Carney calls on G20 leaders to continue the push for banking reform as the Financial Stability Board delivers its third annual report

Lucy White
Governor Of The Bank Of England Delivers The Annual Peston Lecture
Carney emphasised that regulation must evolve as new risks develop (Source: Getty)

The Financial Stability Board (FSB) today renewed its call for G20 world leaders to continue their support for banking reform.

In a press briefing today, FSB chair Mark Carney said that the reforms which G20 leaders had agreed upon were making banks around the world "stronger, more liquid and more focused".

In particular, he pointed to the elimination of toxic “shadow banking”, where financial activities are conducted by unregulated institutions.

“The real economy is beginning to realise the benefits of your sustained efforts,” Carney wrote in a letter to G20 leaders.

“Credit is now growing in all major economies while the cost of financing has remained low. Sources of finance are increasingly diversified between banks and markets. And the system is demonstrating an ability to dampen shocks rather than amplify them.”

According to Carney, a number of goals have already been achieved by the G20 reforms to the financial system which have “addressed the fault lines that caused the global financial crisis”.

But he emphasised that regulation must evolve as new risks develop, and called on G20 leaders ahead of the summit in Hamburg later this week to keep their focus on the reform of the banking system.

What has been achieved?

Area of reform What Carney said

The largest banks are required to have as much as ten times more of the highest quality capital than before the crisis.

“A decade on, the largest banks have raised more than $1.5 trillion of capital, and all major internationally active banks meet minimum risk-based capital and leverage ratio requirements well in advance of the deadline,” wrote Carney.

He also noted that FSB members are making good progress on implementing standards to help failing banks, but that there was “no room for complacency”.

“Toxic forms of shadow banking” are being eliminated.

Carney pointed out that a decade ago, “enormous risks” were built up outside the core banking system in an ineffectively supervised environment. However, he said this shadow banking no longer represents a global stability risk, thanks to measures which G20 members have implemented to reduce the size of the shadow banking market.

Over-the-counter (OTC) derivative markets are becoming more transparent.

Pre-financial crisis, OTC derivatives were largely unregulated, unreported and bilaterally cleared. As the crisis dawned, uncertainty about exposures “contributed to the panic”, said Carney. But since then, there has been “progress in trade reporting, central clearing frameworks, and new capital and margin requirements”. Using central counterparties to clear the transactions has also helped to reduce systemic risk.

What still needs to be done?

Area of reform What Carney said

Basel III must be completed urgently and then implemented faithfully.

The Basel Committee's Basel III reforms include revisions to the risk-weighted asset framework, which looks at the risk in a bank's assets and uses this to calculate how much capital it should hold, and the finalisation of the international leverage ratio standard, or how leveraged a bank can be in relation to its consolidated assets. But there are still measures which the Basel Committee must agree on. Carney said he is confident that these will be agreed upon by the different countries in the committee, but noted that a lack of agreement would throw into doubt the momentum for reform.

Increased importance of asset management requires attention.

In 2008, asset management constituted 30 per cent of the total financial system's assets, and this number has since grown to around 40 per cent in 2015. Although Carney notes that this is “fundamentally positive”, since asset management can reduce reliance on banks, there are risks involved. The FSB has identified these as the mismatch in open-ended funds between the liquidity of fund investments and the redemption terms, the leverage within the funds, the operational risks at asset managers in stressed conditions and the securities lending activities of these funds. Carney noted that measures to address these concerns are being put in place, but the FSB must report back to the G20 on whether they are working.

Further work is needed on trade reporting.

Trades in OTC derivatives markets should now be reported to increase transparency, but national legal barriers in some countries are preventing regulators from seeing this data. Carney recommends G20 leaders should step up their efforts to remove these barriers.

Individual accountability should be increased.

Carney said that “ex post penalties” to punish misconduct in the financial services industry, where an institution is retrospectively fined, are relied upon too much. Instead, there needs to be increased individual accountability and a focus on governance – factors which the FSB intends to explore.