Guidance on banking reform shortly

Impact assessment study results due in the summer should provide guidance on the appropriate timing and implementation of international banking reform, Central Bank Governor Michael C. Bonello told the Institute of Financial Services' annual seminar last Friday.

In a wide-ranging address on the lessons learned and on the open questions about risk, capital and financial stability after the recent crisis, Mr Bonello gave an overview of the "critical weaknesses" in the financial ecosystem which led to the crisis. He outlined the work of the European Commission, the Financial Stability Board and the Basel Committee on Banking Supervision to review legislative and regulatory frameworks to pre-empt or better manage similar situations in future.

He explained how under new capitalisation requirements, financial institutions will be required to build robust capital buffers in favourable periods to be drawn down during periods of stress.

The Governor also outlined how EU regulations, which are to come into effect later this year, will require credit rating agencies - which came under fire during the crisis - to register and be supervised by the proposed European Securities and Markets Authority and highlighted the establishment of a European Systemic Risk Board as recommended by a European Commission report.

The ambitious regulatory reform effort designed to strengthen the financial sector's resilience has been a commendable example of broad consultation and deep reflection, he said.

Mr Bonello called for care to be taken so that the risk of undermining the recovery, already threatened by the sovereign debt crisis, is avoided. He pointed out that a level playing field was necessary and that the potential for arbitrage through harmonisation, especially in the case of the proposed bank levy currently under discussion at international tables, be minimised.

The Governor said the industry had to ensure that banks, particularly the larger ones, went back to their core business of extending credit to the real economy without taking the risks that led to the meltdown. The one measure that was most likely to influence banks' ability to take risk - the Basel Committee on Banking Supervision's proposals on bank capital - must be given priority.

"Capital buffers must be commensurate with the degree of risk undertaken," Mr Bonello emphasised. "It is no longer acceptable that profits are privatised and losses socialised. In a broader context, another important challenge is to ensure that systemic risks are addressed without unduly constraining financial innovation and integration. The opportunity provided by the current period of reflection should also be used to examine the possible consequences of some of the reform proposals for the functioning of financial markets and for the implementation of monetary policy, and by extension also for the real economy."