Ensuring that Banks Continue to Serve the Real Economy While the effect of regulatory reforms on the broader economy has so far been benign, regulators must continue to pay close attention to the cumulative effects of various reforms and seek to minimise adverse consequences for the real economy. Let me highlight two areas that bear close watching: •  First, profitability in the banking sector. •  Second, distribution of credit to key segments of the economy. BIS central bankers’ speeches  3  Bank Profitability is Important for Bank Stability Let me start with bank profitability. Regulators are not in the business of ensuring profits for banks. But we have an interest in the profitability of banks for two reasons. First, banks need to be profitable in order to be strong. •  Retained earnings are one of the major sources of equity, which is in turn the highest quality capital held by banks. •  Healthy capital buffers in turn improve the resilience of banks against losses. Second, banks need to be profitable in order to be able to support the real economy. •  Banks have to earn a decent return on their credit intermediation role. •  A study by the Bank for International Settlements shows that banks with high capital ratios at the start of the Basel III process and strong profitability in the post-crisis years have tended to expand their lending more.
Conversely, unprofitable banks are a potential source of instability. •  Poor profitability and low retained earnings will inhibit banks in building up their capital buffers. •  Without sufficient capital buffers, banks may be less willing to lend, which may constrain the availability of financing to the economy. The Basel Committee is working hard at finetuning the Basel III capital rules: •  to reduce the variability in risk weighted assets applied by banks;  •  to revise the standardised approaches for credit and operational risk; and  •  to implement the leverage ratio. 4  BIS central bankers’ speeches  But in the course of adjusting the capital rules to better achieve these outcomes, it is important that the overall capital requirements on banks are not significantly increased. There is a real risk that overall capital requirements on banks could indeed increase significantly if we are not careful: •  if internal modelling for certain portfolios are completely removed; and  •  if risk weights and credit conversion factors under the revised standardised approach are calibrated too conservatively. We need to take a holistic perspective in this final stage of the Basel III capital reforms. •  In trying to get the design right, we must not end up making the overall level of capital requirements too high. •  In trying to get the micro calibrations right, we must not end up getting the macro settings wrong.