"I don't see Basel III as a burden – I see a compelling case to get it done."

Interview with Carolyn Rogers, Secretary General of the Basel Committee on Banking Supervision, ECB Supervision Newsletter.

Carolyn Rogers, Secretary General of the Basel Committee on Banking Supervision, talks about the complexity of global standards, Europe's role in the Basel Committee and why Basel III should be implemented sooner rather than later.

You will be leaving the Bank for International Settlements to become Senior Deputy Governor of the Bank of Canada one year after the decision was taken to end the Basel III policy agenda. You have also made it clear that any future adjustments to Basel III will be limited in nature. What does this "hard stop" mean in practice, and how can the effectiveness of the reforms be monitored? 

The Basel III reforms were the centrepiece of the regulatory response to the great financial crisis and they were more than ten years in the making. When the completion of the reforms was first announced in December 2017, there were still a small number of outstanding details that required finalisation, including some targeted calibrations and revisions to the market risk framework. Those details were completed by early 2020 and shortly after that, the Group of Central Bank Governors and Heads of Supervision (GHOS) announced an end to the policy work on Basel III reforms. The objective of marking this clear end – what is now referred to as the "hard stop" – was to bring stability to the framework so that member jurisdictions and banks could move forward with implementation. It was also an important signal that the Basel Committee was turning its focus to new and emerging risks. 

There is still work to do to complete Basel III, but that work is focused on implementing the reforms in a full, timely and consistent manner. Global financial stability is a public good: the full benefits of Basel III can only be locked in if all members implement these reforms. 

You once said delaying Basel III implementation would be a "huge mistake", but banks claim that facilitating the economic recovery in the aftermath of the pandemic while strictly implementing Basel III is putting an extra burden on them. Do you agree? 

First, we should be clear that the implementation date of the final set of Basel III reforms already provides for a five-year phase-in period. It's also worth noting that GHOS provided a one-year extension to the original implementation date of 2022, setting it to 2023, as part of its response to the impact of the pandemic. So my starting point is that there is ample time for banks to prepare for the new standards, and they will have until 2028 to fully meet them. 

Second, over the last year we have learned that a healthy, well-capitalised banking system can support an economy, even under severe stress. This is in contrast to what we learned during the great financial crisis, which was that weak banks not only create a financial crisis but they can also amplify the effects of that crisis on the real economy. 

So we have clear evidence that the reforms are working and ample time to prepare and phase in the final reforms. I don't see a burden. I see a compelling case to get it done. 

Some stakeholders are arguing that the output floor might penalise European banks. Is the output floor, which ensures that model-based risk estimates do not go too far below the outputs of regulators' standardised models, actually disadvantaging European banks vis-à-vis their global competitors? 

It's really important to remember that one of the key objectives of the output floor was to ensure a level playing field among global banks. The first round of Basel III reforms was targeted at the amount and quality of capital – the numerator in the capital ratio. But the Committee discovered through its quantitative analysis work that there was still a high level of variability in how banks were risk-weighting their assets – the denominator of the capital ratio. Some variability in risk-weighted assets will always exist, and some is warranted. But we saw banks applying different risk weights to exactly the same exposures. Put differently, some banks were much more aggressive in their use of models to calculate regulatory capital requirements. This is neither prudent nor fair, and the final set of Basel III reforms is designed to fix this. The final reforms, including the floor, make sure that capital ratios among banks are comparable, that banks are calculating both the numerator and the denominator consistently, and that there is a standard limit to the amount a bank can reduce its regulatory capital through the use of models. 

In my view, stakeholders that argue that the floor needs to be adjusted to accommodate banks that are disproportionately impacted have lost sight of what we were trying to achieve. Any reform that is designed to level the playing field will necessarily impact banks differently. If a bank, or group of banks, is disproportionately impacted by the final Basel III reforms, and by the capital floor in particular, it is likely because they are benefiting disproportionately from the gaps we are trying to fix. In other words, they are exactly the banks that most need to implement the reforms. 

The Single Supervisory Mechanism (SSM) created the largest supervisory jurisdiction, spanning 21 European countries. What is Europe's role and responsibility in the Basel Committee? 

Europe has a critical voice at the Basel Committee table and the SSM is a very important part of that voice given the significant scope of its authority. Europe represents about one-third of the membership of the Committee and supervises about one-third of global systemically important banks, so it obviously carries a lot of influence in our deliberations. But what I have also come to appreciate in my two years as Secretary General is that our European members are strong supporters of multilateralism and very practised at a consensus-based approach to setting standards. The fact that this is also how things are done by those jurisdictions that are part of the SSM probably contributes to this. It's a great asset to the Committee! 

The current capital framework is very complex: some parts are risk-based and some parts leverage-based, covering both going concern and gone concern situations. In the end, we have numerous ratios (Common Equity Tier 1, Tier 1 capital, Total capital, Total loss-absorbing capacity) and related triggers. Do you think there is a possibility of simplifying the framework? 

Absolutely! This is something Andrea Enria has spoken about recently and I agree with him. Guarding against complexity is a real challenge when setting global standards. Often we start with a more simplified solution, but by the time we adjust it to reflect the many different jurisdictions and the feedback from banks in these jurisdictions, a lot of complexity creeps in. Over time this complexity can become a problem. It makes the rules more challenging to implement for both banks and supervisors and it can make it more difficult for stakeholders to understand what supervisors expect from banks. We saw this problem play out in the recent crisis where we had to work quite hard to help the market understand the Basel III buffer regime. Complexity is something I think the Committee will turn its mind to as we work through our evaluation of the reforms and the lessons learned from the pandemic. 

The Basel Committee is consulting on a new and conservative prudential treatment for crypto-asset exposures, including, for example, a 1,250% risk weight for bitcoin. Banks' current exposures are limited, so why do you see the need to enhance the existing prudential framework? 

It's true that banks' exposures to crypto-assets are currently limited, but the continued growth and innovation in crypto-assets and related services, along with the heightened interest of some banks, could increase global financial stability concerns and risks to the banking system in the absence of a specified prudential treatment. So it's important we do the work now, rather than try to catch up later. This is also an area that is evolving rapidly, so it's likely that the Committee will undertake more than one round of consultations on this topic. 

Digitalisation will affect banks' business models. As non-bank competition increases and individuals can transact and invest without any banks involved, how could this affect the regulatory perimeter? 

I think it's already affecting the regulatory perimeter and this is resulting in a number of challenges for supervisors. In many cases, non-bank competitors remain connected in various ways to banks, so the risks still find their way back to banks and often in complex ways that are hard to spot until things go wrong. There is also the challenge of public expectations. Although supervisors, in most cases, don't have the legal powers or tools to regulate non-banks, because these firms are providing banking services, the public assumes they are regulated and expects the supervisor to protect them. We have seen this dynamic play out recently when non-bank players have failed. This is a challenge that supervisors cannot address on their own. They will need governments to adjust their mandates and powers in a way that reflects the shift in how banking services are being provided. 

The Basel Committee is planning to look into the effects of the "low-for-long" interest rate environment. Some argue that low interest rates lead to search for yield which in turn leads to excessive risk-taking. Is this counteracting supervisory efforts to increase bank solvency through higher capital requirements? 

I don't know that it's counteracting supervisory efforts, but it is certainly adding to the risks that supervisors need to monitor. Even before the pandemic the banking sector was feeling the impact of a prolonged period of low interest rates. Given the scale of fiscal and monetary intervention in the last year, we cannot expect that interest rates will increase materially anytime soon. That means the pressure on the traditional bank business model – one that relies on net interest margin – will continue. There is a lot of history that tells us that this introduces risks as banks look for ways to make up lost income. All the more reason to finish the job of Basel III, so that banks have robust and globally comparable levels of capital. And all the more reason for the Basel Committee to remain forward-looking in its assessment of risks and vulnerabilities and maintain its focus on building supervisory capacity.