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

Luis M. Linde

Governor

XCVII MEETING OF CENTRAL BANK GOVERNORS OF THE CENTER FOR LATIN AMERICAN MONETARY

STUDIES

São Paulo

28 April 2014

LEHMAN BROTHERS:

Lehman was not one of the biggest failed banks

… but it was one of the biggest and more complex firms to be

orderly liquidated by traditional channels

691.1

103.9 91.1 80.5 65.5 61.4

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LehmanBrothers (2008)

WorldCom (2002) GeneralMotors (2009)

CITGroup (2008)

Enron (2001) Conseco(2002)

MAIN LIQUIDATIONS OF FINANCIAL ENTITIES

ASSET SIZEbln$

Lehman Brothers (2008)

3,744.5

1,750.31,359.0 1,302.2

1,049.9 896.3639.4

399.0 309.7 229.8 227.4

0500

10001500200025003000350040004500

RBS Lloyds HBOS ABNAmro

AIG Dexia LehmanBrothers

BearSterans

WashingtonMutual

Bankia NorthernRock

MAIN FINANCIAL ENTITIES INTERVENED

ASSET SIZE BEFORE INTERVENTIONbln$

Lehman Brothers

1

MAIN LIQUIDATIONS: LEHMAN VERSUS OTHER BANKRUPTCIES

ASSET SIZE

and reduced cross

border financial flows

Lehman’s liquidation revealed how demanding was to

solve complex and interconnected financial firms

Something that

exacerbated global

uncertainty

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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

MOVE (bonds volatility)

VIX (S&P 500 volatility)

VSTOXX (Euro Stoxx volatility)

VOLATILITY INDICES

January 2006 = 100

-4,000

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-1,000

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Cross border bank claims

Total financial claims (excluding other investment)bln $

FINANCIAL FLOWS AFTER THE BANKRUPTCY OF LEHMAN BROTHERS

2

Public authorities reacted with all the available tools to

avoid a financial collapse

… at the risk of validating expectations

that failed systemic banks will

eventually be bailed out

With conventional and unconventional

monetary policies…

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US ECB Japan UK

OFFICIAL INTEREST RATES

%

0

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2,000

3,000

4,000

5,000

20-feb-0827-oct-0804-jul-0911-mar-1016-nov-1024-jul-1130-mar-1205-dic-1212-ago-13

FED BALANCE SHEET COMPOSITION , ASSET SIDE

Term auction credit (a) CP funding faclity

CB liquidity swaps Rest of liquidity facilities

Agencies MBS Agencies' debt

Treasuries Total assets (c)

Total liquidity facilities (b)

bln. $

3

NEW INTERNATIONAL ECONOMIC ORDER

International Monetary Fund

• Strengthened surveillance

• Quadrupling of resources

• New lending policy

• Governance

World Bank

• Increased resources

• Enlarged lending policy

• Governance

4

Financial Stability Board (FSB)

(Sep. 2008- April 2009)

Regulation Supervision

G-20 G-7

Reform of Bretton Woods IFIs New pillar of the International Economic Order

FSB. – PRIORITY AREAS OF THE REGULATORY

REFORM

FSB (in coordination with other

International Committees and Organisations)

Assessment of vulnerabilities

(“EWEs”)

Information gathering (Data gaps, shadow banking

monitoring)

Leadership and coordination of

financial regulatory reform in response to the 2007-2008 crisis

Priority Areas

Building resilience of financial institutions

“Basel III”

SIFIs Project (Systemically Important Financial Institutions)

Ending Too-Big-To-Fail (TBTF)

Shadow Banking

OTC derivatives market reforms

Other areas of the regulatory reform:

Reform of compensation practices

Enhancement and convergence of accounting standards

Reducing reliance on CRA’s ratings

Macro-prudential supervisory frameworks and tools

Underwriting practices for residential mortgages, etc.

Monitoring of implementation of

internationally agreed standards and

recommendations

Peer Reviews

5

FSB. – “ENDING TOO-BIG-TO-FAIL” PROJECT

•TARGET: Reducing probability of failure of a G-SIFI

• Annual publication of the list of G-SIBs (Global Systemically Important Banks)

• Capital surcharges, 5 buckets: 1%, 1,5%, 2%, 2,5% and a 5th “empty bucket” with a 3,5% surcharge (to avoid that firms become more systemic)

Identification of G-SIFIs

capital surcharges

•TARGET: Reducing the impact in case of failure of a G-SIFI

• Key Attributes of Effective Resolution Regimes (“KA”) New international standard for the resolution of financial institutions

Resolution

•TARGET: Reducing probability of failure of a G-SIFI

• Supervisory Independence and Resources

• Enhancing supervisory practices of systemic groups.

Intensity and Effectiveness of

Supervision

6

FSB – “ENDING TBTF” – RESOLUTION OF

SYSTEMIC INSTITUTIONS

Key Attributes of Effective Resolution Regimes

(FSB, October 2011)

Legislative Reforms

“bail-in”

Recovery and Resolution Plans

(“RRP”)

Resolution Strategies

“SPE”

Single Point of Entry

“MPE”

Multiple Point of Entry

Resolvability Assessments

(“RAP”)

GLAC

Gone-concern Loss Absorbing Capacity

7

STRUCTURAL REFORM PROPOSALS

A comparison of selected structural reform proposals

Volcker Liikanen Vickers

Broad

approach

Institutional separation

commercial banking and

investment activities

have to be separated

Subsidiarisation

Proprietary and high-

risk trading activity in

separate legal entities

Ring-fencing

Structural separation

of activities via a ring

fence for retail banks

• Alternative domestic initiatives

• Need for international coordination

7 bis

FIVE YEARS AFTER LEHMAN’S COLLAPSE: WHERE

ARE WE GOING TO?

Regulatory and supervisory initiatives in response to the international

financial crisis (in particular after Lehman failure)

New institutions + significative reform of existing ones

New rules, especially for internationally active banks

A credible and effective global resolution regime for SIFIs

Advances but still some key aspects under discussion

Impact of regulatory and supervisory changes in financial intermediation

Financial stability, financial complexity and financing of growth

Perspectives for bank businesses

Structural reforms

8

EURO AREA : CRISIS AND AUTHORITIES’ RESPONSE

THE EUROPEAN SOVEREIGN DEBT CRISIS

10

- The Greek crisis expanded to Euro area countries that had accumulated macroeconomic imbalances and vulnerabilities.

- Fragmentation of financial markets

- Sovereign and banking risk link

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GERMANY FRANCE ITALY SPAIN

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5 YEARS BANKS CDS

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FRANCE ITALY SPAIN

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TEN YEARS SOVEREIGN SPREADS OVER GERMANY

BANKING UNION

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Single Supervisory Mechanism

Council Regulation 1024/2013 (SSMR)

ECB: macro and micro prudential tasks

CRD IV- CRR

EBA - Single Rule Book

SSM

A mechanism integrated by the ECB and the NCAs

Single Resolution Mechanism

Banking Resolution Directive (BRRD)

Agreement: December 2013

Approval: April 2014

(pending final revision)

SRM

Single Resolution Mechanism and National Resolution

Authorities

Deposit Guarantee Scheme

Deposit Guarantee Scheme Directive (DGS)

Harmonization of Deposit Guarantee Schemes

Agreement: February 2014

Approval: April 2014

(pending final revision)

European System of Deposit Guarantee Schemes

Legal

Fra

me

wo

rk

Institu

tion

al

Fra

me

wo

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SINGLE SUPERVISORY MECHANISM (MICRO PRUDENTIAL SUPERVISION)

SSM = ECB supported by National Competent

Authorities (NCAs)

Perimeter: euro zone plus opt-in non euro

countries

Significant banks

Size: Assets > €30 billion

Importance: > 20% GDP

Cross-border activities

The three most significant credit

institutions in each jurisdiction

Micro prudential supervision

Significant Banks ECB Direct

supervision Joint Supervisory Teams

Other Banks ECB indirect supervision

NCAs

Joint Supervisory Teams (JST)

ECB Coordinator

National Subcoordinators

Supervisors 1 BCE by 3,3 NCAs

Significant Banks

130 banks, 85% euro assets

Governing Council

Joint Supervisory Teams

ECB staff NCA staff

ECB General

Directorates

I, II, III & IV

Supervisory Board

12

COMPREHENSIVE ASSESSMENT

• Two main elements: Asset Quality Review and Stress Test

• Objective twofold: improve transparency and recapitalize viable banks with

inadequate solvency levels final objective: strengthen confidence in the

soundness of European banks

• The Asset quality Review will examine the asset side of bank balance sheets as

at 31 December 2013

• The stress test is a forward-looking exercise, which analysis the ability of

institutions to maintain adequate solvency levels in stressed scenarios

• The relevant thresholds already established: 8% CET1 in the baseline scenario

; 5.5% under the adverse scenario

• Publication of the results in late October, before the ECB takes over the

supervision of significant institutions on 4 November

13

MACROPRUDENCIAL POLICY IN THE EU

Microprudential policy was not enough , there is a need to address system-wide risks

Risks across the banking sector: Size, interconnections, complexity, etc.

Cyclical risks: Excessive credit growth, possibly concentrated (eg: real estate), excessive

maturity mismatch, misaligned incentives, excessive leverage, etc.

Identification

of systemic

risk sources

Macroprudential instruments

Dynamic provisions, countercyclical

capital buffer, capital surchages for

systemic institutions

EU

institutional

framework

ESRB: Macroprudential oversight of the financial system within the EU

ECB: Share macroprudential powers with SSM national authorities

National Authorities: Implement macroprudential policies at national level

14

SINGLE RESOLUTION MECHANISM (SRM)

Geographical Scope: as the SSM

Single Resolution Board (SRB):

Plenary Board General Rules

Executive Board: 5 members and the

National Resolution Authority on an ad-hoc

basis For a specific bank

Single Resolution Fund (SRF)

Industry contributions ranging from €55-

60 billion

National buckets

Progressive mutualization from 40% in

2016 up to 100% in 2023

Decision process: as in the SSM

SSM Significant banks and cross border

entities Direct Resolution by the SRB

Other entities National Authorities

Resolution steps

1. Bail- in: minimum 8% assets

2. Single Resolution Funds

1st National buckets

2nd Other buckets (mutualization

calendar)

3. Additional industry contributions, or

national public backstop

RESOLUTION

FUNDING Single

Resolution Fund

RULES

Banking Resolution Directive BRDD

INSTITUTION

European Resolution

Board

15

THE FINANCIAL SYSTEM FIVE YEARS AFTER

LEHMAN BROTHERS

International Coordination:

How much international coordination of financial regulation is needed? Are

we making (un)even progress depending on the topic at stake? Are there any

areas requiring further harmonization? Is the system becoming too complex?

Banks versus other intermediaries and their role in financial intermediation:

Implications for financial stability and economic growth.

Is there a need for greater cooperation and harmonization on entities’

supervision and resolution?

16

THANK YOU FOR YOUR ATTENTION