WASHINGTON — Though it’s not clear how much the Trump administration is committed to international regulatory cooperation, one of Europe’s leading voices in banking supervision says the need is greater than ever.
Andreas Dombret, who heads the Department of Banking and Financial Supervision at Deutsche Bundesbank, Germany’s central bank, told American Banker that not only is it critical that global powers establish compatible regulatory standards in banking, but it is equally important that those standards be vigorously enforced and implemented.
“Just to set up the rules is not going to be enough, but implementation is at least as important,” Dombret said. “We cannot rely solely on the existence of an international standard — we must fill it with life.”
Dombret, who also serves on the European Central Bank, the Basel Committee on Banking Supervision and the Financial Stability Board, likewise said that making sensible rules that can apply worldwide is challenging, which is part of the reason the Basel panel has taken so long to finish the last few provisions of the Basel III accords.
“Changes in capital requirements cannot diverge substantially between banking systems,” Dombret said. “So harmonization is very important, but so is a regionally balanced outcome. That’s why things are not moving ahead as quickly as you would think.”
What follows is an edited transcript of our conversation with Dombret. For the full interview, listen to our podcast here.
How do you see global banking standards changing in the next few years, in terms of stringency or consistency of implementation?
ANDREAS DOMBRET: Let me be clear on this: I sincerely hope that we will see a high degree of commitment to high and serious regulatory standards and the idea of international regulatory cooperation.
The Basel Committee’s work on Basel III as well as the important standards set forth by the Financial Stability Board have been an achievement after the crisis with the idea of preventing another crisis. So we should maintain our commitment to high global banking standards. But at the same time we should not forget our national responsibilities: to implement and also to supervise these rules in a robust fashion. Just to set up the rules is not going to be enough, but implementation is at least as important. We cannot rely solely on the existence of an international standard — we must fill it with life.
Germany, the Bundesbank, also myself — we do what we can to maintain a global accord and to maintain global standards. This of course does not work at any price, but global standards play a very important role for us.
There seems to be a retrenchment in many countries — including the U.S. and in Europe — away from global standards and in favor of a more nationalistic approach. Can those global standards survive in such an environment?
I agree with you, but as central bankers we are independent from these political elections. For us as technocrats that we may be, the goal is to make sure there is no regulatory arbitrage, [or] as little regulatory arbitrage as possible. And I strongly believe that if we deregulate, if we take regulation back, we run the risk of forgetting the root causes of the crisis, which [was] only 10 years [ago]. That would be a big mistake.
Let me remind you that Germany is an open economy, and for us international trade and international regulation are very important.
What are the main differences and similarities between the European-German and U.S. approaches to banking regulation, and how do those differences play out in forums like the Basel Committee?
I think there are many similarities, let me start by saying that. For example, Europe, as well as the United States, have both implemented most of the international standards that we just talked about. So the similarities are much higher than the differences.
Of course, there are differences. Think about stress testing, which is done differently here from there. Of course the banking sector in Europe is much more fragmented, with very diverse business models. The sizes of the banks vary even more than they do in the U.S.
But I fail to see a problem coming from that. If you unify everything, this rarely makes things better. That’s why I think there will always be some differences. But, I see more similarities than differences, though.
The deadline for the final Basel capital rules has been delayed by several months. Why the delay?
I think we’re rather close to striking a deal. We do have, of course, one obstacle in the way, which is the calibration of the output floor, which is still out there.
We also need to make sure, despite the fact that we’re looking for a global standard, that we consider regionally balanced capital requirements. That is, changes in capital requirements cannot diverge substantially between banking systems. Harmonization is very important, but so is a regionally balanced outcome. That’s why things are not moving ahead as quickly as we all wish.
The Basel III accord was supposed to be finished by the end of 2015, and got an extension to the end of 2016. But we have already solved a number of conflicts, for example, the issue of the treatment of real estate exposures and the issue of limits to the banks’ internal risk calculation model. Again, the calibration of the output floor is still open, but most issues have been solved.
We are, as representatives in the Basel Committee, working towards an agreement over the coming months, and if we find an agreement, the effects on capital requirements for banks around the globe will be manageable. I also believe that transition periods will be rather comfortable and that in line with the promise of the governors and heads of supervision, there will not be a significant increase of capital requirements over and above the status quo.
Let me also stress that high regulatory standards are very important for the global economy. Please rest assured that we remain dedicated to making Basel III a success, because if there is an uncertainty about what will be the outcome of Basel III, banks will not be able to do their proper capital planning. Banks, however, need some certainty with regard to the global rules.
Does international regulatory harmonization help or hurt economic growth, and how?
I’m a former banker myself, so I’ve seen public service as well as private-sector banking. Solid regulation does have positive implications for all parties involved. I would actually argue that this is no news whatsoever, but I will repeat it anyhow: If you harmonize rules, this safeguards an international level playing field and guarantees a political equilibrium that prevents a regulatory race to the bottom. I believe, therefore, that harmonization of regulation for banks competing internationally is actually a prerequisite for stable economic development in the long run. So it is not hurting, it is rather supporting.
But it must be hard to strike that balance that prevents that regulatory race to the bottom.
This is why it is taking longer than you’re expecting! We are talking about a global regulation across very different banking business models. Look at Europe, or at Germany. In Germany, 75% of all bank revenues are coming from the interest rate spread. We are having a lending-based economy. In the United States, you have a capital market-based economy. To compare different business models in totally different setups is going to be very tough. So it does take time.
If you look back to the history, the Basel Committee, in my view, always was a paradigm of how to internationally agree on standards — that this is not easy is sometimes forgotten once the standard is in place. These standards still need to be implemented and accepted.
Banks in the U.S. have generally complained that the capital and liquidity rules are holding them back. Do German and European banks have a similar complaint?
In Germany, you have all these lobby groups that come and see me on an almost daily basis, and if you believe everything you hear, you’re wrong in your job. You should distance yourself, but you should still listen. I believe, if you look at independent studies, which are available, they indicate that better-capitalized banks tend to lend more money and tend to support the economy better [than] thinly capitalized banks, which tend to focus on other activities such as, say, proprietary trading or other activities.
So if you start from that starting point, thinking that better-capitalized banks support an economy better, and if you then think about our banking structure in Europe being so lending-based … there is really no alternative but to think about strong capital and liquidity positions, which only come out of strong capital and liquidity rules.
This is generally accepted. But of course you will have the lobby complain about the cost associated with this, but I would argue that the cost of a failing banking system or a banking system having to support other parts of the [bank holding company] is much higher. The cost of a crisis is ever so much higher than the cost of higher and stricter capital and liquidity.
We do have to learn something from the last crisis — let’s not forget where this led us. And that’s why when you take away the lobby talk and if you talk to the responsible bankers, they also see a benefit from the fact that they are [facing] tough regulation and tough supervision. This is a sort of “clean health” statement, which they need in order to find the trust of the investors, find the trust of their business partners and counterparties. So there is no real alternative to having a reasonable but fair supervisory regime.
And do you think capital is either too high or too low in either jurisdiction, from a macroprudential standpoint?
I think they are pretty appropriate. Building up capital always creates costs in the short term, but the balance shifts in the long term. So when you ask the question, "What do you think at the moment?" we really should be thinking about what is the medium- and long-term effect of having these tighter capital rules.
If very, very tight capital rules become difficult in a way that we come to a credit crunch, then obviously there is an issue. But I don’t see a credit crunch right now anywhere, looking around. I just see that our banking system needed to be strengthened after the crisis.
Actually I can say for Germany and other European countries — as I also sit on the supervisory board of the European Central Bank — that capital has been strengthened quite a bit since 2008 and 2009. And that is important, because banks have such a vital function for financing the economy that without them, it won’t work. So I think we are in a very good state of capital. It can always be higher, but it really should depend on the risk profile of the individual bank.
How might distributed ledger and blockchain technology change bank regulation in the future?
Let me start by saying those technologies have a great potential in improving processes and governance in financial institutions, because there is a potential regarding lower administration costs and increased speed, etc. I must add that these technologies may also serve as a precautionary measure against operational risk … if they are designed properly and introduced properly.
That being said, distributed ledger and blockchain remain technologies. As banal as this may be, they do not change regulatory ideas at all. Institutions have to make sure that they apply those technologies in a responsible way — and this is really important — according to the existing rules and the laws. Blockchain, in the end, is more determined by law and by rules than by anything else. So if you don’t keep within those rules, you cannot really expect to operate. I am not so sure whether this makes it safe or more troublesome. We have to wait and see, and we have to watch very closely.
Are there aspects of U.S. financial regulation that you would like to see implemented in Europe?
What I really like about your system compared to the German system is your different regulatory treatment of small, regional, and not-so-risky credit institutions. What I mean is, when Basel II was implemented, you only implemented it for the larger, systemically relevant U.S. banks, and you left the not-so-risky, not-so-systemically-relevant banks out of that regulation. That is something that I tend to admire to a certain degree.
Of course, after the global financial crisis, we thought about the risky, interconnected, international banks with a lot of derivative exposure, and our regulation was written of those types of banks. Why would you start regulating banks with no risk? We’d rather go after those with lots of risk. But now, regulation has admittedly become so complex — and contrary to the United States, we put the same regulation on each and every bank — that the tiny and small banks, the community banks, are overwhelmed by complexity. Although, by the way, in Germany, they do hold kind of high equity buffers, liquidity buffers. It’s not that they would be short on any of those, but they are drowning in complexity.
So your, if I may say so, two-tier system of differentiating what is systemically relevant and putting adequate and appropriate regulation on those, and having breaks of the smaller institutions is something I would like to introduce in Germany and, when it can be done, in European legislation.
This is something where I think you have not done what you’ve promised you only implemented Basel II for the large banks. But in retrospect this looks like a very good idea to me.