Charting the course: prudential regulation and supervision for smooth sailing

Keynote speech by Erik Thedéen, Chair of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank, at the Institute of International Finance Annual Membership Meeting, Washington DC, 23 October 2024.

Introduction

Good afternoon, and thank you for inviting me to speak at this conference today.

It is a privilege to be speaking today as the Chair of the Basel Committee, following my appointment by the Group of Governors and Heads of Supervision (GHOS) in May of this year.¹ This is a position that has been previously enjoyed by only 11 people during the Committee's 50 years. As a Reserve Officer in the Royal Swedish Navy, I would liken this honour as akin to taking the helm of a well steered vessel by seasoned captains. 

As you know, the work of the Basel Committee since the Great Financial Crisis (GFC) – under the leadership of Nout Wellink, Stefan Ingves and, more recently, Pablo Hernández de Cos – has fundamentally reshaped the regulatory landscape for internationally active banks. The Basel Framework is the cornerstone of the international community's response to the GFC. Since 2011, banks' Common Equity Tier 1 (CET1) risk-based capital ratio has increased by over 70% and now stands at around 13.8%.² Global banking system leverage has almost halved during this period, with an average Tier 1 leverage ratio of just over 6%.³ And banks' holdings of high-quality liquid assets have more than doubled to over €12.5 trillion, with a corresponding Liquidity Coverage Ratio of over 135%.⁴

The Basel III reforms have brought tangible benefits. In sailing, no matter how skilled you are, you can't control the weather. However, you can prepare your boat with safety protocols and solid equipment. The Committee helps ensure that the global banking system is prepared for the unexpected. There is now an extensive empirical literature that suggests that the Basel III reforms have had an unambiguously positive net macroeconomic effect.⁵ The reforms have clearly strengthened bank resilience at both the bank and system-wide level, which in turn will help reduce the likelihood and impact of future banking crises. At the same time, banks, particularly strongly capitalised ones, have continued to meet the demand for lending from households and businesses.⁶

Just as important as the effects of Basel III is the process by which the reforms were finalised. The Committee consulted extensively when developing Basel III – we do not operate in a vacuum or opaquely. It published no fewer than 10 consultation papers, which collectively spanned a consultation period of almost three years. It engaged extensively with a wide range of external stakeholders. Each consultation was accompanied by a rigorous quantitative impact study, which was supplemented by a half-yearly public Basel III monitoring exercise. So it is reassuring and appropriate to find that a recent academic study concluded that the Committee's consultation approach is "one of the most procedurally sophisticated" processes among policymaking bodies.⁷ Moreover, member jurisdictions have undertaken their own rigorous domestic rule-making processes to transpose these standards.

But the work to fix the banking system fault lines exposed by the GFC is not done. We need to lock in the financial stability benefits of implementing the outstanding Basel III standards in full and consistently, and as soon as possible. I take comfort in the recent unanimous reaffirmation by the GHOS to achieve such an outcome.⁸ The Committee has been actively monitoring and assessing the full and consistent implementation of Basel III and will continue to do so.

As this is my maiden speech as Committee Chair, I will outline some high-level principles that I will be relying upon to help guide how I view the work of the Committee. I will also offer a few personal reflections on some topical issues. As a keen sailor, I should apologise in advance for my continued use of maritime language!

Principle 1: Sail forward but always glance back

My starting point is that we cannot afford to ignore, or forget, the lessons of history. This time is not different. There have been no fewer than 150 systemic banking crises since 1970.⁹ Just last year, we saw the most significant system-wide banking stress since the GFC, including the distress of five banks with total assets exceeding one trillion US dollars. While each banking crisis may have had its unique characteristics, the common thread throughout history is that we simply cannot predict when or from where the next crisis will emerge. We therefore need to ensure robust and durable resilience for the global banking system to withstand a range of potential shocks.    

Banking crises have a profound impact on our economies and social welfare. In my home country of Sweden, the 1990s banking crisis and the GFC resulted in output losses of over 30% and 25%, respectively.¹⁰ These are not just numbers, but reflect economic hardships endured by citizens, including job losses and foregone growth potential. We must always remember this stark reality when regulating and supervising banks.

And yet, despite the painful effects of banking crises, history suggests that the lessons from such events are often forgotten as part of a "regulatory cycle".¹¹ Memories fade over time, and a view takes hold that this time really is different. As the cycle turns, policymakers, supervisors and risk managers at banks sometimes become complacent and give in to pressures to dilute regulatory safeguards. Such a journey never ends well: it is only a matter of time until stormy waters reveal banks' stress points and fractures.

This is not a course that I intend to chart. The reality is that a banking system built upon leverage and maturity transformation will inevitably face episodes of distress. Misconduct, governance failures and imprudent risk management practices further increase the likelihood and impact of crises.

To be clear, the first and most important source of resilience comes from banks' own risk management practices and governance arrangements. The boards and management of banks should be the first port of call in managing and overseeing risks; they cannot outsource these functions to supervisors. Yet history suggests that some banks' boards and senior management occasionally fail in their most elementary responsibilities. So it is critical that bankers, policymakers and supervisors do not forget the lessons from the past and take a medium-term perspective. Consider, for example, the recent growth in the use of so-called synthetic risk transfers (SRTs) by banks across several regions.¹² Such transactions are intended to reduce banks' capital requirements by "transferring" the risks associated with some exposures to a third party – often a non-bank financial intermediary (NBFI) – which provides credit protection or insurance. The Basel Framework allows for such transactions to take place subject to meeting certain criteria, and they may in instances be an effective risk management technique. However, I personally believe that we should not lose sight of the bigger picture and lessons from the GFC. In particular, we should ask ourselves: are there system-wide risks that warrant closer attention? For example, what are the risks if NBFI investors of SRTs are in turn borrowing from other banks? Is there sufficient transparency about the interconnections and potential spillover of risks between banks and NBFIs in these – and other – markets? A natural starting point to help answer these questions is to remind ourselves of the lessons from the GFC. 

Just like a sailor needs steady winds, strong sails and safety gear for times of stress to ensure a smooth voyage, a bank requires strong prudential regulation and supervision to ensure stability. And its board and senior management should display the leadership and competency of a veteran captain. In addition, it is critical that the Committee remains vigilant and pursues a forward-looking approach to assessing risks and vulnerabilities to help reduce the risk of the global banking system being blown off course into financial storms.

The Committee's work should also continue to be anchored by rigorous empirical analysis and not succumb to short-term or specific interests of some external stakeholders. And the GHOS agreed to mark a clear end to the Basel III policy agenda in 2020 when it noted that any further potential adjustments to Basel III "will be limited in nature and consistent with the Committee's evaluation work".¹³ This is why the Committee is pursuing analytical work based on empirical evidence to assess whether specific features of the Basel Framework performed as intended during the 2023 banking turmoil, such as liquidity risk and interest rate risk in the banking book.¹⁴ On this note, we recently provided a progress report to the G20 which outlines the progress we have made in the area of liquidity risk.¹⁵ This is a good start, but there is still more work to be done. Structural changes affecting the financial system, such as the ongoing digitalisation of finance and role of social media, require policymakers and supervisors to remain alert and be open-minded as to whether any additional regulatory and supervisory measures are needed.

Principle 2: All hands on deck

My second guiding principle is the need for global and transparent engagement with a wide range of stakeholders.

Financial stability is a global public good that requires cross-border cooperation. An open global financial system requires global prudential standards. Failure on this count could result in regulatory fragmentation, regulatory arbitrage and a potential "race to the bottom" leading to a dilution of banks' resilience.¹⁶

So I will strive to build on the strong track record of Committee members to cooperate and collaborate in tackling cross-border financial stability challenges and shoring up the resilience of the global banking system. We have witnessed the benefits of global cooperation throughout the Committee's history, including with the Concordat, Basel I, II and III, and the Basel Core Principles, and of course more recently during the Covid-19 period and last year's banking turmoil. And in a world facing major geopolitical uncertainty, and where the merits of multilateralism are sometimes questioned, it is even more critical for the Committee to remind all stakeholders of the necessity of cross-border cooperation.

The need for cooperation is not just among Committee members themselves. Given the increasingly cross-sectoral and cross-cutting nature of developments affecting the global financial system – such as the ongoing digitalisation of finance, the growing role of NBFIs, the increasing nodes of interconnections among banks, central counterparties and NBFIs, or climate-related financial risks – the Committee will need to increasingly liaise with a wide range of authorities. This includes ongoing cooperation with central banks and supervisory authorities outside the Basel Committee's membership, but also financial sector authorities in charge of overseeing conduct, resolution, deposit insurance, payment systems, securities and other NBFIs. In fact, for certain topics there may also be a need to go beyond the financial sector sphere and liaise with authorities with responsibility for accounting, competition, data privacy and security, just to mention a few.

To this end, it is critical that the Committee continues to seek the views of a wide range of stakeholders, including academics, civil society, legislators, market participants and the general public. Even if we may have different views on specific elements of the Committee's work, these engagements unquestionably enhance the Committee's outputs by bringing in different perspectives.

Principle 3: Keep your heading steady

My third principle is the importance for the Committee to act as a lighthouse, cutting through the fog and stormy conditions.

Bank regulation and financial supervision are an anchor to help prevent banks from drifting into risky waters that could endanger the entire economy. A resilient and healthy banking system is one that can best support households and businesses through the robust provision of key financial services across the financial cycle.¹⁷

Let me give you an example from my home country. Before the pandemic, the initial set of Basel III standards were fully implemented in Sweden. These reforms significantly increased Swedish banks' resilience to shocks. In addition, the Swedish authorities activated the Basel III countercyclical buffer and set it at 2.5%, with the aim to further enhance Swedish banks' resilience. Doing so allowed us to release this buffer in response to the Covid-19 crisis, which in turn helped Swedish banks to absorb shocks and to lend to creditworthy households and companies throughout the pandemic. The releasability of this buffer facilitated its drawdown by banks in a way that made it genuinely usable.

It may be tempting for some to argue that regulations should be watered down and that supervision should be less intrusive, in order to promote lending to specific sectors or to "unlock" economic growth. But, as with other areas of economic policymaking, any perceived short-term gains are usually more than offset by longer-term pain. Shaving off a few basis points of capital will not unlock a wave of new lending, but it will weaken your resilience. More generally, being well capitalised is a competitive advantage for banks and their shareholders, as it ensures that they can continue to grow and invest in profitable projects across the financial cycle. The Committee's work should therefore continue to be centred around its mandate.

To be clear, this is entirely compatible with stable and healthy earnings that are fundamental to banking and financial stability. So it is reassuring that the sample of banks for which we regularly collect data – many of which are represented here today – have over time been able to both meet new regulatory requirements, make healthy profits and pay out significant dividends. For example, in 2011 banks faced a CET1 capital shortfall from Basel III of about €485 billion. Since then, their profits have exceeded €4 trillion and banks have paid out over €1.3 trillion of common share dividends, while at the same time building capital and liquidity buffers to meet the new requirements.¹⁸

More generally, the Committee will continue to focus its work on those prudential areas that require a global and coordinated response. Its outputs will continue to take the form of global minimum standards to provide a common financial stability baseline across jurisdictions. Jurisdictions are, of course, free to go beyond this baseline if the size and structure of their banking system and the associated risks warrant additional measures. Such measures only reinforce global financial stability. Just as importantly, we will continue to promote strong supervision, including by sharing supervisory experiences and, when needed, developing additional guidance to assist supervisors worldwide.

In that regard, I am sure all of us can agree that it is in our collective best interest to have global standards. We may have different opinions about Basel III, but I think we can all agree that having a globally consistent level playing field is preferable to a patchwork of disparate regulations. A global compromise – however imperfect it may appear to some – is preferable to a free-for-all framework. Internationally active banks then have a common minimum regulatory baseline which they can manage their business around. Supervisors are able to better assess the relative resilience of their banks across jurisdictions. The scope for regulatory arbitrage is reduced. Level playing fields are enhanced. Now compare this with a fragmented bank regulatory world, where banks would have to comply with completely different rules across borders with no common minimum baseline. Such a scenario could also trigger a race to the bottom across jurisdictions, resulting in a frail regulatory framework that would threaten global financial stability and banks' own viability. We would all be worse off in such a situation. It is therefore in your own interest to avoid such a scenario and to promote a common and consistent implementation of Basel III.

Finally, we should keep the fundamentals of bank regulation and supervision in mind. While it may be tempting to focus on the "newest" trends affecting the banking system, we should not lose sight of the more traditional risks, such as credit risk and liquidity risk. Regarding the former, despite repeated headwinds over the past few years, the feared wave of financial problems for households and corporate defaults has yet to appear. Yet I am personally concerned about some stakeholders' seeming complacency in assuming that the worst is over and that the seas are calm. It is a universal truth that a calm sea does not make a clever sailor.

With continued uncertainty about interest rate trajectories and the economic outlook, hidden currents and unseen reefs could still pose a challenge. Banks and supervisors must remain vigilant to such risks.

Principle 4: Sailing to simplicity

My last principle is to ensure that the Committee continues to adequately balance risk sensitivity with simplicity and comparability. Finance and banking are complex activities, so there is perhaps an understandable temptation to match that complexity in the regulatory framework.

Yet one does not always fight fire with fire. Undue complexity in prudential regulation can undermine the ability for a bank's board and senior management to fully understand the risk profile of their bank. It can also impede supervisors' ability to effectively assess the resilience of banks and create opaque opportunities for arbitrage. And while complex rules may sound conceptually appealing, they may also prove to be challenging to operationalise in practice.

Banking is as much about risk as it is about uncertainty.¹⁹ In such a world, simpler approaches can sometimes be more robust and outperform more complex ones.²⁰ So I personally think that policymaking initiatives should ensure that sufficient attention is placed at striking the right balance between risk sensitivity, simplicity and comparability.

Conclusion

In conclusion, the Committee will continue to be guided by its mandate of strengthening the regulation, supervision and practices of banks worldwide. In the near term, when it comes to Basel III, all GHOS members have unanimously reaffirmed their expectation of implementing all aspects of the framework in full, consistently and as soon as possible.²¹

More generally, fulfilling our mandate requires us all to remember that:

• Banks' boards and senior management are the captains of their ships. You have both the primary and ultimate responsibility for overseeing and managing risks. Regulation and supervision can provide safeguards, but cannot and should not be a substitute for your role in managing your risks prudently.
• Global bank prudential standards are a public good. We are collectively all better off in a world with global standards than in an autarkic one. Lobbying for deviations at a national level can perhaps provide short-term (private) gains but will ultimately threaten global financial stability. As internationally active banks, it is not in your interest to sail in such an environment.
• We cannot forget the lessons from past banking crises to prepare effectively for the future. In a financial system undergoing profound structural transformations, such as the digitalisation of finance, the Committee should keep an open mind as to whether additional adjustments to the Basel Framework are warranted over the medium term. And we will focus on global financial stability issues that require a global response.

As Chair, I am fully committed to leading the Committee in that direction.

References

Aikman, D, M Glaesic, G Gigerenzer, S Kapadia, K Kastikopoulos, A Kothiyal, E Murphy and T Neumann (2021): "Taking uncertainty seriously: simplicity versus complexity in financial regulation", Industrial and Corporate Change, vol 30, no 2, April.

Basel Committee on Banking Supervision (BCBS) (2020): "Governors and Heads of Supervision commit to ongoing coordinated approach to mitigate Covid-19 risks to the global banking system and endorse future direction of Basel Committee work", press release, 30 November.

--- (2022a): Evaluation of the impact and efficacy of the Basel III reforms, December.

--- (2022b): Evaluation of the impact and efficacy of the Basel III reforms – Annex, December.

--- (2023): Report on the 2023 banking turmoil, October.

--- (2024a): "Erik Thedéen appointed as Chair of the Basel Committee on Banking Supervision", press release, 13 May.

--- (2024b): "Governors and Heads of Supervision reiterate commitment to Basel III implementation and provide update on cryptoasset standard", press release, 13 May.

--- (2024c): "BCBS dashboards", September.

--- (2024d): The 2023 banking turmoil and liquidity risk: a progress report, October.

Carstens, A (2019): "The role of regulation, implementation and research in promoting financial stability", keynote address at the Bank of Spain and CEMFI Second Conference on Financial Stability, Madrid, 3 June.

Hernández de Cos, P (2019): "The future path of the Basel Committee: some guiding principles", keynote speech at the Institute for International Finance Annual Membership Meeting, Washington DC, 17 October.

--- (2022): "A resilient transition to net zero", remarks at the International Economic Forum of the Americas, 28th edition of the Conference of Montreal, 11 July.

--- (2024): "Building on 50 years of global cooperation", keynote speech at the 23rd International Conference of Banking Supervisors, Basel, 24 April.

Knight, F (1921): Risk, uncertainty and profit, Houghton Mifflin.

Laeven, L and F Valencia (2018): "Systemic banking crises revisited", IMF Working Paper, no 18/206.

S&P Global (2024): "Banks ramp up credit risk transfers to optimise regulatory capital", 22 February.

Viterbo, A (2019): "The European Union in the transnational financial regulatory arena: the case of the Basel Committee on Banking Supervision", Journal of International Economic Law, vol 1, no 24, June.

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This speech and the views expressed are those of the individual and do not necessarily reflect the views and/or position of the BIS or CPMI.

¹ BCBS (2024a).

² BCBS (2024b). For a balanced sample of 66 internationally active banks.

³ BCBS (2024b). For a balanced sample of 53 internationally active banks.

⁴ BCBS (2024b). For a balanced sample of 64 internationally active banks.

⁵ See, for example, BCBS (2022a).

⁶ See, for example, Graph A.18 in BCBS (2022b).

⁷ Viterbo (2019).

⁸ BCBS (2024b).

⁹ Laeven and Valencia (2018).

¹⁰ Ibid.

¹¹ See Carstens (2019) and Hernández de Cos (2019).

¹² See, for example, S&P Global (2024).

¹³ BCBS (2020).

¹⁴ BCBS (2023).

¹⁵ BCBS (2024d).

¹⁶ Hernández de Cos (2024).

¹⁷ Hernández de Cos (2022).

¹⁸ BCBS (2024c). For a balanced sample of 70 internationally active banks.

¹⁹ Knight (1921).

²⁰ See, for example, Aikman et al (2021).

²¹ BCBS (2024b).