit more system or a systematic way And one of these issues is regulating in a more consistent way I've talked about activity approach, but there's also a French institutions approach where we still don't necessarily regulate the same Type of entity that does the same type of function in the same way So what as broker dealers or was investment banks? They've sometimes fallen different regulatory buckets of regulatory regimes and as a consequence We don't regulate them necessarily although they act like a bank in terms of maturity transformation or money issues But they are falling outside of a regulatory apparatus And we should then however not fall in a temptation of regulating everything like a bank There are many ones that do not need the same regulations I'm not arguing for the same regulation for everybody I'm arguing for consistent regulation according to the function that you perform In addition to that the macro potential approach for capital market activity We have started to move there But I think we need to go much much further in terms of thinking of systemic risk Externalities in the same way that we have started to do within the banking system in terms of looking at the overall risk the Interactions the externalities and again this through the cycle approach is important that both on the bottom in terms of let's say minimum haircuts But also on the top in terms of maximum haircuts. We have a much more longer term Perspective that will have to involve somewhat a discretionary approach in terms of the same as a third pillar in Basel that we sometimes have add-on requirements in terms of capital liquidity for systemically important institutions And we need to be willing to do that because I think otherwise we really gonna be losing the battle in the non mark non-market financing Ford and this is something that is easier said and and then while looted that we need to have a more generic equilibrium approach I'm skeptical that we ever will have this generally equilibrium approach really worked out But I think there are still some low-hanging fruits to be made so Charles mentioned housing financing Where do we want housing financing to occur with that we have views on that we can Through regulation through the risk ways and otherwise put it in the bucket where it makes the least risk for the overall system And I think there are other issues as well if we think particular clarity is a problem of some types of financing Let's not move it to an area of non-market financing where we're going to apply the same kind of regulations Let's say solvency to do insurance companies. We're just making the system more volatile in other parts We're not really gaining it so we need to have a comparative advantage What is which is the best provider on the demands on the supply side? Let's match that with the demand side I give some other examples here as well And I think we can can do a lot better although it's hard to do generally equilibrium. There is scope for improvement Lastly, I think the issues for regulatory governance and regulatory mandates Obviously regulators on the capital market side are low to take on a system-wide view But I think it's unavoidable that they do and we should tell them to do so We meaning the public the national parliaments to give them a more mandate for system oversight So that they can indeed look at the risk with a bit of more comprehensive perspective It's not going to be everything. We still have to have the market discipline as well And I think there are proposals in which we can make the market take some clues from Prices and from information such as you start to behave more more rational I think the way in that sense to have market discipline regulatory discipline coincide We were they doing that in banking, right? I mean a bank regulator would look at market prices and you can think of a t-lack and the like as Making regulatory market discipline cooperate. We can do something similar in terms of the really non-bank financing as well That means some adopt adaptation of the governance of the toolkit. It can like I said not have full predictability It can use key principles But from time to time it has to have some discretion and again in the banks We do that distress test have some discretion We can also apply some of that using high-level principles to the to the non banks as well So main message market-based financing, we would like to have it increased that may come with some more volatility I think there are ways in which we can adapt regulation Such that we minimize the cost of that particular quality and yet gain the benefits of the more equity-based the more market-based Financing which is key for importance for growth I'm giving you some some clues But I would love one end up with the last three point number three is that we want we want to be careful to dub bank type Regulations towards non-market-based financing. This is not necessarily the best thing if these forms of financing are different We're going to extend the regulatory perimeter We're going to make too much of the same kind of financing if you keep doing that We need to extend the macro potential approach to the non bank We need to make it specific to the systemic risk tax analysis that exist in that market And lastly we need to assure systemic oversight We need to have the regulatory governance improvement there to make sure it works I have two slides with caveats and qualifications, but I'm gonna leave those to the discussants I'm sure he will bring up some issues in that respect. Thank you very much Let me just stop by saying it's a great pleasure to be here and to discuss this very good paper as You saw there are two themes in this paper It's I really Recommend this paper to you because it's a very short but a very comprehensive Overview of the of the issues the first thing is that financial structure matters for efficiency and risks so that in some ways May sound quite obvious, but actually it's there is there are some very important points underlying that And the second is that regulation should also take account of the financial structure Now what are some of the dimensions of financial structure, but one is as dine described the Difference between a bank-based system versus a market-based system, but even here it turns out that That distinction may not capture Everything in fact, it's actually much more about how the financial intermediaries conduct the intermediation activities and the banks versus markets distinction spills over into the Intermediation activities and I'll say more about this shortly There are also three other themes in the in the paper about regulation the first is Pro-cyclicality how does pro-cyclicality depend on the financial structure To what extent can you do something about it through a macro prudential regulation and How the non-banks fit into this picture? So let me organize a discussion With this chart and here we have ultimate creditors on the right-hand side And then there are debtors on the left-hand side and the flows go from right to left That's because liabilities are on the right-hand side of the balance sheet and the assets on the left-hand side We typically think of the intermediation Happening through banks in this way, but then we say there's also a market-based Direct intermediation and typically we could think of think of this as the bond market for corporates and in fact if we look at Just this distinction intermediated versus the direct financing The pattern actually looks very different and what I've done here is to go to the US flow funds and Go to the non-financial corporate business sector liability side and ask what happens over the cycle to the Borrowing of non-financial corporates in the US from banks on one hand and From the bond market on the other So the red bars are the quarterly growth in the total amounts outstanding of loans and the blue bars are the quarterly Changes in the amounts of bonds outstanding and The gray vertical bars are periods of recession in the US And what you clearly see is that the red and the blue bars behave very differently. So After a recession you see the red bars going into negative territory. So the the loans are contracting But the bonds are actually the bond market is stepping up to the plate It's actually acting as a spare tire and we see it especially in the most recent crisis So whereas bank lending was booming before The answer to the crisis it really shrank very sharply, but then we had the bond market stepping in because the other story behind this is that spreads were exploding and so there was a There was a huge demand for funding which was being met by the by the bond market Now if you see this chart you may wonder what was Stein talking about when he Said that the the market-based system is more pro cyclical You may have said well, perhaps the market-based system isn't so pro cyclical But actually what we should consider is rather the what's going on in the intermediation box itself so let's think of this this Initial position think of this as the situation in the movie. It's a wonderful life So the Jimmy Stewart, maybe that some of you who spent time in the US will know this is a the depositors are financing Mortgages of the of the borrowers and that's basically it so the funding is coming from the deposits and all the lending is in mortgages But suppose that we open up this financial system. We open it up to wholesale funding What will happen is that as the intermediaries expand new borrowers will have access to credit and and Almost by definition, the new borrowers are those who were not Granted credit before the expansion and If you believe that the ordering is by credit quality, then the new borrowers will have a lower So the new loans will have a lower credit quality But the interesting thing is what's happening on the liability side Because this new lending is being financed Somehow and if we look at the liability side the new creditors will be Those creditors who were not Providing funding to the system before but are now doing so So typically this will be wholesale funding wholesale funding sometimes from abroad Now let's look at this from the perspective of Spain And what I've done here is just take some data from the Bank of Spain's website And these are the categories of lending by Spanish banks And the way to look at this is the the bottom portion in green The loans to non-financial corporates That are unrelated to the property sector and Then the dark blue strip at the top is some miscellaneous household Lending but everything in gray in the middle has something to do with housing And this is very much reinforcing Charles's point earlier. So for example, we have credit for home ownership Loans for real estate financing credit for construction Etc credit for consumer durable and for home improvement If we think back to the eve of the euro So it's the end of 1998 the total face value of loans It by the Spanish banking sector was 414 billion euros Over the next 10 years that grew fivefold. So there's a huge Expansion of lending now the question is how was this being financed? So what's on the liability side? If we look at the the liability side at least from the from the deposits what we see is that almost coincidentally at the end of 1998 total deposit funding of the Spanish banks was almost exactly the same number 413 billion So for every euro of lending being done by Spanish banks There was a deposit of a Spanish household or a Spanish firm Now the deposits also increased but by far less and if we superimpose the two the red and the yellow Is the difference between the lending and the deposit funding So whereas at the beginning of the period There was no difference between the lending and the deposit funding by the end of the period. We have a huge gap a Lot of the funding here Was in the form of covered bonds, so there were long-term Securities they are not runnable in the same way that short-term also funding was but nevertheless it was a lot of it was being Provided by foreign investors. So this was the current account deficit being financed through the banking sector Through long-term liabilities and at the end of the period we have the yellow Which is the the euro system funding for the Spanish banks? So what are the so what are the lessons there the lesson there is that? We should look at both sides of the balance sheet. We have we have to think about Where are the liabilities? coming from and Here we have to distinguish I think quite sharply between the runnable deposits and runnable funding which is short-term funding and long-term financing But nevertheless even if the financing is long-term and quite stable It is Non-core financing to the extent that this is coming from new liabilities that are being generated as the balance sheet expands So if you believe that you have to do something about this beforehand and lean against This type of expansion you may invoke some macro potential tools and here one taxonomy would be to say Let's go to the diagram we had before and have a taxonomy Where we distinguish the tools by whether they operate on the asset side Whether they operate on the balance sheet as a whole or whether they operate on the liability side the asset side tools would include things like l2v and debt service to income caps There are tools that operate on the whole balance sheet like the Basel 3 counter-cyclical capital buffer or the leverage cap And you could also imagine tools that are operating on the liability side and here the the Korean FX measures would be one example of that where you could either put a Levy on some wholesale funding or you could actually also provide Further restrictions on on the liability side on on foreign currency mismatch and so on now one interesting Topic here is the is the similarity between some of those measures and monetary policy What if we think about monetary policy as being something which operates on the balance sheet of intermediaries as well and here There is a lot of there is a lot of commonality by raising interest rates what you're doing is your postponing spending by Your postponing spending through the price mechanism and macro potential policy that restricts credit is also a way of postponing spending Monetary policy that operates on the leverage of the intermediary the risk-taking channel is another way to Restrain the activity of the intermediary and Quite clearly monetary policy that raises the funding cost is something that operates on the liability side So to that extent there is a lot of commonality But but I would say that there are two crucial differences between macro potential policy and Monetary policy that is that with monetary policy This is something that operates across the whole system as Jeremy Stein says this is Monetary policy gets into all the cracks Whereas if you believe that there are hotspots and you you can operate on specific sectors You would want to use specific macro potential tools But I think the far more important point is the second one, which is the fact that with macro potential policy you're more you're better able to deal with global factors and Let me introduce that discussion in the remaining three minutes by telling you about the currency swap market So what this chart show you are the the difference between The interest rate on the euro that you can extract from the foreign exchange market and The interest rate of the euro in the money market the principle of covered interest parity is the statement that Those two interest rate should be the same Otherwise, there would be an arbitrage opportunity. So covered interest parity says that the interest rate that's implicit in the foreign exchange market Should be the same as the interest rate in the money market But whereas that principle held before the crisis that principle has now completely broken down what we see is a divergence of these interest rates and The left-hand panel shows you the the cost advantage of borrowing euros through an FX swap and in an FX swap what you do is you pledge One of these currencies the yen Norwegian Krona Danish Krona or the Swedish Krona, and then you borrow euros instead And in a forward rate, which is the agreed rate at which you unwind You can then from the forward rate and the current spot rate you can work out the implied interest rate on the euro For most currencies the difference turns out to be to be negative in the sense that it's more expensive to borrow euros in The foreign exchange market then it is just to borrow in the in the currency market But there are two conspicuous exceptions in in in this region, which is the Norwegian Krona and the Swedish Krona So in Sweden What this suggests is that there is an abundance of euros So the euro interest rate that you can borrow at by pledging Swedish Krona is actually lower than the euro interest rate that you can borrow in the money market and One very important reason is this And this chart shows you the the total amount of euro denominated bond issuance by the banking sector on the left-hand panel in the euro area and In Sweden on the right-hand panel and the size of the bubble indicates The face value. So how much euro denominated bonds are you issuing? And the height of the bubble is the maturity. What's the weighted average maturity of the bonds? Now in the euro area, we see that the bubbles are getting smaller So the banks are issuing less bonds. There's less wholesale funding going on But it's had a longer and longer maturity because the yield curve is now much shallower In Sweden, it's actually not much smaller than before the crisis and the and the and the maturity is also very very high and What's going on here is that in Sweden as in many Countries with a very large pension fund sector most of the household wealth is locked up in the pension funds and So the banks are borrowing in the wholesale market and then swapping the borrowed funds in euros and dollars sometimes and lending to domestic borrowers in Swedish Krona So there is if you like an abundance of euros in that respect because the banks are now providing that What this raises and I'll finish here is That if we have this global dimension monetary policy itself is going to be very Ineffective in addressing that because then you're going to have to operate in the whole economy rather than on the specific on the specific sectors and Any macro prudential instrument is also going to be quite leaky it'll be a leaky bucket, but the question is is a leaky bucket better than no bucket at all and If you have a second best perspective You may argue that that is indeed the case and in some respects. It's really a matter of how long can I hang on? before the global financial cycle actually turns Let me finish there So, thank you very much to all speaker. That was an incredibly rich Set of papers Let me before I open the discussion. I would first turn back to the speakers to comment on each other But let me let me make three short comments and one Put one request to the audience. So the comments are the following first Well, it's really a pity that Mark Karni couldn't join for many reasons For broader reasons, but also because if Mark would have been here He would certainly have stressed how much the FSB has achieved and he's Achieving to answer some of the questions that have been asked today in particular when it comes to Improving incentives and that was very much in Charles discussion incentives for shareholders and Bond holders and that's T-lack and all what comes with T-lack Incentives for bank management and that's compensation policies So there can be a discussion but still a lot has been done and maybe some more can be done on Individual liabilities for bank managers. So it's still an open discussion Also in terms of broadening the scope of the discussion and that's a guidance that has been recently issued on asset management Work being done on insurance work being done on ccp on ccps Which Darrell mentioned and there will be two important reports by cpmi and ayosco coming in july on ccps and and That's I mean a lot a lot is being done. The second remark is that still what what comes from from from your presentations and What I take from from your presentation is that so far the the regulatory approach or the regulatory answer has been piecemeal and so what we're trying to do together today is also to to connect the dots and put some some sense into that discussion in a in a In a more systemic perspective. It has been very piecemeal which Runs two risks first first risk is to lose sight of the Of the way prosyclicality can develop at a global level and that was hewn discussion A lot has been done against prosyclicality But in a piecemeal partial equilibrium way segment by segment industry by industry and not that much at a global level also Out of lack of relevant data as we know And that that has that as a that raises a broader issue Which is that the regulatory discussion has been very much led by vested interests because it has been segment by segment losing sight of Public interest at some point and the second risk is that we lose sight of efficiency Considerations and that was also very important in your discussions that It's usually not the same people who care the book care about stability and book care about efficiency That's a bureaucratic dimension of it And so it's also time to reconsider the efficiency consequences of what we've been doing in terms of allocating capital to the right places And the third remark is that there was one word was totally absent of the discussion and that was FinTech so Stein spoke a little bit to technical change and the way it can shift a Boundaries incentives. I'm not a I'm not as thrilled by FinTech as some are I mean a lot of it is not technological at all Some of it will have disappeared by the time we do understand it So it may not not be worth spending that much time on it But still this has a potential to shift the boundary of the banking industry To significantly raise the importance the importance of the footprint of non-banks and so that can change the landscape that Stein was describing and it also has a potential to change the The way economies of scales are produced in that industry and the way and the kind of choice between decentralized and Centralized approaches to financial intermediation and I was in a FSB discussion recently and I'm not giving names But we were discussing blockchain and somebody said oh, but blockchain is a fantastic opportunity because The the whole system can be more decentralized which will make it safer Which is more or less the opposite of everything we've tried to achieve over the last five years So that was an interesting remark. So it shows that FinTech can shake a little bit the discussion by changing the The the technology so I stop it here I let me first give an opportunity to all speakers to come back and then I'll open the floor more Who'd like to start? Dara Thank You Benoit and first of all let me reinforce what you said about the important work done by the financial stability board in my report I emphasize that the FSB your committee the CPMI the committee on payments and market infrastructure Biosco Basel committee on banking supervision these all of this progress that I described would not have been possible without G20 Coordination through these to these committees very important and that's why I mentioned that maybe we should have a financial efficiency board in addition to get some more harmonization harmonization on on getting financial markets Trading efficient A little bit of competition is good we know about that in the US the only the only remark I would like to make about Charles very helpful Discussion is on what to do about the supplementary leverage ratio And I guess we have a mild difference of opinion Charles mentioned one one thing we could do is to Remeasure the amount of assets involved So that it's more commensurate for example by netting the other alternative that he mentioned is to increase the risk weights at least on some assets and I would argue in favor of both of those and the third option and by the way the Suggestion that increasing risk weights is very complicated. That's not complicated You just put a floor on all of them not not as high as the supplementary leverage ratio and that takes care of this sovereign Debt problem where it isn't the banks causing the distortion. It's the regulators saying Zero risk weight on sovereign bonds The third option I mentioned in my in my paper is to follow the European model on market infrastructure where Europe has direct repo We don't need to use the balance sheets of the banks to do this job if its government securities repo We can do all to all direct repo about 50% of European Repo trade is done direct repo and more central counterparty So that again, we don't use the bank Of the bank balance sheets. This is crucially important in the government securities market It's the basis for market liquidity of bonds, of course But also for hedging and for monetary policy the we're gonna hear at Jackson Hole this summer a lot about Why a effective government securities repo market is so important to central banks to get monetary policy transmission? So I'll pass the baton Thank you Darryl sign Obviously, I'm not here to criticize the FSB. They have done a great deal and I've achieved it quite a bit But there are some issues that are just without outside the mandate and by definition almost on the issues of course regulatory governance I think that's an important who is oversight of the about the non-bank markets I think that's a big ticket item that we have to address as a community as a whole You mentioned it efficiency is not always on the on the agenda and the general equilibrium approach Of course, it's very difficult, but there I think there is progress to be made. So I would encourage at least building in some more trade-off Analysis excellent in the regulatory design so that we get a better cost-benefit analysis And I know those words are often misused But I think we need to do at least even in a partial equilibrium sense some of that time are you wish on FinTech? People will differ on it. I am still worried that down the road. We're gonna have a system Somewhat similar to utilities where the marginal provider is the solar guy and he gets gets the benefit of it But then the core utilities have to be paid for by Somebody else and then we're gonna get some stranded assets and we can think of banks Some of them in Europe having that stranded asset because we're having to support the basic payment system And what have you but not having the ability to to generate profit enough because that's being marginalized Around the system and along with that FinTech kind of a world You're gonna have more peak pricing the uber pricing in which you you and I cannot get your your car at a certain point Unless you pay a thousand dollar per minute or something like that And I think that is a problem for the system as a whole as well So I think we have to be more careful about that dimension. I would say the last point on Darrell on the Leverage ratio Again one can differ on it But in some sense the evidence that you mentioned in which you said the prices are starting to divert a little bit Maybe that was the intention You're arguing that it shouldn't have been the intention But maybe some of that was the idea to have some more Frictions and some more cost in the system to discourage some of that. Thank you Stein Charles no well And the FSB has done a lot and there's a lot that has been improved in regulation and I Focused on things that hadn't been done. So I wasn't intending to be fair or give it all balanced account And if you I'm the best thing that I think the regulators have done is the greater reliance on stress tests Which I think is a huge improvement My worry is that you were put too many Too much too much of your reputation on Balin working and I'm a Balin skeptic I just don't think it if it's a systemic crisis. I just don't think it'll work I think it'll give you you'll have about four days before you fall back and bail out Okay, I'm not going Thank you very much. I could I Take a slightly different perspective on the leverage ratio than than Darryl did and we've had this discussion before I think it would be somewhat simplistic to say that some of the strength that we're seeing are purely due to regulation and Let me cite some evidence for why it may not simply be regulation over the weekend the BIS Without the annual report and If you look at my presentation that's on the BIS website, so could I just put in a plug for that? There is a chart that I think you will find very interesting which is Getting a sense of where the strains of financial intermediaries are showing up and one area is The breakdown of covered interest parity So the one chart that I showed you was just to illustrate the the funding balance within each market, but it turns out that Coverage of parity is now failing in a pretty widespread way and That's a very good indicator of the shadow value of balance sheet capacity because if The intermediaries could take leverage then they would just borrow at the low rate and Lend out at the high rate and just close the gap the fact that that is not happening It's quite indicative of there being some limits on the capacity now the question is is that due to? regulation or is it due to other market risk factors and If we think back to what was happening in the deleveraging the very sharp deleveraging At the height of the crisis that wasn't due to regulation that was the tightening financial conditions raising the the haircuts on repos and just generally leading to a downward spiral and One of the charts in my presentation So please come to the bias website and take a look at those slides Shows that the value of the dollar is a very good indicator of balance sheet stress and if you look at the euro dollar cross-currency basis at almost At a daily frequency you see that that's actually a function of the value of the dollar and Why is that the dollar well because there's a lot of dollar debts out there? And it turns out not only in the emerging markets, but also in advanced economies for reasons that I weren't going to now And as the dollar goes up That is tightening Financial conditions it in the regressions. It turns out that the value of the dollar has a very similar impact as the VIX a High of dollar has a very similar impact as an increase in the VIX so To the extent that you know regulation doesn't change from one day to the next like that this is daily frequency I Think it's it's not just regulation like there may be some complex interaction between regulation and Market risk factors, but I think it would be think a simplistic to say that it's just regulation And if it is a complex interaction, I think we have to ask how does that interaction take place? And I think at face value a much simpler hypothesis is that These strains are showing because of market risk factors because at the juncture Of the global financial cycle that we finance that we find ourselves in right now There are some tensions out there that just have to do with the natural cycle Thank you. Let me open the floor So I've got Richard Portes first Two questions on What can be done as it were one is for Daryl and Benoit spoke about Two reports forthcoming on Central Counter parties Daryl in your paper you meant you talk a little bit about Central Counter parties and Indicates some disquiet Some worries about the risks there And I'm wondering what you might tell us about What you think ought to be done to mitigate those risks and the second is for starting it's about data We now have lots and lots of data especially in Europe we've got emir producing huge amounts of data on the derivatives markets But we still have major areas Of security for example, we're we're publishing ESRB you're publishing in the summer a First edition of a shadow banking monitor But when you look at it, and it makes considerable progress when you look at it the data Behind it are our limited very very limited And we know very little about for example synthetic leverage We know very little about exposures between the banking system and the shadow banking system What can be done? to get the system to produce more data and to make it available to the different regulars and to researchers Thank you Richard, let me ask you to be really short because there are many many questions and Let me also apologize if I don't give all your names because sometimes I just can't see you very well But I could see an ill here On the back Can you can you stand up? Yeah? So as long as we're inventing new regulators, I'd like a shadow banking Basel committee and I would charge the shadow banking committee to do two things if you look at Daryl's List from the FSB on page 37 of how they classify shadow banking. It really comes to two things. It's credit extension and maturity transformation And it seems like the answer I would like to have is that capital travels with an asset Regardless of how it's funded and you can kind of imagine how that works using something like margin Requirements that are attached to an asset. I don't see how to do the analog of a liquidity Requirement that taxes maturity transformation in all the various other ways, so I wonder if you have Some thoughts on how that could be done Thank you I really appreciate Stein's Comment that we should balance the probability of risk against the likely reduction in mean growth That's a very important trade-off that is very real in the data. We have some very good research on that But I'd like to take that to Benoit's Request for us to think about the international aspect and ask the question. What do we do when we have the risk? mean growth preferences Different across different countries and we have international capital flows Because there's an inconsistency Okay, let me stop it here for the time being and go back to the panel Okay, I'll take the first question that Richard passed out. What do we do about The risks that's being created by these giant new central counterparties in my report Discuss two areas that should be addressed Number one we need a global stress test framework right now. There's Regulatory stress tests are just getting started Esma has conducted one it reports the results is satisfactory with some quibbles But as Benoit Mentioned in his speech at ESRB. We don't yet have and he is his committee is promoting a global stress test Framework so that there's comparability across the globe on central counterparties if a bank major bank fails in one CCP It's going to be failing in many CCP's. We need a high standard for how those stress tests are done second area Failure resolution that is surprisingly late, and I'm not sure why we've been very successful in moving all these swaps Into the CCP's we have yet to have a framework or even any jurisdiction as yet to announce What its plan would be an operating manual for what to do? that we already have in the area of financial institutions the United States as I mentioned in my remarks this morning is The slowest in this area in the sense that no single agency in the United States has even stood up and said We are working on a plan let alone having a date for a plan or having a plan in hand and so I think No to the extent that regulators can put some heat on each other. I'm sure discussions are happening in the background, but Pushing this up the agenda. It's not as though it's going to happen in the next month year Or even a few years, but it although remote it needs to be done because it could happen someday and it's It's important your on the European side We're having intense discussions on CCP resolution in our community and this is a commission will soon come with with a text on CCP recovery and resolution presumably in September I guess but they will be ahead of the of the US and there will be no global framework yet on Supervisory stress testing for CCP's it's an incredibly it's an incredibly important project, but it's it's an enormous project So we are still at the at the we're standing at the foot of the mountain and we've got that mountain to climb It will take years. So The sooner the better, but don't be too Patient about it. It will take years Mean the question of Richard's on data. I think it even goes beyond the shadow banking I think even in banking without there yet It's still surprising to me that I can get data from the website of an emerging market country About individual banks and I have a challenge doing that for Europe and some people have actually commented that that since the crisis Maybe transparency and even on the banking side has declined Nicholas Ron has some analysis on that I think we need to do better in many ways because otherwise we're not going to get market discipline Obviously to work in a shadow banking that's always going to be very challenging in this because back to the regulatory governance We need the security market regulators to be willing to analyze and use the data That's typically not the case. This is more the legal SEC mentality from some of these regulators and I think that that's a Big challenge to be done because the data are there and we increasingly have that then it's going to be a big data in Sometimes overload unless we put in place the analytical apparatus to make these data usable Synthetic leverage you mentioned specifically that is going to be very very challenging Conceptually and everywhere. I know Ayoska has been asked last week about FSB to start developing some templates and some standards Etc. I think we're never going to get one single view on this So we'll have to improvise to some degree, but yes, I agree Go hardly with you. Okay this point I'm not sure that if you have big risk preferences of countries in the risk return trade off that capital flows May necessarily make things worse In some sense you could argue well, that's allows for risk to be diversified and risk views to be It's like the equivalent to diversity within the financial domestic system, right? So if people have different risk preferences having more ability to Access a large larger set of assets and largest set of investment opportunities. It may actually improve the ability to achieve these different risk preferences Yes, maybe we'll need some potential approaches Maybe in some cases capital flow approach management approaches as well, but I'm not sure it is necessarily inconsistency Can I just pick up on on on Kathy's point about Like capital flows and and the trade-off between efficiency and stability I think I would have a slightly more nuanced view on this because To the extent that equity is the base on which you can build leverage Having more equity actually may Also be conducive to to better macro outcomes as well and in that context. It really is a puzzle Why slow moving capital in Darrell's terminology why slow moving capital isn't flowing in to take up To take advantage of these market anomalies and close the gap The gaps are actually very very large and I suspect that one elements of story is the very low market to book ratios We know that in Tobin's Q theory if the market to book ratio is less than one You're better off by liquidating the firm Well, if it's the bank, how would you liquidate the bank? Well, you would you would then Take out some of the capital and so the incentive to pay dividends is actually higher as the market to book ratio becomes lower and I think this really puts the focus on the business model of banks I think if we want to fix many of The ills are out there. I think we we do need to have a think a Very detailed look at the business models. What is actually driving the market to book ratio so low? I think as long as the market to book ratio is so low We're not going to see that much retention of capital and therefore it's not conducive to increasing the capacity of the banking sector It's the forecast of very very low interest rates That have been driving that I'm the very low profitability that are prospective and Again, one of the I'm mine. I think my main criticism Of the regulators is not what they've done, but that they haven't taken into account the impact of what they've done on the commercial banks Business models and therefore what the commercial banks are likely to do so every time they drive down interest rates They screw with the banks the banks don't lend and they get absolutely nowhere. What's the point?