ECB Vice President on Future of Finance and Outlook for Regulation

He noted that the recent financial crisis had its origins in excessive leverage and excessive credit or debt creation in the financial system as a whole, as in the past. The expansion of the financial sector was not enabled by savings invested in the capital of financial institutions, but mostly by a redefinition of risk capital and its endorsement by regulators. He also highlighted that the usual arguments against financial regulation rely on the notion that finance is good for growth—and more finance is always better. The financial industry argues that finance has been over-regulated, especially in terms of high capital requirements. The recovery of credit growth, however, seems to disprove this. After discussing about finance and growth, the ECB Vice President talked about another challenge to regulation that comes from the spread of FinTech: the use of new technologies to develop and distribute financial products and services. FinTech has penetrated mostly into payment systems. Banks’ payment-related income has decreased but some is retained, as bank accounts are still the ultimate way of settling. FinTech can have a big impact on cross-border payments by using the blockchain technology to eliminate several intermediate steps, speed up global transfers, and promote worldwide financial inclusion. FinTech firms are much less regulated than traditional institutions under the presumption that it is good to allow new competition. The hope of FinTech enthusiasts is that its spread will lead to much lighter financial regulation. However, new technologies generate new risks and do not eliminate the old ones which provide the rationale for financial regulation in the first place.

He also discussed the overview of the regulatory reform and its limitations. He stated that there are already attempts to roll back financial regulation. The main points under pressure are the leverage ratio, the limitation of the use of internal models to assess credit risk and corresponding capital requirements, the Net Stable Funding Ratio (NSFR) and the Fundamental Review of the Trading Book. There are pressures to exclude repos, sovereign bonds, and export credits from the leverage ratio. He explained that this weakening of the standard should be avoided, as it increases the probability of crises and output losses. However, beyond solvency and high capital ratios, the crisis has illustrated liquidity risk, thus the importance of liquidity management rules introduced for the first time in Basel III standards. The Dodd-Frank Act in the U.S. and the Bank Recovery and Resolution Directive in the EU marked a shift away from the previously prevailing bailout approach to a bail-in regime. However, on cross-border resolutions, the new framework still has some issues to clarify. He also discussed the role of the shadow banking sector in the crisis, focusing on the use of securitization, repos and over-the-counter derivatives. The crisis revealed the important contribution of these dynamics in derivatives and securities financing transactions (SFT) to systemic stress. The overall progress in reducing risk in SFTs and derivative markets has been significant, but might not be sufficient. With regard to the macro-prudential policy, he said: "It is my contention that without an effective macro-prudential policy, advanced economies will not be able to safeguard financial stability. It is therefore an important endeavor to keep fighting for the appropriate tools and policies to smooth the financial cycle and to sufficiently tame finance in order to avoid crises that may threaten the future of our economies."

Related Link: Speech

Keywords: Europe, EU, Banking, Securities, Basel III, Fintech, Regulatory Reform, NSFR, LR, Shadow Banking, Securitization, OTC Derivatives, Macro-prudential Policy, ECB