BIS central bankers’ speeches  1  In this presentation I will try to explain why I think this is so. I will also speak about what is still lacking and the regulatory challenges we face ahead. Why we shouldn’t back-track on regulation There are several reasons why I don’t think the regulatory agenda has gone too far. First of all, my experience is that important regulatory and structural reforms are all too often hindered by myopia. People tend to focus on costs and pains in the short run, leaving aside the longer term gains that reforms aim to achieve. The perceived short-term costs are simply much easier to sell politically, compared to the abstract benefits of lowering the risk of crises. This is especially so, since the benefits may accrue only to future generations – a group that has difficulties making its voice heard in today’s policy debate. This time has been no exception: for years, people shied away from necessary actions to strengthen the financial system. When the crisis hit, perceptions changed, providing a window of opportunity for regulatory reforms that were long overdue. However, we mustn’t begin to close this window and lose sight of why we are undertaking these reforms. Let me start with a reminder of the regulatory framework before the crisis. Both Basel I and II included a risk-weighted capital adequacy framework. However, for the last 20 years banks’ balance sheets ballooned, while their equity failed to take off.
The results showed that banks’ risk-weighted assets differ to an extent that goes well beyond what can be explained by business models and historical experiences. If we just take the banking-book results, two banks with exactly the same assets could report capital ratios that differ by as much as 4 percentage points. The potential for differences this wide, particularly as they are derived from only a part of a bank’s business, weakens confidence in the measurement of bank capital. Of course, this was not a total surprise. It was a reflection of what I mentioned earlier; that internallymodelled risk weights lead to capital not keeping pace with asset expansion. This has undermined the confidence in banks and in the credibility of the whole concept of banks’ internally-modelled risk weights. Ensuring consistency in the implementation of risk-based capital standards will therefore be a key factor in restoring confidence in banks. The Committee is thus assessing bank capital ratios with a view to ensuring that they appropriately reflect the risks that banks face. There should be “truth in advertising” for the regulatory ratios that banks present. To achieve this, the regulatory framework needs to deliver readily comprehensible and comparable outcomes. In my view, these assessments, both the jurisdictional and the thematic that compares risk-weighted assets, are absolutely vital for achieving our goals. This will be an important focus for the Committee in the coming years. I would now like to take a step further and focus on the link between implementation and how the system should be calibrated.