In contrast, a new U.S. Treasury repo reference rate will be based on actual transactions in a deep and liquid market, and is designed to be compliant with new principles set forth by the International Organization of Securities Commissions.7 In the foreign-exchange market, bad incentives helped encourage rate rigging at particular rate-fixing times. Reforms were subsequently introduced, including recommendations from the Financial Stability Board’s Report on Foreign Exchange Benchmarks and the recent publication of the FX Global Code, developed by central banks and market participants.8 The creation of millions of unauthorized accounts at Wells Fargo also reflected bad incentives. Bank employees were compensated on sales volume with aggressive crossselling targets without customers actually receiving beneficial services. In response, the Federal Reserve Board entered into a consent cease-and-desist order with Wells Fargo that requires the firm to improve its governance and risk management processes. These recent cases were particularly disturbing in terms of their scale and flagrancy, and—in the case of the rate-rigging scandals—the collusion by employees across firms. I am particularly struck by the fact that manipulation of the foreign exchange market occurred even after the LIBOR scandal was well known. These episodes underscore the tremendous power that incentives have to influence and distort behavior, potentially leading to massive damage to bank cultures, reputations, and finances.
After all, misaligned incentives contributed greatly to the financial crisis and continue to affect bank conduct and behavior.2 Today, I will address this issue of incentives, with emphasis on the complementary roles of regulation, supervision, and bank culture. Each of these is necessary to ensure that we have a robust and resilient financial system not just today, but also in the future. Progress since the financial crisis The financial crisis was a watershed event that exposed severe deficiencies in the financial system—including the inadequacy of bank capital and liquidity buffers, poor risk management and internal controls, and bad bank cultures. Many financial firms took on an excessive amount of risk and did not always act in ways consistent with the interests of their customers or the broader public. The crisis revealed woeful shortcomings in many of these elements, with terrible consequences for the economy and millions of people. Over the past decade, the official sector and the financial industry have made considerable progress in addressing these problems. The banking system is much sounder and more resilient as a result, in a number of ways. First, systemically important banks are much safer.3 They have much bigger liquidity and capital buffers, and the quality of capital is much improved. Moreover, the capital regime now has a forward-looking element in which annual stress tests examine banks’ ability to withstand losses under severely adverse economic conditions and constrain the amount of capital that can be returned to shareholders via dividends and share repurchases.